The majority of the “form” commercial construction contracts commonly used in apartment projects, such as the AIA forms, contain “dispute resolution” clauses that mandate unresolved disputes be resolved by binding “arbitration” as opposed to the standard legal system of filing a lawsuit in court.
Most courts, faced with the overwhelming number of cases flooding the legal system, enforce arbitration clauses. However, the decision to resolve disputes via arbitration should not be taken lightly. There are pros and cons, and one size does not fit all. Many experienced lawyers detest arbitration. The purpose of this short article is to help decision-makers made a good business decision about the use of binding arbitration clauses in their contracts.
Problems with the Current Legal System
The primary reason why especially the construction and commercial real estate communities have accepted arbitration is the perception of problems with the existing legal system. Any business that has been through a lawsuit, even if resolved in its favor, does not wish to go through the process again. Some of these problems are as follows.
Costs of Litigation
Going through the existing court system is extremely expensive and time consuming. Lawyers are very expensive. More important, while fully 95 percent of all civil cases settle before an actual trial, settlement usually takes place on the courthouse steps after the parties have incurred the vast majority of the hard and soft costs of litigation. A company must consider the hard costs of litigation, such as attorney fees and expenses, and under most state’s laws, unless there is an attorneys' fees provision in the contract, fees are not recoverable—even to the winning party. A company may win the battle in court but lose the war when it realizes that after subtracting the fees and expenses spent on a litigated case, the bottom line is a net zero recovery. There are many horror stories in which the attorneys' fees and expenses incurred by all sides to a dispute far exceed the amounts at stake, and even when a party wins, can the monies awarded be collectible? Holding a paper judgment against a bankrupt or shut down contractor (or a single use LLC developer after a foreclosure) does not put money on the table—or pay lawyers.
Clients (and sometimes their lawyers) also forget that there are substantial softcosts of litigation. Time is money. In any lawsuit, management and other key employees must give and spend a considerable amount of time to the dispute. One development client said it best: "while only 1 percent of my deals have ended up in a lawsuit, that one deal cost me 75 percent of the profit I made on the other 99 percent.”
Publicity and Public Filings
Lawsuits can damage reputations and sometimes help competitors. Court filings are public record, and one cannot "un-ring" a bell. While the filing of a lawsuit, even if frivolous, may make the front page of the newspaper, the dismissal of that claim a year later may not get reported. All filings in court and transcripts of testimony at trial are open to any competitor seeking a competitive edge or inside information. In a case involving a claim for lost profits, for instance, the business making the claim must open up its records in order to prevail.
Lawsuits can take years to get to trial, and then, even after a trial, the losing party has an automatic right to appeal…which may take another two to three years. The fact is that any smart client/lawyer, if they want, can make the other side wait a considerable amount of time before paying the piper—which in some circumstances may be exactly what they intended. There are many instances where an otherwise solvent defendant has been able to delay a final hearing for frivolous reasons, and by the time a judgment has been rendered, that company’s assets are gone or a bankruptcy has been filed. While there are ways in which to trace the assets, that process can mean (yes) more lawsuits and more fees.
There is no way to guarantee what a judge or jury may do in a civil case. More important, if the case involves complicated facts, expert testimony, or industry-specific issues, there is a potential for the jury and even the judge to get confused and render an unfair judgment. It is also very difficult in a short time of a trial to educate the jury and judge about the particular subject matter of the dispute. Therefore, when a business places a substantial legal dispute (especially where the outcome of the business may be at stake) in the hands of a judge or jury, it is engaging in nothing less than legalized gambling.
Binding arbitration is the reference of the dispute to an impartial (third) person chosen by the parties, who agree in advance to abide by the arbitrator's award issued after a hearing at which both parties have an opportunity to present evidence much like a court trial. When parties agree to arbitrate a dispute, they forego enforcing their legal rights to go to court, choosing to rely instead upon an arbitrator to be the final judge. The arbitrator is also normally someone with training and knowledge and expertise in the field being disputed. Legal considerations in arbitration will not be disregarded entirely, but the rules of procedure and evidence specifically followed in the courts are not employed unless the parties agree otherwise. For example, it is almost impossible to appeal an arbitration decision. Unlike litigation, finality is the rule rather than the exception.
As set out above, the decision to place an arbitration clause in a contract or to agree to arbitrate a claim after a dispute has arisen is a vital business decision that cannot be taken lightly. Many businesses and lawyers are firmly opposed to arbitration. For these reasons, especially when reviewing all of the "disadvantages" of litigation set out above, it is important for a business making this decision to fully understand the pros and cons of binding arbitration.
Pros and Cons of Binding Arbitration: Predictability
Probably the most frequent complaint of litigation is that the judges or juries do not understand complicated business disputes, often leading to unpredictable and unsatisfactory results. There can never be any real answer to why a jury or judge ruled the way it did in a case. Arbitration employs a third party neutral or neutrals with extensive experience and knowledge in the area of dispute, e.g., construction/real estate development. Arbitrators also do not have to be lawyers. This characteristic of arbitration can eliminate substantial problems and costs of educating a judge or jury in the nuances of a specified business field. Properly selected arbitrators are able to understand and focus on the most relevant issues in the dispute and are not easily swayed by lawyers' emotional arguments. Moreover, there is considerably less formality in an arbitration hearing. For instance, strict adherence to conventional rules of evidence and procedure are not followed. Instead, the focus is on the facts and testimony and not any archaic rule of evidence.
Because there is no need to conform to a crowded court docket, arbitration can be set for hearing in a matter of months, not years, even when millions of dollars are at stake. In addition, it is almost impossible to appeal an arbitration award, and so finality is the rule rather than the exception. Being able to schedule a hearing and have a dispute resolved quickly is to the benefit of all parties.
In most cases, the costs and expenses of arbitration are much less than litigation. Since litigation is most often criticized for the abuse of pretrial discovery (i.e., scores of unnecessary depositions), it is significant that, with a few exceptions, such discovery is limited. The absence of prehearing motions and depositions, as well as the finality of the decision, can significantly reduce attorneys' fees and costs. The normal rule is that one day of arbitration equals two to three days in court, again saving money for both parties. Finally, prolonged personal involvement by crucial officers and employees of a company in depositions and discovery-planning conferences, which takes away from the pursuit of other business, is avoided.
Unlike the public court system, arbitration is private and confidential. The proceedings are not subject to the requirement for openness and accessibility in proceedings of civil litigation. Arbitrators maintain the privacy of the hearings unless some law provides to the contrary.
Arbitration is not a panacea to all that ails the established legal process. In some instances parties are better off in court. However, businesses should determine with their lawyers whether or not they want to include or eliminate an arbitration clause. Any lawyer advising a company should, as an ethical requirement, advise a client that there are, in fact, alternatives to court. A business should not charge blindly headfirst into litigation but should examine all alternatives available to resolve a dispute to its best interests. With very few exceptions, going through an expensive, delay-ridden trial is not in the best interests of any business. If the dispute can be resolved through arbitration (non-binding mediation is a topic for another column) clients can be assured of proceedings that will in most instances, be faster, more confidential, more predictable and less expensive than litigation.
Republished with permission. This article first appeared on studenthousingbusiness.com on October 12, 2014.