Are Arbitration Clauses a Good Option for Your Family Business?

What Is Arbitration and How Does It Compare With Mediation?

Arbitration is a form of alternative dispute resolution for parties to resolve their grievances outside of the courtroom. Arbitration is normally a process that involves one or more hearings and presentation of arguments by letters or other types of submissions.

In an arbitration, a neutral third party (either contractually determined before the dispute starts or mutually agreed upon by the parties after the dispute arises) is engaged by the parties to hear both sides of the dispute. Both parties will have contractually agreed to respect and adhere to whatever decision the arbitrator makes as to how the dispute should be resolved.

While arbitration is often linked with mediation, the two processes are notably distinct. Unlike an arbitrator, a mediator does not make a binding decision or "ruling" on the dispute. Instead, the mediator becomes familiar with the facts of the dispute and the arguments of the parties, facilitates the discussion between the two sides, and attempts to secure mutual agreement or settlement.

Mediators often meet separately with the parties to influence their views of their own arguments and to understand the strengths or weaknesses of their opponents' arguments. Mediators are more focused on the process of dispute resolution whereas arbitrators are more focused on ruling on the parties' legal arguments.

Binding arbitration, then, is a contractual provision entered into by two or more parties where the parties agree that all disputes between them will be resolved by an arbitrator. This means that neither party will be able to commence any formal litigation against the other.

Federal law requires arbitration provisions be enforced such that if a party commences litigation, courts will stay or dismiss it to allow the arbitration to proceed until completed. Arbitration awards can be enforced in court.

What Kinds of Contracts Provide for Binding Arbitration?

Binding arbitration clauses can and often do appear in all kinds of contracts and may be a matter of negotiation by the parties to the contract. Employment contracts and vendor contracts are examples of the kinds of contracts in which many family businesses might find or consider implementing binding arbitration clauses. Most contracts with arbitration clauses also provide that a party may elect to go to court for equitable relief—for example, a temporary restraining order or an injunction.

Advantages of Binding Arbitration

Compared to litigation, arbitration typically reduces the amount of time and money spent on resolving disputes. With a relaxed discovery process and different rules of evidence, attorneys and parties need less time and fewer resources to prepare for arbitration.

According to the American Bar Association, arbitration in the employment context tends to favor employers. This means that statistically employers receive favorable decisions more often than employees do when issues are resolved via arbitration. Family businesses may choose to include arbitration provisions in their employment contracts to mitigate the likelihood of an unfavorable result.

Another significant advantage to arbitration is that, unlike a trial, it is a completely private procedure. The public has no access to any information concerning the dispute or how it was resolved other than that which the parties are willing to share. Ensuring both parties have signed a non-disclosure agreement can guarantee that all facts about the dispute remain private.

Arbitration results also do not create legal precedents, as might result from a litigated case that goes up on appeal.

Arbitration may also be preferable when fair resolution of the dispute requires subject matter expertise. Some arbitrators specialize in a certain area such as patents, trust law, real estate, or construction law. These arbitrators have technical knowledge and industry fluency that a judge might not have. These skills allow them to make better decisions regarding the matters before them.

Drawbacks to Binding Arbitration

While arbitrations typically result in faster and less expensive resolutions, the relaxed discovery and evidentiary rules unique to arbitration can also be drawbacks. Because of the differing procedural rules, an arbitrator may make a decision based on information that would not have been admissible in court. This procedural norm may create additional risk and might result in an unfavorable outcome.

The lack of an appeals process is another potential drawback. The ability to appeal exists in the justice system because judges and juries are human and thus prone to error. However, under a binding arbitration agreement, legal recourse is extremely limited, and an arbitration award can be filed with the court and enforced by the court.

Conclusion

Whether or not it is prudent to include a binding arbitration clause in a contract should be made on a case-by-case basis. To ensure that contracts are crafted most favorably towards your family business, be sure to consult legal counsel.