The Hidden Costs Of Arbitration

Arbitration isn’t always a sure bet.

Arbitration is fast, efficient, and inexpensive. That’s how the process is widely viewed but the experience of many lawyers is quite different. Arbitration can be more expensive than litigation and less efficient. For that reason, when we draft agreements, we are careful to use arbitration clauses only to resolve narrow issues. Arbitration is an alternative to resolving disputes in court. Whereas anybody can force any other person into court, people can only be forced to arbitrate if they agreed to arbitration in advance.

Many contracts include arbitration clauses. When a dispute arises, the parties first have to hire an arbitrator to resolve the dispute. Most contracts specify that one of the major arbitration companies, such as the American Arbitration Association, will conduct the arbitration. The company will charge a fee and then the arbitrator gets a fee, anywhere from $300 per hour and up. And, of course, the lawyers get a fee.

These combined hourly fees can rack up huge totals compared to the size of the dispute. The court process has many opportunities for one side or the other to have the case thrown out before trial. Arbitrators, however, generally want to hear the entire case. That means the parties essentially have to try their cases to the end. Moreover, being paid by the hour, arbitrators have a built-in conflict of interest in favor of prolonging the case.

Here’s a horror story illustrating these dynamics. A client accidentally received $10,000 of a “dot com” stock into his account belonging to another person. His broker sold the stock the next day for a profit of about $300. Three years later, when the mistake was discovered, the person who should have received the stock started an arbitration proceeding seeking $3 million. He claimed that he was entitled to the highest market value of the stock despite that it was by then trading for pennies.

Under the rules of the New York Stock Exchange, three arbitrators were appointed to hear the case. The arbitration stretched over eight months. Testimony was taken in twenty-one sessions in Texas, Florida and New York. In the end, the arbitrators ruled that the person who should have received the stock was entitled to $10,300. To get to that result, the client had to spend $150,000 in fees.

At my firm, we have experience with both transactions and litigation. When we draft arbitration clauses, we know how these clauses will actually work. Having seen the abuse that can result from arbitration, we favor using arbitration only to resolve narrow, discrete issues. For example, a lease might provide that the question of whether a landlord reasonably withheld consent might be the subject of arbitration but we do not want arbitrators to decide whether and how much the tenant suffered as a result of the consent being withheld.

So, next time you are considering agreeing to arbitration, be careful. Arbitration is not cheap, not efficient and not fast.