The Advantages and Disadvantages of Arbitration Clauses In Business Contracts

Arbitration clauses are typical in business contracts for several reasons. Most importantly, they allow businesses to settle disputes in a timely and cost-effective manner, without entering into costly, time-consuming litigation. Arbitration significantly limits discovery costs such as interrogatories, depositions, and pretrial motions that often constitute the bulk of litigation expense. In addition, arbitrators are often specialists in their various fields and tend to be more knowledgeable than juries.


Arbitration may be binding or non-binding. Non-binding arbitration involves the determination of liability without the dispensation of an award. While the arbitrator may suggest possible awards, parties are not legally obligated to accept the suggestions. Binding arbitration, on the other hand, involves not only the determination of liability, but also the terms of the award for the wronged party. Moreover, the arbitrator’s determination is final (with few exceptions), and precludes further dispute and appeal. In California, an arbitration clause may be disregarded where all parties agree, where the clause exists as part of an invalid contract or where third parties are involved in the litigation (where third party claims arise out of the same transaction or series of related transactions).

Binding arbitration has significant advantages to both small and large business. Avoiding costly litigation is priceless to small business owners especially because they are typically priced out of litigation by large corporate entities. Large corporate entities like binding arbitration because they fear the uncertainty of jury trials. Putting the decision in the hands of an experienced arbitrator assists larger businesses in anticipating outcomes. In addition, binding arbitration is faster and less formal. On the other side of the coin, small businesses give up the right to a jury trial in exchange for affordable conflict resolution and large businesses give up their ability to steam roll smaller opponents. Other cons include the potential for being stuck with a bad arbitrator, being stuck with a bad and/or legally incorrect decision that cannot be appealed and having less time to properly investigate claims. Either way, courts, bar associations and state bar entities across the country are encouraging parties to look to informal resolution before resorting to the court house steps.

It’s important that businesses consider these pros and cons carefully and enter into contracts that clearly set forth the terms of arbitration. Significantly, in order to put teeth into a binding arbitration clause, it needs to specifically state that binding arbitration is mandatory. Arbitration law in California is evolving and now allows for judicial review of “legal” errors by arbitrators where the parties specifically contract for it. In addition, contracts may include language that: requires claims be made within certain time limitations; requires parties to first negotiate in good faith before demanding arbitration; requires the party demanding arbitration advance arbitrator fees (which can be substantial); requires the losing party to pay the other side’s attorney fees; requires the parties to comply with pre-set procedural rules created by entities such as the American Arbitration Association; and/or puts limits on the types of damages allowed (such as prohibiting punitive damages). A contracts attorney will assist San Diego businesses in navigating the pros and cons of arbitration clauses and ensure that they are drafted appropriately.

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