Arbitration is an out-of-court proceeding in which a neutral third party called an arbitrator hears evidence and then makes a binding decision. Arbitration is the most commonly used method of alternative dispute resolution (ADR), and you'll find an arbitration clause in the fine print of all kinds of contracts these days. Read on to find out whether you should include an arbitration clause in your agreement.
Arbitration can be binding (which means the participants must follow the arbitrator's decision and courts will enforce it) or nonbinding (meaning either party is free to reject the arbitrator's decision and take the dispute to court, as if the arbitration had never taken place). Binding arbitration is more common.
Arbitration can be voluntary (the parties agree to do it) or mandatory (required by law). Most contract arbitration occurs because the parties included an arbitration clause requiring them to arbitrate any disputes "arising under or related to" the contract. Not all contracts can require mandatory (or forced) arbitration. In March 2022, the Ending Forced Arbitration of Sexual Assault Harassment Act made pre-dispute arbitration agreements in employment contracts invalid and unenforceable for sexual assault and sexual harassment claims.
In any dispute, the parties can agree to arbitration at any point (although it's often tough to reach an agreement to arbitrate once a dispute has started).
For simple contract disputes in which the matter can be heard in one day, arbitration is usually a good choice. However, if in doubt, consider the advantages and disadvantages, below.
Advantages. Arbitration is usually faster, simpler, more efficient, and more flexible for scheduling than litigation. Also, it avoids some of the hostility of courtroom disputes, perhaps because it's a private proceeding versus the public drama of the courtroom. And if the subject of the dispute is technical—for example, about a patent—the parties can select an arbitrator who has expertise in that field, rather than a judge who might not be familiar with the issues.
Disadvantages. Unlike a court ruling, a binding arbitration ruling can't be appealed. It can be set aside only if a party can prove that the arbitrator was biased or that the arbitrator's decision violated public policy. Unlike a court case, there is no automatic right to discovery (the process by which the parties have to exchange information about their cases), but the parties can agree to discovery. The costs of arbitration can be significant; In some cases, they might even exceed the costs of litigation (see below).
Learn more in Nolo's article Arbitration Pros and Cons.
According to a 2002 survey by Public Citizen, a consumer watchdog group, the cost of initiating an arbitration is significantly higher than the cost of filing a lawsuit. On average, it costs around $9,000 to start arbitrating an $80,000 consumer claim. Filing the same claim in state court would cost around $250. Keep in mind that the people in the dispute pay the arbitrators, and arbitration fees can run to $10,000 or more. Add in administrative costs and your own attorney fees (if you hire one) and the process might even cost more than litigation. (For more on the ins and outs of arbitration, check out Nolo's article Arbitration Basics.)
If you want to include an arbitration clause in your contract, below are some examples to take a look at. Example 1 shows a simple no-frills arbitration clause; Example 2 offers more conditions and obligations.
If you have a significant amount of money or property in dispute, you should consider hiring a lawyer to help you in the arbitration. If the arbitrator's decision is binding, you only have one chance to win.
You can use Nolo's Lawyer Directory to find an experienced alternative dispute resolution attorney in your area.