Robert Smith

Arbitration Overview


Arbitration may still be the most widely used Alternative Dispute Resolution (ADR) technique. Aristotle wrote, “For an arbitrator goes by the equity of a case, a judge by the law, and arbitration was invented with the express purpose of securing full power for equity.” George Washington included a clause in his will that called for arbitration of any dispute over the interpretation of his will and the distribution of his estate. Its advantages include savings of time and cost, as well as hearings at convenient times. There is limited discovery, and smaller attorney’s fees. The process should be faster than court procedures, and the parties can choose as a dispute resolver someone with experience in the subject matter if they want to. The process is private, confidential and usually final. The disadvantages include very limited possibilities of appeal, the lack of precedent, and often no explanation for the reasoning behind the award. There is also the feeling on the part of some (much disputed) that arbitrators tend to “split the baby.”

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“I cannot emphasize too strongly to those in business and industry- and especially to lawyers- that every private contract of real consequence to the parties ought to be treated as a ‘candidate’ for binding private arbitration.”

Excerpt of a speech given by Chief Justice Warren E. Burger

Arbitration is a process by which parties refer, usually voluntarily, their disputes to an impartial third person, an arbitrator, selected by them for a decision based on the evidence and arguments to be presented before the arbitration tribunal. Arbitration may still be the most widely used form of ADR.

Although arbitration is often referred to as an innovation, it has in fact existed for centuries. Archaeologists have uncovered evidence of the use of arbitration in the ancient civilizations of Egypt, Mesopotamia, and Assyria. Arbitration was extensively used by the ancient Greeks and Romans and in a form substantially similar to that used today. Aristotle wrote, “For an arbitrator goes by the equity of a case, a judge by the law, and arbitration was invented with the express purpose of securing full power for equity.”

Two of Lombardie
In 1606 the States of Edward III referred to what is today called a commercial arbitration panel: “And two Englishmen, two of Lombardie and two of Almaigne shall [be] chosen as mediators of questions between sellers and buyers.”

In an American context, it is worth noting that George Washington included in his will a clause calling for arbitration of any dispute over the interpretation of his will and the distribution of his estate.

In 1635, a Boston town meeting agreed that inhabitants would not sue one another, but rather settle their disputes “amicably by arbitration … without recourse to law and courts.”

Private vs. Judicial
Formerly, all arbitration was contractually based, which meant that it was private and voluntary. Recently, a non-consensual type of arbitration has evolved, which operates under the aegis of the courts, but remains an alternative to the full use of the litigation system. Sometimes the voluntary form of arbitration is termed “private” or “commercial” or “contractual” arbitration, and the court-associated form is referred to as “judicial” arbitration. Unless otherwise indicated, when arbitration is mentioned in this chapter, the reference is to private contractual arbitration.

Arbitration has been used for so long and so extensively in some industries in the United States that it has become the standard process for resolving many kinds of disputes. These industries include maritime, securities, commodities, international trade, labor, construction, medical malpractice, and escrow. However, arbitration was not commonly used in the banking industry until 1986.

The Courts
Although arbitration was disfavored by some courts for many years, due to the courts’ disfavor of the subversion of their jurisdiction by a contractual clause and mistrust of the arbitration process, most federal and state courts now strongly support the use of arbitration, even contractual arbitration, and will routinely enforce arbitration agreements except in the most inequitable situations.

The adoption of the Federal Arbitration Act and the adoption of similar statutes by most states have made arbitration agreements readily enforceable in most courts and have fostered a general acceptance by courts of arbitration as an alternative to litigation.

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process overview

Arbitration is initiated by any party invoking a pre-dispute agreement to arbitrate, such as an arbitration clause in a contract, or by the parties executing a post-dispute arbitration submission agreement.

Thus, an arbitration cannot validly occur unless the parties have specifically agreed to use this process to settle their dispute.

Arbitration tribunals are commonly established to resolve a specific dispute and dissolve after the dispute is resolved, in contrast to courts which continue to exist after a case is resolved.

Further, unlike courts, arbitration tribunals are not required to apply court-established procedural or evidentiary rules, unless the parties specifically agree otherwise. If a party refuses to honor an arbitration agreement, the other party may apply to the courts for an order compelling the recalcitrant party to submit to the arbitration.

Sometimes, the dispute is submitted for arbitration to an administrative organization, such as the American Arbitration Association (AAA) or Judicial Arbitration and Mediation Services, Inc. (JAMS), which handles most of the administration of the arbitration, including such activities as coordinating arbitrator selection, scheduling hearing space, transmitting papers, and making certain the parties and the arbitrators adhere to time deadlines.

Designing the Process
Designing the details of the arbitration process is left entirely to the parties. The parties may decide how long the hearings are going to last, how long each side will have to present its case, whether the rules of evidence will be strictly adhered to, how many arbitrators will there be and how they are to be chosen, the form of the award, how much discovery (if any) will be allowed and how long the parties have to accomplish discovery.

However, many ADR provider organizations have promulgated their own procedural rules for arbitration; the parties may use them, or may alter them if they wish.

Initiating the arbitration is followed by selection of the arbitrators: a single arbitrator is often used for simpler disputes with smaller claims, while three-person panels are common for complex disputes with larger claims.

Unless the parties have provided for a selection process or have named the arbitrators in their agreement, the administering agency’s rules generally govern selection of the arbitrator. These rules usually provide for the administering agency to submit a list of potential arbitrators to the parties, who either select or eliminate names from the list. If the parties cannot decide on the arbitrators, the administering agency or a court can appoint the arbitrators for them.

Prior to the hearing, the parties and the arbitrators usually hold a prehearing conference, at which they may establish ground rules and set procedures (including discussing modifications to standard procedures) for the main hearing; schedule hearing dates; identify witnesses; narrow the issues; and deal with discovery and other prehearing problems.

Parties sometimes engage in abbreviated discovery before the arbitration hearing. Preliminary relief, such as injunctions or attachment, may be available from the arbitrators or from the courts.

The arbitration hearing has some of the look and feel of a court trial. The parties make opening statements and then present their cases through the introduction of evidence, including the testimony of witnesses. However, the process is more informal than a court trial, and the arbitrators take a more active role than judges usually do. For example, they may engage in in-depth questioning of the witnesses. Also, arbitration hearings are usually private.

At the close of the hearing, the parties generally make closing statements. The arbitrators then have a set period of time in which to render a decision on the merits of the parties’ claims. This decision is called an “award.”

Not “Reasoned”
Arbitration awards need not be “reasoned,” i.e., they need not contain findings of fact or conclusions of law, unless the parties request that the arbitrators deliver a reasoned award. Arbitrators may generally make any award that is “just and equitable,” although the award of punitive damages by arbitrators is not allowed in all jurisdictions.

After the award is delivered, the parties have a set period of time in which to challenge the award. Challenging the award is usually done by a motion to the appropriate court to modify or vacate the award.

The grounds for modifying or vacating an arbitration award are narrow. This gives arbitration one of its hallmarks– the finality of awards. The winning party may apply to the courts to confirm the arbitration award. This procedure has the effect of turning the arbitration award into a court judgment and allowing the winning party to take advantage of the court’s procedures for the enforcement of judgments.

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The array of commercial disputes that can involve banks generally fit into the generic classification of arbitrable disputes.

However, some cases are not good candidates for arbitration, particularly constitutional or public policy test cases where one or more of the parties seeks to establish precedent in support of its point of view. These cases are not many, but are often of great value, both monetarily and in terms of policy.

One of the main advantages of arbitration over litigation is cost and time savings. Savings of 20 to 50 percent in legal fees over litigation have been reported for arbitration. Total savings in processing disputes under a bank arbitration program have been estimated at 20 to 30 percent.

Hours to Days
Arbitration hearings can last anywhere from a few hours to many days depending on the size of the case. However, arbitration usually takes less time to reach resolution than does litigation, particularly considering the congested court calendars in most areas of the country.

Most arbitrations, particularly those using an administering agency and comprehensive rules, take less than a year from the filing to resolution.

Private and Informal
The cost and time savings are the result of two factors– arbitration is private and arbitration procedures are generally less formal than litigation procedures.

Because arbitration is private, scheduling of hearing dates does not depend on the vagaries of a crowded court calendar. Hearings are scheduled at the convenience of the parties and the arbitrators. Arbitration generally involves fewer, if any, prehearing matters that often prolong court proceedings. There are usually no extensive preheating discovery procedures, and motion practice is generally restricted.

Less Discovery
Reduced discovery may not be a problem for banks in suits with borrowers, because banks usually acquire a great deal of information about a borrower as part of the loan approval and loan administration processes. Thus, they may be willing to forego extensive discovery opportunities in exchange for the speed and ease of resolution which arbitration offers.

Some lenders have complained that plaintiffs’ attorneys use the extensive discovery procedures available through the courts to harass the lenders and their top executives and directors. The reduced discovery available in private arbitration may discourage this practice.

Although the direct costs of arbitration are generally higher than the direct costs of litigation, the cost savings in arbitration is realized from reduced attorneys’ fees and expert witness fees.

The direct costs of arbitration can include:

The arbitrator’s fees. The arbitrator’s fees for large, complex cases that require multiple hearing dates can be quite high, as the arbitrators’ fees can be when a three-person panel, rather than a single arbitrator, is chosen.

Expenses for arbitrator travel and hearing room rental.

The costs of site inspection or an expert appointed to assist the arbitrator.

A court fee, usually nominal, for filing a petition to confirm, vacate or correct the arbitrator’s award, or for bringing an action for provisional relief or to stay pending court proceedings.

Legal Fees
The cost savings in reduced attorney fees is a result of the less formal procedures usually employed in private arbitration. The attorneys spend less time attending depositions and answering interrogatories; participating in pretrial conferences and other hearings; preparing pretrial memoranda; and engaging in pretrial motion practice.

Private arbitration generally requires only one prehearing conference of one to two hours. The inapplicability of formal civil procedure and evidence rules allows the disputants to realize further savings because of the lack of need for pretrial motions, papers, and hearings to consider pretrial motions.

The nonrefundable initial filing and administrative fees associated with arbitration, particularly the sliding fee schedule, may also deter widely speculative claims and encourage plaintiffs to be more reasonable in their initial demands. They may also deter some plaintiffs from bringing nuisance claims or strike suits.

Another important advantage of arbitration is the use of experts as dispute resolvers. Private arbitration allows the parties to choose the dispute resolver–something litigation does not allow. Thus, a person with knowledge and experience in the industry or area in which the dispute arose may be employed as arbitrator.

This situation increases the likelihood that the award will be in keeping with industry or local custom and decreases the likelihood of “runaway” awards or awards not conforming to established practice or law. Private arbitration allows financial institutions to avoid the uncertainty of presenting claims to juries, which many institutions view as being sympathetic to borrowers. Some jurisdictions also do not allow punitive damages in arbitration, thus further reducing the likelihood of “runaway” awards.

Privacy and confidentiality are other important advantages of arbitration. Generally, the public and the media are not legally entitled to participate in, observe or report on a private arbitration, without the consent of the parties.

Privacy can be an important advantage of arbitration over litigation where the dispute involves allegations of fraud, malpractice, or another practice or activity that could hold a party up to ridicule or embarrassment.

Another advantage to private arbitration is its finality. Generally, private arbitration awards are binding on the parties, and cannot be overturned except on narrow grounds.

Arbitration also tends to encourage earlier and more reasonable settlements. The reasons for this phenomenon are not fully understood, but they may have something to do with the tendency of most people to put off decision-making until the eve of some important event. Thus, the closer a deadline approaches, the more inclined a plaintiff and plaintiff’s counsel may be to review their case critically.

Arbitration generally creates earlier deadlines than litigation. This may spur plaintiffs to earlier settlement decision.

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Arbitration–the most widely used ADR procedure–has its own distinct disadvantages. One disadvantage is that, if discovery is not provided for in the arbitration agreement and not allowed by the arbitrator, surprise evidence may pop up and result in “arbitration by ambush.”

“Split the Baby”
Many people have expressed the opinion–right or wrong–that arbitrators are inclined to “split the baby” and always award something (if not fully half).

However, this opinion may not be accurate. The AAA surveyed over 4,000 commercial and construction arbitrations held in 1992 and found a wide variety of results. In more than one-quarter of the cases, the arbitrators awarded 80 to 100 percent of the claims. The arbitrators denied the entire claim in 31 percent of the cases, and they awarded less than 40 percent in another 22 percent of the cases. In only 11 percent of the cases did the arbitrators make an award of approximately 50 percent of the claim.

Setting Aside an Award
Arbitration is also perceived to have some procedural shortcomings. One perceived procedural disadvantage to arbitration is that if one loses, the chances of having the award set aside on appeal are extremely limited, even if the arbitrator’s award appears to be entirely erroneous. In short, an outrageous arbitration award is much more difficult to reverse than a court judgment.

Lack of clearly established pretrial motion procedures in arbitration can preclude the use of summary judgment motions to dismiss frivolous or unmeritorious claims. Some commentators also see the inapplicability of the rules of evidence and of court rules of civil procedure in arbitration as other procedural shortcomings.

No Precedent
Another disadvantage of private arbitration is the lack of any setting of precedent by the arbitration award. Except for securities arbitrations and some labor arbitrations, arbitration awards are generally not reported. They do not bind any person other than the parties, and may be used in other proceedings only under the principles of res judicata and collateral estoppel.

Moreover, arbitrators often do not give reasons for, or explanations of, their awards.

“Single Action” Rule
Another disadvantage to arbitration may arise in those states that have adopted what is commonly known as the “single action” rule in their anti-deficiency statutes. The single action rule precludes more than one form of action for the recovery of any debt, or for the enforcement of any right, secured by a mortgage on real property.

Under this rule, lenders generally may not pursue separate actions against the borrower and against the borrower’s collateral; all claims against either the borrower or the collateral must be brought in a single action.

Some states require lenders to proceed against the real property collateral first. Others prohibit deficiency actions against borrowers, leaving the lenders with only actions against the real property collateral. Lenders in states with this rule may be confronted by a number of questions about arbitration clauses and arbitrations involving obligations secured by real property. Foremost among these questions is the effect, if any, of the single action rule on the enforceability of an arbitration agreement. Also important is the question of whether the arbitration constitutes an action for the purposes of the single action rule.

No Jury
Some borrowers and consumers may see the lack of jury trial in arbitration as a shortcoming. This thought sometimes arises only after a dispute with the financial institution has blossomed.

A borrower or account holder engaged in negotiating a loan or in opening an account is usually not focused on the particulars of how disputes are to be resolved. They may not be concerned with preserving their right to present their case to a jury.

The implementation of an institutional arbitration policy requires a long-term commitment by a financial institution. The integration of arbitration clauses into standard contracts means that the clauses will govern disputes for years to come. Moreover, an institutional policy encouraging arbitration requires changes in the thinking of executives and counsel. Change is not always welcome. This long-term commitment may be daunting for some financial institutions and may be seen as a disadvantage.

Planning and Drafting
Many of arbitration’s perceived disadvantages and shortcomings may be eliminated or mitigated by sound planning for arbitration and careful drafting of arbitration clauses and agreements.

Other shortcomings may be overcome or reduced by the choice of knowledgeable, experienced arbitrators who will control the process.

This is adapted from ADR for Financial Institutions by Robert M. Smith (West Group, 2nd ed.1998,
1200 pp.) [Footnotes omitted]

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