Arbitration Q&A

Arbitration Q&A

April 26, 2002

  • What is a mandatory arbitration clause?

A mandatory, pre-dispute arbitration clause requires you to waive your right of access to the courts, and submit any claims to a costly private legal system selected by the defendant. These clauses are found in many types of contracts: employment, credit, telecommunication services, insurance, and franchise agreements, to name a few.

Individuals seldom know that they are subject to these clauses. They may be contained in the fine print of a contract a consumer signs, e.g. a car lease or HMO enrollment form. A consumer may become subject to the clause after being sent a "bill stuffer" with a credit card or cell phone statement?by using the credit card or phone, the consumer is deemed bound. A clause may take affect when a worker is given an "employee handbook" after accepting a new job, or even an interoffice memo at a current job.

Mandatory, pre-dispute arbitration clauses are distinct from voluntary, post-dispute agreements to arbitrate. Post-dispute agreements are made after a party understands the nature of his claim, has consulted with legal counsel, and can weigh the costs and benefits of both arbitration and court litigation. Under these circumstances, consumers and employees can choose the most economically viable alternative.

Buyers of consumer products such as automobiles may be subject to non-binding, "first resort" arbitration. Under the Magnuson-Moss Warranty Act, consumers may be required to first submit a claim to arbitration, but may reject an award they disagree with and then take their claim to court. This type of arbitration is offered for free by the Better Business Bureau.

  • Isn’t arbitration a cheaper alternative than filing suit in court?

Generally speaking, no – this canard is repeated regularly without any substantiation. In fact, as Public Citizen’s comprehensive report on arbitration costs demonstrates, in most consumer and employment disputes, the high fees associated with mandatory arbitration make it impossible for consumers and employees to vindicate their rights. Most arbitration providers require hundreds of dollars in filing fees, and thousands more to be advanced for the arbitrator’s daily or hourly fees.

Consumers, particularly those who have just suffered a financial loss, are generally unable to pay these fees and are therefore precluded from any remedy. Similarly, high fees may preclude workers, whose financial future may already be endangered due to a wrongful discharge, from pursuing their anti-discrimination claims. These high up-front costs strip away the benefits of attorney contingency fee arrangements, by which plaintiffs receive legal representation without advancing any money.

There are some types of routine cases for which arbitration can be cheaper, such as auto lemon law claims. However, inexpensive arbitration programs for such cases only exist when required by government agencies.

-Why do businesses use arbitration clauses?

A business will use an arbitration clause when it anticipates being the defendant in a civil lawsuit. Businesses generally do not use them if they anticipate being a plaintiff in a lawsuit, and usually draft the clauses so that only the business can force the consumer, employee, or franchisee into arbitration, and not the other way around. Because the high costs of arbitration and inability to bring class actions in arbitration discourage claims from being brought, arbitration clauses give an advantage to a potential defendant.

  • What are the differences between a judge and a private arbitrator hearing a case?

Accountability: A judge is accountable to higher courts and to the public. Arbitrators are not legally accountable for errors they make. Arbitrators are accountable only to the market, and the market for arbitrator services is dominated by "repeat players" – litigants that are likely to hire arbitrators in the future. This creates a subtle incentive to rule in favor of companies that impose mandatory arbitration clauses.

Awards: Judges follow the law, but arbitrators are free to act as "amiable compositeurs" and often split the difference between two parties’ positions. As a result, awards by arbitrators tend to be much lower than awards by judges or juries.

  • Will AAA’s recent consumer rule changes solve the mandatory arbitration problem?

The American Arbitration Association (AAA) recently announced that it would cap consumers’ arbitration costs at $375, and require the business to pay the remainder. It also announced that it would no longer enforce pre-dispute arbitration clauses in health insurance contracts. These measures are inadequate for several reasons.

   1. Cases can migrate to other arbitration providers. AAA has been named in arbitration clauses primarily by companies that expected AAA’s high costs to deter claims. These companies will switch to new arbitration providers.

   2. They don’t affect employment cases. Employees will still be forced to pay filing fees and arbitrators’ hourly fees.

   3. The changes are not being applied to cases already in system, report some attorneys who have inquired about their clients’ cases.

   4. The changes don’t apply to cases involving more than $75,000. The average home value in the United States is $108,300. Most predatory lending cases involve sums in excess of $75,000, because the most skilled mortgage sales personnel will convince their victims to refinance as much of a home’s value as possible. Defective construction cases brought by new home buyers are likely to involve claims exceeding $75,000 as well.

   5. If AAA refuses to arbitrate under a clause in which it was named, it is unknown whether the legal effect is to send the case to court, or send the case to another arbitration provider. If it is the latter, the consumer could go "out of the frying pan and into the fire."

  • What evidence is there of bias by arbitration providers?

We can point to two main indicators of explicit bias of arbitration providers toward big businesses.

The National Arbitration Forum has produced a great deal of promotional material aimed at corporate counsels. They have sent direct mail to corporate lawyers touting NAF as "the alternative to the million dollar lawsuit," saying that they will not allow companies to be sued on a class action basis and that they permit companies to impose "do-it-yourself civil justice reform."

The American Arbitration Association debated whether to market its employment arbitration services to both employers and employees on a post-dispute basis, or to encourage employers to impose arbitration on a pre-dispute basis. AAA opted for the latter.

For the most part, however, we believe the bias is built into the system, not the result of conscious decisions to favor big business. First of all, a fee structure that imposes costs disproportionately on claimants rather than defendants will necessarily favor defendants, because it discourages claims.

Second, arbitrator panels that consist primarily of business executives and corporate lawyers are less likely to have sympathy for claimants.

Third, businesses are more likely to be repeat customers of arbitrators, so there is a disincentive for an arbitrator to displease them.

The evidence that the second and third factors produce bias is the award amounts. Side-by-side comparisons of arbitrator awards to jury verdicts in similar types of cases consistently show that claimants in arbitration are awarded less than plaintiffs in court.

  • How are courts reacting to charges that arbitration is unfair to consumers and employees?

For the most part, courts have been unmoved by arguments that arbitration is unfair. The U.S. Supreme Court, in particular, has rebuffed all pleas for relief from burdensome clauses, citing the "pro-arbitration policy" of the Federal Arbitration Act (FAA). FAA is a 1925 law that requires state and federal courts to enforce arbitration clauses unless they are unconscionable. FAA was passed in an era when arbitration clauses were used only in business-to-business transactions, and its drafters never anticipated its extension to consumers and employees.
Most judges view the courts, and themselves, as overburdened and find it hard to resist an opportunity to clear a case from their dockets. As a result, most arbitration clauses challenged in court are ultimately enforced by the judge. There have been a few recent court victories for arbitration opponents, but they have been concentrated in just a few states.

  • What legislative initiatives are under way to restrict arbitration?

On the federal level, bills have been introduced in the House and Senate to invalidate arbitration clauses in consumer credit and employment contracts. A bill has been introduced in the House that would prohibit binding arbitration clauses in contracts to purchase new homes. Several years ago, the Senate Banking Committee held a hearing on arbitration abuses in the securities industry, and they may hold a hearing on the use of arbitration in predatory lending transactions later this year.

In 2000, the House passed a bill relieving auto dealers from arbitration clauses in contracts with auto manufacturers. Last year, the House passed a version of the Patients’ Bill of Rights that would have prohibited HMOs from imposing arbitration, and the Senate passed a version of the farm bill invalidating arbitration clauses in contracts between agribusinesses and farmers. None of these measures have become law.

On the state level, the power of legislatures to regulate arbitration is restricted by the Federal Arbitration Act, but there are some exceptions to federal pre-emption. Some states have prohibited arbitration clauses in insurance policies. The California legislature has considered legislation regulating arbitrators and arbitration provider organizations. Last year, New Mexico adopted the Fair Bargain Act, a law intended to make arbitration fairer. All of these issues are being raised on the state level as states consider enactment of a model bill, the Revised Uniform Arbitration Act.