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October 1, 2019

Arbitration Clauses in Contracts: Useful, but Specifying AAA Rules May Be Detrimental

When entering into a contract with an entity across the US-Canada border, issues may arise over which country’s courts have jurisdiction over the parties. One popular and effective means of mitigating objections to jurisdiction is having an agreement between the contracting parties to privately arbitrate their disputes rather than resolve them in court. To demonstrate the power of arbitration clauses, in the United States, a contract arbitration provision will generally be a valid defense to a lawsuit claiming a breach of the contract.

Arbitrations are known for limited discovery and, thus, typically lower costs than litigation since serial depositions and complex motions can significantly increase the cost of litigation. Arbitrators will usually provide for some discovery and limited motions, but generally much less than in litigation. The lower cost and typically shorter time for a decision make arbitration an attractive dispute-resolution vehicle. 

However, arbitration isn’t always the lighter, cheaper, and faster option. Many business contracts stipulate that the rules of the American Arbitration Association will control the arbitration, and designating the AAA can dramatically change the arbitration cost and time frame. When the AAA administers the arbitration, in order to initiate the process, the complaining party—the person who may not have been paid or is dealing with a defective product (in other words, the person who may be least able to afford it)—must pay the AAA’s administrative fee. This fee is separate from the arbitrator or arbitration panel fee. 

The AAA has a fee schedule for its case administration. In a commercial dispute where the claim is between US$1 million and US$10 million, the AAA’s administration fee is US$16,175. In addition, the arbitrators themselves must be paid their hourly rate, which, depending on the city the arbitrator comes from, is often between US$400 and US$700. And depending on the dollar amount of the dispute, the AAA’s rules may require a three-arbitrator panel. The arbitrators’ fees can be substantial if the hearing is, for example, two days long, and the arbitrators also need a day to review and maybe two days to decide the case and write the decision. So, if, for example, each arbitrator on the three-arbitrator panel charges US$500 hourly across five eight-hour days, the total would be US$60,000.

AAA administration can also slow dispute resolution. The AAA rules provide for phone conferences with the administrator and then a process for choosing the arbitrators, which can cause delays because each side has broad discretion to strike a number of potential arbitrators from the list provided by the AAA. If all the potential arbitrators are stricken from the list, a new list must then be circulated to the parties. The parties can’t use a local arbitrator who is not on the AAA’s list—and, in many cities, there are excellent arbitrators who have not signed up with the AAA.

The arbitration clause doesn’t have to provide for AAA rules. Instead, it could simply provide that the dispute must be arbitrated in a location the contracting parties can agree on. Should the need for arbitration arise, by not stating that AAA arbitration rules will apply, parties are then free to work out a rational, inexpensive arbitration plan.

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