Arbitation, Part 2: Cost

One of the supposed benefits of Arbitration is the decreased costs in comparison to traditional litigation. The arbitration process is more compact and is briefer, and attempts to dispense with extended discovery (in fact, often opting for no discovery at all), thus reducing the costs of numerous lawyer's hours, court reporter's hours, deposition transcripts, etc. While in the case I just finished, it is true less money was spent on attorneys and depositions, the other costs that were incurred at the very least were equal if not greater than traditional litigation fees.

First, unlike in traditional litigation, the parties are required to pay the "judge" (i.e., the Arbitrator), whose fees per hour will rival or even exceed his attorney counterparts. While from a purely abstract libertarian perspective, I like the idea that the parties to a dispute pay the full costs of the legal proceedings rather than burdening the taxpayers through tax-funded courts and personnel, as a practical matter, this can sometimes end up being more costly for a client than simply going through the state- or federally-funded litigation process.

Second, in my specific case, the costs were trebled through legal maneuvering from the other party's attorneys. The case at issue involved an owner/contractor disagreement, involving three different properties the contract was constructing for my client. Instead of filing one lawsuit or one arbitration, the contractor filed three. In traditional litigation, a judge likely would have combined all three into one case for the sake of judicial efficiency. In this case, however, the arbitrator assigned to rule just on this motion (whom had to be paid separately) ruled against it. That meant my client was required to ante up money for three different arbitrators, assigned to three distinct cases, when one paid arbitrator could have decided it in about the time it would cost to hear one case. It was an interesting tactic, because I believe my client was more able to absorb the costs than his opponent.

We estimated that the case, if consolidated, would take about a week to try, but unfortunately, because each arbitrator would be hearing his particular case anew, each time we'd need to spend a few days simply laying out the facts. Instead of paying for one week's arbitration, we would now pay for approximately three. Do the math on arbitrators who charge about $300 per hour, assume eight hour days, times 21 days. It's not cheap. Now add in attorneys for each side who will also be litigating for three weeks.

Finally, even though trial litigation can be expensive, the reality is many cases never make it that far--not because of settlement (which of course happens often)--but because the case is disposed of earlier by motions. I've litigated numerous cases for this particular client, but more than half of them never made it to trial because I got them dismissed early on. Because the arbitration procedure does not typically rule on such dispositive motions, and simply lets it go to a hearing (and if you think about it, it's in the arbitrator's financial self-interest to keep the case going so he can be paid), my client would have spent far more if those cases had been arbitrated than it did by litigating them.

Although I am sure each arbitration varies on its merits, my experience thus far is that arbitration has not been less expensive than litigation, and in fact has been more so.

Arbitration and Arbitration Clauses in Contracts -- Overview

Many of my more sophisticated clients, for whom I draw contracts, commonly ask if we should put in a provision to require "Binding Arbitration" in the event of a legal dispute.

The idea, in theory, is a good one. Arbitration, it is said, will reduce the legal costs otherwise incurred in court; will produce fairer results less dependent on technicalities and based more on the merits and equities; and will resolve matters more quickly.

I'd sat on the sidelines for a long time and advised against them, primarily from cases I had watched and from my own personal convictions that I was able to use the mechanics of the legal system to obtain a more favorable result for most of my clients.

However, I finally got the benefit of putting Arbitration to the test, recently, when a client of mine got into a dispute with a large commercial contractor over several projects. Each project was governed by a separate contract, each of which provided for binding arbitration in the event of a dispute, and the contractor, pursuant to his rights, demanded binding arbitration. Because the contractor's attorney was a litigator who specialized in construction litigation, and because I did not want my first experience in arbitration to be against an experienced specialist when hundreds of thousands of dollars were on the line, I associated a colleage of mine who was also a construction litigation specialist.

Through the process, I got the opportunity to watch how binding arbitration worked, to see its advantages and disadvantages in action, and now feel more qualified than before to speak about arbitration.

First, my opinion: putting binding arbitration clauses in contracts is still, in my opinion, a bad idea. Arbitration, in my experience, does not adequately deliver on its promised benefits (costs and fairness), while subjecting its participants to a procedure and to rulings that are only loosely bound by a rule of law and, for the most part, are non-appealable.

Next, in the upcoming articles, I will discuss the structure of binding arbitration, its alleged benefits and its drawbacks, and allow the reader to draw his own conclusions. Stay tuned....

Reader's questions about minority shareholders

A reader recently wrote a very good question about minority shareholders, and I thought the situation would be worthy of posting. Here is the question, and answer, with permission.

"Hi,

I read your article about minority shareholders. I got an offer to become a shareholder of a small company without paying anything, just because I have been working for them for a period of time.

However, my plans are to go to grad school and then after a year or two look for a position in a large company. Can I then go to work for another company if now I've agreed to become a shareholder of the small company that is just starting? If not, can I, after a year or two, tell that small company that I don't want to be a shareholder anymore? I'm being told by the other shareholders that everything will need to be confidential, so I don't know if my husband and I can show the shareholder agreement to a lawyer."

--------------


First, understand that I am only licensed to practice in North Carolina, and this does not constitute legal advice.

Second, at least in North Carolina, but usually in other states, it is a general industry practice that any agreements which would involve you personally but are labelled "confidential" can still be studied, shared, reviewed by legal counsel before you decide to sign it. Still, the best practice is to let the others know you'd like your personal attorney to review the documents.

Finally, there are two things which may prevent you from joining a big company while still a shareholder of the smaller one. The first is that (assuming their businesses are similar), if you're involved with the smaller company, you owe a duty of loyalty to that smaller venture. If you go to another company, you are not able to use your best efforts for the smaller company. In fact, your actions may go further and violate specific provisions of your shareholders' agreement.

The second issue is also a serious one: what if you just give up your stock rights and leave the company; will that solve everything? There still may be a problem if the remaining shareholders allege that you are using proprietary or confidential information you obtained while a shareholder in the small company. This may specifically violate terms of your shareholder's agreement (which may contain a non-disclosure provision) or it may violate your state's common law rules (i.e., civil rules created by caselaw) regarding what information from your former employer/partnership/venture/etc. that you can use once you leave.

The best thing you can do? Be upfront with the other shareholders, and negotiate a provision that, while protecting their interests, allows you the freedom one day to leave for bigger things: e.g., perhaps an agreement that allows you to leave and join a competing business, but provides that the remaining shareholders can buy out your interest at a fair price (the determination of which would be a subject in itself). If they won't agree to this, both sides are already on notice that there will be a potential conflict in the future--so why buy into it? Either walk away, or understand you may have a fight on your hands when you leave.