Reprinted From Houston Business Journal, May 7, 2004
In an attempt to control litigation costs, many companies are looking to employ alternative dispute resolution mechanisms – commonly referred to as "ADR" – to avoid the courthouse. Two of the most commonly used ADR mechanisms are mediation and arbitration. Mediation is a voluntary process in which the parties use an objective third-party facilitator to try to negotiate a resolution to their dispute. Arbitration, however, results in a binding decision that the parties can seek to enforce through the courts. Here are a few things you should know about arbitration before embarking on this means of resolving a business dispute.
The Governing Law of Arbitration
As stated above, arbitration is binding, and parties can seek to enforce a decision through the courts. For arbitration proceedings in Texas, either the Federal Arbitration Act (FAA) or the Texas Arbitration Act (TAA) will be the governing law. The FAA can be applicable only if the dispute relates to a maritime transaction or a contract involving interstate or foreign commerce. In such matters, the FAA preempts all other applicable state laws, including the TAA. When the FAA does not apply to a dispute, the TAA or the Texas Common Law (for actions in Texas ) will govern the matter, unless some other states law is applicable.
Contractual Arbitration Requirements
Under both the FAA and the TAA, arbitration is a matter of contract between the parties, and the parties to the arbitration agreement may choose the terms under which they will arbitrate. Because public policy favors arbitration, a court will resolve any doubts regarding the applicability of an arbitration provision in favor of arbitration.
Even tort claims may be the subject of a contractual arbitration provision. A judge will determine as a question of law whether the facts allegedly underlying the tort are sufficiently intertwined with the contract. If they are sufficiently intertwined, then the matter may be subject to arbitration. However, the fact that a tort claim would not have risen "but for" the contract does not guarantee that the claim is subject to arbitration. The test is whether the particular tort claim is so interwoven with the contract that it could not stand alone or, on the other hand, is a tort completely independent of the contract and could be maintained without reference to the contract.
What Happens in an Arbitration
Once a matter is referred to arbitration, the arbitrator or arbitrators will be selected according to the contract between the parties. Failure to follow the procedures set forth by the agreement of the parties may result in any award being vacated. The parties may agree to have arbitrators selected based on the rules of organizations like the American Arbitration Association or the CPR Institute. Parties may agree on the number of arbitrators, which is usually either one or three. In cases where the parties have agreed to have their matter considered by three arbitrators, all three may be what are termed "neutral arbitrators," which are usually appointed pursuant to a selection process. In some contracts, each party is required to appoint one arbitrator (either a party arbitrator or an impartial arbitrator), and then the party-selected arbitrators choose the third, neutral arbitrator.
The actual conduct of the arbitration can be less formal than a trial. Discovery in arbitration, and any limits to it, are provided by the contract of the parties or the arbitration rules the parties have selected to govern the arbitration. Most rules promulgated by the various arbitration organizations provide for some limited discovery, including depositions. In addition, the arbitrators are not required to apply either the Texas or Federal rules of evidence unless the agreement of the parties requires it. An arbitration award will not be set aside due to the arbitrator's refusal to hear evidence, unless the exclusion of the contested evidence prevented the offering party from receiving a fundamentally fair hearing.
Limited Options for Appeal
After the arbitration, a party has very limited rights to appeal the arbitration award, unless otherwise specified in the party's contract. The statutory bases under the FAA and the TAA for vacating an arbitration award are similar. Both statutes provide that an award may be vacated if it was obtained pursuant to (1) corruption, fraud, or undue means; (2) evident partiality or corruption of the arbitrator; (3) arbitrator misconduct (refusing to postpone hearing, hear pertinent material evidence, or any other behavior which prejudices a party's rights); or (4) the arbitrators exceeded their powers, or the award is not final or definitive.
The bases for modifying or correcting an award are similar under the FAA and TAA. They are (1) there is a material miscalculation of numbers or an evident mistake in the description of a person, thing, or property referred to in the award; (2) the arbitrators have made an award with respect to a matter not submitted to them, unless it does not affect the merits of the decision of the matter that was submitted for consideration; and (3) the award is imperfect in matter or form not affecting the merits of the controversy.
The Advantages and Disadvantages of Arbitration
Whether arbitration presents advantages or disadvantages may largely be dependent on whether you are the plaintiff or the defendant. Arbitration typically minimizes the plaintiff's chances of obtaining large punitive damage verdicts as well as large actual damages based on questionable damage theories or calculations. In addition, the plaintiff loses the intimidation effect that normally goes along with these types of damages in settlement negotiations. However, when a large verdict is awarded, there is usually no appeal, and it is extremely difficult to have the award vacated by a court. While a party may save litigation costs with the limited discovery that characterizes arbitration, that savings can be quickly offset by the cost of the fees and expenses associated with three arbitrators in a protracted arbitration. Further, the cost for initiating a lawsuit can also increase substantially in arbitration. So when it comes to arbitration, you should be careful for what you wish, because you may just get it.