Arbitration Clause and Post-Dispute Considerations for In-House Counsel

David A. Kotler

Arbitration clauses are included in virtually every type of contract between sophisticated commercial entities, from the closely-held company to the Fortune 100 publicly-traded company.  Undoubtedly, parties negotiating a contract include arbitration clauses because of the general perception that arbitration has the potential to provide significant benefits over in-court litigation.  But, these perceived benefits often overshadow the particular challenges that arbitration actually pose.  In-house counsel should be aware of both the potential benefits and the possible pitfalls when crafting the arbitration clause in the next contract that they negotiate.  In particular, one of the most useful -- and perhaps most overlooked -- benefits of arbitration is that it gives the parties a second chance to craft the rules and procedures to fit their specific dispute.  Therefore, in-house counsel should be open to the possibility of negotiating with their opposition once an arbitration has commenced to arrive an arbitration plan tailored to the specific issues about which they disagree.

The most commonly acknowledged benefit of arbitration over litigation is that arbitration is more efficient and less costly than an in-court trial.  Vis-à-vis a jury trial, an arbitrator is generally more sophisticated than a jury, meaning that an arbitrator can process the factual and industry background and focus on the key issues more expeditiously than a jury.  Arbitration also has potential efficiencies over a bench trial, as parties often have the opportunity to select one or more of the arbitrators.  This allows the parties to choose an individual or individuals who have some familiarity with either the type of dispute or the companies’ industries.

Another commonly acknowledged benefit of arbitration is that discovery in arbitration has the potential to proceed more rapidly and with less cost than in-court litigation because the arbitrator can keep close tabs on the parties’ discovery strategies and focus the parties on truly necessary discovery (rather than allowing “fishing expeditions”).  And, indeed, this perception is true in many cases.  However, where a case involves complex issues, the efficiency and cost savings achieved through arbitration discovery may be slight or none.  In one of our recent cases, for example, the parties disputed whether one of the parties had used “all commercially reasonable efforts” to develop and market a particular product.  Discovery, therefore, necessarily involved hundreds of thousands of pages regarding everything from research and development to the company’s worldwide marketing activities.  Hence, where a dispute involves complex issues, any cost savings from arbitration are likely to be a result of the speed and efficiency of the hearing rather than a reduction in the volume of discovery.

With these potential costs and benefits in mind, in-house counsel should consider the following ideas when negotiating their next arbitration clause:

• Consult with litigation counsel.  We are all aware of the circumstance where the attorneys negotiating a transaction agreement will use boilerplate language in the arbitration clause.  This, of course, is understandable, because during contract negotiations, the parties generally are more focused on the substantive issues rather than the potential for the contractual relationship to erode and for the parties to end up in a legal battle against each other.  For this reason, it is crucial that the attorney drafting the contract consult with litigation counsel regarding the language in the arbitration clause.  Litigation counsel likely has experienced how the language in certain arbitration clauses can help or hinder a party in achieving its goals, which will allow litigation counsel to suggest the language that would be most beneficial to the client.
  
  
• Consider an arbitration clause that permits dispositive motions.  Arbitrators tend to prohibit dispositive motions, or refuse to grant them even in the face of compelling reasons to do so.  But, these motions can focus the issues in an arbitration -- knocking out claims that lack merit -- or even resolve the case altogether.  To ensure that the arbitrator receives dispositive motions and treats them seriously, the parties should explicitly address the issue in the arbitration clause. 
  
  
• Craft an arbitration clause that allows for flexibility over specificity in timing and scope of discovery.  It generally makes little sense for the parties to negotiate a limit on aspects of discovery before a dispute has arisen.  Once the actual dispute is clear, the parties, working with the arbitrator, can develop a discovery plan and timeline that fits that dispute.  For example, it is not uncommon for an arbitration clause to require that a dispute be resolved within a specified period of time.  However, the complexity of the dispute may prevent compliance with that requirement, thus compelling the parties to spend time essentially re-negotiating the arbitration clause after the arbitration had already commenced.  Therefore, a more general arbitration clause is often preferential to an arbitration clause with specific dates and discovery limits.

In the event that a dispute does arise, the parties will have to put the arbitration clause into effect.  But, this does not mean that the parties should proceed on auto-pilot as if the case had been filed in court.  Rather, as noted above, the parties should engage in an open dialogue with each other and the arbitrator(s) to arrive at a plan for the discovery and hearing processes that best fits the dispute.  Thus, once the arbitration has been filed, in-house counsel should consider the following:

• Tailor the scope of fact discovery to the actual dispute.  It can be difficult for parties when they are negotiating a contract to foresee what forms of discovery will be necessary should a dispute ever arise under that contract.  But, once the arbitration papers have been filed, the parties should consider whether discovery should include or exclude fact depositions, corporate designee depositions, interrogatories, or other discovery tools.  While these types of discovery have the potential to narrow the issues for trial, they often increase discovery expense and time, making the discovery process -- and legal fees -- resemble that of large-scale court litigation.
  
  
• Designate rules to apply to evidence at the hearing.  When it comes to putting on evidence at the hearing, arbitrators usually employ a “let it all in” philosophy.  But this approach can be problematic for the parties for at least two reasons.  First, without something like the Federal Rules of Evidence guiding them, the parties are less likely to carefully consider what evidence to put on and focus on the specific issues in dispute.  This makes for a less efficient and more costly hearing.  Second, the parties are forced to prepare witnesses to deal with tangential or potentially irrelevant evidence, again increasing the cost of preparing for the hearing and responding to evidence at the hearing.  By agreeing that the hearing will be governed by the Federal Rules of Evidence, for example, the hearing should be more focused and efficient.
  
  
• Consider how to limit the time necessary for the hearing.  Often, once the contours of the dispute are clear, the parties have an opportunity to define how the arbitration hearing should be conducted in a way that can significantly limit the length of the hearing.  One possibility is to have witnesses prepare witness statements to serve as their direct testimony, limiting in-person testimony to primarily cross-examination by the opposing party. 

While arbitration disputes will never fall into a “one size fits all” category, in-house counsel would be wise to consider the concepts described above when negotiating their next arbitration clause.

David A. Kotler is a partner in the Princeton office of Dechert LLP in the White Collar and Securities Litigation group.  He was assisted in this article by Jennie Krasner and William Gibson, both of whom are also members of the White Collar and Securities Litigation Group in the Dechert Princeton office.