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In the past several decades, arbitration clauses in commercial contracts have gained favor in the business community. They are viewed as devices to expedite and reduce the costs of litigation and to avoid the risk of excessive judgments. Businesses would be wise to take a second look. Surprisingly, in light of the widespread use of arbitration clauses, there are no reliable statistical data to support the assumptions underlying the business community’s decision to embrace the concept, and logic and individual case studies strongly suggest that the supposed benefits of arbitration do not outweigh the risks. Arbitration is not necessarily fast or cheap The belief that arbitration will significantly reduce the length and cost of litigation often proves illusory. In the first place, arbitration often generates its own litigation. Parties often mount judicial challenges at both ends of the process. Moreover, lawyers who participate in arbitration of major commercial cases often quickly learn that the arbitration proceeding itself is neither fast nor cheap. Judges, constrained by crowded dockets and, at the state level, limited courtroom availability, utilize rules of practice to streamline cases. Arbitrators, not faced with such constraints, have no incentive to set limits that reduce length or complexity of the proceeding. Two recent cases illustrate the point. In July 1997, Stephen Sawtelle began an arbitration proceeding against his former employer, Waddell & Reed Inc., alleging interference with Sawtelle’s prospective business relations. The arbitration proceeding itself lasted for 50 days stretched over 2 1/2 years, and the subsequent trial court battles and appeal were not resolved until February 2003. Even then the matter was not final. The New York appellate court vacated a $25 million punitive damages award and returned the matter to the arbitration panel for further proceedings. Sawtelle v. Waddell & Reed Inc., 304 A.D.2d 103 (N.Y. App. Div. 2003). The presentation of evidence and argument in the arbitration proceeding reviewed in Engel v. REFCO Inc., 746 N.Y.S.2d 826 (N.Y. Sup. Ct. 2002), continued for almost three years, involved 59 witnesses, generated more than 24,000 pages of hearing transcripts and more than 700 pages of post-hearing memoranda, and resulted in a plaintiff’s attorney fee of $747,000. Sawtelle and Engel may not be typical, but they are not rare, and they illustrate that there is nothing inherent in arbitration that ensures a shorter and less costly process. The primary basis for the assumption that arbitration will be shorter than litigation is the limited discovery and motion practice available in arbitration. In fact, this can have the opposite effect. Motion practice defines and crystallizes the issues. Discovery provides a window into the opposition’s case and avoids surprises. Together, they increase the chance of settlement and enable a lawyer to craft a precisely developed case with confidence that there will be no lurking traps. Without motion practice and discovery, the lawyer must spend the time and money to prepare for every conceivable eventuality, and the incentive to settle that comes with knowledge of the opposition’s case is absent. The belief that arbitration is likely to result in lower awards than a trial makes no sense. If the fear is of runaway jury verdicts, a clause waiving jury trial can be included in the contract. Nor is there reason to assume that arbitrators, often retired judges, will tend toward lower awards than judges. The $27 million award in Sawtelle and $42 million award in Engel, among others, should disabuse anyone of that idea. It is likely that the perception that arbitration produces smaller recoveries is generated by the relatively smaller amounts awarded on average by securities exchange panels. Those results have been attributed to a number of factors unique to such panels that would not suggest elements indicative of arbitrators in general. Even before such panels, however, there is no guarantee of a low award. Despite the small number of such arbitrations annually compared to dispute resolution in general, barely a year passes without at least one six- or seven-figure award. (Examples include a 2000 Pacific Stock Exchange $3.9 million award, a 2001 National Futures Association $43 million award, a 2002 private arbitration panel $7.7 million award, a 2002 National Association of Securities Dealers $7.3 million award and a 2003 NASD $27 million award.) Arbitration’s questionable promise of fast and cheap dispute resolution comes at a high price. Once made, the contractual election to arbitrate cannot unilaterally be undone, and the client sacrifices fundamental protections against arbitrary and unfair treatment. Arbitration subject to the Federal Arbitration Act or the Uniform Arbitration Act, which includes most arbitrations, provides no right to prehearing discovery. A party may request the arbitrators to issue a subpoena for attendance or production at trial, but it is discretionary with the panel. Whether an arbitrator even has authority to order discovery depositions is unsettled under either act. In any case, there is no assurance that a party will be able to engage in any discovery, much less thorough discovery, prior to final hearing. Arbitrators are also not bound by the rules of evidence and it is commonplace for them to consider evidence that would be inadmissible in a judicial forum. Discovery practice was developed to reform a system in which guesswork and surprise had more influence over the outcome than truth and justice. Rules and codes of evidence reflect centuries of experience that taught that certain items of evidence and methods of presentation are so unreliable and unfairly prejudicial as to outweigh their probative value. To jettison those rights simply to reduce costs is analogous to declining to take antibiotics before surgery in order to reduce medical costs. The right of appeal is considered by virtually all democratic societies to be an important safety net in the process of adjudicating disputes. It serves as both an opportunity to correct errors of law committed at the trial level and an incentive to trial judges to avoid arbitrary conduct and to strive for accurate application of the law. For all practical purposes, the right of appeal from an arbitration decision is nonexistent. Under both the federal and uniform acts, a court is empowered to vacate an award only upon finding that the award was procured by corruption, fraud or undue means; there was evident partiality or corruption by an arbitrator; the arbitrators exceeded their powers; or the arbitrators refused to postpone the hearing upon sufficient cause shown or refused to hear evidence material to the controversy or otherwise so misbehaved in the conduct of the hearing as to prejudice the rights of a party. Courts have also added the ground of “manifest disregard” of the law. This has been interpreted to mean that the law was clearly defined and clearly applicable to the facts of the case, and the arbitrators knew the law and intentionally disregarded it. A mistake of law or fact is insufficient. The scope of a court’s review of an arbitration award under the federal act has been described as “among the narrowest known to the law.” ARW Exploration Corp. v. Aguirre, 45 F.3d 1455 (10th Cir. 1955), and the act has been held to pre-empt state law to the extent that it is inconsistent with such deference. The same clients who are enamored of the idea of sidestepping the courtroom when the contract is drafted often become incredulous when they are confronted with an arbitration award they consider unjust and are informed that there is no meaningful right of appeal. Punitive damages are usually deemed authorized Arbitration is no protection from punitive damages. Federal and state courts have generally held that the question of whether an arbitrator has the authority to award punitive damages depends upon the intent of the parties as embodied in the arbitration agreement. In the absence of an express prohibition, the tendency has been to find that punitive damages are authorized. Even a clear prohibition in the agreement is no guarantee. In Thicklin v. Fantasy Mobile Homes Inc., 824 So. 2d 723 (Ala. 2002), the Alabama Supreme Court held that a provision in an arbitration agreement barring the award of punitive damages was against public policy and declared it void, allowing the award of punitives. Of course, courts can award punitive damages as well, but there are significant restraints upon punitive damages assessed in judicial proceedings that may not exist in arbitration. The U.S. Supreme Court, in a series of cases culminating in State Farm Mut. Auto. Ins. Co. v. Campbell, 538 U.S. 408 (2003), has set constitutional limits on the amount of punitive damages. Among other things, the court has held that due process requires that punitive damages should rarely be more than a single-digit multiplier of compensatory damages and that four times compensatory approaches the outer limits of constitutionality. Although courts are split, some have held that due process restraints do not apply to arbitration proceedings because they do not involve state action. The court in Bowen v. Amoco Pipeline Co., 254 F.3d 925 (10th Cir. 2001), avoided the issue altogether by holding that the defendant implicitly agreed to give the arbitration panel unlimited authority to impose damages, including punitive. I am not suggesting that parties should never agree to arbitration. I do strongly believe that it is a mistake for a party to blindly bind itself to a contractual arbitration requirement from which it cannot unilaterally extricate itself. If arbitration is agreed to, it should only be after the dispute arises and only with advice of counsel after careful consideration of all surrounding circumstances, and only with appropriately drafted limitations. Barry Richard, based in Tallahassee, Fla., is a principal shareholder at Greenberg Traurig. He was lead litigation counsel in Florida for George W. Bush during the 2000 Bush-Gore election dispute.

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