By Dr. Gary Deel, Ph.D., J.D.
Faculty Director, School of Business, American Public University
This is the first of three articles examining the legal concept of arbitration.
Last year, the U.S. Supreme Court granted certiorari review (re-examination) of two different cases. One case involved a company attempting to force arbitration of a dispute with a business partner because the contract governing the matter was ambiguous. The other case involved a company attempting to force class action arbitration of an employment dispute that affected the company’s entire workforce.
Start a management degree at American Public University.
The rulings of the Supreme Court on these cases were pivotal to the future of case law in the field of arbitration. I cite them to open a discussion about why large companies are so attracted to arbitration as a means to resolve legal disputes in the modern era.
First, it’s worth defining. Arbitration is a kind of alternative dispute resolution (ADR), by which parties that encounter conflict may resolve the dispute without subjecting it to formal litigation procedures. It is adjudication by a neutral third party out of court.
In Our Early History, Traditional Arbitration Was Thought of as a Sort of ‘People’s Court’
Arbitration can be traced back hundreds of years in our nation’s history. Traditional arbitration was thought of as a sort of “people’s court,” where disputants could settle conflicts in a binding way, but without the complexity of formal court proceedings.
This system was widely adopted in social institutions such as churches and ethnic communities. It was appealing to these institutions because their customs and values were often more familiar to the disputants than the seemingly esoteric rules of formal law; also, they might have a greater weight in the outcome.
However, what once was a people-driven alternative to litigation over time became a more formalized, codified and established process in the modern justice system. This began with the United States Federal Arbitration Act (FAA) of 1925. The FAA had the effect of providing legal enforceability to arbitrate any contracted agreements.
Then, in 1947, arbitration was included in the Taft-Hartley Act as a principal means of resolving conflicts between unions and employers. Since that time, Supreme Court decisions and legislative actions have ramified the procedural codifications and formal regulations of arbitration.
Arbitration Has Expanded So That Today There Are Many Different Types
Far from being the informal “people’s court” of earlier times, arbitration has expanded in scope and complexity so that today there are many different types of it. Each type has different implications concerning control, costs, time frame and the likelihood of success for disputants.
Arbitration comes in two primary forms: binding and non-binding. Binding arbitration is also called “formal arbitration.” Binding arbitration involves the appointment of an arbitrator, an attorney or judge who is licensed to practice arbitration. After a formal process during which both sides present evidence and make arguments, the arbitrator renders a binding decision that both parties are legally bound to honor.
Non-binding arbitration is sometimes known as “advisory arbitration.” In these cases, the parties present evidence and the arbitrator renders an opinion in the same way as in binding arbitration. As the name suggests, the key difference here is that such opinions are not binding on the parties. If either party rejects the decision, the legal dispute may then move to the courts or to another form of ADR.
There Is Also a Special Type of Advisory Arbitration Called ‘Incentive Arbitration’
There is also a special type of advisory arbitration called “incentive arbitration.” In this unique type of arbitration, disputants agree in advance that, if either party is dissatisfied by the outcome, that party may reject it.
The dispute will then move to a formal trial setting, with the understanding that the party that rejected the arbitration outcome shall incur a penalty in terms of the final outcome. So if the rejecting party wins and is entitled to monetary compensation, their award shall be reduced.
On the other hand, if the rejecting party loses and owes payment to their opponents, then the total owed may be increased. This provides an “out” for a party that may be disadvantaged. But that party must carefully weigh the potential gains of a trial — over and above the arbitration decision — against the penalty for rejecting the outcome.
Many proceedings today arise from previously established agreements between parties. This is sometimes referred to as “executory arbitration,” meaning that the agreement to arbitrate came before the dispute in question ever existed.
In early American judicial history, courts originally established the “ouster doctrine” to preclude such preemptive agreements. This was done on the basis that they violated a court’s authority to litigate disputes. However, the “ouster doctrine” has since been shelved, and parties are usually free to bind themselves to litigation a priori if they wish.
But even if the parties do not preemptively agree to arbitrate, it is important to remember that they may still agree to arbitrate after a dispute arises. And such agreements may still be binding on the parties provided that they satisfy the elements of a valid, enforceable contract.
Court of Law May Mandate Arbitration as a Preliminary Step to Avoid a Trial
Also, while parties may freely and of their own volition agree to arbitration, a court of law may also mandate it as a preliminary step to avoid a trial. However, court-mandated arbitration can never actually be binding on the disputants, lest it violate laws of due process and rights to trials by juries of one’s peers. As such, calling such court-mandated procedures “arbitration” is a bit of a misnomer.
Although courts may still call it “arbitration,” it is instead a form of mandatory negotiation between the parties akin to mediation. Any “decision” or “finding” from an arbitrator is advisory at best. In any such case, the disputants may always choose not to accept the arbitrator’s conclusions, in which case formal trial proceedings must commence.
There may also be a variety of limitations placed upon arbitrators in terms of awards. An arbitrator is usually unrestricted in deliberating the merits of a case. However, once the arbitrator has determined an appropriate disposition, different paradigms may restrict the arbitrator in terms of relief for the prevailing party.
In some cases, the arbitrator is free to declare an award with no greater limitations than those of a court judge. In other cases, the disputants establish ahead of time the minimum and maximum awards to which the prevailing party may be entitled.
Still, in other cases, the award may be based on settlement offers submitted by the parties in advance; this is commonly referred to as “final offer selection” arbitration. These are important considerations for any potential disputant in deliberating the terms of a clause.
In the second part of this article, we’ll break down the typical steps in the process and discuss some of the dynamics that affect decisions by disputants whether to pursue it or not.
About the Author
Dr. Gary Deel is a Faculty Director with the School of Business at American Public University. He holds a J.D. in Law and a Ph.D. in Hospitality/Business Management. He teaches human resources and employment law classes for American Public University, the University of Central Florida, Colorado State University and others.