Commercial arbitration has become more complex, time-consuming, and expensive – in other words, more like litigation.  In Part One, we discussed the increasing skepticism among corporate counsel about the purported “better, faster, and cheaper” advantages of arbitration.  This week, we take a look inside the arbitration process – from the arbitrators’ point of view – to explore the factors driving this trend.

One major reason why arbitration is becoming more like litigation is that the arbitrators themselves are increasingly and exclusively drawn from the ranks of the legal profession.  The non-lawyer arbitrator is becoming vanishingly rare.  A recent survey of experienced commercial arbitrators found that 98% are lawyers and/or former judges – a much higher number than had been the case 15 to 20 years previously.[1]  Arbitrators are more likely to view arbitration as a full-time “profession” rather than an occasional activity, and three-fourths of them depend on their arbitral practice for additional income.  More arbitrators are competing for fewer cases, and a majority say they are getting less work than they would like to get.[2]

Another factor driving the increased cost and complexity of arbitration is the tendency of arbitrators to allow more process (such as pre-hearing motion practice, extensive document discovery, and post-hearing briefing) while failing to employ tools that can promote early resolution (such as granting early dispositive motions or encouraging settlement).  Arbitration is often praised for its procedural flexibility, but in practice that flexibility can often mean parties spend more time arguing about procedure and arbitrators spend more time dealing with case-management issues.

Cases in arbitration are more likely to proceed all the way to final hearing, because arbitrators are reluctant to grant dispositive motions (such as motions to dismiss or for summary judgment) that could potentially bring an early end to the case or at least narrow its scope.  In a recent survey, 21% of arbitrators reported that they had never granted an early dispositive motion, and another 70% said they had done so only rarely.[3]

Resolution by early settlement is also much less common in arbitration than in litigation.  Most arbitrators make little or no effort to encourage mediation or early settlement, and many of them believe that is simply not part of their job.  One arbitrator even complained that settlement prior to final hearing “causes havoc” to his schedule and results in “lost income” from other cases he turned down.^[4]  In the 2011 CCA survey, only 15% of arbitrators reported that the majority of their cases settled prior to the final hearing – an astonishingly low number compared to the over 95% of civil lawsuits that settle before trial.   More than half of arbitrators said that they “never” concern themselves with encouraging settlement, many believing that such an approach would conflict with their duty of impartiality and their responsibility to see the arbitral process through to its end.[5]

The result of arbitrators’ tendency to allow more process while not promoting early resolution is that, in many cases, arbitration has become more expensive and time-consuming than litigation.  A 2012 study found that, on average, parties in arbitration incurred attorneys’ fees and related costs 31% higher than they would have incurred in equivalent court litigation.[6]  In former years, an arbitration might take six months “cradle to grave.”  Today, however, the fastest way to resolve a case may be before a jury, because – unlike paid-by-the-hour arbitrators – “they want to go home.”[7]

Separate and apart from the increased time and expense, modern commercial arbitration can also entail considerable uncertainty and risk.  The same procedural flexibility that makes arbitration attractive also makes it unpredictable.  Arbitrators are typically free to consider hearsay and other evidence that would not be admissible in court, and the vast majority of them do so.[8]  The limited scope of judicial review can exacerbate the harm done by a bad evidentiary ruling.  An arbitrator may exclude highly relevant evidence that is essential to a party’s case, or even order the disclosure of privileged documents to the opposing party.  Unlike in a court, the aggrieved party has no recourse to mandamus review.

The outcome of an arbitration is not necessarily more predictable or reliable than a court’s verdict.  Survey evidence lends some credence to the common stereotype that arbitrators are prone to make “split the baby” compromise awards even when the facts and the law clearly favor one side.  Commercial arbitrators who serve on multi-arbitrator panels report that they “almost never” dissent from the panel majority, and 90% say they negotiate with the other panel members over the amount of the award.[9]  This predisposition toward compromise can raise costs by giving more bargaining power to parties with weak (or even plainly meritless) claims, because the party with the stronger case cannot be certain of beating those claims quickly or cheaply.

At the other extreme is the risk of a “runaway arbitration” in which the arbitrator, guided only by a sense of fairness, makes a massive award against the party he or she believes is in the wrong.  Between one-fourth and one-fifth of arbitrators freely admit that they sometimes render decisions based on their “sense of equity and fairness” even if the result is contrary to the law.^[10]  Arbitrators are less constrained to follow the law, because their decisions will almost always be upheld on judicial review even if they get it badly wrong.  The grounds for challenging an arbitral award in court are extremely limited,[11] and the U.S. Supreme Court has held that parties cannot agree to expand the scope of judicial review.[12]  Even if the parties wished it to, a court cannot overturn an arbitrator’s decision on account of clear legal error or a grossly excessive award.  A court challenge is highly unlikely to succeed – and it may even make things worse, because some courts will impose sanctions on “losers” who bring “frivolous” challenges to arbitration awards.[13]

The combination of unpredictability and unreviewability makes arbitration a particularly risky choice for high-stakes “bet the company” disputes.  Several companies have learned this lesson the hard way:

• In 2009, an arbitrator ruled against iFreedom Communications in an employment dispute with its chief marketing officer. The arbitrator awarded $4.1 billion against the company, nearly $3 billion of which represented punitive damages.  The award was upheld in court.
• In 2013, an arbitrator awarded $2.76 billion to Kraft Foods in a contract dispute with Starbucks – an amount that exceeded Starbucks’ total profits for 2011–2012.
• In 2014, an arbitrator awarded Swatch $449 million in a dispute over a failed partnership with jeweler Tiffany – an amount that exceeded Tiffany’s total profits for 2012.^[14]

The risks and disadvantages of arbitration are serious, but they are not insurmountable.  Many of these problems can be avoided or mitigated – and the “better, faster, cheaper” promise of arbitration can be realized – by careful and thoughtful drafting of arbitration agreements.  Our next article on the Fish Litigation Blog will discuss the “best practices” that can make arbitration work.

[1] Thomas J. Stipanowich & Zachary P. Ulrich, “Arbitration in Evolution:  Current Practices and Perspectives of Experienced Commercial Arbitrators,” 25 Am. Rev. of Int’l Arbitration 396, 404, 439–41 (2014), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2519196 (discussing 2011 College of Commercial Arbitrators survey).

[2] See Stipanowich, “Arbitration in Evolution” at 413 (two-thirds spend at least half their working time on arbitration); id. at 417–18 (76% listed “increasing or maintaining my income” as one of their motivations for service as an arbitrator); id. at 414–15 (57% complained of “somewhat less work than I would like” or “a lot less work than I would like”).

[3] See Edna Sussman, “The Arbitrator Survey:  Practices, Preferences and Changes on the Horizon,” 26 Am. Rev. of Int’l Arbitration 517 (2015), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2824441 (discussing e-mail survey of 401 experienced arbitrators conducted between October 2012 and February 2013).  Over 55% of respondents had served as an arbitrator in over 50 cases; another 20% had served in between 21 and 50 cases.  Id. at 517 n.2.  21.4% reported that they had “never” granted an dispositive motion that terminated a case or eliminated a significant claim or defense; another 48.7% said they had only done so on five or fewer occasions; and an additional 21.7% said they had only done so in ten or fewer cases.  Id. at 523.

[4] Stipanowich, “Arbitration in Evolution” at 474 n.188.

[5] See Stipanowich, “Arbitration in Evolution” at 457 (only 15% of arbitrators report that a majority of their cases settle prior to hearing); id. at 459 (more than half say they “never” concern themselves with informal settlement).  In the Sussman survey, likewise, 23% of arbitrators expressed the belief that it was “never” appropriate for them to suggest or discuss mediation, and another 52% stated that it was only sometimes appropriate.  Only 4% believed it was appropriate for arbitrators to give the parties their “preliminary view” of the case prior to the final hearing, while 72% disagreed.  See Sussman, “Arbitration Survey” at 526, 536.

[6] See Aaron Foldenauer, “Big Risks and Disadvantages of Arbitration vs. Litigation,” Corporate Counsel, July 29, 2014, available at http://www.corpcounsel.com/printerfriendly/id=1202665052210.

[7] See Gina Passarella, “Litigators Losing Love of Arbitration Argue for Trials,” The Legal Intelligencer (Sept. 1, 2010), available at http://www.thelegalintelligencer.com/id=1202471400934/Litigators-Losing-Love-of-Arbitration-Argue-for-Trials?slreturn=20161114235608 (quoting Cozen O’Connor litigator Philip G. Kircher and Villlanova University law professor Abraham Gafni).

[8] See Sussman, “Arbitration Survey” at 521 (34% of arbitrators “never” exclude evidence that would be inadmissible in court; 55% do so only 25% of the time; only 11% do so always or often).

[9] Stipanowich, “Arbitration in Evolution” at 456; Sussman, “Arbitration Survey” at 535.

[10] Stipanowich, “Arbitration in Evolution” at 455 (26% of arbitrators admit they sometimes decide on “sense of equity and fairness” even if contrary to the law); Sussman, “Arbitration Survey” at 519 (25% say they are influenced more by the facts than by the law); id. at 531 (22% agree that “an arbitrator may properly issue an award believed to be in accordance with equity even if that outcome cannot be justified with the application of the law to the facts”).

[11] The Federal Arbitration Act (9 U.S.C. § 10(a)) allows courts to vacate arbitration awards only “(1) where the award was procured by corruption, fraud, or undue means; (2) where there was evident partiality or corruption in the arbitrators, or either of them; (3) where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or of any other misbehavior by which the rights of any party have been prejudiced; or (4) where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.”

[12] Hall Street Assoc., LLC v. Mattel, Inc., 552 U.S. 576 (2008).

[13] See, e.g., Johnson Controls, Inc. v. Edman Controls, Inc., 712 F.3d 1021, 1022, 1028 (7th Cir. 2013) (warning of a “high risk of sanctions” for “losers” who “cannot resist the urge to try for a second bite at the apple” by challenging commercial arbitral awards); Flexible Mfg. Sys. Pty. Ltd. v. Super Products Corp., 86 F.3d 96, 101 (7th Cir. 1996) (sanctioning party for “frivolous” challenge to arbitral award that “had absolutely no prospect of success”).

[14] Michael D. Young, “$4.1B Arbitration Award for Wrongful Termination?” Law360 (June 15, 2009), available at http://www.law360.com/articles/106564/ (iFreedom Communications); Foldenauer, “Big Risks” (Starbucks/Kraft and Tiffany/Swatch); see Sarah Rudolph Cole, “Curbing the Runaway Arbitrator in Commercial Arbitration:  Making Exceeding the Powers Count,” Alabama Law Review (forthcoming), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2773657 (discussing numerous additional examples of “runaway” arbitration awards).