Are Arbitration Clauses Good for Small Businesses?


There are two sides to every coin. An arbitration clause can work for you or against you, depending on how a dispute may arise. Say your vendor never shows up with your product and you want to file a claim. If there is an arbitration clause in your contract you may be barred from filing a lawsuit, forced to resolve the case in arbitration. If you don’t like the results, too bad. Arbitration is binding and you can’t file any appeal once a decision has been made.

On the other hand, an arbitration clause in an employment contract or founders’ agreement could work in your favor. An arbitration clause can prevent a class action, a public record of employee claims, and could save you from paying thousands defending your company in litigation.

So, what exactly is arbitration?
Unless you are a lawyer or have been forced into the process yourself, you probably don’t know how a lot about how arbitration works. Arbitration is one form of alternative dispute resolution (ADR) that gives parties the opportunity to resolve disputes without the intervention of a judiciary. This means no lawsuit, no public filing, no judgement. Instead, an independent party (the arbitrator), will hear the facts from both sides and make a decision. Unlike mediation which may or may not have a resolution, arbitration decisions are binding so you cannot appeal if you lose.

Should I agree to an arbitration clause?
No two contracts are alike, or they shouldn’t be, so it is always recommended to review your individual contract and the terms of an agreement on a case by case basis. If an investor, partner, vendor, or other third-party includes an arbitration clause in a business contract, should you agree to it? If you have room to negotiate, consider including modifications. A clause that is extremely broad or restrictive may be adjusted to give you more control over who he arbitrator is and to require full disclosure to prevent potential biases.

Arbitration clauses are becoming increasingly common practice in many standard contracts. Before signing any contract, be sure you read thoroughly and understand the implications of language you don’t understand. Ask a lawyer if you are unsure. You don’t want to sign away your rights to take someone to court if you don’t have to. Remember that arbitration will prevent you from filing a claim and from getting your “day in court” if you suffer any financial or business losses.

Should I include an arbitration clause in my business contracts?
If you think arbitration rather than litigation would be a benefit to your employment, vendor, or other third-party contracts, consider the implications as well as other terms that could protect you in the event of a dispute. Business owners are wise to enlist an experienced contracts attorney to frame the contract in your favor.

An arbitration clause can be especially beneficial in the employment contract and favor the employer. Claims related to discrimination, wrongful termination, sexual harassment, or wage and hour violations are common and can be a setback to business owners. Whether the claims are legitimate or not, they can lower morale among your workforce, lead to other claims, and lead to costly litigation. Resolving employee claims through arbitration can save you time, money, and your business reputation.

So, what are the real pros and cons?
As a small business owner, you know that a legal problem can be a major hindrance to operations. In extreme cases, one big legal problem could put you under. You will always want to balance your legal interests with the ability to take necessary risks to grow and expand your business. All of this strategy and forward-thinking is also tempered by your projections and bottom line.

An arbitration clause can give you an edge if you want to avoid being dragged into court by your employees and other third parties. It will also prevent a public record that could damage the reputation of your business. Overall, arbitration clauses are a reliable way to reduce the potential for legal costs. It is faster, less complicated, and far cheaper than litigation. An added bonus: you don’t have to deal with lawyers!

Now the cons. If you sign a contract with a third party and there is a breach or if you suffered some significant financial harm, you want some flexibility in how to resolve the dispute, including filing a lawsuit if necessary. Arbitration gives you only one option and if you don’t like the result, you don’t have any further appellate options.

Commercial contracts and provisions in an arbitration clause
Like most legal descriptions, the clause will contain a lot of information. Usually, the clause will state that all disputes must be settled where you do business and the jurisdiction of the arbitrator. It will say that the dispute should be reviewed and decided by an independent arbitrator under current arbitration rules, each party will pay their own legal expenses, and the judgement is binding and final. An arbitrator will also preside over discovery requests (collection of documents and evidence), what rules apply to evidence, expert witness and cross examinations, arguments, and settlement using commercial standard rules.

How much does arbitration actually cost?
Even though arbitration is cheaper than litigation, it’s not cheap. According to a survey by the consumer watchdog group, Public Citizen, the cost of initiating arbitration is $9,000 for a contract claim worth $80,000. Arbitrators will also need to be paid and these fees can run up to $10,000. You may end up hiring your own attorney anyway and adding administrative costs. Depending on the strength of your position heading into a dispute, filing a lawsuit could be a cheaper option.

Do you need a lawyer for arbitration or for your contract?
Business owners are always smart to consult with an attorney before legal problems arise. This could mean working with an experienced lawyer to create or modify a contract with an arbitration clause that works in your favor. If you are facing arbitration, you may also be wise to consult with an attorney, especially if you are at risk of losing a lot of money or property.


About Author

Kate Leismer

Kate Leismer is a licensed attorney with experience in business and employment law. She has worked for several law firms in the U.S., the ACLU and is a former editor for University of Minnesota's Journal of International Law. She is currently a freelance writer living in Berlin. For more information about her writing, research, and legal experience, please visit