Disputes are a fact of life and courts exist to resolve them. Yet the costs of traditional litigation, frequent delays, and lack of faith in juries compel consideration of other options, collected under the term “Alternative Dispute Resolution” or “ADR.” The subject is increasingly addressed in contracts with parties agreeing in advance to use an ADR method if a dispute arises. The prospect of avoiding litigation is so attractive that parties often agree to an ADR method without understanding how it will apply, only to be surprised down the road when a dispute arises. Familiarity with ADR methods is therefore essential, both at the contract drafting stage as well as after a dispute erupts. This article will generally describe three ADR methods—arbitration, judicial reference, and mediation—and will highlight pertinent drafting considerations for agreements mandating ADR.
Arbitration and Judicial Reference
Prior to August 2005 it was not unusual for contracts to include a jury trial waiver provision, contemplating that disputes would be litigated in court, but any trial would be before a judge with no jury. But then the California Supreme Court decided Gafton Partners, L.P. v. Superior Court (August 4, 2005) 36 Cal.4th 944 and held that such clauses are unenforceable. Since then, contracting parties seeking to avoid the potential for a jury trial have increasingly included provisions requiring that disputes be submitted to arbitration or judicial reference.
In arbitration the parties jointly hire someone, or a panel of people, to hear evidence without a jury and issue a binding decision that terminates the dispute. Arbitration decisions can be confirmed as court judgments for enforcement purposes with very limited opportunities for judicial review by appeal or otherwise. Often retired judges and experienced attorneys serve as arbitrators, but sometimes other professionals such as appraisers, architects, or contractors are designated to decide specified disputes. Parties can agree in advance through their contract to arbitrate all or specified types of future disputes, or they can agree to arbitration as a litigation alternative after a dispute arises.
Parties agreeing to arbitration typically perceive the process as one that will be faster and more efficient than litigation. When a hearing date is scheduled, the arbitrator’s time is reserved for only that case so the parties know the hearing will proceed on the stated date (barring unforeseen circumstances such as family emergency or illness that compels rescheduling.) Arbitration is also thought to cost less than traditional litigation, although the parties must pay for the arbitrator’s time and administrative costs in addition to paying their attorneys. Other aspects of arbitration can be viewed as either positive or negative, depending on one’s perspective and the case being arbitrated. For example, unless prohibited by the terms of a contractual arbitration agreement, pre-hearing discovery such as document productions and depositions is permitted. Therefore, the significant expense of discovery is not always avoided, although limits can be imposed by the arbitrator or built into the contractual arbitration provision. There is no jury. Courtroom rules of evidence and procedure tend to be loosely applied. Unless required by the terms of the arbitration agreement, the arbitrator is not required to follow the law in rendering a decision and may instead issue an award based on broad principles of justice and fairness. There is no right to appeal the decision, although there are some limited circumstances in which an award can be challenged, such as when the arbitrator has an undisclosed conflict of interest.
Voluntary Judicial Reference
Judicial reference is a less common procedure whereby a referee is appointed by the court to hear and decide all or part of a case. Parties may contractually agree that all or certain described types of disputes will be determined through the judicial reference procedure or mutually decide to use the process after a dispute arises. Typically, the referee is a retired judge or attorney, but the parties can also agree to use a layperson such as an accountant or appraiser to determine issues specific to their area of expertise. The agreement can specify the use of a single referee or a panel of up to three members.
Unlike arbitration which occurs outside of the court system, a judicial reference remains within the court system and begins by opening a court action seeking an order appointing a referee. Once appointed, the referee manages the case with the parties under the same rules of procedure, discovery, and evidence as apply to court cases. The fees and expenses charged by the referee are paid by the parties. The parties and referee do not use court facilities or court personnel, but documents and exhibits must still be filed with the court with copies provided to the referee. The filings can therefore be accessed by the public. The trial of the matter is conducted by the referee without a jury. Although proceedings before the referee, including trial, are held in non-court locations such as private offices, all proceedings must nevertheless be open to the public. The referee is required to file a notice with the court with contact information so that anyone wishing to attend a proceeding can learn about scheduling and the location of hearings and trial. After trial, the referee must issue a written statement of decision. That decision is then adopted by the court which issues a judgment consistent with the decision. The decision can be appealed like any other court issued judgment.
Arbitration and Judicial Reference Compared
Both arbitration and judicial reference involve hiring a single decision maker, such as a retired judge, or a panel of decision makers, to decide a dispute without a jury. Both methods contemplate a faster process than traditional litigation which can take several years to the point of trial. In both proceedings the parties will pay for the arbitrator or referee’s time and expenses, which can be significant.
Arbitration is largely a private process—there is no public file unless the parties open a court case to compel arbitration or to convert an award to a judgment. Members of the public and press are not entitled to attend any of the arbitration hearings. By contrast, judicial reference proceedings include a court file containing all written filings and exhibits and the hearings are open to the public and press. Unless specified in the parties’ contract, arbitrators are not required to follow the law or rules of evidence whereas judicial reference proceedings more closely mimic the rules of procedure and evidence with decisions made in accordance with the law. The right to appeal exists in judicial reference cases but not in arbitration. Parties who strive to include a contractual judicial reference term rather than arbitration usually do so because they want to avoid a jury trial (like arbitration) but also want to retain the right to appeal (unlike arbitration.) Parties seeking arbitration are typically interested in a less formal proceeding with no jury and are willing to be bound by a decision without a right of appeal.
Mediation is one of the most common forms of ADR. Through mediation, the parties retain a neutral third party who will work with the parties in an effort to achieve a negotiated resolution. Mediators are typically retired judges or experienced attorneys. The mediator usually receives and reviews written submissions about the facts, nature of the dispute, and positions of the parties before the session begins. Unlike arbitrators or judicial referees, the mediator has no decision-making authority, but will often ask probing questions and provide commentary to help each party realistically evaluate their side of the dispute while fostering an understanding of the opponent’s view. In most mediations, the parties stay in separate rooms with the mediator moving from room to room. That process allows for the candid, private, and non-threatening discussions often necessary for the parties to come to an agreement. Attorneys typically accompany their clients to the mediation and actively participate in the process, but the parties themselves are engaged and ultimately decide for themselves to settle or not. There is little downside in mediating a case because parties are in control and cannot be forced to settle. Although there are costs involved to pay the mediator’s fee and attorney time associated with the mediation, that money is well spent if the process brings the dispute to any end. Even when a settlement does not occur, the process can nevertheless assist in narrowing issues and provide a foundation for a future resolution.
Whether or not to include a contractual provision mandating ADR in the event of a dispute requires careful consideration and exploration of the parties’ objectives. If the desire is to try to resolve disputes before resorting to litigation then a provision requiring mediation of disputes before filing a lawsuit would be appropriate, with some reasonable time parameters specified. Consulting with a litigator can be helpful to develop realistic expectations and craft appropriate terms to apply to the process. For example, a provision that mandates completion of mediation within 30 days of one side’s demand may sound reasonable to the parties, but mediators are often booked several months in advance making it very difficult to comply with the 30-day time frame. If desired, an ADR provision can specify that if mediation is attempted without success then the dispute will be resolved through binding arbitration or judicial reference. Consideration should also be given to excluding certain types of disputes from the ADR provision. A landlord will want to exclude eviction proceedings because the court system provides an expeditious process to remove a defaulting tenant from leased property. A threshold dollar amount in dispute might also be specified. A party wanting to resolve a $35,000 dispute may balk at the idea of having to pay a $1,500 filing fee to commence an arbitration plus the arbitrator’s hourly rate of $500 or more (in addition to fees for an attorney), but those costs may seem reasonable to decide a dispute involving $500,000. Parties may want to limit discovery to document exchanges and a limited number of depositions per side unless permission for additional discovery is sought and obtained in advance from the arbitrator or they may prefer to place no limit on discovery. The clause should specify the number of arbitrators or referees to be used and their minimum qualifications, but careful consideration should be given to clauses specifying multiple arbitrators or referees, with at least a minimum amount in controversy triggering use of a panel; otherwise, paying for three decision makers can render the process cost prohibitive. Further, if a panel is to be used in an arbitration, the clause should specify whether all arbitrators are to be neutral. Frequently a clause specifying a panel will give each party the right to choose one arbitrator and the two party-appointed arbitrators select a third. Often the party-appointed arbitrators are thought to be aligned with the position of the party appointing them and treated as such by the parties, with the third arbitrator serving as a neutral to provide impartiality and resolve disagreements between the party arbitrators. This concept can surprise parties after a dispute arises and they learn that their expectation of three neutral decision makers may not match reality.
So What to Do?
Whether or not to include an ADR provision in a contract is a question to consider just like any other important clause. Agreeing to arbitration or judicial reference in a contract means the parties are giving up significant rights before a dispute arises. They should think about what disputes might arise, their complexity, and potential dollar exposure and recognize that ADR requires hiring arbitrators, referees, or mediators who typically charge over $500 per hour. The distinction between arbitration and judicial reference also needs to be explored to determine the comfort level with each method. Once a decision is made to include the provision, a carefully drafted clause will enhance the satisfaction of the parties in employing the method if a dispute does arise.