Legal Update: Contracts – Tailoring Contractual Dispute Resolution Provisions

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In any relationship we enter into – whether it is a marriage, friendship or business venture – we enter into it with certain expectations for the relationship and the parties’ conduct under such relationship. These expectations may be expressed to the other party in order to ensure that both parties share the same set of expectations, in fact to establish a legally enforceable agreement the proposed obligations and expectations of both parties must be both expressed and there must be a meeting of the minds agreeing to such propositions (i.e., an agreement). In commercial activities parties frequently recognize that one or more parties to the agreement may, for whatever reason, fail to meet their end of the bargain and, consequently, in preparing the terms of the agreement these parties will include dispute resolution provisions to address either party’s claim that the other has failed to perform. The agreement therefore includes both the parties’ expectations of what will happen and their method to address what will happen in their expectations are not met. In the context of marriage, the pre-nuptial agreement serves the same purposes. Although seemingly pessimistic, it is important to many parties to provide a clear dispute resolution process and exit strategy; otherwise such parties may never enter into the agreement in the first place. Please review the below dispute resolution provision we included in a recent LLC operating agreement:

This Agreement and the rights and liabilities of the parties hereunder shall be governed by and determined in accordance with the laws of the State of Maryland. Any dispute, controversy or claim arising out of or in connection with the Agreement or any breach or alleged breach hereof shall, upon the request of any party involved, be submitted to, and settled by, arbitration in the city in which the principal place of business of the Limited Liability Company is then located, pursuant to the commercial arbitration rules then in effect of JAMS (or at any other time or place or under any other form of arbitration mutually acceptable to the parties involved). Any award rendered shall be final and conclusive upon the parties and a judgment thereon may be entered in a court of competent jurisdiction. The expenses of the arbitration shall be borne equally by the parties to the arbitration, provided that each party shall pay for and bear the cost of its own experts, evidence and attorneys’ fee, except that in the discretion of the arbitrator any award may include the attorneys’ fees of a party if the arbitrator expressly determines that the party against whom such award is entered has caused the dispute, controversy or claim to be submitted to arbitration as a dilatory tactic or in bad faith.

Please take note of all the issue that are address: (1) the governing law, (2) the scope of the dispute resolution provision, (3) the manner of resolution, (4) the location of the arbitration proceeding, (5) the appointment of the arbitration firm and applicable rules, (6) the entry of the judgment award, (7) cost splitting and the (8) award of attorneys’ fee to the prevailing party. In drafting these provisions, each of the terms must be carefully scrutinized.

The objective behind including a dispute resolution provision in an agreement is to control the manner in which any disputes, and their attendant costs, time and resources  will be address, rather than leaving a dispute to be adjudicated in our court system. Principally, most parties’ goal is to provide for prompt and final resolution of the matter, at minimal costs. Therefore, most people’s default expectation is to arbitrate most disputes. However, in addition to binding arbitration, other options exist, such as mediation or simply limiting any legal actions to a specific court. Maintaining costs to resolve disputes is always critical. With that in mind, arbitration is generally less costly than going to court-arbitration is less formal, requiring fewer appearances, simpler discovery and greater flexibility to scale-up or scale-down the process based on the parties’ interests and resources-with one large exception. In court the parties do not pay for the judge’s time. You may pay a nominal filing fee but most of the costs are legal fees for your counsel, expert witness fee and transcription costs for discovery and trial. In arbitration, in addition to paying counsel’s fees and expert witness’ fees, you also are required to pay the arbitrator’s fees. Most arbitrators are retired judges or lawyers, with fees routinely reaching $600 per hour. Additionally, the firm administering the arbitration (e.g., JAMS or American Arbitration Association (“AAA”)) charges sizeable fees. Therefore, while the accelerated schedule and less-formal process may mitigate legal fees, in arbitrator the parties are also required to pay the arbitrator’s fees and the arbitration firm’s fees – costs that the public or taxpayer would pay in court.

In one recent case, per the parties’ dispute resolution procedure outlined in their agreement, we filed a Demand for Arbitration with AAA which required an up-front, non-refundable $12,000 filing fee. That is a tough pill to swallow when you know there will still be legal fees and arbitrator fees still to come. Also recently, we reviewed a services agreement where one party was owed approximately $8,000 from a customer. The agreement was self-prepared and the drafter had lifted a dispute resolution provision from another agreement which called for AAA arbitration with three arbitrators, and with no award of fees to the prevailing party. Before considering legal fees, the fees to AAA and the three arbitrators would have trumped the potential recovery. He thought he was in good position due to the arbitration clause. Had he simply been silent or limited the provision to the governing law and selection of a court, we could have filed a simple civil action and likely received a default judgment. Arbitration has many advantages and costs are usually, but not always, one of them.

When entering into a relationship it is always helpful to think of the worst case scenario and your exit strategy in such a situation. Any dispute resolution provision included in the agreement should be aimed at delivering the best exit strategy in terms of costs, time and resources. Every contract term is important and the analysis of every term should hinge on whether it will make it easier or harder to extricate yourself from the relationship. Prompt and final resolution is desirable, but all factors must be considered. Every agreement is different and in each instance you need to foresee what possible claims may lay ahead and the appropriate means to address them. A one-size-fits-all solution does not exist.

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