Rethinking the “Standard” Arbitration Clause in Cloud Agreements

Cloud TechnologyTwenty or so years ago, arbitration began to gain wide acceptance among lawyers as a viable alternative for the effective resolution of civil disputes.  Clients were beginning to view “alternative dispute resolution” (ADR) as the best hope for avoiding the expensive morass that litigation in court can sometimes be.  As a result, many trial lawyers began to jump on the bandwagon and tout their skills not only as trial lawyers, but also as experts in “all forms of dispute resolution.”  Certainly, very few lawyers ever attempted to talk their client out of inserting an arbitration clause into an agreement.  Indeed, many lawyers began to insert “standard” arbitration clauses into every agreement they drafted.  This is the first of a three-part article on why using a “standard” arbitration clause in all of your cloud agreements is not such a great idea.

Among many clients and lawyers, “ADR” – pretty soon after its advent – became almost synonymous with what is only one of its forms – arbitration.  Moreover, the “standard” arbitration clause has become more and more “plain vanilla” over the past twenty years.  As a result, ADR may have lost many of the attractive qualities that made it appear to so many two decades ago as a panacea.  The one advantage of ADR clauses in agreements is that they provide the opportunity for creativity and flexibility.  However, when drafting contracts these days, many lawyers and clients blindly insert into each new agreement the same arbitration clause they used in the last agreement.

The “cloud” offers many advantages over the old ways of delivering technology and related services to customers.  Of those advantages, among the most often discussed is the potential to lower costs, without the huge upfront investments that were required in many arrangements in the past.  However, cloud vendors and customers should be aware that the ADR provision of a cloud agreement is not a provision that should be overlooked, or merely cut from a previous agreement and pasted into a new one.  If the “standard” arbitration clause is blindly inserted into each new cloud agreement, the cost savings that were hoped for from moving to the cloud may be consumed by costly litigation if a dispute arises.

That is because, over time, arbitration – which is often the only type of ADR that is contemplated by a cloud agreement – has begun to look more and more like just another form of trial.  Despite what many lawyers and clients think, arbitration as it is widely used today is not necessarily “cheaper, faster and better” than a traditional case filed in court.  Because the “standard” arbitration clause has become so widespread, the parties to an agreement may end up getting stuck with a process that is at least as expensive as traditional litigation, takes as long or longer to complete and has perhaps more potential than a jury trial to leave everyone unsatisfied.  There are a number of reasons why you should think twice before inserting to the “standard” arbitration clause into a cloud agreement, or agreeing to it.

“ADR” Does Not Equal “Arbitration”
Arbitration is not the only form of ADR.  All forms of ADR usually result from the parties’ agreement.  Thus, the possible forms of ADR are really only limited by the parties’ creativity.  Rather than take advantage of this flexibility, however, most parties to an agreement simply agree to arbitrate.  In many cloud agreements, the “standard” arbitration clause usually looks something like this:

The parties agree that any dispute arising from this Agreement shall be submitted to binding arbitration to resolve.  Such arbitration shall be held in Atlanta, Georgia in accordance with the commercial rules of the American Arbitration Association (“AAA”).  All disputes shall be before a panel of three arbitrators, chosen by the AAA, who have at least ten years’ experience in commercial litigation in the software industry.

Although clients (and some lawyers) sometimes refer to the option of “non-binding” arbitration, true arbitration is generally binding.  The claims are heard and decided by an arbitrator or panel of arbitrators instead of a judge or jury, and the arbitration hearing proceeds much like a courtroom trial, although with less formality.  It is this type of arbitration that will result from the use of an arbitration clause like the one above.

mediationBut parties may agree to engage in other forms of ADR.  For instance, parties may agree to engage in a “summary trial.”  This is what is typically in the mind of lawyers and clients who speak of “non-binding” arbitration.  The idea is that the parties will present their case, in substantially truncated fashion, to an independent third party and seek an “advisory” decision.  The “decision-maker” in a summary trial will provide the parties with a non-binding evaluation of the case, in the hope that this independent evaluation will lead to a settlement.

Parties may also agree to mediate, rather than arbitrate.  Mediation involves no decision-making at all, but is a process by which the parties submit their dispute to a trained facilitator whose function it is to help the parties reach a settlement agreement.

Parties may even create their own, creative forms of ADR.  For example, the parties to a contract might agree that, in the event of a dispute, the CEOs of the parties are required to personally meet, perhaps multiple times, to attempt to resolve the dispute before initiating any formal action.  Parties may agree, in advance of a dispute, to use any of the various forms of ADR instead of or in addition to traditional arbitration.  They may also agree to use different types of ADR in combination.

Even the terms of an eventual arbitration may be specifically defined in the parties’ agreement.  The parties may agree on how many arbitrators will hear the case, how arbitrators will be chosen or even who the arbitrators will be (in advance).  They may also agree on whether there will be mechanisms for summary relief (like motions to dismiss), what discovery will be allowed, or just about anything else.  However, instead of taking advantage of this flexibility that ADR promises, many clients and lawyers simply revert to the “standard clause.”

What’s So Bad About the “Standard” Arbitration Clause?
By “standard” arbitration clause, we mean that there is usually very little critical analysis given to the terms of the clause.  The parties typically do not negotiate the terms of the clause.  Hence, they typically do not think proactively about what arbitration in accordance with the clause that they choose to insert will look like.  Most arbitration that occurs under the “standard” arbitration clause proceeds very much like a trial in court.  Those who advocate the superiority of arbitration over traditional lawsuits usually cite three primary advantages:  Arbitration is less expensive, faster, and results in more rational decisions than a traditional lawsuit.  But parties would generally be better served if, before their agreement to arbitrate, they seriously considered whether the claimed advantages to arbitration versus a traditional lawsuit really exist and whether their particular circumstances will be better served by arbitration or a traditional lawsuit.  This is especially true given that there are some decided disadvantages to a typical arbitration.

Next week, Part II of this Article will examine the question of whether arbitration is really “cheaper, faster and better” than traditional litigation.

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