Rethinking the “Standard” Arbitration Clause in Cloud Agreements (Part II)

Cloud AgreementsPart I of this article included a little bit of history about how it came to be so common that modern technology agreements – including “cloud agreements” – often include a rather ubiquitous, sort of “standard” arbitration clause. The first article in this three-part series also put forth the question of whether some of the common assumptions about arbitration – namely, that arbitration is cheaper, faster and better than a traditional lawsuit – are true.

This middle article in the series aims to try to answer that question: Is arbitration truly “cheaper, faster or better?” A close examination of these common assumptions reveals that, while there are indeed some clear advantages to arbitration, some of the claimed advantages may be lost if parties simply agree to a “standard” arbitration clause, without giving the matter any considered thought on the front end of a transaction. This kind of inertia often leads to an arbitration proceeding that looks very much like a traditional lawsuit. The parties who agree to an arbitration provision without giving it any thought will find that arbitration is often just as expensive as a traditional lawsuit, that it may not be any faster, and that a “more rational result” does not necessarily work to every party’s advantage.

Is Arbitration Really Cheaper?
Many do not realize that arbitration involves costs that are not incurred in a traditional lawsuit. Most obvious, arbitrations are usually administered by an arbitration organization, like the AAA and JAMS, which charge fees for case administration. In a typical complex arbitration under the AAA rules, the initial filing fee and case administration fee can easily total more than $10,000. The fee to file a civil lawsuit, in just about any court in America, is usually less than $500.

In addition, the parties must pay the arbitrators. Most arbitrators are lawyers who charge the equivalent of their normal hourly rates. These fees quickly add up. For a panel of three arbitrators in Atlanta, a weeklong arbitration hearing can easily cost $30,000 to $40,000 in arbitrators’ fees. Arbitration in San Francisco or New York can double this expense. Obviously, judges and juries do not charge by the hour.

Some may argue that arbitration is still cheaper than a traditional lawsuit because the process in arbitration is more efficient. However, because many commercial arbitrations are now conducted in a very similar manner to a traditional lawsuit, much of the efficiency claimed to be present does not exist. Depending on the arbitrators (who have wide discretion), significant discovery is often allowed, including interrogatories, production of documents and depositions. If you think arbitration necessarily includes cost advantages because, by definition, it has more limited discovery, think again. Whether this is true depends on a number of factors, including who your arbitrator is, the rules governing your arbitration, the size and complexity of the case, etc.

Another substantial cost factor in arbitration is that arbitration usually lacks an effective procedure for the early disposition of claims without a full evidentiary hearing, like motions to dismiss or for summary judgment. Early dispositive motions are often very efficient in resolving traditional law suits before the substantial expense of a trial.

Is Arbitration Really Faster?
Whether arbitration is faster than a traditional lawsuit depends upon several factors, including:

  1. which court is used for comparison;
  2. whether there is a mechanism in arbitration for early disposition on motions; and,
  3. the resolve of the arbitrator.

The speed at which cases move through courts varies. Complex commercial cases that cannot be decided by motion will likely take two or three years to bring to trial in U.S. District Court in Atlanta. However, in the Southern District of New York, trial will often occur within a year of filing suit. Few complex arbitrations proceed more swiftly than this. In the Eastern District of Virginia, a trial will usually take place four months from the date of filing, even in a complex commercial case. Virtually no arbitration proceeds this quickly.

arbitration-clauses-cloud-agreementsThere are also unique aspects of arbitration that delay resolution of a dispute. Again, the lack of an effective procedure for early disposition comes into play. A surprising number of commercial disputes are resolved by a motion before trial. Disputes regarding technology agreements are often ripe for such early resolution because it is common to find that the contract limits the buyer’s remedy or includes a complete waiver of consequential damages. Most judges, in most states, will not hesitate to enforce these “exculpatory clauses,” and a pre-trial motion can often, therefore, completely eliminate or severely limit the plaintiff’s claimed damages. Even where outright dismissal is not the result, such a ruling from a court often leads to settlement. But because dispositive motions are generally disfavored in arbitration, a similar case in arbitration may not be resolved until after a complete evidentiary hearing.

In addition, arbitrators typically seek agreement from counsel regarding a convenient hearing date and other details of the proceeding. Most courts set trial dates without consulting counsel. It can be very challenging to coordinate the schedules of three busy arbitrators, counsel for two or more parties and witnesses for each party involved. It is even more difficult when an arbitration hearing is likely to last a week or longer. Such scheduling issues many times require arbitration proceedings to be postponed for months – or to be conducted in stages – in order to find a time that works for all involved.

Many clients and lawyers think that the arbitration hearing itself moves faster than a typical courtroom trial. However, there are aspects of arbitration that call this assumption into question. Arbitrations tend to be very cordial proceedings, lacking the formality of a courtroom. This lack of formality often causes all involved, including the arbitrators, to “meander” back into the hearing room after breaks, rather than re-starting promptly at a precise time dictated by a judge. This may at first seem inconsequential, but these small increments of time aggregate over the course of a long arbitration and may often add up to as much as a half day or more to the length of the proceeding. At a combined rate of around $6,000 to $8,000 per day just for arbitrators’ fees, a half day is not inconsequential. Additionally, because arbitrators are not typically bound by the rules of evidence, the somewhat “flexible” evidentiary standards usually applied in arbitration sometimes lead to the presentation of much evidence that is irrelevant or cumulative and would be excluded by a court. Thus, whether an arbitration hearing proceeds more quickly and efficiently than a courtroom trial depends in no small part on the arbitrators involved, as compared to any particular judge to whom comparison is made.

Arbitration is plainly faster in one respect, which is that there is no practical right to appeal an arbitration award. Because appellate courts sometimes take more than a year to process an appeal, this is a clear advantage of arbitration in terms of speed. But, as we will discuss in Part III of this article, this speed advantage may come at the expense of justice.

Does Arbitration Provide a Better Result?
One of the most often-cited advantages of arbitration is the promise that it leads to better, more rational decisions, especially in complex cases. In the technology industry, it is widely believed to be an advantage to have a decision-maker with industry expertise to decide what are sometimes very technical issues, as opposed to asking a judge or jury to decide. Although there is certainly merit to this assertion, there is another side to the coin.

The first question one must ask in considering this factor is which party profits from this perceived advantage. Certainly, both parties cannot benefit from this same advantage. In fact, having a sophisticated lawyer with industry expertise decide the outcome of a dispute may decidedly disadvantage certain parties. For instance, a purchaser of a large software system may, in fact, be a sophisticated user of technology. It may have its own IT staff or have considerable experience in managing implementations of new software. Nonetheless, an effective advocate may well be able to sway an uninformed jury to his client’s position that it relied heavily on the expertise of the seller, who claimed to be an “expert.” It may not be so easy to convince a sophisticated arbitrator, who has heard this claim 100 times before.

An arbitrator is also likely to fully grasp the implications of contract provisions such as a limited warranty or performance requirements, which may provide technical defenses but have very little jury appeal. Likewise, although it may be helpful from the perspective of one of the parties to a transaction for a decision-maker to have a detailed knowledge of the way that source code is written or to understand the nuances of software testing, it may be to the advantage of another party to have the opportunity to “educate” the trier of fact from scratch.

There are other aspects of arbitration that may lead to more “rational” decisions and actually level the playing field. Arbitration should ameliorate concerns that the decision-maker may be influenced by “territorial” concerns or other factors that should not be taken into account by an impartial decision-maker. Foreign companies are often fearful of being “home cooked” in the U.S. court system. International arbitrations can be conducted before arbitrators from neutral countries. Domestic companies may have similar concerns about litigating in a hostile jurisdiction. Although most federal courts near major metropolitan areas draw from a large enough jury pool that this is not a legitimate concern in large commercial cases, there may be exceptions. For example, if one party may end up litigating in a jurisdiction where the other party is a major employer, arbitration should be strongly considered. Arbitrators are probably less likely to be unduly influenced by this factor.

One clear advantage of arbitration is that arbitration hearings are usually private. This may be a substantial advantage for technology companies, which often have disputes that involve trade secrets or confidential business information. Although courts have become rather adept at dealing with such issues through confidentiality orders, some courts still resist broad confidentiality orders, even if the parties agree. This really becomes a non-issue in arbitration.

Perhaps the biggest fear that leads to agreements to arbitrate is the fear of a “run away” jury award, including punitive damages. In technology cases, however, such awards are actually very unusual. Moreover, if a jury has rendered a verdict that is clearly unsupported by the evidence, trial judges or appellate courts can (and most often do) correct these excesses. Nonetheless, arbitrators are certainly less likely than a jury to let their emotions get the best of them in making an award.

Many lawyers also believe that compromise decisions are more likely in arbitration than if the case is decided by a judge or a jury, especially if there is a panel of arbitrators. Even if arbitrators do not know each other before the commencement of an arbitration proceeding, they usually get to know each other quite well by the time they are called upon to make a decision. If two of the arbitrators generally agree on how an award should be reached, but the third arbitrator does not, the first two arbitrators may be inclined to compromise so that the panel can reach a unanimous result. (The tendency to compromise may be more significant in cases where the parties nominate two of the arbitrators, who then pick the third arbitrator.) Although a jury may also render compromise verdicts, juries tend to want to identify a winner and a loser. Moreover, many claims in a civil jury trial may not reach the jury because of prior dispositive motions. There is also the opportunity to seek correction of a jury mistake from the trial judge, or of a mistake by the trial judge or the jury on appeal. This opportunity for oversight is absent in arbitration.

Conclusion – Part II
Thus, some of the common assumptions that arbitration is cheaper, faster and better are not always true. In fact, arbitration of complex commercial cases is often just as expensive as a traditional lawsuit. Depending on the jurisdiction and the availability of summary relief, arbitration can take just as long as a traditional lawsuit to achieve a result, and may actually take longer. Finally, although there are some aspects of arbitration that tend to lead to a more rational result, this characteristic of arbitration does not always work to every party’s advantage, and arbitration may in fact be more likely to lead to a compromise result rather than a clear winner and loser.

Part III of this article will focus on some of the clear disadvantages of arbitration and make some suggestions regarding how to better take advantage of the availability of ADR.

This entry was posted in Cloud Computing and tagged , , . Bookmark the permalink.

One Response to Rethinking the “Standard” Arbitration Clause in Cloud Agreements (Part II)

  1. Sirpa Isotupa says:

    In disputes where parties are located in different countries, the possibility to have the resolution enforced and executed in a foreign country is of essence. Many more countries currently have ratified the New York convention which requires them to enforce an arbitration award given in another ratified country, than the Hague choice of court convention, which would require enforcement of the ruling of a court of another country. Therefore arbitration may be the only rational choice, because what is the value of a ruling without possibility to enforce it?

Leave a Reply