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Badger: Using arbitration clauses to reduce potential liability risk

Steven Badger
January 16, 2013
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By Steven M. Badger
 

badger-steven Badger

In the first part of this column, I outlined the advantages and disadvantages of arbitration as an alternative to litigation in court and concluded that neither arbitration nor litigation is preferable in all situations. This second part provides more specific suggestions on when to use arbitration in certain high-risk, “bet-the-company” situations. Businesses must navigate litigation risks proactively to minimize exposure to large potential liabilities. Arbitration clauses can serve as a key element in such a strategy.

Use of arbitration to reduce risk of class actions

Class-action litigation in the United States poses one of the greatest liability risks to businesses. Even insignificant monetary claims that would never be worthy of litigation can, when aggregated in a class action, create substantial liability risks that are often difficult or even impossible to foresee. A class action is like a nuclear bomb in its capacity to inflict widespread devastation in a single salvo. The mere filing of a class-action lawsuit can compel risk-adverse companies to pay large sums to settle even meritless claims. Fortunately, in recent years, policymakers in Congress and jurists at the highest levels of the judiciary have worked to curb some of the abuses of class-action litigation.

One of the most significant of these developments enhances the ability of companies to reduce their exposure to class-action litigation by including carefully crafted arbitration provisions in agreements. In its 2011 decision in AT&T Mobility, LLC v. Concepcion, the United States Supreme Court overturned a series of lower court precedents that had barred enforcement of arbitration clauses against claimants seeking to bring class actions in court. Concepcion makes clear that arbitration agreements are fully enforceable even when the provisions would foreclose potential claimants from litigating or arbitrating their claims as a class action.

The advantage of limiting or avoiding class actions is too powerful to ignore. Where such risks are particularly acute, such as in consumer contracts and warranties, contracts should include well-tailored, mandatory arbitration and class-waiver provisions. However, the United States Supreme Court will be re-examining class waivers and mandatory arbitration during 2013, so legal developments could affect the utility of such contractual provisions.

Next month, the Supreme Court will hear whether a class-action waiver provision in a contract between retailers and American Express is enforceable when the claimants have shown that the expense required to vindicate their alleged rights under a federal statute individually (as distinguished from collectively in a class action) is cost-prohibitive. A federal Circuit Court ruled, both before and after Concepcion, that American Express’s mandatory arbitration provision was unenforceable because the only practical way for retailers to enforce their alleged rights under federal antitrust laws was through a class action.

The American Express case has the potential to undermine the utility of class-waiver arbitration provisions because the same argument by the retailers in American Express could be made in virtually any case brought as a class action. For that reason, it is unlikely the Supreme Court will adopt the retailers’ argument. During 2012, the Supreme Court repeatedly reaffirmed Concepcion and overturned efforts by lower courts to limit its impact. Yet, the American Express case certainly bears watching for those seeking to utilize mandatory arbitration clauses to limit their exposure to class actions.

The distinct advantages of litigation in other “bet-the-company” situations

In other commercial disputes with large potential liabilities, litigation in court is usually preferable to arbitration. Arbitration’s informality of processes, broad discretion in a single decision-maker or panel, and finality pose distinct disadvantages in major cases.

First, a judge is more likely than an arbitrator to terminate litigation before a trial or hearing by granting a motion to dismiss or motion for summary judgment. Such robust motion practice in courts of law offers companies defending large-exposure cases a relatively risk-free opportunity to challenge a claim on legal grounds before a trial. If a motion to dismiss or summary judgment is denied, that denial results in no liability or final decision on the merits. In contrast, testing such claims in arbitration is more likely to require an arbitration hearing and final decision on the merits. That means the outcome of arbitration often rides entirely on a single event – the arbitration hearing.

Second, when the stakes are very high, placing virtually unbridled discretion in the hands of an arbitrator or panel places the party at greater risk of individual bias, misperception or outright human error. In contrast, court procedures for case management, discovery, pre-trial motion practice and other aspects of the proceedings are refined in minute detail. Even more importantly, litigants in a court of law have the right to appeal an adverse decision. Thus, the losing side in litigation has recourse against the erroneous application and interpretation of contracts and law. In arbitration, the arbitrator’s decision generally is not subject to appeal even if it can be shown the arbitrator’s decision was in “manifest disregard” of the law.

An expanded right to appeal and other due process rights that would otherwise be denied in arbitration can be specifically incorporated into an arbitration agreement. However, as addressed in Part 1 of the column, such an approach dilutes the key benefit of arbitration in providing a swift and efficient dispute resolution mechanism. Rather than trying to reshape arbitration procedure to create appeal and other procedural rights, it is preferable simply to limit the scope of arbitration by amount or nature of claims so that larger and more complicated legal disputes must be resolved in litigation.

In sum, carefully crafted arbitration agreements offer businesses a viable way to control exposure to class-action litigation. Legal counsel should be consulted concerning the structure and scope of such agreements, however, to ensure such benefits are realized and that important due process and appeal rights are preserved in appropriate “bet-the-company” situations.•

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Steven Badger is a member of Benesch Friedlander Coplan & Aronoff LLP’s litigation practice group in Indianapolis and represents business clients in commercial litigation, arbitration and appeals. The opinions expressed are those of the author.

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  1. So that none are misinformed by my posting wihtout a non de plume here, please allow me to state that I am NOT an Indiana licensed attorney, although I am an Indiana resident approved to practice law and represent clients in Indiana's fed court of Nth Dist and before the 7th circuit. I remain licensed in KS, since 1996, no discipline. This must be clarified since the IN court records will reveal that I did sit for and pass the Indiana bar last February. Yet be not confused by the fact that I was so allowed to be tested .... I am not, to be clear in the service of my duty to be absolutely candid about this, I AM NOT a member of the Indiana bar, and might never be so licensed given my unrepented from errors of thought documented in this opinion, at fn2, which likely supports Mr Smith's initial post in this thread: http://caselaw.findlaw.com/us-7th-circuit/1592921.html

  2. When I served the State of Kansas as Deputy AG over Consumer Protection & Antitrust for four years, supervising 20 special agents and assistant attorneys general (back before the IBLE denied me the right to practice law in Indiana for not having the right stuff and pretty much crushed my legal career) we had a saying around the office: Resist the lure of the ring!!! It was a take off on Tolkiem, the idea that absolute power (I signed investigative subpoenas as a judge would in many other contexts, no need to show probable cause)could corrupt absolutely. We feared that we would overreach constitutional limits if not reminded, over and over, to be mindful to not do so. Our approach in so challenging one another was Madisonian, as the following quotes from the Father of our Constitution reveal: The essence of Government is power; and power, lodged as it must be in human hands, will ever be liable to abuse. We are right to take alarm at the first experiment upon our liberties. I believe there are more instances of the abridgement of freedom of the people by gradual and silent encroachments by those in power than by violent and sudden usurpations. Liberty may be endangered by the abuse of liberty, but also by the abuse of power. All men having power ought to be mistrusted. -- James Madison, Federalist Papers and other sources: http://www.constitution.org/jm/jm_quotes.htm RESIST THE LURE OF THE RING ALL YE WITH POLITICAL OR JUDICIAL POWER!

  3. My dear Mr Smith, I respect your opinions and much enjoy your posts here. We do differ on our view of the benefits and viability of the American Experiment in Ordered Liberty. While I do agree that it could be better, and that your points in criticism are well taken, Utopia does indeed mean nowhere. I think Madison, Jefferson, Adams and company got it about as good as it gets in a fallen post-Enlightenment social order. That said, a constitution only protects the citizens if it is followed. We currently have a bevy of public officials and judicial agents who believe that their subjectivism, their personal ideology, their elitist fears and concerns and cause celebs trump the constitutions of our forefathers. This is most troubling. More to follow in the next post on that subject.

  4. Yep I am not Bryan Brown. Bryan you appear to be a bigger believer in the Constitution than I am. Were I still a big believer then I might be using my real name like you. Personally, I am no longer a fan of secularism. I favor the confessional state. In religious mattes, it seems to me that social diversity is chaos and conflict, while uniformity is order and peace.... secularism has been imposed by America on other nations now by force and that has not exactly worked out very well.... I think the American historical experiment with disestablishmentarianism is withering on the vine before our eyes..... Since I do not know if that is OK for an officially licensed lawyer to say, I keep the nom de plume.

  5. I am compelled to announce that I am not posting under any Smith monikers here. That said, the post below does have a certain ring to it that sounds familiar to me: http://www.catholicnewworld.com/cnwonline/2014/0907/cardinal.aspx

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