Business owners often see arbitration clauses in vendor agreements, employment contracts and partnership deals. These clauses can require future disputes to be resolved outside court, so it is important to know when arbitration is mandatory and when it is only an option.
How does arbitration differ from litigation?
Arbitration is a way to resolve a dispute outside court. A neutral third party hears both sides and makes a decision. In many cases, that decision is binding.
Arbitration is often faster than a lawsuit and usually uses less formal rules. Parties often choose it for its privacy, the ability to select an arbitrator with relevant industry knowledge and the generally faster timeline compared to litigation. Courts can overturn arbitration awards only on narrow grounds – such as fraud, arbitrator bias or an arbitrator exceeding authority – not simply because a party disagrees with the result.
When does a contract require arbitration?
A contract can require arbitration if the parties agree to a valid arbitration clause. Arbitration clauses are often enforced under the Federal Arbitration Act and contract law, depending on the agreement and the dispute. If a clause covers the issue in dispute, a court may require arbitration instead of letting the case move forward in court.
Some industries, including securities, employment and consumer finance, often use arbitration clauses. Other contracts give the parties a choice after a dispute begins. The wording of the agreement controls whether arbitration is required or optional.
For example, in New York, arbitration clauses are often enforced under CPLR Article 75 and the Federal Arbitration Act, although courts may still consider recognized legal grounds to challenge enforcement or review an award. Some federal and New York laws also limit enforcement of pre-dispute arbitration clauses for certain sexual harassment and sexual assault claims. Under these laws, a party with such a claim may have the right to bring it in court even if the contract includes a mandatory arbitration clause.
What to check in an arbitration clause before signing
Read the clause before you sign. Check what disputes it covers, whether it is binding and what rules apply. If the clause is unclear, have it reviewed so you know what to expect if a dispute comes up.