What Is an Arbitration Agreement?

An arbitration agreement is a contract in which parties agree to resolve disputes through arbitration instead of litigation—in other words, out of court and according to the judgment of a neutral legal professional. Chances are you’ve signed an arbitration agreement when you clicked “agree” to a software license, signed an employment contract, or when you purchased ordinary goods or services online.

By agreeing to arbitrate, you give up certain rights while also gaining some benefits. For that reason, it's vital to understand the pros and cons ahead of time so that you can make an informed decision when you’re asked to sign.

What is arbitration?

Arbitration is a way of resolving a dispute without filing a lawsuit and going to court. The arbitration process is similar to the proceedings in a court case in the following ways:

• The parties may have lawyers.
• They exchange information.
• There is a hearing where they question witnesses and present their cases.
• After the hearing, the arbitrator will make a decision.

However, arbitration is more informal than litigation and the procedures are simplified. The following are some of the ways arbitration differs from litigation:

• The parties usually have a more limited right to obtain documents and other information from one another.
• Most arbitrations occur in a conference room rather than a courtroom.
• The arbitrator may be a lawyer, a retired judge or a person with experience in a relevant industry.
• Most arbitrations are binding, meaning that the parties must accept the arbitrator’s decision and cannot try to resolve the same dispute in court.

When you sign an arbitration agreement, you may be giving up your right to go to court over any disputes outlined in that agreement.

What’s in an arbitration agreement?

Before arbitration can go forward, the parties must have agreed to arbitrate the dispute. Arbitration agreements are usually signed at the beginning of a business relationship—long before there’s a disagreement. However, the parties to a dispute may also agree to arbitration after a conflict has arisen, or even after a lawsuit has been filed.

They are often just a few sentences long, and are commonly found near the end of a larger contract under a heading such as “Arbitration” or “Dispute Resolution.” Employee arbitration agreements may be buried in an employment contract or employee handbook.

The rules for arbitration

The agreement may specify certain arbitration rules, such as the American Arbitration Association (AAA) rules, which establish guidelines to factors such as the mediation procedure, how the arbitrator will be selected, the arbitrator's jurisdiction, and more.

The scope of disputes covered

The agreement's scope should outline which disputes both parties agree to resolve through arbitration. An arbitration clause will typically say that all disputes arising under the larger contract will be submitted to binding arbitration, but some contracts will say that only certain disputes will be arbitrated. For example, in an employment context, the scope may be any disputes related to invoicing.

Conditions for conducting arbitration

The agreement may also say how the arbitration will be conducted, such as requiring separate meetings with both parties and their representatives before, during, and after any scheduled mediation conference. Additionally, it may contain guidelines on how both parties will decide on the date, time, and place of the hearing.

The method for selecting arbitrators

The agreement may also specify how the arbitrator will be chosen. For example, it may say whether there will be one arbitrator or a panel of arbitrators, or it may specify the group or company from which you'll choose an arbitrator.

Arbitration agreement examples

Arbitration agreements are most common in business transactions. They are often just a few sentences long, and are commonly found near the end of a larger contract under a heading such as “Arbitration” or “Dispute Resolution,” such as in the following scenarios:

• Employment contracts. Employee arbitration agreements may be buried in an employment contract or employee handbook.
• Contractor agreements. Contractors, such as home builders, insurance companies, communications providers, and manufacturers of various products, will often include arbitration clauses in their contracts.
• Consumer contracts. Pre-printed consumer contracts with banks, financial service providers, insurance companies, communications providers, automobile and mobile home dealers frequently contain arbitration agreements.
• Software agreement. Arbitration clauses are also often embedded in broader software agreements.

Advantages of signing an arbitration agreement

If written comprehensively, arbitration agreements are meant to benefit both parties by streamlining the dispute resolution process. The following are some of the benefits that arbitration offers:

• Speed and cost. Arbitration proceedings are usually faster and less expensive than litigating a case in court.
• Privacy. Arbitrations are confidential, which means that you will not have to publicly testify. The specifics of your dispute will not be in the public court records.
• Flexibility. In arbitration, you can choose who will decide your dispute, such as a decision-maker who has specialized technical knowledge or experience in your industry.
• Smooth employment. Some employers will not hire you if you refuse to sign an employment arbitration agreement.

Disadvantages of signing an arbitration agreement

Although there are a number of benefits to signing an arbitration agreement, there are also some disadvantages. When signing an agreement, it's important to understand the context of the agreement and weigh whether or not arbitration is right for you.

Below are some of the disadvantages of signing an arbitration agreement:

• Decisions are final. Arbitration awards cannot be appealed. You must accept the arbitrator’s decision as final.
• You cannot have a jury trial. This can lead to a worse result if you have an employment dispute because juries are often sympathetic to employees.
• Limited right to information. The parties’ exchange of information is more limited in arbitration. This can make it harder to develop your case in an employment arbitration or in any other situation where the other party has most of the information and documents.
• Lack of context. If you are asked to agree to arbitration before you even have a dispute, you may not know whether you want to arbitrate or not. If you sign the agreement and decide later that you would rather pursue a claim in court, you won’t be able to—or, you will rack up legal fees trying to invalidate the arbitration agreement.
• Potentially one-sided. Like all contracts, arbitration agreements can be one-sided in favor of the party who wrote the agreement. You should be on the lookout for this and make sure the agreement gives you an equal voice in choosing the arbitrator, does not limit the remedies available to you, and does not deny you the right to an attorney.

What to do before signing an arbitration agreement

Before signing an arbitration agreement, thoroughly read the agreement and assess if the terms are as equally beneficial to you as they are to the opposite party. If it feels one-sided, try and negotiate the terms of the agreement.

Arbitration agreements are a way to limit litigation costs and keep disputes confidential. But signing an arbitration agreement also means giving up important rights. Before signing, it pays to have a contract review with a legal expert and reject or renegotiate anything that you’re uncomfortable with.

FAQs

How does arbitration work?

Arbitration is an alternative dispute resolution to litigation in which a neutral arbitrator acts as a judge to determine the outcome of your dispute. It takes place out of court and isn't public. The process can be quick or take up to a few weeks or months. The process typically involves selecting an arbitrator who will meet with both parties to discuss the details of the dispute and then make a decision. The arbitrator's decision is binding, meaning a court most likely won't overturn it.

Is arbitration mandatory if I sign an arbitration agreement?

If the agreement is valid—meaning there's a defined legal relationship, clear arbitration clause that states both parties' intention to arbitrate, and a smooth and effective process—then arbitration is often considered mandatory. For example, the Supreme Court ruled in favor of the enforceability of mandatory employment arbitration agreements In 1991 and continues to stand by the decision.

Can I opt out of an arbitration agreement?

In some cases, yes. Some arbitration agreements contain an “opt-out” provision that allows the employee or consumer to opt out of arbitration within a specified time frame—often 30 to 60 days after signing. If your contact has this provision, read the instructions carefully and record proof that you requested to opt out of arbitration according to the rules of the contract and within the deadline. 

What happens if I don’t agree to an arbitration clause in a contract?

Technically, you have the choice to sign an arbitration agreement or not. However, the employer or consumer service can simply rescind its offer of employment or shield you from purchasing the goods or services if you refuse to sign.

What is the Forced Arbitration Injustice Repeal Act?

The Forced Arbitration Injustice Repeal (FAIR) Act aims to prohibit the enforceability of mandatory arbitration clauses related to an employment, consumer, or civil rights claim against a corporation. This legislation has been brought to Congress several times, but has yet to pass. 

Jane Haskins, Esq. contributed to this article.