Arbitration, a common form of alternate dispute resolution, can often be a desirable alternative to litigation. Its popularity is due in large part to flexible, streamlined procedures that allow disputes to be resolved more quickly and less expensively.
In international transactions there’s also the added benefit of enforceability. The New York Convention, a multilateral treaty that requires the courts of participating countries to enforce an arbitration award (unless such enforcement falls within some narrow exceptions), makes it relatively easy to enforce such awards where ever assets are located. There is no equivalent treaty governing court judgments. U.S. courts are generally willing to recognize and enforce foreign judgments, but many foreign courts do not return the favor. That makes it harder to get your money, or enforce the contractual performance you originally bargained for.
So how do you get to arbitration? What makes a case go to arbitration instead of litigation?
Arbitration is a function of contract law. The parties must agree to arbitrate. That agreement can be reached after a dispute has arisen, but more commonly it is built into a business contract up front as part of the transactional terms and conditions. The terms of arbitration are part of an arbitration clause.
When crafting a contract strategy that includes arbitration it’s helpful to remember that one size agreement does not fit all. There may be certain types of disputes you’ll want to arbitrate and others you don’t. Some of the factors to consider in deciding which is which include the size of the potential claim, the type of claimant, and the need for privacy, and enforceability. Small, consumer type claims are often arbitrated. For example, disputes between stock brokerage firms and their clients. International claims are also prime candidates for arbitration because of the ease of enforceability.
Arbitration can be binding or non-binding. Some will argue that if the decision is non-binding, “what’s the point?” The answer is that even non-binding arbitration provides a useful reality check for the parties. It can identify weaknesses in a case and motivate the parties to reach a negotiated settlement.
Binding arbitration, however, carries its own risk. Absent a contractual provision to the contrary, there is no right of appeal. That means binding arbitration is not a dress rehearsal. It can be as binding as a jury trial, if not more binding. It also means that if you don’t pay attention to the process and treat it seriously you can be in a world of hurt.
That’s what happened to iFreedom Communications International Holdings Ltd. The company got hit with a $4.1 billion arbitration award in a case involving the termination of a senior level employee without cause. That’s not a typo. Seriously, its billions with a big bucks capital B.
What happened is that iFreedom failed to produce requested financial information. The financial data was important because the plaintiff’s compensation agreement said he was going to be paid a 5% commission on gross sales. There was also a sweetener in the agreement that provided for commissions on an ongoing and permanent basis if the employee was terminated without cause.
The company did not cooperate with requests for financial information with which to calculate gross sales. It left the arbitrator and the plaintiff to look to publically available information. What they found was a letter iFreedom sent to its shareholders announcing a monthly revenue stream of $535,000 and a growth rate of 10% per month. Armed with the letter, the numbers multiplied into the eight figure range very quickly.
To make matters worse, iFreedom fired its attorney and the owner decided to represent the company himself. He then decided not show up for the arbitration hearing. Before they knew it, iFreedom had exposed itself to punitive damages, in effect tripling the award to $4.1 billion.
When properly managed and integrated into a business strategy, arbitration clauses can save time and money. If not, they can be an iFreedom nightmare.