How A Well-Drafted Contract With An Effective Alternative Dispute Resolution (ADR) Clause Can Save You Thousands In Legal Costs And Keep You Out Of Court

HOW A PROPERLY DRAFTED CONTRACT WITH AN EFFECTIVE ALTERNATIVE DISPUTE RESOLUTION CLAUSE CAN SAVE YOU THOUSANDS OF DOLLARS IN LEGAL COSTS AND KEEP YOU OUT OF COURT By: Richard E. Korb, Esq.[1] ©2010

With the current healthcare debate, we all understand the importance of preventive medicine,–exercise, eating right, getting regular checks-ups and taking other preventive measures to stay healthy and reduce the risk of major illness …but how many of us apply that same wisdom to our legal and business affairs?

Regardless of one’s business or occupation, age or income, chances are that at one time or another, you will enter into a legally enforceable agreement (called a contract) with a person or company involving significant sums of money (a contractor wanting to remodel your home, a buyer  wanting to buy your car, a realtor wanting a listing on your house, an employer wanting you to sign a non-compete or non-solicitation agreement; a supplier wanting to supply your company with software; a distributor wanting to sell some product you own to others.)

Whether it is a personal contract worth a few thousand dollars or a business transaction worth hundreds of thousands, in each case, you are agreeing to terms that could significantly impact your future. Yet how many folks actually take the time to actually review their contracts bother to consult a lawyer BEFORE or they sign them? Very few. Over the last 30 years, time and time again, I’ve seen clients who came to me only after they were in the middle of a legal dispute. When I asked to see the contract they signed, I was often shocked by the content, or lack of it—leaving them exposed to legal or financial risk.

The bad news is that despite the fact that written contracts are supposed to protect you in the event of a legal dispute, often they are so confusing or ambiguous or one-sided or incomplete—that they do little to protect you from the financial and emotional risks and costs of court…The good news is that there are basic preventive steps that you can take up-front to help minimize the risk and costs of litigation:[2] FIVE Clauses To Consider Inserting In Your Contracts To Help You Control Costs And Avoid Court: ADR, Attorney’s Fees, Forum Selection, Indemnification and Limitations On Liability.

I. The Alternative Dispute Resolution (“ADR”) CLAUSE:

What Is an ADR clause in a contract and how can it keep me out of court in the event of a dispute? ADR is a term covering the full range and array of techniques designed to resolve disputes early and with the goal of avoiding the time, expense and stress associated with going to trial in a public court of law. ADR does not replace the court system. Certain cases will always have to be tried in a public forum. ADR complements the court system by making methods available to resolve some disputes at less cost, in less time, and often without the win-lose outcome that characterizes conventional litigation. Private vs. Court-Ordered ADR: ADR methods include private, voluntary procedures, as well as court-mandated programs:

Why ADR?   ADR Obtains Better Results: It is now widely recognized that in many cases clients can obtain better overall results through ADR than through conventional litigation. With ADR, the parties can: a. Avoid delay and expense of litigation: While over 90% of the lawsuits filed eventually settle, too often they settle only on the eve of trial, after rounds of pleadings and exhaustive discovery. As a result, attorney fees and costs often outstrip the value of a case, giving the client with the “deepest pocket” unfair leverage. Conciliatory ADR procedures, such as mediation) facilitate settlement before hostilities escalate and the litigation process gets under way. b. Maintain confidentiality: For the most part, ADR proceedings are conducted in private, and the parties can maintain the results of the proceeding in confidence. This can be important in certain cases, such as sensitive trade secret cases or divorce. By contrast, court cases are public and with few exceptions, documents filed in court are matters of public record absent a gag order or “air-tight” protective order re confidentiality.   c. Maintain control over the process: ADR is a consensual process. The parties make the key decisions. They select the person who will facilitate the negotiations, conduct the hearing, or preside over the trial. They control the timing and pace of litigation. They can set deadlines for completion of pretrial proceedings, can limit discovery, and can determine where, when and in what sequence the trial will be held. They can alter applicable procedural rules as they wish. Their unique concerns can be addressed; and much of the “delays and inefficiency” of normal court proceedings can be avoided.   d. Achieve a better outcome without “collateral damage”: Conciliatory ADR procedures, such as mediation are particularly effective in resolving disputes because the parties participate directly. Direct party participation in the ADR process usually results in consideration of particular needs (emotional, financial, etc.) that are often neglected in the courtroom. Addressing these needs may lead to more appropriate solutions than those resulting when a problem is forced into a legal “cause of action” and its associated remedy. (For example, parties to an unfair competition dispute may agree to cooperate in cross-licensing of products and information rather than pursuing a tort action that can result only in a damages or injunction remedy.) Also, parties having a continuing relationship with each other are more likely to adhere to agreements reached through their direct participation.

What ADR Options Are Available And What Are Their Pros & Cons?   The next step is to determine what form or forms of ADR may be appropriate for the particular case. In the interests of time, I will address two major forms of ADR:

1. Mediation
2. Arbitration-Binding & Non-Binding

A.  Mediation: Mediation involves a neutral third party in the dispute resolution process who assists or “facilitates” the negotiating process. There are many types of mediation but in traditional mediation, the mediator’s function is to assist the parties’ to reach a final binding settlement. The mediator helps the parties define the issues, overcome barriers to communication, and explore alternative methods of resolving their dispute. Part of the mediator’s function is to make sure each party is evaluating his or her position realistically. The mediator may deal directly with the parties or their attorneys or both depending on the ground rules in place. The mediator is NOT a decision-maker and he/she may not issue a ruling or decision in favor of either party and he/she may NOT take sides. The mediator does not assign blame or dictate solutions and has no authority to render binding decisions. The parties retain complete control over the process and make their own decisions about what solutions will work for them. Unless the parties agree otherwise, either party has the right to terminate the mediation at any time.

Pros & Cons: The potential advantages of mediation as a dispute resolution technique include: • mediation is relatively inexpensive; • the proceedings are confidential; any communications/documents exchanged in mediation are confidential and cannot be used in trial or discovery—with some limited exceptions; • mediation reduces the emotional barriers to communication and helps parties focus on their interests; • the parties control the process and decide the outcome; • as a result of the parties direct involvement as opposed to a court process where the attorneys are principally involved, the process is more likely than litigation to result in a solution satisfactory to both parties; • Flexibility: Mediation, like arbitration, can be binding or non-binding—although I strongly urge parties to make it binding or it loses its effectiveness and is self-defeating in terms of cost saving.   The potential disadvantages of mediation include: • participation cannot be compelled unless court ordered or mandated by contract; • the results are not binding on the parties unless both parties agree that the results are binding; • whether the mediation is successful depends to a significant extent on the mediator’s skills; •  some attorneys/parties use mediation to discover the strengths and weaknesses of their opponent’s case without any real intention to settle; • it can be counter-productive if either side withholds information necessary to settlement; by contrast, if either side produces all of its “smoking guns” and crucial evidence,  it may remove the element of surprise and give the opposition an advantage.

Disputes suitable for mediation: Mediation should be considered in almost any situation when direct negotiations have reached a stalemate. To be effective, it is necessary only that the parties have sufficient information to negotiate intelligently and that they have a good faith interest in settling their dispute. Mediation is a particularly good choice in the following cases:

• Where Costs are prohibitive: The most compelling reason is to save money. Often the attorney’s fees in a court case exceed the amount in dispute. Early-pre-litigation mediation can be an extremely cost-effective way to settle a case before both parties are so invested financially, that they feel compelled to “go all the way (trial);”

• When emotions are running high: Mediation is helpful when the principal barriers to settlement are emotional. Part of the mediator’s role is to open up constructive communication by encouraging the parties to express openly the fears, beliefs and feelings that underlie the conflict. Once this is done, a skilled mediator can help the parties separate their feelings from the issues at hand and focus on a realistic solution to the problem;

• When ongoing relationships involved: Mediation also works well when the parties expect to deal with each other in the future. Examples: Disputes between landlord and tenant; between customer and supplier, and in domestic relations and neighborhood disputes. In such cases, the parties have an incentive to address their underlying problems and come to mutually satisfactory decisions. This is far more constructive to an ongoing relationship than the residual feelings of hostility or sense of having been treated “unfairly” that frequently result from court  litigation;

Arbitration: Arbitration is a dispute resolution process in which a neutral third party or panel hears a dispute between two or more parties and, after carefully reviewing all relevant information, issues a decision or judgment. Whether or not that decision becomes final depends on whether the arbitration is binding or not; and whether it is “judicial” arbitration or ”contractual” arbitration—discussed below. Although arbitrators generally base their decisions on published rule sets and substantive law, the procedures and rules they follow may differ depending the nature of the arbitration—judicial or contractual— depending on the terms of the contract or agreement regarding arbitration (contractual arbitration) and depending on  the organization conducting the arbitration t. The arbitration decision may be either binding, in which case the decision is final, legally enforceable, and has limited grounds for appeal; or it may be non-binding, in which case either party may reject the arbitrator’s decision and opt to litigate (or pursue another form of ADR) to resolve the dispute.   C.

Arbitration v. Mediation: Mediation is a  dispute resolution process where all parties must consent to participate in good faith and work toward a mutually agreeable resolution. Mediating parties are not bound to resolve their dispute (although mediated settlements, once reached, can be made binding if the parties decide to draft a contract called a settlement agreement). Mediations are not “decided” in favor of one party or another; rather, the mediator simply facilitates the negotiation process. Mediators will counsel parties on the strengths and weaknesses of their case and gauge each party’s likelihood of success if the dispute proceeds to arbitration or litigation. Arbitration, on the other hand, is a dispute resolution process in which a third-party (the arbitrator) hears a dispute between one or more parties and, after considering all relevant  information, renders a final decision in favor of one of the parties. Arbitration decisions may be either binding or non-binding, depending on the terms of the arbitration agreement and whether it is judicially-mandated. Binding arbitration decisions may be confirmed by a court and carry the same significance as a court judgment.

Drafting ADR Agreements: Predispute ADR Agreements: Most ADR agreements are entered into as part of an underlying contract (e.g., arbitration clauses in insurance policies or sales agreements) before any dispute has arisen. Advantages: There are several obvious advantages to such agreements: Best time to negotiate ADR: The best time to negotiate an ADR agreement is when the contract is entered into. At that point, there is usually a collaborative effort to establish a contractual or business relationship that will be mutually satisfactory. The parties therefore are usually receptive to suggestions that they include an appropriate ADR mechanism to resolve any disputes that might impair their relationship. Prevents future disputes: The mere fact the contract contains a dispute resolution mechanism tends to encourage negotiation and settlement.

Form and Content: No particular form is required for a dispute resolution clause. As with other contract provisions, however, it must identify the parties’ obligations with sufficient specificity to be enforced. [See Chan v. Drexel Burnham Lambert, Inc. (1986) 178 CA3d 632, 643, 223 CR 838, 844] .To draft an ADR agreement, the lawyer must make some basic decisions as to:   —the ADR procedure(s) to be utilized; —the method of administration; —the selection of the neutral; and —the “ground rules” under which the proceedings will be conducted.

“Customizing” the ADR agreement: The most important drafting consideration is to design an ADR process that is customized to the parties’ needs and interests. Sometimes it will require combining procedures: For example, for insurance claims, it is foreseeable that the insurer and insured may disagree regarding the amount of damage claimed by an insured, and whether there is coverage under the policy for the loss incurred. Accordingly, the ADR agreement may require the insurer and insured first to arbitrate the coverage issue; and then (if the arbitrator finds coverage) to submit the damage issue to neutral fact-finding (such as nonbinding appraisal process).

SAMPLE ADR CLAUSES: ARBITRATION: Typical “short form” arbitration clauses: The following are two of the most common “short form” agreements:

SAMPLE 1. AAA form: The short form arbitration clause recommended by the American Arbitration Association provides:   “Any controversy or claim arising out of or relating to this contract, or the breach thereof, shall be settled by arbitration administered by the American Arbitration Association in accordance with its Commercial [or other] Arbitration Rules [including the Optional Rules for Emergency Measures of Protection], and judgment on the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof.” [See Drafting Dispute Resolution Clauses—A Practical Guide (amended eff. 7/1/04).]

SAMPLE 2. JAMS form: The “short form” arbitration clause recommended by JAMS provides:   “Any dispute, claim or controversy arising out of or relating to this Agreement or the breach, termination, enforcement, interpretation or validity thereof, including the determination of the scope or applicability of this agreement to arbitrate, shall be determined by arbitration in (insert the desired place of arbitration), before (one) (three) arbitrator(s). The arbitration shall be administered by JAMS pursuant to its Comprehensive Arbitration Rules and Procedures (Streamlined Arbitration Rules and Procedures). Judgment on the Award may be entered in any court having jurisdiction. This clause shall not preclude parties from seeking provisional remedies in aid of arbitration from a court of appropriate jurisdiction. “(Optional) Allocation of Fees and Costs: The arbitrator may, in the Award, allocate all or part of the costs of the arbitration, including the fees of the arbitrator and the reasonable attorneys‘ fees of the prevailing party.” [See JAMS Guide to Dispute Resolution for Commercial Contracts (emphasis in original omitted).]

MEDIATION: SAMPLE 1. In the event any controversy or dispute is not resolved by informal negotiation within 30 days (or any mutually agreed extension of time), the case shall be referred to the nearest office of [ADR provider] for mediation. The parties are free to select any mutually acceptable panel member from the list of mediators at [ADR provider/location]. If the parties cannot agree or have no particular choice of mediator and simply request that [ADR provider] assign one to the case, a list and resumes of available mediators numbering one more than there are parties will be sent to the parties, each of whom may strike one name, leaving the remaining name as the mediator. If more than one name remains, [ADR provider] will make the selection. Note: Some agreements may direct each party to suggest a number of individual mediators (e.g., three names) and to strike names until reaching agreement.

SAMPLE 2. MEDIATION COMBINED WITH ARBITRATION In the event of any controversy, claim or dispute arising out of or relating to this Agreement or the breach, termination, enforcement, interpretation or validity thereof, including determination of the scope or applicability of this Agreement (“Dispute”), the parties agree first to attempt in good faith to settle the dispute by mediation administered by [ADR provider] under its [applicable rules]. If the parties cannot agree on a mediator, the mediator shall be selected by [ADR provider] in accordance with its [applicable rules]. All disputes not resolved by mediation shall be determined by arbitration administered by [ADR provider] in accordance with its [applicable rules]. The mediator shall serve as arbitrator unless the parties agree to select a different person as arbitrator. The parties understand that this process will likely cause the arbitrator to receive information that might not otherwise have been received as evidence in the arbitration and to receive information confidentially from each of the parties that may not be disclosed to the other side. The parties waive the right to seek disqualification of the arbitrator by reason of participation in the mediation and waive the right to seek to vacate any award on this basis. The parties also recognize that determinations that may ultimately be made by the arbitrator might be influenced by confidential information or other information received in the mediation. The parties waive the right to seek to vacate any arbitration award on this basis. Judgment on the award rendered by the arbitrator may be entered in any court having jurisdiction.

For more information or fora free consultation with an experienced business attorney with offices in Berkeley-Oakland -Walnut Creek, Please call Richard Korb at 510-524-0903.