5 Steps to Understanding Arbitration Clauses

January 1, 2014

Mark Davis,

Increasingly, small-business contracts include arbitration clauses that seek to limit potential lawsuits. Mark Davis, a partner with Davis Levin Livingston, offers these tips to help you understand arbitration clauses and avoid potential pitfalls.

1. Know the purpose of an arbitration clause

In its purest form, arbitration is meant to solve disputes between equally positioned parties by employing a trusted third party to decide the issue. By doing so, the disputing parties avoid the costs and time needed to resolve their disputes in court. Arbitration can be mandatory or voluntary. In binding arbitration, the decision of the arbitrator is final and cannot be appealed.

2. Know the potential dangers

Increasingly, arbitration clauses are used by one party to tilt the playing field. Many arbitration clauses strictly limit a party’s ability to file a lawsuit in state or federal courts. Arbitration clauses can also limit the potential recovery and the ways in which one party may investigate its claim. Therefore, it is crucial that you understand the limits imposed by a particular arbitration clause.

3. Know if your contract contains an arbitration clause

Under Hawaii law, all arbitration agreements must be in writing, showing that the contracting parties intend to resolve their disputes through arbitration instead of court. Often, these clauses will be buried deep in the legalese of a contract. Look at the contract for words such as “binding” or “mandatory” arbitration to determine whether arbitration is required or voluntary. Unlike some states, Hawaii law does not require that the arbitration provision be highlighted or located above a contract’s signature lines.

4. Know your alternatives

Arbitration clauses are everywhere, especially in contracts for consumer goods and services. Often, the only alternative is to choose another product or service. However, between contracting parties, arbitration provisions can often be negotiated and tailored to meet the needs of both parties.

5. Know when to seek professional guidance

Seek the advice of an attorney whenever you are drafting a contract containing an arbitration clause, because the wording must be precise. Also, seek an attorney’s advice if a contract contains an arbitration clause that severely limits your rights and remedies.

This article appears in the January 2014 issue of Hawaii Business Magazine.