Time to Fix Arbitration Loophole

By Stuart Sobel

During the past few decades, arbitration has gained traction as an attractive alternative to court trials for resolving disputes. Major providers of alternative dispute resolution services have promulgated rules governing their proceedings which, when incorporated into contracts between disputants, are binding and enforceable. Arbitration is promoted as quicker and cheaper than traditional litigation (mostly because of tight constraints on the scope and duration of discovery) with more reliable results stemming from the use of arbitrators selected for their expertise in the subject matter in dispute. However, an arbitrator's inability to sanction a party that fails to pay its share of the arbitration expense (either as a delaying tactic or simply because of lack of funds) can lead to delays or suspensions of the proceedings, which undermine the reliability of arbitration as an effective means of ADR.

Noticeably absent from the rules promulgated by the leaders in the industry are rules affording either the service provider (such as the American Arbitration Association, JAMS or the International Chamber of Commerce) or the appointed arbitrators the power to impose meaningful sanctions upon a party that fails to pay its share of the arbitration expense.

The parties are typically required by the rules of arbitration to deposit the fees anticipated to be earned by the arbitrator in advance of the hearing, and those expenses are typically shared equally in advance of the hearing (to be taxed in accordance with the final award at the conclusion of the proceeding).

Incentives Against Payments

However, a party, typically a defendant, that lacks the funds or has nothing to gain by the prompt conclusion of a proceeding that will likely result in an adverse award, may not voluntarily comply with the deposit obligation. Such a failure, in the context of court litigation, might be viewed as a failure to comply with a court order and could result in the striking of pleadings, entry of default or even sanctions for contempt of court. However, in arbitration, the remedies are far more limited and far less satisfactory. In arbitration, the only express remedies call for the party that has already paid to be afforded the option to advance the nonpaying party's share (in addition to its own share -- thus shouldering, initially, the entire burden of the arbitrator's fees) or the arbitrator may suspend the proceeding, pending payment -- effectively preventing the paying party from proceeding with the arbitration.

Contrary to court rules, the most widely used arbitration rules do not contain any express provision by which an arbitrator can strike the pleadings of a party that does not pay its share of the arbitrator's compensation or enter a default award against that party. Nor do the rules expressly allow for an arbitrator to preclude a nonpaying party from offering evidence at the final hearing.

Rule R-36 of the American Arbitration Association Construction Industry Arbitration Rules (and Commercial Arbitration Rules) does authorize an arbitrator to "take whatever interim measures he or she deems necessary." There is no reported court decisions upholding an arbitrator's reliance on this rule to justify a meaningful sanction against a nonpaying party, such as striking of pleadings, entry of default or preclusion from presenting evidence. In fact, Rule R-55 purports to address "Remedies for Non-Payment," and is silent as to the propriety of such a remedy. Thus, arbitrators are discouraged from such drastic sanctions, resulting in a Hobson's choice for the party anxious to proceed with the arbitration. Until this circumstance is addressed, the viability of arbitration, as a legitimate alternative to court, is jeopardized.

Courts called upon to remedy the problem -- either by ordering the nonpaying party to pay or by construing nonpayment as a waiver of the right to arbitrate and thus allowing the dispute to proceed in court -- are hesitant to involve themselves in the arbitration proceeding, in light of federal and state law strongly favoring enforcement of arbitration agreements. Even those few courts stepping in to solve the problem, however, do so only after a prolonged delay and additional expense, incurred only because the arbitration rules themselves fail to afford the arbitrator or the arbitration provider the authority to impose meaningful sanctions.

Because arbitration is by agreement, and typically the contract containing the agreement to arbitrate incorporates the rules of the arbitration provider, it would seem that incorporation of rules providing for imposition of meaningful sanctions would be viewed as simply one more aspect of the agreed-upon procedure and, therefore, enforceable by a reviewing court. Having been both an advocate and neutral in many arbitrations, I am hard-pressed to understand why this has yet to occur. Alternatively, or perhaps preferably, legislators can enact statutory authorization within the arbitration codes themselves, which provide the arbitrators with the ability to impose meaningful sanctions.

With some relatively minor changes to applicable rules, the loophole that allows a recalcitrant party to arbitration to derail the process can be closed and arbitration can continue to be a viable alternative method of dispute resolution.

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Stuart Sobel is an AV-rated board certified construction lawyer, a certified circuit civil mediator and, since 1995, a shareholder with the Coral Gables-based law firm of Siegfried Rivera He is active as a neutral on the American Arbitration Association’s Large and Complex Case Panel and as a Fellow in the American College of Construction Lawyers, and he has tried dozens of cases to verdict. www.srhl-law.com, [email protected].

Reprinted with permission from the “March 21, 2011 edition of the “Daily Business Review”© 2011 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, [email protected] or visit www.almreprints.com.