With early signs of an economic recovery, developers, investors, and lenders have cautiously started exploring new deals. With new deals come new contracts, and with new contracts it is important to take another look at some of the “standard” provisions to which many of us have grown accustomed.  One such provision which has become standard in many real estate and lending contracts is the mandatory arbitration provision.  Instead of treating it as an afterthought, parties to the contract should carefully consider whether arbitration makes sense for them.

To begin, it is important to understand some of the potentially beneficial characteristics of arbitration:

• In an arbitration the parties have the ability to agree on an arbitrator, rather than having a judge assigned to their case at random;
• While arbitration files remain confidential, court records are generally open to the public unless specifically filed under seal;
• In an arbitration, the parties can set the discovery and procedural rules ahead of time instead of being bound by the rules of civil procedure (though blindly choosing standard arbitration rules could result in a process at least as expensive as a court proceeding without the tried and true benefits of standard discovery practices); and
• A binding arbitration provision might allow a large institutional party dealing with many customers to avoid class action law suits.

That said, arbitration comes with a cost. In an arbitration, the parties are responsible for paying the hourly rate of the arbitrator and certain default arbitration rules might even require the use of three arbitrators for high-dollar disputes (regardless of the complexity). Additionally, some arbitration firms charge heavy administrative fees. Therefore, depending on the dollar amounts involved, arbitration might not make sense. 

One final point to consider is that the court system might be better suited for certain types of disputes.  Many courts have special rules and procedures for evictions, suits on promissory notes, and replevins.  In these cases it will likely be much easier to go through the courts rather than trying to reinvent the wheel in an arbitration.

Therefore, prior to including an arbitration provision it is important to consider both the characteristics of arbitration as well as the nature of the parties’ deal. This will allow the parties to make an informed decision about whether arbitration is the best option for them. If it is, then it becomes vital to craft the arbitration provision carefully so that the ground rules for the arbitration are in place before a dispute arises.