Should You Agree to “Arbitration Clauses?”

It is increasingly common to find consumer contracts (the things you agree to when you buy stuff or services, like a rental car, Netflix subscription, or anything that contains a written warranty) containing “arbitration clauses.”  They’re usually in capital letters or bold print, most often buried many clauses deep in the contract, and say something to the effect of this:

…IN THE EVENT A DISPUTE SHALL ARISE BETWEEN THE PARTIES TO THIS CONTRACT, IT IS HEREBY AGREED THAT THE DISPUTE SHALL BE REFERRED FOR BINDING ARBITRATION IN ACCORDANCE WITH THE FEDERAL ARBITRATION ACT. THE ARBITRATOR’S DECISION SHALL BE FINAL AND BINDING AND JUDGMENT MAY BE ENTERED THEREON…

What this language means is that if you and the company have a dispute, you both agree that you won’t take it to court, but will instead hire a “neutral” “arbitrator” to resolve the issue.  The arbitrator can award any amount of money he or she sees fit, based upon the contract and the law.

Here’s why this sucks for the consumer:

1. Your right to proceed class action is cancelled.  A “class action” is a lawsuit where lots of people claim that a company wronged them in the same way.  Generally, it is for small amounts (maybe only a few dollars) that wouldn’t make sense for 1 person to waste their time going to court for, but if there are 10,000 people just like you and you can all sue in one joint lawsuit, the company can be held accountable.  You generally can’t “contract away” the right to proceed as a class under most states’ laws, but by requiring arbitration, the Federal Arbitration Act (FAA) takes over the terms of dispute resolution, and the FAA allows for class rights to be signed away.  You should therefore take an arbitration clause as a sign that the company is afraid that it has, or may, piss off a large consumer base, and wants to protect itself from any damages that can come from that.  It’s a bad sign.
2. Your right to an appeal is cancelled.  An arbitrator’s award, in general, cannot be appealed.  Did your arbitrator turn out to be biased, or literally fall asleep during proceedings?  Too bad, according to the FAA.  With exceptions too narrow to be worth pursuing, a court cannot overturn an arbitrator’s award, no matter how unfair.
3. Your right to a cheap, quick resolution of small claims might be cancelled.  Some arbitration clauses allow small claims to be heard by a small claims court — and some arbitrators refuse to hear cases based on contracts without such an allowance.  This is a good thing: small claims can generally be resolved in less than 3 court appearances, for nominal court fees, without the need for an attorney, and within a few months.  But, some arbitration clauses do not allow for this, and therefore even a claim for $5 comes with a hefty arbitration fee and longer, and more difficult, proceedings than in small claims court.  The text of the arbitration clause will tell you if you can resort to a small claims court, but even this is not guaranteed, as some states will allow any party in small claims court to move a case to a regular civil court, at which point the company can argue that arbitration is now required. (Not the first time I’ve written about Citibank being sneaky and abusive!)
4. No case law is created.  “Case law” is the decisions of courts in the past that influence decisions of courts in the future.  For courts of the same jurisdiction and same level or lower, a decision on an issue is usually binding.  For example, if the U.S. Supreme Court decides that TSA body scanners are unconstitutional and Plaintiff X, who was forced to go through one, gets $100 in damages, every other court in the country must follow suit and award similar damages to anyone who presents a similar case.  When an arbitrator makes a ruling, it may or may not be public, but either way, it is binding on no one.  Therefore, if the company has wronged 10 people in the same way, but has an arbitration agreement, even if the 1st to arbitrate wins, people 2 – 10 still need to argue the issue anew.
5. Oh, you thought the arbitrator was neutral?  There’s a pretty big conflict of interest here.  The companies are the ones including arbitration agreements in their contracts and sending work to the arbitrators.  If one of the two parties sends all the work and the other does not, where does loyalty lie?  Even if an individual arbitrator is conscientious enough to remain neutral, what effect does the conflict of interest have on the rules that the arbitrator has to follow?

For balance, I’ll note that arbitration can have some benefits for the consumer.  For example, if the claim is for a large amount of money, it will be a shorter “trial,” and therefore you’ll be paying your attorneys less money.  Arbitrators are also more likely to award attorney’s fees to you if you win.  Also, in non-consumer contracts, you may sometime have an edge.  A friend of mine involved in an employment contract dispute against a major corporation recently lamented to me that the attorney’s fees to take the major corporation — which could afford to prolong litigation to gain an advantage — may be unsustainable, forcing this friend to consider settlements beneath what his or her claim was worth.  But in consumer contracts, the overall balance is clearly in favor of the company (which, of course, is why they put the clause in there in the first place).

But what can you really do about it?  Well, to start, many arbitration clauses have an “opt-out” option, whereby you notify the company that you disagree, and the clause no longer applies.  If this is an option in your contract, follow the instructions carefully to make an effective opt-out (before the TSA bans those opt-outs too :)).  If it doesn’t, you can try negotiating the contract, even if the company is large.  If it’s a paper contract, you may “negotiate” simply by crossing out the provision and initialing the change before signing. You’d be shocked as to how many times I’ve crossed out arbitration agreements and simply said, “I don’t arbitrate,” and they’ve said “Um, ok I guess.” If all else fails, tell them you’re heading to a competitor.  Lost sales are, in the end, the greatest motivator to companies to create fair agreements with their customers.