What is an Arbitration Clause?

An arbitration clause is a part of a contract that states how disagreements will be handled. It is often used in insurance policies and investment accounts. The clause states that if the two sides can’t agree, they will use arbitration instead of going to court.

Why Arbitration Clauses are Used

Companies like arbitration clauses for a few reasons:

• Arbitration is usually faster and costs less than going to court. Companies want to avoid lengthy, expensive lawsuits.
• Arbitration is private. Court cases are public, but arbitration is behind closed doors. Companies often prefer to keep disputes out of the public eye.
• Companies usually get to pick the arbitrator. They may choose someone they think will take their side.

How Arbitration Works

If there is a disagreement, the process goes like this:

1. One side starts arbitration based on what the contract says.
2. An arbitrator is selected, either by the company or by both sides together.
3. Both sides present their case to the arbitrator. This is like a mini-trial but less formal than a court.
4. The arbitrator makes a binding decision that both sides have to follow.

There are a few critical points about arbitration:

• The arbitrator’s decision is final. It is tough to appeal an arbitration ruling.
• Discovery (sharing information) is limited compared to court. This can make it harder to build a case.
• Arbitration may remove the right to a class action (when many people sue together).

Concerns About Arbitration Clauses

While companies like arbitration clauses, many consumer advocates don’t. Here’s why:

Lack of Choice for Consumers

Arbitration clauses are often presented in a “take it or leave it” way. If you want the product or service, you must agree to arbitration. You can’t negotiate the clause.

This is especially true for essential services like cell phones, credit cards, and bank accounts. It can be hard to find an option without an arbitration clause.

Bias Towards Companies

In court, the judge should be neutral. However, companies usually get to choose the arbitration firm in their contracts. Critics say this makes arbitration biased in favor of companies.

Arbitrators may favor companies, so they are selected for future cases. Companies are “repeat players,” while consumers only arbitrate once.

Limited Discovery and Appeal Rights

Arbitration has different rules than court:

• There is less fact-finding through depositions and documents. This can make it harder for consumers to get evidence.
• Appeal rights are minimal after an arbitrator’s decision. Even if an arbitrator makes an apparent mistake, it is hard to get it overturned.

The process is more thorough in court, and decisions can be appealed.

Elimination of Class Actions

Many arbitration clauses also prevent class actions. Consumers have to arbitrate individually instead of joining with others.

Class actions allow many small claims to be combined into a big case. Alone, it may not be worth suing over a small amount. But joined together, consumers have more leverage.

Companies prefer arbitration, so they only have to face claims individually. Critics say this eliminates many valid claims because cases are too small to pursue alone.

Efforts to Limit Arbitration Clauses

Some groups have tried to limit or ban unfair arbitration clauses:

Consumer Financial Protection Bureau (CFPB) Rule

2017, the CFPB issued a rule limiting arbitration clauses in financial products like bank accounts and credit cards. The rule would have allowed consumers to join class actions.

However, Congress overturned the rule before it took effect. The political debate highlighted the controversy around arbitration clauses.

State Laws and Court Rulings

A few states have laws that limit arbitration clauses in specific contexts, like employment. However, courts often find that federal law overrides state laws.

Occasionally, courts will refuse to enforce a particularly unfair arbitration clause. But in general, courts have upheld arbitration based on current federal law.

Voluntary Efforts by Companies

A few companies have voluntarily stopped using arbitration clauses or have limited their scope. This usually happens after negative publicity or legal pressure.

However, voluntary efforts are limited. Most companies continue to use arbitration clauses across many industries.

The Future of Arbitration Clauses

Arbitration clauses remain very common, especially in consumer contracts. Federal law and court rulings have allowed mainly the expansion of these clauses.

However, there is an ongoing debate about their fairness, led by consumer advocates. Key concerns include:

• Should customers have more of a natural choice?
• Can the arbitration system be made more neutral?
• Should companies be able to eliminate class actions?

Potential changes could come from new laws, regulations, or court rulings. But for now, arbitration clauses continue to impact how disputes are resolved significantly.