One way small business owners can control the risk factors in litigation is by entering into mediation and arbitration agreements.
Mediation and arbitration are consensual. This means that both parties must agree to mediate or arbitrate the dispute. Usually, this is done before the dispute arises, in a contract between the two parties, although it is possible to agree to mediation or arbitration after a dispute arises.
Usually, the agreement requires that the parties split the fee of the mediator or arbitrator. Typically, both a mediation and arbitration clause specifies that the two parties will select a single mediator or arbitrator. However, an arbitration clause also may specify that three arbitrators will hear the case. In this situation, each party will choose an arbitrator, and these two arbitrators will select the third arbitrator.
The clause may specify that the dispute is to be mediated or arbitrated by a particular organization, such as the American Arbitration Association (AAA).
While courts tend to disfavor exculpatory clauses, exactly the opposite is true with respect to mediation and arbitration clauses. There is a strong presumption in favor of the validity of such clauses, because the courts encourage parties to resolve their disputes outside of the court system.
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The U.S. Supreme Court recently held that an employer could have a job applicant sign an agreement to arbitrate any disputes that arise by virtue of his employment. The Court held that signing the agreement could be a condition of hire and, once the agreement was signed, the employee had no recourse in the courts.
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In fact, arbitration clauses between business owners and consumers have been upheld by the courts even when the clauses were disclosed in the instructions enclosed with a product, and even when the clauses were printed on the outside of the box that contained the product. In these situations, to better ensure that the clause will be upheld, it may be advisable to allow the consumer a certain period (e.g., 60 days) to void the arbitration clause, by notifying the business in writing of this decision. Professional legal guidance should always be sought in using arbitration clauses, especially in consumer contracts.
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In 1997, a U.S. Court of Appeals upheld an arbitration clause that was included in the packaging materials that Gateway shipped along with its computers. The clause could be voided by consumers within a fixed period, but became binding after that period had expired. The plaintiff, who had purchased a Gateway computer, had sought to invalidate the clause after this period had expired and sue Gateway in court.
The Court ruled that the clause was valid and binding, and that, accordingly, the consumer's only remedy was through an arbitration hearing.
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Ultimately, mediation and arbitration hearings involve low costs, no jury and no complex rules of evidence. Accordingly, mediation and arbitration can mitigate or eliminate significant risk factors inherent in the civil litigation system.
Therefore, mediation and arbitration clauses should be used in agreements for the sale of goods and services to consumers, and in contracts between two business parties, as well as in operating agreements that govern the relationship among a business entity's owners.
Because mediation is more informal, and usually less costly, consideration should be given to including a mediation clause in addition to an arbitration clause. In this situation, the mediation clause would provide that, if mediation failed to resolve the dispute, the matter would proceed to arbitration. Mediation and arbitration clauses should be professionally drafted.