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This page contains answers to common questions about arbitration clauses and the effect of such clauses on the public.
What is arbitration?
What are the different types of arbitration?
What laws permit companies to force the public to arbitrate disputes?
Why are arbitration clauses usually unfair to a consumer?
What can I do to preserve my legal rights?
What needs to be done to protect consumers?

   

What is an arbitration clause?

             An arbitration clause is a contractual provision whereby those bound to it give up their right to go to court and instead have any disputes underlying the contract resolved by an ?arbitrator? or ?arbitration panel.?  Generally, an arbitration clause ("agreement") must be in writing. The written arbitration agreement sets forth the rules that will be followed if a dispute arises, and indicates the types of disputes that may be arbitrated.  In some instances, a person may be bound to arbitrate a dispute against a party to a contract while that party retains the right to sue that person. Arbitration clauses have been included in consumer contracts with increasing frequency in recent years.  Arbitration clauses are also frequently a part of collective bargaining agreements in the employment and labor law area.

            Arbitration may be voluntary and nonbinding. For instance, a contract may provide that before a lawsuit is filed the parties agree nonbinding arbitration will first be used in an effort to settle any dispute.  If a party should then disagree with the arbitrator?s decision, and settlement of the dispute is not achieved, a lawsuit may be filed and the arbitration decision is ignored.

            Arbitration may also be compulsory and binding. In consumer transactions where arbitration agreements control, the public is almost invariably bound to mandatory arbitration.   In this situation, the consumer is forced to arbitrate any dispute and the arbitrator?s decision is final.  Even if the consumer objects to the arbitrator?s decision, there is no right to appeal.  If the consumer fails to pay the amount the arbitrator awards or fails to fulfill an obligation the arbitrator found existed under the contract, the prevailing party may then sue the consumer in court to enforce the arbitrator?s award.  In that lawsuit, the court will only determine if an agreement existed, if the terms of the agreement required the arbitration, and if so, the decision of the arbitrator will be made a judgment of a court.  Although there are circumstances in which a court may refuse to enter judgment on an arbitration award, it is very difficult in most situations to convince a court not to enter judgment on the award. After judgment is entered against the loser in an arbitration proceeding, the holder of the judgment may then execute on the judgment.

 

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What are the different types of arbitration?

             Arbitration may be voluntary and nonbinding. For instance, a contract may provide that before a lawsuit is filed the parties agree nonbinding arbitration will first be used in an effort to settle any dispute.  If a party should then disagree with the arbitrator?s decision, and settlement of the dispute is not achieved, a lawsuit may be filed and the arbitration decision is ignored.

            Arbitration may also be compulsory and binding. In consumer transactions where arbitration agreements control, the public is almost invariably bound to mandatory arbitration.   In this situation, the consumer is forced to arbitrate any dispute and the arbitrator?s decision is final.  Even if the consumer objects to the arbitrator?s decision, there is no right to appeal.  If the consumer fails to pay the amount the arbitrator awards or fails to fulfill an obligation the arbitrator found existed under the contract, the prevailing party may then sue the consumer in court to enforce the arbitrator?s award.  In that lawsuit, the court will only determine if an agreement existed, if the terms of the agreement required the arbitration, and if so, the decision of the arbitrator will be made a judgment of a court.  Although there are circumstances in which a court may refuse to enter judgment on an arbitration award, it is very difficult in most situations to convince a court not to enter judgment on the award. After judgment is entered against the loser in an arbitration proceeding, the holder of the judgment may then execute on the judgment.

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What laws permit companies to force the public to arbitrate disputes?

States have passed laws permitting arbitration.  In some instances, whether arbitration may be compelled may depend on whether the arbitration clause complies with the applicable law of a given state.  For instance, under some state laws, the fact a contract is governed by an arbitration agreement must be conspicuously displayed on the face of the document.  Otherwise, arbitration may not be compelled.

However, under federal law, conspicuous warning that an arbitration agreement is in a contract is not necessarily required.  Further, under federal law, a consumer may be bound to an arbitration clause even though he or she did not specifically sign an agreement to arbitrate. Federal law requires only that there be ?an agreement in writing.?  The failure of federal law to adequately protect consumers in the United States has created many cases of unfairness where individuals have effectively been bound to arbitration clauses they were unaware of at the time they entered into contractual agreements. The failure of federal law to properly protect consumers is understandable if the law is examined in the context of its intended purpose at the time it was enacted.

In the early 1900's congress passed a law called the "Federal Arbitration Act."  This law which was intended to apply to merchants engaged in interstate commerce at the time it was passed, is now in the 1990's being used as to force consumers to give up their right to sue in court.  Arbitration was intended to be a process whereby equally sophisticated businessmen could negotiate an agreement with each other to submit any dispute they might have to an independent third party for resolution instead of a court.  The theory was that as to businessmen, the law should permit an alternative method for them to quickly resolve their differences outside of court. The fact is that most businesses engaged in such transactions have lawyers on retainer or on staff to negotiate contracts. They fully understand the ramifications of arbitration, and parties of equal bargaining strength agree to the terms of the arbitration. However, most consumers do not understand fully the impact of arbitration agreements and the severe limitations that these agreements place on their ability to have a remedy if they are cheated. In consumer contracts, also known as ?contracts of adhesion,? the public has no ability to reject the arbitration clause, and is presented with a transaction only on ?take it or leave basis.?

Contracts with arbitration clauses involving credit, banking, insurance, and even home construction projects are now appearing with increasing frequency. Often the arbitration clause is hidden in the middle of fine print, or sometimes printed on the back of a page of text.  At the time a consumer signs a contract containing an arbitration clause, the consumer may not even know the clause is in the document.  However, when a dispute, an unfair charge, a breach of warranty, or a failure on the company?s part to perform occurs, the person victimized learns that in the process of signing the contract, legal rights were also signed away.  Among those rights signed away was the right to go to court.

 

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Why are arbitration clauses usually unfair to a consumer?

There are several reasons why arbitration clauses are bad for consumers.

(1) An arbitration clause generally prohibits a consumer from filing any lawsuit in a court of law. In a lawsuit people have much broader procedural protections and rights than they have in arbitration.  After a lawsuit is filed in court, a lawyer can force a defendant to submit his employees for deposition, to answer questions under oath in writing, and to allow an inspection of documents.  If a defendant or its lawyers are caught concealing information or lying, a judge can impose severe penalties.  If a defendant refuses to produce documents or is evasive in answering questions, they can be forced by a court to fully answer, or in extreme cases a defendant can be found liable without a trial. 

             In an arbitration proceeding, these rights may not exist, or may be severely curtailed. Since a plaintiff likely will never be able to obtain full discovery, many frauds, lies and deceptions may go totally undiscovered. Even if a consumer, for instance finds an intentional pattern of fraud by a defendant to cheat thousands of people out of money in the same manner the consumer in arbitration was cheated, there is little that can be done to provide a remedy for those other people.   Why?

(2) Because arbitration clauses generally prohibit the resolution of any dispute as a class action.  Since no claims can be arbitrated as a class action, the most the defendant could ever be held accountable for is the claim of the individual who filed a demand for arbitration. So as long as the corporation only cheats each consumer out of two or three hundred dollars, they probably have a license to steal. Even if the consumer gets mad, in the absence of a right to pursue a class action, he would likely never find a lawyer willing to take a case that involves only a couple hundred dollars. Therefore, the consumer would probably have to represent himself in an arbitration. If the consumer does try to represent himself, the filing fee to demand arbitration could be as much as a hundred dollars or more.  If the consumer pays the filing fee and attempts to represent himself, he won't likely get the " legal discovery" that he needs to prove his claim. Finally, when the claim comes up for hearing, generally corporations will send in highly skilled lawyers to object to any evidence the consumer wants to present.  Does this sound lop-sided?  Now you know why corporations like arbitration clauses.

 

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What can I do to preserve my legal rights?

As a general rule, if any business tries to force consumers give up their right to go to court, you should consider finding a different place to do business. An honest company should not be afraid of the legal system or of being sued. Any arbitration agreement included in a contract involving a transaction where a consumer doesn?t have a lawyer representing him or her, and where the person is not actively negotiating the "contract as a whole" is almost invariably bad news for the consumer. Any company that is engaged in consumer transactions and feels it needs protection from lawsuits is probably engaged in questionable business practices. In fact, including an arbitration clause in any consumer contract is itself a questionable business practice but is becoming increasingly common.

Finally, if you have a contract with an arbitration clause and a serious dispute arises between you and the company you contracted with, you should have the contract examined by a lawyer.  In some instances, courts have held arbitration clauses don?t comply with applicable state or federal law and are unenforceable.  Also, arbitration clauses have been invalidated in some instances as unfair or ?unconscionable.?  

 

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What needs to be done to protect consumers?

The solution to the problem is very simple.  Congress needs to pass a law banning the use of mandatory arbitration clauses in all consumer contracts.  In this day and age, so much has been done by big business and the insurance industry to attack lawyers representing consumers in class actions, that people might be mislead into the belief that class actions are nothing but "lawyer cases."  The truth of the mater is that lawyers are the only safeguard the public has to police unethical and cheating companies.  The effort to destroy consumer rights is serious. The public needs to be aware of the fact that without class actions providing an effective tool to punish companies that cheat, everyone will be cheated. 

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