The Danger of Arbitration Clauses

If you do business in the State of Texas for long enough, you’ll eventually be asked to sign contracts that require that all legal disputes be settled through binding arbitration. Many consumers and businesses agree to binding arbitration because:

  1. They feel that they don’t have a choice (which is never the case with any contract—you can always walk away).
  2. They don’t understand what binding arbitration means.
  3. They somehow feel that the private process will be less costly than settling the matter in the Texas courts. (This is not usually true.)

As a Houston, TX business litigation attorney, I advise my clients not to give up their legal writes by signing documents that bind them to arbitration. To understand why signing a business contract with an arbitration clause is almost never a good idea, it’s important to understand how the arbitration process works. In Texas corporate law, binding arbitration means that the parties are required to bring their disputes before a third party—usually a lawyer or a retired judge. After listening to the parties, the arbitrator makes a ruling. The parties are now contractually bound to abide by that ruling. The mechanisms for appealing an arbitrator’s decisions are very challenging. Furthermore, the company that created the document may stack the odds in its favor.

For instance, consider a Houston software development firm that contracts to write programs for a large computer company out of Pasadena, CA. The computer manufacturer does a lot of intellectual property business with independent Texas companies, so they’ve had their corporate lawyers draft a standard contract for all of their business partners—complete with a mandatory binding arbitration clause. This clause is written so that the Texas companies have to use a Pasadena arbitrator of the computer manufacturer’s choosing—who will probably be someone that they use often. As you can see, before the contract dispute even occurs, the Pasadena computer manufacturer has an enormous advantage over the Houston software developer. The case is brought to its venue with a handpicked arbitrator deciding on it. What makes matters worse is that because the Houston software developer has agreed to be bound by the arbitrator’s decision, it has little recourse in the Texas courts or anywhere else.

It’s also important to note that the arbitrator is not necessarily bound to common legal practices. If the arbitrator makes an erroneous decision—regardless of his or her motive—the parties lack a venue in which to appeal that verdict.

To avoid these pitfalls, before signing a contract with another business, ask a reputable corporate lawyer to review the document for arbitration clauses. Remember, you always have the ability to walk away from the deal at any point before its finalized. There’s a good chance that your new partner may be willing to drop the clause in the interest of keeping your business.

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