Private Justice

The case of BFN v. Adair, decided today in the Colorado Court of Appeals, is legally unexceptional. A collection of all the cases which, like this one, have held that parties in a contract with an arbitration clause can't have the merits of their case decided by a court would probably fill more pages than the Internal Revenue Code and all of the regulations that go with it. But, the window that opinion provides into the shadow world of private justice that the case involves is notable.

BFN hired Adair to build to a couple of large apartment complexes in Colorado. BFN was unhappy with some of the charges and/or work done, and withheld payment from Adair. We don't know exactly how big the projects were, or how much was withheld, but we do know that Adair was awarded $1.3 million by arbitrators out of the amount withheld by BFN which was presumably less than the total amount that BFN withheld. It is safe to guess that the total deal involved, at least, tens of millions, if not hundreds of millions of dollars. In short, this was a big time construction deal, between two large, sophisticated companies in the construction industry.

Notably, despite the scale of the job and sophistication of the parties, only a small part of the contract was actually individually drafted for this job. Much of the contract, probably the bulk of it, consisted of boilerplate standard terms incorporated by reference, prepared by the American Institute of Architects, which in turn referenced boilerplate rules of arbitration procedure of the American Arbitration Association. This is not unusual. Commercial agreements are usually done with standard forms, a fact which has attracted a great deal of attention from academics who study contract law.

The "dickered" agreement tailored to the specific circumstances of a transaction is the marginal exception in our economy, rather than the norm, despite the fact that the notion of a dickered individually tailored contract is the paradigm upon which Anglo-American contract law is based, even in big dollar transactions between sophisticated parties whom one often thinks of as the typical place where individually negotiated contracts would be used. (European commercial practice is for statutes to supply many of the terms found in boilerplate contract terms in Anglo-American law, resulting in far shorter contracts, often prepared by legally trained non-lawyers employed by the companies involved in their legal or contract departments or by legally trained independent notaries). In practice, dickered custom agreements are far more common in non-commercial contracts between two one time players, often without counsel, than they are in the ordinary deal by regular participants in a particular industry.

One of the main benefits of choosing arbitration (i.e. having a private third party rather than a court resolve disputed over contract), generally, is that your case is heard by decision makers who have time to listen to the evidence promptly on a schedule that suits the parties. This is certainly in evidence in this case. The case went from an initial request for arbitration to a preliminary judgment on the merits (with jurisdiction retained to supervise how their judgment was carried out) in just seven months, yet the arbitrators found time to take nineteen days of testimony. In contrast, it would be years before an ordinary court would have time to hold nineteen days of trial in a case like this one, and when it did, it would be unlikely to be able to break up the hearing into multiple piecemeal parts, as the arbitrators appear to have done in this case.

The arbitration also put the decision into the hands of more sophisticated decision makers than the court system would have in a case like this one. It would not be at all unusual for a case like this to be tried to a judge who had never handled a construction case in private practice in his entire life (quite likely the judge's background would have been in criminal law), and a jury of six ordinary people with no sense outside the trial of what was involved in a multi-million dollar construction project. In contrast, the arbitrators almost certainly had considerable specific experience in dealing with construction contracts on large projects, and hence would have been familiar with construction industry norms, how these projects are usually handled in real life, and what facts the participants would have considered important at the time.

This, of course, didn't come cheap. I suspect that it cost the parties something on the order of $100,000 give or take a factor of two, and probably didn't save either party a huge amount of attorneys' fees, although it probably did compress those attorneys' fees into a shorter amount of time.

This case is typical of arbitration cases. One of the biggest downsides of arbitration is that it is almost never possible to appeal the arbitrator's decision, even if they a grossly incorrect on the law or the facts. As a result, arbitration is usually inserted in a contract only where expediency is more important that getting precisely the right result in each particular case. People in one time transactions who can't afford to lose if they are in the right almost never choose arbitration. (Colorado's newly revised rule of civil procedure 122, providing for private judges who are in almost all respects but availability the exact equivalent of a judge on the public payroll are designed to offer the scheduling benefits of arbitration without the other downsides that have so far largely prevented parties from agreeing to it after the fact.) But, two big companies who engage in numerous multi-million dollar deals can afford to take that kind of risk. So, can large employers with unions with hundreds of thousands of employees, another situation where arbitration agreements are common.

When you see arbitration clauses in consumer contacts, they are almost always found in boilerplate contracts of adhesion drafted by repeat players who don't really care how individual cases come out, so long as the results, on average, can't threaten to cripple the merchant. In these cases, one of the other important factors is that consumers may be discouraged from taking action at all. A consumer faced with an arbitration clause knows that he or she will be before decision makers chosen in a process established by the merchant (who will lose the merchant's arbitration business if they consistently rule against the merchant, regardless of whether that is or is not the right decision), that he or she will forego legal rights that they had in the ordinary courts, and that the high costs of an arbitrator may end up being paid by him or her if the merchant wins. Consumers agree to these terms only because they have no choice and recognize that the vast majority of the time that there will not be a dispute.

The private justice of arbitration has proven far less popular than most people suspected that it would when it was first catching on. Parties to a real dispute that has already arisen very rarely agree to it. The expense involved and need for court involvement to enforce an award once an arbitrator makes one (a key factor in consumer cases where collectability is often a bigger issue than liability), has discouraged most businesses engaged in small, simple transactions that are handled satisfactorily in limited jurisdiction courts from choosing it. For example, residential landlords and businesses that make small unsecured loans, very rarely include arbitration clauses, even though they could easily do so, because the court process, which often ends in a prompt default judgment or agreed settlement or short and prompt trial, works well enough and creates judgments that are immediately enforceable against third parties. Other businesses have declined to use arbitration clauses as a matter of business marketing because consumers rightly view them as unfair to them, and the downside of not having an arbitration clause for the business is often modest. However, the low budget approach of the inexpensive publicly operated limited jurisdiction courts is unattractive in a case where big dollar amounts are at risk.

The availability of arbitration is one of the main reasons that there is no "commercial law reform" movement out there to rival the "tort reform movement" and that the demand for courts designed to serve commercial cases has been subdued. Tort cases often involve people who had no relationship with each other prior to an accident happening, and hence can't be governed by an arbitration clause entered into in advance. Thus, people involved in those cases have no choice but to make the public court system work for them. In contrast, in contract cases, people who are unhappy with the system often can systemically opt out of the public court system, so they don't need to reform it. However, if we do ever want to substantially reform the courts so that parties in the kinds of cases that go to arbitration now don't choose to opt out of the system, arbitration shows us what features that system needs to have (particularly prompt rulings reached by decision makers who have ample judicial resources to actually hear evidence).