Arbitration Clause

An arbitration clause is a contract provision requiring that disputes between the parties be resolved through binding arbitration rather than court litigation. The clause typically specifies the arbitration provider (AAA, JAMS, ICC), the rules, location, arbitrator selection, class action waivers, and confidentiality terms. It has implications for cost, speed, privacy (arbitration is private; court is public record), appeal rights (extremely limited in arbitration), and discovery scope (typically more limited than court). Arbitration clauses are increasingly common in commercial contracts, employment agreements, and consumer terms of service. It's the contract provision that determines whether disputes go to court or to a private arbitrator.

The key elements:

Scope of arbitration: what disputes are covered. Often "any dispute arising out of or relating to this agreement." Sometimes carved out for IP claims or injunctive relief.

Arbitration rules and provider: which rules govern (AAA, JAMS, ICC), and which arbitration provider administers.

Location: where arbitration takes place (often the company's location).

Arbitrator selection: single arbitrator or panel; selection process.

Class action waiver: prohibition on class arbitration or class actions. Increasingly standard but enforceability varies by state.

Confidentiality: whether proceedings and outcome are confidential.

Discovery: scope of allowed discovery (typically more limited than court).

Arbitration vs. litigation:

Cost:

• Arbitration: lower court fees but arbitrator fees ($500-$2000/hour); often comparable to litigation in complex cases.
• Litigation: filing fees but no judge fees; can be cheaper for simple cases.

Speed:

• Arbitration: typically 6-18 months.
• Litigation: can take 2-4 years for trial.

Privacy:

• Arbitration: private; outcome confidential.
• Litigation: public record.

Appeal rights:

• Arbitration: extremely limited (only for arbitrator misconduct).
• Litigation: full appellate review.

Decision-maker:

• Arbitration: parties select arbitrator with relevant expertise.
• Litigation: random judge assignment.

Discovery:

• Arbitration: limited; faster.
• Litigation: extensive; slower.

Common arbitration scenarios:

Commercial contracts: increasingly standard in B2B agreements.

Employment agreements: often include arbitration clauses (subject to recent legal changes; sexual harassment claims often carved out by law).

Consumer terms of service: very common in SaaS, e-commerce; often with class action waivers.

M&A agreements: arbitration of post-closing disputes (purchase price adjustments, indemnification claims).

What founders should consider:

For company: arbitration generally favorable (privacy, no public lawsuit, expert decision-maker, limited discovery).

Class action waivers: significantly reduce class action exposure (enforceability varies).

Carve-outs: consider carving out IP claims (often need injunctive relief in court) and small claims (court is fine for small disputes).

Enforceability: most arbitration clauses enforceable in US (Federal Arbitration Act); some state law restrictions on consumer/employment arbitration.

What founders get wrong: Assuming arbitration is always cheaper and faster than court, then being surprised when complex arbitrations cost as much as litigation. The right discipline: choose arbitration for privacy, decision-maker control, and limited discovery; carve out claims where court is better.

Related: Terms of Service · Customer Contract · Master Services Agreement · Employment Agreement · Dispute Resolution

FAQ

What is an arbitration clause?
A contract provision requiring disputes between parties to be resolved through binding arbitration (a private dispute resolution process) rather than court litigation. Has implications for cost, speed, privacy, appeal rights, and discovery.

Is arbitration cheaper than court?
Sometimes. Arbitration has lower court fees but arbitrator fees ($500-$2000/hour) can offset savings. Often comparable to litigation in complex cases. Arbitration is typically faster (6-18 months vs. 2-4 years for trial).

Should startups include arbitration clauses?
Generally yes for B2B contracts and consumer terms of service. Benefits include privacy, expert decision-maker selection, limited discovery, and class action waivers (in consumer ToS). Consider carve-outs for IP claims and injunctive relief.