What is an Arbitration Clause?

Signing a contract together doesn’t always lead to a happily-ever-after.  There may be disagreements over contract interpretation, or an unforeseen event that alters the circumstances around the deal. One party (or both) may find themselves unable or unwilling to comply with their obligations.

However it happens, contract disputes are messy. If the parties can’t come to some agreement, they may have to go to court over the issue—and then, no matter how the dispute is resolved, everyone loses time, money, and goodwill.

Used correctly, an arbitration clause can circumvent this worst-case scenario as soon as a dispute arises.

Here’s a guide to the arbitration clause, including what arbitration is, how it differs from litigation, and why an arbitration clause in your contract could save you considerable time and money.

What is an arbitration clause?

An arbitration clause, sometimes also known as an arbitration agreement, is a clause in a contract that specifies situations in which the involved parties can summon each other for arbitration. By signing a contract with an arbitration clause, all signing parties agree in advance to resolve the conflicts specified in the clause through arbitration. 

What is arbitration?

Arbitration is a private and confidential Alternative Dispute Resolution (ADR) procedure that allows contractual disputes to be settled out of court. Arbitration requires the express consent of both parties involved in the dispute. Together, these parties agree upon a neutral third party called an arbitrator. Arbitrators are usually (but need not necessarily be) professionals provided by an arbitration authority such as the American Arbitration Association.

During the arbitration proceeding, the arbitrator will hear both parties argue their side of the dispute, presenting evidence and articulating their preferred resolution, just like a judge would in a court case. Unlike a public court case, however, the arguments will not be evaluated by a jury of the two party’s peers. Instead, after hearing both sides' arguments, the arbitrator makes a binding decision that both parties agree to follow. This decision could favor either party or force both to compromise.

The American Arbitration Association (AAA) has more detailed explanations of the different types of arbitration available on its website. For example, there are very important differences between commercial and consumer arbitrations.

What kind of disputes can and cannot be settled by arbitration?

The main difference between arbitration and litigation is that arbitration can never be compelled. If both parties can’t agree to meet for arbitration or honor the third-party arbitrator's decision, then arbitration cannot occur.

For this reason, any disputes where one or more parties cannot reasonably be expected to agree to arbitration without admission of guilt or coercion are generally not solvable through arbitration. For example, most criminal, family, matrimonial, and labor disputes can’t be settled by arbitration. Instead, as in the case of a criminal dispute, the prosecuting authority would compel the defendant to appear in court with the force of law.

Why would someone choose arbitration over litigation?

The biggest advantage of arbitration is that it's much faster and cheaper than going through the courts. Instead of hiring lawyers, preparing cases, and waiting months or even years for their court date, parties coordinating an arbitration need only find a time when the agreed-upon arbitrator and party representatives can meet to resolve the dispute.

Arbitration may also be preferable to litigation when the source of the dispute is highly technical. In such cases, the parties involved may find an arbitrator with the required technical expertise to make an informed decision, rather than dealing with a judge or jury who might not be as well-equipped to understand the problem. 

How can I start arbitration?

The International Centre for Dispute Resolution details the specific steps for filing an arbitration case online.

It’s important to note that, unlike litigation, arbitration cannot be compelled without advance agreement. When one party formally submits a request of arbitration to another and/or to an arbitration authority, all other parties involved in the dispute must agree to undergo arbitration before it can move forward.

The arbitration clause was created to establish this advance agreement.

Why should I include an arbitration clause in my contract? 

You should include an arbitration clause in a contract whenever the agreement may lead to disputes all parties can agree to resolve through arbitration.

With an effective arbitration clause in place, you have an established and legally binding plan for resolving specified disputes. If a signee refuses to participate in an arbitration legitimately outlined in their arbitration clause, they will be considered in breach of contract.  

How do I include an arbitration clause in my contract?

The AAA includes several samples of different forms of arbitration clauses on its website. You can copy and paste these samples into your contract and amend them as necessary.

If you’d like to make inserting arbitration clauses now and in the future even easier, Docusign can help. Document generation allows you to create arbitration clauses as a saveable template to use, edit, and reuse as needed.

This content is for general educational purposes only and is not intended, and should not be considered, legal advice. Laws frequently change and this information may not be current or accurate.  Docusign disclaims all warranties of any kind with respect to this material including merchantability, fitness for a particular purpose, or accuracy.  You should consult with a licensed attorney in your area for legal advice.