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Mandatory binding arbitration is a proceeding used to settle disagreements between two parties. As the name implies, the parties are required (or mandated) to use an arbiter to hear their arguments, and have to accept the arbitrator's decision. The outcome of the arbitration hearing is binding.
In the financial world, arbitration is a common mechanism for resolving disputes between clients and their financial institutions; investors and brokers or money managers; or between brokers.
When one party to a contract believes that the other party has not upheld the terms of the agreement, the former typically has the right to sue and seek damages in court.
If the case is not settled before it goes to trial, the court may award the plaintiff with monetary damages. For example, that might happen if it finds that the defendant has broken or violated the contract—either the spirit or the letter of it—causing loss or harm to the plaintiff.
Arbitration is an alternative form of dispute settlement in which the parties to a contract agree to have their case reviewed by a third party other than a judge (an arbitrator).
A provision in a contract may designate mandatory arbitration as the settlement form and require two parties to resolve disputes via an arbitration proceeding rather than through the court system.
Mandatory binding arbitration often requires the parties to waive specific rights. Specifically, the relevant contract provision removes or limits a party from suing if they feel wronged. They must go to arbitration instead.
It also takes away their right to appeal any decision. By its binding nature, the proceeding means the arbiter’s judgment is final.
At their most basic, binding arbitration clauses typically state the conditions under which arbitrations occur. You may see something like this:
Arbitration. All claims and disputes arising under or relating to this Agreement are to be settled by binding arbitration in the state of [insert state in which parties agree to arbitrate] or another location mutually agreeable to the parties. An award of arbitration may be confirmed in a court of competent jurisdiction.
On the other hand, clauses can be more detailed:
Arbitration. All claims and disputes arising under or relating to this Agreement are to be settled by binding arbitration in the state of [insert state in which parties agree to arbitrate] or another location mutually agreeable to the parties. The arbitration shall be conducted on a confidential basis pursuant to the Commercial Arbitration Rules of the American Arbitration Association.
Any decision or award as a result of any such arbitration proceeding shall be in writing and shall provide an explanation for all conclusions of law and fact and shall include the assessment of costs, expenses, and reasonable attorneys' fees.
Any such arbitration shall be conducted by an arbitrator experienced in [insert industry or legal experience required for arbitrator] and shall include a written record of the arbitration hearing. The parties reserve the right to object to any individual who shall be employed by or affiliated with a competing organization or entity. An award of arbitration may be confirmed in a court of competent jurisdiction.
Arbitrations tend to be less formal, less costly, and faster than court trials. However, in cases involving large financial sums or with significant impact, an arbitration may be heard and decided by a committee or tribunal that functions similarly to a jury.
Arbitration costs can vary greatly, depending on the jurisdiction, the amount of time the arbitration takes, and the complexity of the proceedings. Arbitrators' fees and other fees accrue at a daily or hourly rate.
Potential costs include:
For arbitrations provided by the American Arbitration Association, consumers pay a $200 filing fee for cases they initiate.
The business filing fee is $300 for a decision without a hearing, $300 for one arbitrator, and $425 for three arbitrators, with a $1,400 case management fee for one arbitrator, $1775 for three arbitrators, and a $500 hearing fee. Arbitrator fees are $1,500 for no hearing and $2,500 for a hearing.
JAMS, another major arbitration services provider, charges a claiming individual a $250 filing fee, but nothing if a business makes the claim. The business then bears all costs and fees. Filing fees for two-party cases are $2,000 and for multiple parties $3,500, with a 13% surcharge on Professional fees to cover case administration.
Arbitrators themselves charge between $375 and $1,125 an hour; while $600 is a typical midpoint, some charge as much as $2,000 per hour.
Contracts, loans, and other agreements created by banks, credit card issuers, and cell phone companies often contain mandatory binding arbitration clauses to prevent customers from being able to join class-action lawsuits.
Because these provisions may be buried deep in the fine print of a contract—and because arbitration itself is often an unknown or misunderstood term—many people are not aware that by signing, their rights, including their ability to sue, become significantly curtailed by the contract.
An additional critique of mandatory binding arbitration is that a customer, client, or individual usually has no say or power in the choice of an arbitrator.
In fact, the clause often states they must agree to an arbitrator selected by the other (corporate) party. Companies can use this to their advantage, engaging an arbitrator who may seem impartial and appropriate, but who actually has ties to the firm or to the industry.
As a result, the arbitrator's judgment may be based on this relationship instead of on the objective merit of each side.
Finally, arbitrators are not bound to follow legal precedent or obey any rules of legal procedure. Arbitrations are usually conducted in private and their outcomes often are kept quiet, too.
As a form of alternative dispute resolution, arbitration proceedings can either be binding or non-binding. The former means that the decision is final and enforceable.
The latter means that the arbitrator’s ruling is advisory and can only be applied if both parties agree to it. Each party maintains the right to reject the decision of the arbitrator and instead request a formal trial.
In other words, non-binding arbitration doesn't involve waiving the right to sue or to appeal, as binding arbitration often does. But the proceedings themselves are likely the same for each type of arbitration.
The maximum amount of time it can take to reach a decision and determine an award in a FINRA arbitration case.
In their terms-of-service agreements, most brokerages require their clients to agree to mandatory binding arbitration to settle potential disputes, rather than going to court. These proceedings are overseen by the Financial Industry Regulatory Authority (FINRA), through its dispute resolution forum.
When an investor has a specific dispute with a broker (presumably one registered with FINRA), they may file a claim within six years of the precipitating event that states the alleged misconduct and the amount of money they are seeking in damages.
FINRA will appoint a single financial industry professional (or a panel of three) who, unless the injured party requests otherwise, will not be employed in the securities industry. This is intended to eliminate partisanship and conflicts of interest. However, if one of the parties suspects that a member of the panel is biased, they may request a change.
The size of the claim determines how the arbitration process works.
A typical arbitration provision specifies that each party pays the costs of its representative (lawyer or non-lawyer) and those associated with providing its own witnesses. The party bringing the claim usually pays the filing fees. The parties split the cost of the arbitrator’s fees—usually charged by the day or hour—and expenses, and administrative fees. In rare cases, the agreement between the parties may specify a different distribution of the cost, such as “loser pays the cost of the arbitrator.”
Arbitrators usually have the right to make the losing person pay the costs of the arbitration, or to divide the costs.
While arbitration is less formal than a court trial, it's generally a good idea to have legal representation with you during the hearing, especially if it's a binding arbitration proceeding.
Arbitration is more formal than mediation and resembles a trial. Mediation is more of a negotiation meeting. Both have an independent, neutral third party who helps settle a dispute between two contractual parties. The mediator doesn't decide who is right but rather facilitates communication between the parties, to help them reach a resolution themselves. In contrast, an arbitrator acts as a judge and decides for one party. If it is binding arbitration, both parties must abide by the arbitrator's decision.
Generally, it's pretty difficult to opt-out, especially if you want to do business with a particular firm and sign its standard agreement or contract. But in some cases, you can opt-out. Companies often require you to do so within 30 days of purchase/signing up for a service and to use specific language in rejecting arbitration. These opt-out clauses often require that you send a letter or email to a specific address stating that you are opting out of the arbitration clause.
Arbitration can be a faster and cheaper way than a lawsuit to resolve contract disputes and differences. However, there do not seem to be many advantages to mandatory binding arbitration for individuals. Any issue they have might be better solved in open court, where the arbiters are truly impartial, and an appeals process exists.