Should You Arbitrate Your Family Business Disputes?
When family business disputes erupt, the parties often end up in court, where a judge or a jury will decide their fates. Litigation of these cases often takes years. In Massachusetts Superior Court, for example, the rules provide for a presumptive 22 month schedule before judgment in a so-called “fast track” case, while an “average” track case has a 36 month time-frame before judgment. Federal courts or other states’ trial courts may have slightly faster deadlines to judgment, but the fact is that litigation in court can be a long, drawn-out exercise. This extended time-frame not only delays the resolution of the dispute, but also can interfere with the ongoing operation of the business during the suit, as management and employees divert their attention to discovery requests, motion practice, and trial preparation over an extended period. Not to mention the strain such a lengthy process puts on already contentious family relationships.
Court-based litigation also tends to be very expensive. The parties are entitled to take formal discovery of each other and third parties, including document requests and depositions, and to engage in motion practice along the way, all well before ever getting to the point of preparing for trial. Preparing for and conducting a trial before a judge or jury is likewise extremely costly. There is also the uncertainty that comes with the prospect of unsophisticated jurors or a randomly-assigned judge (however well-respected) ruling on matters that may involve long-standing and complicated business and family relationships among the parties.
Finally, the publicity and reputation risk that accompanies litigation in the courts is often a negative for all involved. In a family business setting, that may be even more true. Often, the parties to a family business dispute end up airing each other’s personal dirty laundry, or raising irrelevant or very old claims of personal indiscretion or misconduct, in an effort to sway the fact-finder.
…the publicity and reputation risk that accompanies litigation in the courts is often a negative for all involved.
Through arbitration instead of litigation, parties may be able to minimize the publicity, delay, and unpredictability of litigating in the courts. The important point, however, is that the parties must decide at the outset of their business relationship (or through a later amendment) to include an arbitration clause in the agreement(s) governing the parties’ dealings. In the face of a valid arbitration clause, a judge will require parties to arbitrate, even if a party first files the case in court.
Arbitration clauses take various forms but a typical broad form of such a clause – as appearing on the American Arbitration Association’s website (www.adr.org) – provides:
Any controversy or claim arising out of or relating to this contract, or the breach thereof, shall be settled by arbitration administered by the American Arbitration Association in accordance with its Commercial Arbitration Rules, and judgment on the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof.
Such a provision could be included in any or all of the agreements typically entered into among family business owners, including corporate by-laws, operating agreements, buy-sell agreements, and shareholder agreements.
There are many perceived advantages to arbitrating, and not litigating, family business disputes:
Confidentiality. With a court-based lawsuit, all the papers filed are available for review by the public, including the press and competitors (except in the rare case of an impoundment order), and all hearings, trials and other conferences held in the court are likewise open to the public. By contrast, arbitrations are strictly private proceedings. The public has no right to view any papers nor to attend any proceedings. Indeed, it is unlikely that any non-party would ever find out about an ongoing arbitration unless a party told them.
Speed. Arbitrations are not subject to court-based scheduling rules or presumptive case tracking deadlines. Instead, the parties agree upon a schedule, in consultation with the arbitrator, which the arbitrator will then enforce absent a compelling request to extend the schedule. Arbitrations thus can proceed much faster than most court actions.
Selection of decision-maker and process. In court, the judges are typically randomly assigned to cases from the outset. Thus, the parties have little control over which judge will preside over their case after filing. Judges tend to have varied legal backgrounds and likewise hear a wide range of cases on their dockets (from assault and battery to zoning disputes). It is rare (except perhaps in specialized business courts) for any given judge to have extensive experience presiding over cases involving family business disputes. Jurors, who by definition are supposed to represent a cross-section of the community, are even less likely to have dealt with family business issues. Thus, the ultimate decision-maker may well be one or more people who have never before dealt specifically with family businesses, nor the issues particularly in dispute in the case before them. With arbitration, by contrast, the parties select their own decision-maker, typically from a panel of experienced professionals in the relevant field. The parties thus may take comfort in their ability to control the selection of the person who will rule on the issues in the matter, rather than leaving it to the luck of the draw through the court system.
Of course, there are also some downsides to arbitration that parties should consider before agreeing to arbitrate all claims:
Cost. While the relative speed of arbitration compared to court based litigation will typically result in efficiencies and cost-savings, there are additional arbitration costs that do not arise in court. Notably, courts are publicly funded and the initial filing fee (typically in the hundreds of dollars) usually will be the only court costs. By contrast, arbitrations, as private proceedings, are funded from start to finish solely by the parties. The filing and case administration fees for arbitration also tend to be much higher than court filing fees, and can run into the thousands of dollars. Further, unlike judges, arbitrators are typically private legal practitioners or other professionals who will charge hourly rates for their services as arbitrator. Thus, over the course of even a few months of preparing for and conducting an arbitration hearing in a complex family business dispute, arbitrator fees can easily grow to tens of thousands of dollars.
Limited discovery rights. In every case, parties need to develop evidence that will support their claims or help to respond to the other side’s defenses. Unlike civil litigation under the court rules, parties in arbitration are not presumptively entitled to take discovery of the other parties or of non-party witnesses. Thus, the parties would need to agree upon – or convince the arbitrator to allow – the conduct of certain discovery. This process can result in either a limitation on the amount of discovery a party otherwise could take or added expense in arguing about the issue in pursuit of an arbitrator’s allowance of broader discovery rights.
Limited appeal rights. Subject to complying with the proper procedure, litigants in court have the right to appeal any adverse ruling that the trial court enters. An appeals court thus could review the entire trial court record below to decide if the judge or jury made any errors in finding facts or applying the law. With arbitrations, by contrast, there are very limited grounds on which a party can successfully seek judicial review. While state and federal statutes may differ in their details, the grounds for judicial review of an arbitrator’s award are typically limited to: whether the arbitrator exhibited improper partiality to one party over another; whether the arbitrator improperly refused to hear material evidence; whether the arbitrator exceeded his authority; and whether there was no agreement to arbitrate the issue the arbitrator ruled upon. There is typically no ability to challenge the arbitrator’s findings of fact or even his misapplication of law. Thus, far more often than not, a losing party is stuck with the arbitration award with no real opportunity to appeal.
There are many potential benefits to agreeing to arbitrate family business disputes but also certain downsides to opting out of the court system to resolve such disputes. Because an arbitration clause is required to get to arbitration in the first place, the time to consider where and how to resolve disputes will almost always be at the contract negotiation stage. This is the point when parties typically are least likely to be thinking about fighting with one another in the future. But this choice can have lasting and serious consequences later on if a dispute arises.