When Arbitration is An Unwise Choice

Arbitration is an extremely attractive form of alternative dispute resolution, and from the point of view of transactional lawyers, there seems to be an increasingly frequent use of arbitration clauses in transactional documents. The attraction of arbitration is that it appears to offer a less expensive and perhaps less onerous mechanism for resolving disputes. While it may offer these benefits, remember the axiom that when someone offers you something that is too good to be true it usually is not true. More specifically, when you consider what you are gaining from an arbitration clause, consider the two principal procedural devices that are being given up.

The focus of this article is upon the use of such clauses in deeds. In standard instruments of conveyance, one rarely sees an arbitration clause. However, in deeds executed for the purpose of resolving disputes, there is a motivation, borne of the fact that the parties have already spent tens of thousands of dollars in legal fees, to build in a less expensive way of resolving disputes among parties who have already shown themselves to be prepared to go to war. Let’s consider what one gives up in arbitration.

First, the rules of evidence. There are times when the rules of evidence work against us and prevent us from proving something that is relevant, and people perceive that adherence to the rules of evidence unduly prolongs proceedings. But the rules of evidence developed over centuries in the judicial system are designed to assure that binding determinations of the rights of parties are based upon reliable evidence. In arbitration, this protection is not present. To be sure, a capable arbitrator may be able to sift the wheat from the chaff, but the process for choosing arbitrators does not necessarily always lead to people with such qualifications. Furthermore, the AAA arbitration rules often provide that each party is to choose an arbitrator, who is expected to be a partisan, and the remaining two may then choose a neutral. This is not a process that is geared to choosing a person of wisdom and judgment, although one hopes for such an eventuality.

The absence of the second procedural device, in a sense, aggravates the absence of the first: there is an extremely limited scope of judicial review of an arbitration award. In general, in the absence of proof of corruption or that the arbitrator(s) exceeded the scope of his or her authority, there is no remedy for an arbitration award with which a party is dissatisfied.

This brief article focuses upon the possibility — disturbing at best and horrific at worst - that the parties to a deed would include an arbitration clause in the deed. There are certain rules for the construction of a deed that have been established over centuries and which are designed to enable purchasers of real estate to objectively determine how a deed will be interpreted. For instance, absent a patent ambiguity on a deed, the deed must be construed in accordance with what is found within its four corners, and no extrinsic evidence of the intent of the drafter will be admitted or considered. Another set of rules governs the construction of deed descriptions: monuments prevail over distances, etc. Arbitration does not guaranty that any of these rules will be adhered to. Indeed, if an arbitrator tries to adhere to them, he may be contravening the arbitration rule that the rules of evidence do not apply. An arbitrator may consider that he is merely construing or interpreting a deed, but in reality may be revising or reforming a deed. The law requires evidence of mutual mistake or fraud in order for a court to reform a deed. One might think that if an arbitrator seems to be changing what a deed provides, he is exceeding the scope of his authority. However, that would be an argument one would have to make to a court, and one, the disposition of which is entirely uncertain.

In the judicial system, a deed must be construed in accordance with its express text, unless the court first determines that there is an ambiguity; if the trial court exceeds its authority, and decides to revise the express text of a deed, without first hearing evidence of mutual mistake or fraud, and the evidence must be clear and convincing, there is an appellate court to correct the error. No such real protections exist in arbitration.

The conclusion of this article, if it was not already evident, is that one should never, never, never agree to put an arbitration clause in a deed. Having said that, I add a qualification and a suggestion.

In the event the deed in question includes an option to purchase and there is a need to create an enforceable mechanism to determine the purchase price, there is no reason to refuse a provision that leaves the determination of the purchase price only to an arbitration process. Finally, if the parties wish to have a mechanism for enforcement or interpretation of the deed that does not require them to resort to a plenary lawsuit, they may wish to agree in advance to have the dispute referred by the Superior Court to a referee chosen by the court. The parties will usually have to pay for the referee, as they would for an arbitrator, but the referee will be subject to judicial review and will need to adhere to the requirements of law in hearing and resolving the dispute.