December 2001

A Practical Guide To Arbitration For CPAs

By Philip Zimmerman

Arbitration is the ideal tool in the alternative dispute resolution (ADR) toolbox to deal with certain types of disputes where mediation is impractical or has previously failed. A major and increasing use of arbitration is for the resolution of securities disputes, primarily by the National Association of Securities Dealers (NASD) and the New York Stock Exchange. The NASD has estimated that a record 7,000 claims were filed in 2000. Certain other industries, such as textile, architecture, construction, and financial planning, routinely use arbitration clauses in their contracts. The most frequent use of arbitration is in the resolution of no-fault automobile insurance claims. This is the major reason for the growth of cases administered by the American Arbitration Association (AAA).

When a litigant wants a final and binding decision (the award), arbitration works better than mediation. Awards are only subject to judicial appeal on very limited grounds. The award may be enforced in any court having jurisdiction over the parties. The parties also appreciate that the process is generally faster and less expensive than litigation.

What Is Arbitration?

Arbitration is designed to be private and informal, faster than litigation, practical, economical, and confidential. Informality is an important feature. Under the commercial AAA rules, the procedure is relatively simple and can even be amended to suit the needs of the parties. Legal rules of evidence are not applicable, there is little motion practice, and there is no requirement for transcripts of the proceedings or a written opinion from the arbitrator. The discovery process is informal (although the arbitrator can request relevant documents not voluntarily submitted) and allows the limited deposition of witnesses. Each party has the right to be represented by counsel and has a full opportunity to present its claims, proofs, and witnesses (which may be cross-examined). Finally, the process is less acrimonious than litigation.

Arbitration has more significant disadvantages than mediation and many times is used only after mediation has been unsuccessful:

• Even though arbitration is less adversarial than litigation, it is still adversarial and may destroy business relationships.
• The process, if not efficiently administered, can become as drawn out and as costly as litigation.
• The award cannot be appealed and, except in rare circumstances such as when a party successfully challenges an arbitrator's neutrality, a court will not vacate it.
• When third parties are involved, arbitration will not preclude a third party from bringing another proceeding against any of the parties to the arbitration.

Arbitration of Employment Disputes

In recent years, many employers have adopted in-house employment dispute resolution systems to improve morale and reduce the risks of financial and reputation loss after litigation. Large, publicized awards have recently been handed down against employers, as a result of litigation by the U.S. Equal Employment Opportunity Commission (EEOC) and by employees under the discrimination, sexual harassment, old age, and disability discrimination statutes. The cost of defending these lawsuits, much less the awards, can be significant, even if covered by insurance. In-house ADR systems vary, depending on the needs of the company, but generally include human resources, mediation, and arbitration procedures. This arbitration procedure was upheld by a recent Supreme Court decision, Circuit City Stores v. Adams [532 U.S.105 (2001); No. 99-1379]. Employers need to be aware, however, that under other court decisions the in-house process must provide the employee with the same remedies and costs available in court. The AAA will provide employers with model procedures and rules for such programs [www.adr.org; (800) 778-7879].

How Does Arbitration Work?

Generally, arbitration is initiated through a dispute resolution clause in a contract written before the dispute arose. This clause might provide for mediation first and arbitration only if mediation is unsuccessful. Arbitration can also be initiated once the parties are already in a dispute, by the submission of the dispute to an administrative organization, but this is more difficult. The arbitration clause or the submission should also contain language setting forth the administration and rules under which the arbitration will be conducted. A sample standard AAA clause follows:

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 under its Commercial Arbitration Rules, and judgment on the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof. If the AAA is selected as the administrating agency, the claim is filed together with a filing fee based upon the amount of the claim. The defending party must also be put on notice. (Interested readers should contact the AAA for a copy of "A Guide to Mediation and Arbitration for Business People," which details both procedures.)The AAA follows the procedures set forth in its rules, along with amendments agreed to by the parties. The standard clause above is used for commercial disputes. There are other clauses for employment, professional, construction, and other types of disputes, which are arbitrated under their own special rules. CPAs are advised to consult their insurers and attorneys before using an arbitration clause.

The AAA assigns the case to a staff member, who then assists the parties in initiating the arbitration and coordinating communication between the parties and the arbitrator. This case administrator selects, from the AAA's large and specialized rosters of neutrals, a limited list of those they deem qualified to resolve the particular claim. If the parties cannot agree on the arbitrator, the AAA will make the appointment from the appropriate roster. The AAA will select mutually agreeable dates for the hearing. Before the first hearing, the case administrator may hold a conference with the parties to help improve the efficiency of the process.

The parties, with the help of their attorneys, need to prepare for the first hearing. Since the arbitrator will base the award on the exhibits and testimony presented, it is advisable to arrange for any necessary discovery of facts and to prepare witnesses during this time.

The hearing may run for one or more days, depending on the complexity of the claim and the cooperation of the parties. The hearings are less formal than a court proceeding and accordingly take less time.

Each party is given an opportunity to present all evidence that the arbitrator deems relevant and material. Witnesses are sworn to tell the truth and are subject to cross-examination. Upon conclusion of the final hearing, the arbitrator renders the award within a short, prescribed time period.

The CPA and Arbitration

CPAs participate in arbitration as either a party or a neutral. By inserting ADR clauses into client engagement letters or employment and other contracts, CPAs may become a party to an arbitrated dispute. CPAs already have the business and financial training to serve as a neutral; they must also be admitted to the panel of an administrative organization such as the AAA or the NASD or be nominated in an ADR clause. (See "CPAs as Neutrals" in the November 2001 Trusted Professional for details.) Either way, knowing how arbitration works will add to the CPA's professional value.

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