ADR Clauses in Business Contracts

When it comes to operating a successful business, facing litigation over a conflict is a worst case scenario. There are several potential consequences, including valuable time taken away from the business, incurring potentially crippling expenses, the destruction of a previously beneficial business relationship, and the stained reputation a public court battle often produces.

Unfortunately, when different personalities come together, and especially where money is involved, disputes are an inevitability. But when these issues occur, there is no need to risk the potential consequences associated with litigation.

Conflict can be quickly, fairly, and cost-effectively resolved through alternative dispute resolution (ADR). ADR is an umbrella term comprised of several types of semi-formal and formal resolution strategies.

Because these strategies are usually voluntary, planning ahead and agreeing to such a contingency plan before working with someone is the best way to ensure that these techniques are used in place of litigation when an issue arises.

As Benjamin Franklin once said “an ounce of prevention is worth a pound of cure.”

A pre-dispute agreement can be formalized as a clause in your business contract.

Let's dive in and see how to include provisions in business contracts . Many business contracts include arbitration provisions. We will detail following items:

1. Types of ADR
2. Mediation vs arbitration
3. What's an ADR clause
4. Where to include ADR clauses
5. How to Include Arbitration Provisions in Your Business Contracts
6. Are Arbitration Clauses Enforceable?
7. Conclusion

1. Types of Alternative Dispute Resolution (ADR)

There are several different strategies you may want to specify as the agreed process in your ADR clause.

A common feature among most of these strategies is the presence of a neutral third party who oversees the process, although, this may not always be necessary.

These strategies exist on a spectrum of formality, and as a result, some agreements are legally binding while other are not.

The most common types of ADR are mediation and arbitration. But note, these are relatively flexible processes and have several variations each. You and the other party may also specify your own process in the agreement, apart from the traditional conventions of the strategy.

1. Mediation – A confidential, structured form of negotiation where a neutral third party (known as the mediator) helps the parties find a solution to their dispute. A mediator does not make judgements on the case or force parties to agree. The parties retain full control over the outcome. The mediator acts as a bridge to good communication and understanding between the parties.
2. Arbitration – A less formal version of a traditional trial. A neutral third party (known as the arbitrator) acts as the judge. (Sometimes this is a panel of arbitrators that must agree on a decision). All parties are given the opportunity to present evidence and express concerns. The arbitrator will deliberate and issue the final decision. Arbitration can be binding or non-binding and this can be expressly stated in the contract.
3. Conciliation – A similar process to mediation where a neutral third party, the conciliator, oversees negotiations. The major difference between conciliation and mediation is that at some point in the discussion the conciliator will be asked to produce a non-binding settlement proposal for the parties to review.
4. Med-Arb – A combination of mediation and arbitration with benefits from both. The process begins with mediation and moves to arbitration if a solution is not found. The same or different third party may oversee each part of the process.
5. Mini-trial – Allows parties to test their case and get outside viewpoints on the settlement discussions. The parties’ attorneys will present an abridged version of the case to a panel selected by both parties. The panel will decide and outcome. Unlike other methods of ADR, this is often used after litigation is initiated.
6. Summary Jury Trial (SJT) – A mock trial involving a jury that is usually ordered by the court. Once the mock jury offers a verdict, the court will encourage the parties to settle before attempting to litigate.
7. Early Neutral Evaluation – Usually occurring after a case has been filed, a neutral party will learn the details of the case and provide parties with information about the relative strengths and weaknesses of their arguments, chance of winning, and other settlement options.
8. Negotiation – Parties negotiate to achieve an agreeable solution. This can look however the parties decide and does not need to involve outside parties.

2. Mediation vs. Arbitration

Mediation and arbitration are the most common forms of ADR. While they have the same ultimate goal of resolving the dispute and capturing the terms of that resolution in a signed agreement, they have very different methods of getting there.

2.1 Similarities

Mediation and arbitration are both voluntary, confidential forms of ADR where a neutral third party oversees the process. Both strategies also allow each side equal time to outline their case, either on behalf of themselves or through a representative.

Either strategy will save the parties time, money, and stress over litigation. (Although mediation is less expensive than arbitration).

2.2 Differences

In mediation, the parties have full control over the outcome, but in arbitration the arbitrator or panel of arbitrators will decide the outcome based on the presentation of evidence.

Being less formal than arbitration, mediation is also a more flexible process that can be used for almost any type of dispute, barring violent criminal cases. Conversely, arbitration is a more expensive and formally structured process that is usually used for quick resolution of business-related disputes.

Mediation is a non-binding process, but arbitration can be either binding or non-binding.

3. What is an ADR Clause?

An ADR clause is part of a business agreement that stipulates how a potential dispute that arises within the parameters of that agreement will be resolved. This is decided before work begins. 

These clauses may refer to one or more ADR strategies (usually arbitration and/or mediation). It can include a high level of detail, including the name of the third party who will oversee the process and who is responsible for costs involved.

Including such a clause in your contract will save time negotiating a method to resolve a dispute should one arise. By the time you are in dispute tension has increased and trust has decreased, therefore trying to decide how to resolve it at this point is not advisable.

It is important to carefully consider potential scenarios where ADR could be helpful and the type of ADR that will work best for you and the other party in those scenarios. Specify which type of ADR you will use in which scenarios.

For recommended contract clauses and examples, review a helpful resource compiled by JAMS, found here. 

4. Where to Include ADR Contract Clauses

Most business-related contracts can benefit from the inclusion of an ADR clause, but the most common types of contracts are outlined below:

1. Commercial – A contract between two domestic businesses. The contract can apply to a variety of transactions, including, but not limited to, the exchange of goods or services; distribution agreements; commercial representation or agency; factoring; leasing; consulting; licensing; investment; financing; insurance; joint venture; etc.
2. Construction – A contract between the client who commissioned the construction project and the contractor who builds it. Or, a contract between one of the aforementioned parties and an intermediary. These contracts usually apply to the specifications of the project, the time it must be completed, and any unforeseen circumstances such as asbestos in an existing structure.
3. International – A commercial contract between businesses based in different countries. The contract can apply to any commercial transaction. Arbitration is usually administered by the International Centre for Dispute Resolution in accordance with its International Arbitration Rules.
4. Healthcare payor provider – A contract between the payor (the insurance company or other party responsible for paying or facilitating payment for a healthcare service) and the provider (the hospital, physician, etc. that provided the healthcare service). Disputes related to these contracts are often delicate because they involve ongoing relationships.
5. Employment – A contract between an employee and their employer. Disputes may involve allegations of harassment or discrimination. Resolutions may be in the form of workplace-created resolution programs or more formal ADR strategies. Some employment contracts do have Employment Arbitration Rules.
6. Labor – Also a contract between an employee and their employer, but with disputes involving labor laws and allegations of transgressions. Labor Arbitration Rules are often included in these labor agreements.

You can find standard ADR clauses for each of the preceding contract types here. Note, these examples serve as a starting point. Aim for clear, unambiguous clauses in your contracts.

5. How to Include Arbitration Provisions in Your Business Contracts

While an ADR clause can help you avoid litigation and the associated consequences, poorly drafted mediation or arbitration provisions can cause further dispute over interpretation and even increase risk of litigation.

5.1 Make it clear

A clause that stipulates that parties will agree on an ADR process at the time of a dispute leaves too much open and will not be upheld by a court. Trying to decide on an agreement process when you are already having trouble seeing eye to eye with the other party is not advised.

A clause like this may as well not exist in your contract. Specify the process you plan to follow in the event of a dispute.

5.2 Keep the faith

If you want to ensure the resolution process is fair and efficient as part of the outlined process, be sure to keep your wording certain. It is not enough to suggest the process be ‘genuine’ or held ‘in good faith’.

Define what these terms mean by including an objectively clear obligation with these ideals. What are the actions you and the other party must complete to demonstrate that negotiations are being made in good faith?

5.3 Decide if appeals are acceptable

If arbitration is your decided method of ADR in the event of a dispute, you will need to decide if the decision can be appealed and explicitly include this decision in your contract.

A final decision without the option to appeal ensures that the process will end relatively quickly, but it also means that if you are the losing party you will have no options for recourse.

6. Are Arbitration Clauses Enforceable?

Under the Federal Arbitration Act, you may attempt to compel arbitration with an opposing party who is uncooperative. Arbitration is generally a voluntary process, so you must show that there is an arbitration agreement in place that the other party is refusing to comply with. The view of the U.S. Court is that arbitration agreement should be treated as enforceable contracts.  

Although, even with such a provision in your contract, if the wording is ambiguous, the court may not uphold your agreement. The only way to ensure arbitration is enforceable is by making it detailed and clear.

While arbitration clauses can be enforced by law, mediation clauses are not. Including a mediation clause that does not allow for arbitration if a resolution cannot be reached is a risk.

If the opposing side refuses to comply with your agreement, there is nothing you can do to compel them. At this point, the dispute will have to be litigated if the parties cannot decide on another form of ADR.

7.  Conclusion

Business related disputes are common, but litigating these cases is risky. Consequences of litigation can include wasted time and money, loss of reputation, and the destruction of a previously beneficial business relationship.

Risking these issues is not necessary. There are several alternative dispute resolution strategies that can be employed to more quickly and quietly resolve your issues. The two most common methods are mediation and arbitration.

The best way to ensure that you and the other party agree to use these strategies in the event of conflict is to include clauses stipulating this in your business agreement.

Ensure these clauses are unambiguous and as specific as possible. A failure to do so can result in the contract being unenforceable or may cause further dispute related to interpretation of the terms.

Also note that arbitration agreements are enforceable, but mediation agreements that do not allow for arbitration are not. Of course, these agreements can still be used in contracts, but they are more risky.

Do you have any question or story about ADR clauses or Arbitration provisions in a contract, please share and let's chat in the comment section below.