Should Mandatory Arbitration Be Regulated?

July 25, 2012

     “Mandatory arbitration” provisions have come under harsh criticism in recent years. (Since all pre-dispute agreements to arbitrate are “mandatory,” it would be more precise to state that pre-dispute arbitration agreements between parties with unequal bargaining power have raised concerns about their “fairness,” but I will use the shorthand “mandatory arbitration” here.) Such provisions are common in consumer, financial and employment agreements, and increasingly seen in healthcare. Opponents of mandatory arbitration assert that agreements to arbitrate in certain circumstances can be fair only if freely entered into after a dispute arises. The proposed Arbitration Fairness Act of 2009 (now 2011) adopts this stance, and would render unenforceable all pre-dispute arbitration agreements in employment, consumer, franchise and civil rights matters.

      A welcome alternative to the drumbeat of the “Arbitration Fairness” movement is presented by Miles B. Farmer\’s Note in the Yale Law Journal entitled “Mandatory and Fair? A Better System of Mandatory Arbitration.”  If you have any interest in the debate over “mandatory arbitration” and the Arbitration Fairness Act, I recommend that you read this Note in its entirety.

     Mr. Farmer identifies arbitrator bias resulting from the “repeat player” phenomenon as the primary source of unfairness in mandatory arbitration. But he concludes that outlawing all predispute arbitration agreements between parties of unequal bargaining power would be like throwing the baby out with the bathwater. As he explains, the benefits to society and the parties from the widespread use of arbitration in these cases should be maintained.

     The Note proposes the creation of a state or federal regulatory regime under which providers of arbitration services (e.g, the American Arbitration Association) would be required to report data on the selection and use of particular arbitrators for repeat players, and the arbitrators\’ awards in those repeat cases. Arbitration providers would be required to demonstrate that the arbitrator selection process resulted in decisions which, in the aggregate, appeared fair to both sides when compared with (i) a range of outcomes deemed “fair,” and (ii) outcomes reported by other arbitration providers. A failure to report required data, to abide by the required arbitrator selection process, or to achieve a “fair” balance of outcomes (in the aggregate), would subject the arbitration provider and the drafter of the arbitration provision to an enforcement action by a designated law enforcement agency (including financial remedies).

     Mr. Farmer would not provide for a challenge to the outcome of any particular arbitration award (thereby retaining each arbitration\’s finality, and avoiding preemption by the Federal Arbitration Act). Further, he would not provide for a private right of action to enforce the regulatory regime.

     The Note focuses the attention of the “mandatory arbitration” debate where it belongs: on the abuses that can taint the outcomes in repeat player cases. It correctly rejects the Arbitration Fairness Act as overkill and protects individual arbitration awards from challenge by unhappy parties. Requiring arbitration providers to demonstrate fairness in the arbitrator selection process for repeat players would be feasible and effective, although I would prefer to see this occur as a result of market forces than by way of government regulation.

     Where Mr. Farmer loses me is in the suggestion that the outcomes of all cases administered by an arbitration provider for a repeat player should be assessed, in the aggregate, for their “fairness.”  Although an arbitrator who ruled in favor of a repeat player in 100% of a large number of cases probably has some explaining to do, a “50-50” split of outcomes is not necessarily fair and just. A fair and just split is the one that results from the decisions of unbiased arbitrators appointed in accordance with the selection rules Mr. Farmer advocates, whatever that split may be. Setting a “50-50,” “60-40,” or any other split as the “fair” standard for arbitration providers to achieve would have the perverse result of requiring those providers to recruit, select and instruct their arbitrators on outcomes –  exactly the kind of interference that created the original problem.

     Rules for the selection of qualified, unbiased arbitrators should be strictly applied, as should ethical constraints relating to cases involving repeat players. A sufficient rotation of arbitrators should be appointed for any repeat player to assure that undue familiarity will not occur. Arbitration providers should embrace these efforts, and make them an important and transparent part of what they offer both parties to a “mandatory arbitration.” But arbitration providers and the government should stay away from selecting particular arbitrators in an effort to assure some preconceived, “fair” mix of outcomes.

     Bias for and bias against a repeat player are equally bad. You either trust the arbitrators you\’ve picked or you don\’t. If you don\’t, you should look elsewhere.