I am a firm believer in “arbitration clauses” in contracts and agreements. They allow for the means of settling a dispute that is much quicker and much less expensive than by utilizing the courts and lawyers. The most common arbitration clause is that the parties having the disagreement contract with an individual to act as an arbitrator. It is extremely important that the arbitrator be acceptable to both parties. A lot of arbitration clauses state that the decision of the arbitrator is final or that the arbitration is “binding arbitration”. Where there are entities, such as corporations involved in the dispute rather than individuals the arbitration clause may allow for each entity to pick a person to represent them and those two individuals then pick a third, again the arbitration is usually binding.

All parties involved in the dispute usually pay for the costs associated with implementing the arbitration equally. However, arbitration clauses can define a different structure to the terms of payment of any disputes.

Bear in mind when using an arbitrator in a dispute over contracts and/or agreements that the arbitrator is dealing (in the vast majority of all cases) with clarifications based on the intent of both parties as they are defined in the agreements. No matter how many times an agreement is read or vetted for errors and omissions there are always sections and paragraphs which are ambiguous or there are sections or paragraphs of one agreement that are in conflict with a section or paragraph of another agreement. (Under most circumstances when a business is acquired the transaction will take numerous agreements and related documents).

An arbitrator cannot and will not change the basic agreement. As an example when you purchased the company you agreed to pay 8% interest to the owner on the debt that you owe him. Interest rates have now dropped dramatically and you think the previous owner should only charge you 5%. An arbitrator cannot help in this situation, you agreed to 8% and if there are no clauses within the agreements or other documents that state that interest rates would be adjusted to market conditions you must abide by the 8% interest rate you agreed to.

A good example where arbitration can be utilized is as follows. I was asked to arbitrate a dispute between two parties on a clause in a buy/sell agreement. The clause said that the seller was responsible for all expenses pre closing and the buyer was responsible for all expenses post closing, sounds simple enough. The sale closed in the middle of a month (Oct). Two disputes arose. The first dealt with expenses that spanned the month such as facility rent, leases on vehicles and office equipment, and yellow page advertising.

The second dispute arose over two types of yearend bonuses and commissions to employees. One was based on sales that the employees consummated throughout the year (3%) and the second was a longevity bonus, a $100 per year for each full year of employment with the company. There was nothing in the agreements to cover either one of these situations. The seller felt that the agreement stipulated that he was only responsible for expenses that occurred prior to the closing date and he (not defined in the agreements) defined that as invoices received that pertained to the period before he sold the business.

In both cases the seller did not accrue any expense on his financial statements. His rational for not accruing any bonus or commission expense was that if the employee had left the company before the end of the year that the bonus or commission expense was not payable and hence they were not a liability before the end of the year. The buyer, on the other hand, felt that the seller had incurred and received the benefit of the bonus and commission expense before he sold the business and should take the liability and hence the responsibility for paying 10/12ths of all of the longevity bonus and the 3% commission on sales that were consummated when the seller owned the business.

In this case the buyer was aware of the employee bonus and commission incentive plans as they were discovered while performing due diligence. The buyer felt that the Purchase Agreement covered and protected him from the incentive plan expenses that occurred prior to closing.

Generally arbitration works well to resolve disputes that are not covered or are ambiguous within the closing agreements.