Feuding Business Partners in Private Companies: Considering Arbitration to Resolve Partnership Disputes

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It is common for private company co-owners to have disagreements while they operate their business, but they typically work through these disputes themselves.  In those rare instances where conflicts escalate and legal action is required, business partners have two options—filing a lawsuit or participating in an arbitration proceeding.  Arbitration is available, however, only if the parties agreed in advance to arbitrate their disputes.  Therefore, before business partners enter into a buy-sell contact or join other agreements with their co-owners, they will want to consider both the pros and the cons of arbitration.  This post offers input for private company owners and investors to help them decide whether litigation or arbitration provides them with the best forum in which to resolve future disputes with their business partners.

Arbitration is often touted as a faster and less expensive alternative to litigation with the additional benefit of resulting in a final award that is not subject to appeal.  These attributes may not be realized in arbitration, however, and there are other important factors involved, which also merit consideration.  At the outset, it is important to emphasize that arbitrations are created by contract, and parties can therefore custom design the arbitration to be conducted in a manner that meets their specific needs.  The critical factors to be considered are: (i) speed—how important is a quick resolution to the dispute, (ii) confidentiality—how desirable is privacy in resolving the claims, (iii) scope—how broad are the claims to be resolved, (iv) expense—how important is it to limit costs, and (v) finality—is securing a final result more desirable than preserving the right to appeal an adverse decision.

Speed—Prompt Resolution of Dispute

Arbitrations generally resolve claims more promptly than litigation, but that is not always the case as arbitration proceedings can drag on if the arbitration is not subject to any restriction on when the final hearing must take place.  One way to ensure that an arbitration will promptly resolve the dispute, however, is to require an end date in the arbitration agreement.  Specifically, the parties can state in their arbitration provision that the final arbitration hearing must take place within a set period of time, perhaps 60 or 90 days of the date the arbitration panel holds its first scheduling conference.  The arbitrators will then set a date for the final hearing that meets this contractual requirement.  Similarly, in the arbitration provision, the parties can also specify the length for the hearing (no more than 2-3 days), and they can also impose limits on the extent of discovery, including by restricting the number of depositions than can be taken.

If securing a prompt resolution of a dispute with a business partner is important, this result can be assured by requiring that all claims are arbitrated, particularly if the parties specify in the arbitration provision that the final hearing must take place on a fast track basis.

Confidentiality—Arbitration Conducted Privately

Litigation takes place in a public forum and, as a result, all pleadings the parties file, and with only rare exceptions, all testimony and other evidence presented at any hearings and at trial will be available to the public.  Therefore if a business partner wants to avoid having future partnership disputes subject to public scrutiny, arbitration provides this protection. But looking at this from another perspective, a minority investor may want to decline to arbitrate future claims against the majority owner if the owner is sensitive to adverse publicity.  The threat of claims being litigated in a public lawsuit may provide the investor with leverage in the negotiation and settlement of any future claims the investor has against the majority owner.

Scope of Dispute—How Much Discovery Required

Determining the scope of a future dispute with a business partner is difficult to do at the time that business partners enter into their contract when any future claims are unknown.  The downside arises in the arbitration context, because one of the parties may desire broad discovery of the type that is permitted in litigation, which may be necessary to defend against certain types of contentions, such as claims for fraud, personal injury and other types of business torts.  In an arbitration proceeding, discovery is typically more restricted, and it may further be limited by the arbitration provision, which caps the number of depositions and narrows the scope of document discovery.  Under these circumstances, the defending party (the respondent) may be hamstrung by these discovery limitations in defending against the claimant’s allegations in arbitration.

To avoid prejudice to the respondent from restrictions on discovery in arbitration, the parties may decide to agree that not all claims between them would be subject to arbitration.  For example, the parties could agree that all claims related in any way to the value and purchase of a departing partner’s interest in the business would be subject to arbitration, but that other claims of a personal nature (e.g., claims for discrimination, wrongful termination) would be litigated in court rather than arbitrated.  This splitting of claims in this manner may not be practical, but is something to be discussed by the parties when they enter into their agreement at the outset.

Expense of Dispute Resolution

As discussed above, business partners can limit the expense of resolving future claims between them by requiring a fast track arbitration hearing and also by limiting the scope and the extent of allowed discovery.  For example, if the parties require a final arbitration hearing to take place in 90 days after the initial scheduling conference, limit the hearing to two days and permit no more than three fact witness depositions per side.  They will have likely achieved a significant reduction of the cost of resolving their dispute.

The issue of cost requires additional analysis, however, because if the parties are not of equal bargaining power, the partner with more capital may not agree that arbitration is the best forum to resolve disputes with a less solvent partner.  The wealthier partner may believe that he or she would prevail over the less well-capitalized partner in a “war of attrition.” This factor may be so significant that it causes the wealthier partner to reject the arbitration of future disputes in favor of resolving of all future claims by or against the other partner through litigation.

Finality of Arbitration Awards

There is no right of an appeal in arbitration and the grounds for attacking an arbitration award in a court proceeding after the arbitration concludes are narrow and rarely successful.  This finality element may thus be an important factor in selecting arbitration as the forum for resolving partnership disputes with the goal of ending the dispute without having it linger on.

There is another concern here, however, that also bears considering.   The conventional wisdom among trial lawyers is that arbitrators are prone to “split the baby” by not providing a strict construction of the written contract or the controlling statute at issue.  Instead, the belief is that arbitrators are inclined to include something for both sides in the final award in an attempt to be as fair as possible, which results in mixed bag outcome.   That has not been my personal experience, but it is true that if the arbitration award is not fully consistent with the contract or a governing statute, there is no right to appeal the decision.  The bottom line is that, at the end of the arbitration, the parties will have to live with the result, and there is no available path to challenge an unfavorable/undesired outcome.

Conclusion

The takeaway is that arbitration is not a panacea.  It can be structured to take place faster and more cost-effectively than a lawsuit, and it will also be held in private and not be subject to public scrutiny.  But, business partners also need to consider other factors in arbitration, such as specific limits on discovery that may be problematic and the finality of the arbitrators’ decision, which may not be viewed as fully consistent with the partners’ contract or in strict accordance with the applicable law.   To the extent that business partners do opt for arbitration, they should craft the arbitration provision to make sure its terms closely align with their business goals.

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