Why Do So Many Companies Require Arbitration in their Contracts?

Why do so many companies include arbitration clauses in their contracts? The one word answer is: juries. Or more precisely, fear of juries (but that’s three words).

In the American legal system, civil lawsuits (meaning private claims for damages) are decided by juries. A jury consists of a group of citizens chosen (mostly) at random from the local community. Juries are considered a bulwark of liberty because they allow ordinary citizens rather than government functionaries to decide the outcome disputes.

So why would a company fear juries? Several reasons.

First, juries have no expertise. If you were sick and you wanted a diagnosis, you probably wouldn’t gather twelve random people, have a group of experts try to train them over the course of a few days, and then ask them to render an opinion. If it were your life on the line, you would want an expert.

Second, juries might be more inclined toward the “little guy.” Since jurors are chosen at random, it is much more likely that the jury will be filled with regular working people than titans of industry, and in a dispute between an ordinary working person and a faceless company, the worry is that jurors’ natural sympathies will be with the underdog.

Third, juries might not understand just how much money they might be awarding. If a jury finds for the plaintiff in a particular case, the jury must also award damages, that is, a monetary amount that the defendant must pay to the plaintiff. But how much money should a plaintiff get for, say, losing the ability to walk because of an accident or for having their home wrongfully foreclosed? One hundred thousand dollars? One million dollars? Ten million dollars? One hundred million dollars? All the money in the world? Companies are afraid that jurors can’t tell the difference between these vastly different sums of money.

While fear of juries is a primary reason why companies prefer arbitration, there are other reasons as well. Here is a short list:

1. More limited discovery. The most expensive part of litigation is the discovery process (where the parties to the lawsuit exchange information). Many arbitration rules streamline discovery and thereby reduce costs.

2. No class actions. Companies can ban class actions in arbitrations. That limits their exposure in any particular case and is a disincentive for unscrupulous lawyers to bring weak claims with massive potential damages that can force unfair settlements.

3. Faster resolution. Courts in many places are backlogged. Arbitrators are paid by the hour, and so they are generally more available, and so cases can be resolved more quickly.

4. Confidential proceedings. Court trials all take place in public, where reporters can publicize the allegations and the proceedings, which can damage the company’s reputation, even if the company ultimately wins in the end. Arbitrations are more private, so arbitrated disputes attract less attention from the media. Also, the results are often confidential, which limits the risk to the company’s reputation.

5. More sympathetic decision-makers. This one is a bit controversial, but it is possible that companies believe that arbitrators, who are primarily paid by the companies, will have a more business-friendly tilt, at least when compared to judges who are public servants and juries who are ordinary citizens and who might even have an ax to grind against business.

That said, I believe that the primary driver behind consumer arbitration clauses is fear of the jury system. I should note that it is not entirely clear that juries are more likely to make decisions based on sympathy or to award inflated damages, but companies clearly think so.