What Is Mandatory Binding Arbitration?

Mandatory binding arbitration is a proceeding to settle disagreements between two parties. As the name implies, it means that the parties are required (or "mandated") to use an arbiter to hear their arguments, and have to accept the arbitrator's decision; the outcome of the arbitration hearing is "binding," in other words.

In the financial world, arbitration is a common mechanism for resolving disputes between clients and their financial institutions; investors and brokers or money managers; or between brokers.

Key Takeaways

  • Mandatory binding arbitration is a private proceeding to settle disagreements between two parties.
  • Parties to a contract agree to have their case reviewed by a third party—called an arbitrator—and to be bound by the arbitrator's decision.
  • Mandatory binding arbitration often requires the parties to waive specific rights, like the right to sue and the right to appeal any decision.
  • Arbitrations tend to be faster, less formal (and less costly) than court trials.
  • Mandatory binding arbitration has been criticized for denying consumers their rights and for being controlled by, and biased towards, corporate defendants.

Understanding Mandatory Binding Arbitration

When one party in a contract believes that the other party has not upheld the terms of the agreement, it typically has the right to sue, seeking damages in court. If the case is not settled before it goes to trial, the court system may award the plaintiff with monetary damages if it finds that the defendant has broken or violated the contract—either the spirit or the letter of it—in some way, causing loss or harm to the plaintiff.

Arbitration is an alternative form of dispute settlement in which the parties to a contract agree to have their case reviewed by a third party—called an arbitrator—other than a judge. It's set up by a contract provision that requires two parties to resolve disputes via an arbitration proceeding rather than through the court system.

Mandatory binding arbitration often requires the parties to waive specific rights. Specifically, the provision in a contract removes or limits a party from suing if they feel wronged—they must go to arbitration instead. It also takes away their right to appeal any decision. By its binding nature, the proceeding means the arbiter’s judgment is a final one.

Arbitrations tend to be less formal (and less costly) and faster than court trials. However, in cases involving large financial sums or with significant impact, an arbitration may be heard and decided by a committee or tribunal that functions similarly to a jury.

Criticism of Mandatory Binding Arbitration

Contracts, loans, and other agreements created by banks, credit card issuers, and cell phone companies often contain mandatory binding arbitration clauses in order to prevent customers from being able to join class-action lawsuits. Because these provisions may be buried deep in the fine print of a contract—and because arbitration itself is often an unknown or misunderstood term—many people are not aware that, by signing, their rights have become significantly curtailed by the contract, including their ability to sue.

An additional critique of mandatory binding arbitration is that the customer, client, or individual person usually has no say or power in the choice of an arbiter. In fact, the clause often states they must agree to an arbiter selected by the other (corporate) party. Companies can use this to their advantage, engaging an arbiter who may seem impartial and appropriate, but who actually has ties to the firm or to the industry. As a result, their judgment is based on the goods of their acquaintance, instead of on the objective merit of each side.

Finally, arbitrators are not bound to follow legal precedent or obey any rules of legal procedure for that matter. Arbitrations are usually conducted in private and their outcome is typically kept quiet, too.

Binding Arbitration vs. Non-Binding Arbitration

As a form of alternative dispute resolution, arbitration proceedings can either be binding or non-binding. The former simply means the decision is final and enforceable, while the latter that the arbitrator’s ruling is advisory and can only be applied if both parties agree to it. Each party maintains the right to reject the decision of the arbitrator and instead request a formal trial. In other words, non-binding arbitration doesn't involve waiving the right to sue or to appeal, as binding arbitration often does. But the proceedings themselves are pretty much the same for each type of arbitration.

Example of Mandatory Binding Arbitration

In their terms-of-service agreements, most brokerages require their clients to agree to mandatory binding arbitration to settle potential disputes, rather than going to court. These proceedings are overseen by the Financial Industry Regulatory Authority (FINRA), through its dispute resolution forum.

When an investor has a specific dispute with a broker (presumably one registered with FINRA), they may file a claim—within six years of the precipitating event—with the authority that states the alleged misconduct and the amount of money they are seeking in damages. FINRA will appoint a single or a panel of three financial industry professionals who, unless the injured party requests otherwise, will not be employed in the securities industry. This is intended to eliminate partisanship and conflicts of interest, but if one of the parties suspects that a member of the panel is biased, they may request a change.

The size of the claim determines how the arbitration process works.

  • For disputes involving less than $50,000, in-person hearings are not considered necessary; rather, both parties submit written materials to a single arbitrator who decides the case in a "simplified arbitration process."
  • For disputes ranging from $50,000 to $100,000, in-person hearings with a single arbitrator are the most common.
  • For disputes over $100,000, in-person hearings with three arbitrators are standard. A majority of the three-arbitrator panel (that is, two people) is necessary for a decision. Arbitrators are not required to explain their decision.

16 months

The maximum amount of time it can take to reach a decision and determine an award in a FINRA arbitration case.

Binding Arbitration FAQs

What Does a Binding Arbitration Clause Typically State?

At their most basic, binding arbitration clauses typically state the conditions under which arbitrations occur. Something like:

Arbitration. All claims and disputes arising under or relating to this Agreement are to be settled by binding arbitration in the state of [insert state in which parties agree to arbitrate] or another location mutually agreeable to the parties. An award of arbitration may be confirmed in a court of competent jurisdiction.

But clauses can get more detailed:

Arbitration. All claims and disputes arising under or relating to this Agreement are to be settled by binding arbitration in the state of [insert state in which parties agree to arbitrate] or another location mutually agreeable to the parties. The arbitration shall be conducted on a confidential basis pursuant to the Commercial Arbitration Rules of the American Arbitration Association. Any decision or award as a result of any such arbitration proceeding shall be in writing and shall provide an explanation for all conclusions of law and fact and shall include the assessment of costs, expenses, and reasonable attorneys' fees. Any such arbitration shall be conducted by an arbitrator experienced in [insert industry or legal experience required for arbitrator] and shall include a written record of the arbitration hearing. The parties reserve the right to object to any individual who shall be employed by or affiliated with a competing organization or entity. An award of arbitration may be confirmed in a court of competent jurisdiction.

Who Pays for Binding Arbitration?

A typical arbitration provision specifies that each party pays the costs of its representative (lawyer or non-lawyer) and those associated with providing its own witnesses. The party bringing the claim usually pays the filing fees. The parties split the cost of the arbitrator’s fees—arbitrators usually charge by the day or hour—and expenses, and administrative fees. In rare cases, the agreement between the parties may specify a different distribution of the cost, including such provisions as “loser pays the cost of the arbitrator.”

Arbitrators usually have the right to make the losing person pay the costs of the arbitration, or to divide the costs.

How Much Does Arbitration Cost?

Arbitration costs can vary greatly, depending on the jurisdiction, the amount of time the arbitration takes (arbitrators' fees and other fees accrue at a daily or hourly rate), and the complexity of the proceedings.

Potential costs include:

A. Filing fees

B. Hearing fees

C. Administration fees

D. Administrative expenses

E. Hearing room rental

F. Arbitrator and/or mediator fees

G. Discovery costs

For arbitrations provided by the American Arbitration Association, consumers pay a $200 filing fee for cases they initiate. The business filing fee is $200 for a decision without a hearing, $300 for one arbitrator, and $425 for three arbitrators, with a $1,400 case management fee for one arbitrator, $1775 for three arbitrators, and a $500 hearing fee. Arbitrator fees are $1,500 for no hearing and $2,500 for a hearing.

JAMS, another major arbitration services provider, charges a claiming individual a $250 filing fee, but nothing if the business made the claim. The business then bears all costs and fees. Filing fees for two-party cases are $1,750 and for multiple parties $3,000, with a 12% surcharge on Professional fees to cover case administration. The business filing fee is $200 for a decision without a hearing, $300 for one arbitrator, and $425 for three arbitrators, with a $1400 case management fee for one arbitrator, $1,775 for three arbitrators, and a $500 hearing fee. Arbitrator fees are $1,500 for no hearing and $2,500 for a hearing.

Arbitrators themselves charge between $375 and $1,125 an hour; while $600 is a typical midpoint, some charge as much as $2,000 per hour.

Do I Need a Lawyer to Represent Me During Arbitration?

While arbitration is less formal than a court trial, it's generally a good idea to have legal representation with you during the hearing—especially if it's a binding arbitration proceeding.

What Is the Difference Between Mediation and Arbitration?

Arbitration is more formal than mediation and resembles a trial, albeit with greater flexibility. Mediation is more like a negotiation meeting.

Both arbitration and mediation have an independent, neutral third party come in to help settle a dispute between two contractual parties. But the mediator is not called upon to decide who is right but rather to add structure to communication between the disputing parties, so that they can, hopefully, eventually reach a resolution between themselves. The mediator is more of a facilitator—somewhat like a couples therapist. In contrast, an arbitrator acts as a judge and actually decides in favor of one party. If it is binding arbitration, both parties must abide by the arbitrator's decision.

Can You Opt Out of Binding Arbitration?

Generally, it's pretty difficult to opt-out—if you want to do business with a particular firm and sign its standard agreement or contract.

In some cases, a contract lets you opt-out of binding arbitration. Companies often require you to take the step within 30 days of purchase/signing up for a service and to use specific language in rejecting the arbitration. These opt-out clauses often require that you send a letter or email to a specific address stating that you are opting out of the arbitration clause.

The Bottom Line

As a relatively informal proceeding, arbitration can indeed be faster and cheaper than a lawsuit to resolve contract disputes and differences. However, there do not seem to be many advantages to mandatory binding arbitration for individuals. Any issue they have might be better solved in open court, where the arbiters are truly impartial, and an appeals process exists.