Lease Negotiations: to Arbitrate, or Not to Arbitrate?

When signing a commercial lease one of the most difficult decisions is whether an arbitration clause is good for your company. The commercial leasing community is split on whether to keep arbitration clauses in leases or to negotiate them out. Attorneys tend to side with removing arbitration clauses while business persons like to include them in their leases.

A commercial lease should be reviewed by your attorney and certain terms should be negotiated to fit your business. One such term is a mandatory arbitration clause. Such clauses are industry standard in commercial leases. Unfortunately, arbitration clauses are often overlooked during a commercial lease review.

A standard arbitration clause in a commercial lease resembles the following: “Any controversy or claim arising out of or relating to this lease, or the breach thereof, shall be settled by arbitration administered by the American Arbitration Association under its Commercial Arbitration Rules, and judgment on the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof.”

A well written arbitration clause details the process and obligations of the parties to a lease. Arbitration clauses have their pros and cons and a legal analysis should be conducted to decipher what is best for your business.

The following five facts should be taken into consideration when reviewing an arbitration clause:

Binding versus non-Binding. Arbitration clauses come in two flavors: binding and non- binding. This is the most critical issue in analyzing an arbitration clause. A binding arbitration clause does not allow for either of the parties to appeal the decision – the dispute cannot be later heard by a court. Conversely, a non-binding arbitration clause is similar to a mediation session. If a party does not like the arbitrator’s decision, they may proceed with their court case. Non-binding arbitration is a useful tool for an attorney if they are having difficulties convincing their client to settle. Hearing the decision of a non-binding arbitrator may allow the client to see the benefit of settlement. However the cost of a non-binding arbitration that leads to litigation is a major concern.

Cost associated with Arbitration. One issue that should be discussed with your attorney is the cost of arbitration in the event of a breach of lease or in the event of negotiating a lease renewal. A business decision should be made as to whether including – and ultimately enforcing – an arbitration clause fits your business model. During a breakout session at the International Council of Shopping Center’s 2012 RECon Convention, a poll was taken of the presenters and attendees asking whether arbitration proceedings are more cost-effective then proceeding to trial. The brokers and business persons in attendance stated that it was cheaper and they preferred arbitration clauses in their commercial leases. However, the majority of attorneys present, including the general counsel for a major U.S. retailer, disagreed that arbitration is cheaper than litigation. The main reason given was because a good trial lawyer will prepare for arbitration just as meticulously as they would for a trial in court. Whether or not arbitration is more expensive then litigation depends on many factors and requires a thorough analysis of the parties involved and the terms of the arbitration clause.

Arbitration proceedings are not public information. One major advantage to including an arbitration clause in a lease is that any dispute that arises between the parties will remain confidential.

Arbitrators have expertise in the subject area. The ability to choose a fact-finder with industry-specific knowledge is a serious advantage favoring arbitration. An arbitrator with in-depth industry knowledge and experience will make arbitration very efficient. To have the ability to choose who the arbitrator will be is a must. If you have the choice to jointly select an arbitrator, you will be able to ensure that the chosen arbitrator is someone who has the expertise and knowledge to properly handle the controversy.

There are alternatives to arbitration. There are other alternatives besides arbitration which may be negotiated by your attorney. Your attorney may recommend that you waive your right to a trial by jury in exchange for removing an arbitration clause. Oftentimes, landlords prefer binding arbitration because of the costs in relation to jury trials. Offering to waive your right to a jury trial, and thus reducing potential litigation costs, may be an acceptable compromise to a landlord if you wish to avoid arbitration.

A thorough analysis of a commercial lease will flag the arbitration clause as an issue. If, after further discussion with your attorney, you determine that the clause is not good for your business, then it should be negotiated out and/or substituted. Removing arbitration clauses is usually not a deal breaker, and you may also revise the clause to narrow its scope.

To have an attorney from GarbiaPlocki, LLP review and negotiate your commercial lease, contact us at 703-766-8081. Ibrahim is an associate in the firm’s commercial and residential real estate practice.