Is an arbitration clause in a commercial lease a good idea? This question came up several times in the recent ICSC (International Conference of Shopping Centers) law conference that I attended last month with my GSB law partner, Rob Spitzer. There are pros and cons to including an arbitration clause in a commercial lease. Here are some things to consider.
The “pros” to an arbitration clause typically include the following: (i) arbitration is less expensive than resolving a dispute through the court system; (ii) arbitration is less time consuming than litigation in the court system; (iii) arbitration decisions are typically private and confidential; and (iv) the parties can often choose arbitrators who have more experience in the commercial leasing subject matter than judges. Some of the “cons” to an arbitration clause are (i) arbitration decisions are usually binding and cannot be appealed, so there is little recourse if an arbitrator makes a mistake; (ii) there is typically little discovery in arbitration matters, so the right to depose witnesses and subpoena documents may not be available, which can lead to surprises in the arbitration proceeding; and (iii) often the rules of evidence do not apply, which means the arbitrator can be provided, and consider, evidence that would not be admissible in court. In general, the “pros” tend to outweigh the “cons” for many practitioners, but that is not always the case and certainly each client should carefully consider for itself whether arbitration will necessarily be the best way to resolve disputes under a lease. Some clients are surprised to learn that arbitration is not as inexpensive or efficient as they thought it was going to be (for example, consider the expense and potential scheduling delays in an arbitration requiring a three-arbitrator panel and multiple attorneys and parties).
One area where an arbitration clause may be particularly useful in a commercial lease is the renewal provision. It is not uncommon for a lease to grant a tenant a right to renew the lease, with the rent for the renewal term to be set at the “fair rental value.” The determination of the “fair market value” for the renewal term is a significant issue of the renewal, and is probably best addressed by providing for an arbitration procedure to avoid a court fight. One common approach to determining “fair rental value” is sometimes called “baseball arbitration.” In this process the landlord (or its appraiser) proposes a fair market rent figure and the tenant (or its appraiser) proposes a fair market rent figure, and the arbitrator must choose between the two and may not split the difference. The theory with baseball arbitration is that the landlord and tenant will each have an incentive to propose a reasonable figure that will be accepted by the arbitrator, and therefore there will be a natural incentive for each party to propose a reasonable and defensible figure as opposed to an extreme high figure (in the case of the Landlord) or a low figure (in the case of the tenant). Also, because baseball arbitration is a “win or lose” proposition for each party, there is also a natural incentive for the parties to attempt to be reasonable and agree on a “fair rental value” figure without arbitration,. In this sense, the arbitration clause can act as an incentive for the parties to reach mutual agreement, which is more beneficial than arbitration or litigation. Variations on baseball arbitration are also not uncommon.
Arbitration clauses were one of just many topics addressed at the ICSC law conference. Other topics will be discussed in future blogs.
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