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Preparing for Failure: Why Dispute Resolution Clauses Matter

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By Mark Del Bianco

Channel partners tend to have positive outlooks. That’s not surprising, since they are in sales. When negotiating a contract, they are looking to maximize the upside, to create a win-win for both sides. They don’t like to consider possible negative outcomes. But those who’ve been in the business awhile recognize the importance of planning for failure. They pay attention to the dispute resolution clauses in their agreements, and they are proactive in making sure they are protected in the event the relationship sours. 

Each channel partner and each lawyer may have his or her own view about the important issues to consider. Mine, developed over years of negotiating contracts, advising clients, and representing them in arbitration and litigation, is that the most important step is to insist on a fee-shifting provision that requires the loser in any arbitration or litigation to pay the winner’s costs. Why is this so important? Because it goes a long way toward leveling the playing field for smaller players such as competitive carriers and channel partners. 

Under U.S. law, each party in a case pays its own attorney’s  fees and costs unless there is a law or contractual provision that provides that the loser pays the winner’s costs. This default position gives larger corporations and entities with deeper pockets a big advantage in any dispute. They can breach contracts with impunity when the damages amounts are relatively small, knowing that the other party won’t sue because the cost of a lawsuit will eat up any damages recovery less than $75,000 or $100,000. Most rational plaintiffs will decide not to sue in such a case, because the upside is so small. But if there is a cost-shifting clause, the calculation is different on both sides. A plaintiff with a strong case, knowing that it can potentially recover all of its damages and get reimbursed for its costs, is more likely to sue and to pursue litigation to the end. Conversely, a defendant that might otherwise use delaying tactics and run litigation costs up in hopes of driving a plaintiff into a quick and favorable settlement will be less likely to do so because the downside risk is much larger.  

Cost and leveling the playing field are also factors to consider in negotiating a venue clause. There’s no real “home court advantage" for local companies in most state and federal courts today. With very few exceptions, judges are professional and impartial. However, there is usually a marked financial advantage for any party to litigating in its home jurisdiction. Expenses are likely to be lower, because the local company spends less on attorney travel time, hotels, meals, plane flights and other litigation costs. In practice, contract negotiations are usually based on a template provided by the larger party to a proposed relationship — which is usually the carrier, data center or master agent — and the template almost always provides for jurisdiction and venue in the state or federal courts of the party’s home state. Such a clause favors the drafting party financially, if not legally. I advise clients to try to negotiate a fairer provision, such as one that provides that any litigation must be brought in the defendant’s home jurisdiction. While such a clause does not level the playing field entirely, it does make it more expensive for large plaintiffs to initiate less meritorious “bullying" cases.

A third issue is whether to provide for arbitration instead of court litigation. For a long time, the conventional wisdom was that arbitration, particularly in business disputes, was faster and cheaper than litigation. Arbitration is still generally faster (unless you are in a “Rocket Docket" such as the U.S. Eastern District of Virginia) and cheaper (if the discovery process is limited). But the advantages are not always clear, and can be lost with bad drafting. In fact, arbitration can be both more expensive and slower than litigation. For example, I recently had an arbitration based on perhaps the worst arbitration clause I’ve ever seen. The clause provided that (i) the parties could conduct all discovery permitted by the Federal Rules of Civil Procedure that govern federal trials, and (ii) a panel of three AAA arbitrators would have to issue a decision within 90 days of the initiation of the case by AAA. Thankfully, neither I nor the opposing arbitration counsel had been involved in drafting the clause, which combined all the discovery costs of federal litigation with the additional costs of three paid judges. The first thing we did was agree that it was physically impossible to have both (i) and (ii), so we waived the 90-day time limit. We subsequently settled the arbitration on terms very favorable to my client just as depositions and discovery were about to start. Why then? Because the client had an airtight case and there was a cost-shifting clause. The defendant settled at the last possible moment before the litigation costs began ramping up. Its bluff had been called. But this was an outlier. 

The importance of the final issue, the choice of law, is usually small. Most states have similar laws on how contracts are interpreted and implemented, so there’s rarely any  advantage to having, say, Colorado law apply instead of Virginia law. One exception might be New York, which has perhaps the best developed and most stable body of commercial statutes and court decisions. If negotiation over what state’s law will apply is stalemated, I’ll often suggest New York law as a neutral solution.

Of course, the risks and the preferred outcomes on each of these issues are usually very different when international service providers are involved. I’ll address dispute resolution clauses in international contracts in a future blog post.

Mark Del Bianco, principal, Law Office of Mark C. Del Bianco, is based in the metropolitan Washington, D.C., area. His practice focuses on domestic and international telecom clients, particularly those implementing new technologies such as WiMax, Gigabit Ethernet and FTTH. Other clients include applications providers, channel sales agents and enterprise customers. Del Bianco is a member of the 2012-13 Channel Partners Advisory Board.

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