Insights & Reports > Kroll Global Fraud Report

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Asuncion C. Hostin & Annie Cheney

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Businesses are increasingly turning to arbitration to settle disputes: according to the American Arbitration Association (AAA), the total number of cases filed in 2008 rose to 138,447 – up 8 percent from 2007. In the same period, foreign cases filed with the AAA’s International Center for Dispute Resolution jumped 13 percent. Of all the cases filed with the AAA in 2008, a significant proportion involved employment and construction disputes.

Touted as an attractive alternative to expensive and time-consuming litigation, arbitration is not without drawbacks. Its emphasis on speedier results and cost effectiveness may impede a party’s xability to present evidence and defend itself. Unlike litigation, arbitration also severely limits discovery and results in binding judgments with extremely few grounds for appeal. The role of electronic discovery is also murky. Common e-discovery issues raised in arbitration are the production of documents, time and cost burdens, privilege waiver and “claw-back” agreements. However, the ultimate decision on whether to allow e-discovery depends on what the particular arbitrator decides. In this, as indeed in all questions at issue including the main point of dispute, arbitrators are not bound by rules of law, but may base their decisions on broad principles of justice and equity.

Most important, arbitration is, fundamentally, a business. As the court explained in Britz, Inc. v. Alfa-Laval Food & Dairy Co. (1995), “even though state and federal policy favors private arbitration and the AAA is certainly a respected forum for such arbitration, the AAA nevertheless is a business enterprise ‘in competition not only with other private arbitration services but with the courts in providing – in the case of private services, selling – an attractive form of dispute settlement. It may set its standards as high or as low as it thinks its customers want.’”

Arbitration presents particular challenges in disputes where fraud is involved or suspected. The limitations imposed on discovery, for example, may discourage parties from conducting independent investigative due diligence, even in disputes where fact finding is essential to a favourable outcome. In the construction sector, companies facing an arbitration claim may overlook the need to investigate vendors or subcontractors who performed related work.

This could be a costly mistake: in the Kroll Global Fraud Survey 2009 25 percent of firms reported suffering vendor or procurement fraud in the previous three years.

The individual arbitrator can also present problems. Most institutions require impartiality and that arbitrators disclose any ties that would compromise their independence. In such disclosures, however, arbitrators may not be thorough, omitting relevant information or even misjudging the significance of a given professional experience. In O’Flaherty v. Belgum, for example, an AAA arbitrator failed to disclose that he had once been the plaintiff in a dispute in which the claims mirrored those at issue in the case he was arbitrating. The parties did not learn of this conflict until after he rendered his decision. Likewise, in Azteca Construction, Inc. v. ADR Consulting, Inc., an arbitration award was vacated by an appellate court as a result of a challenge to the impartiality of the chosen arbitrator. The court noted that because they wield such mighty and largely unchecked power, the neutrality of arbitrators is of crucial importance and should not be left to the unfettered discretion of a “private business,” such as the AAA.

These issues are causing companies to carefully consider whether to enter into arbitration, and to gather evidence through investigations that could be classified as “extrajudicial discovery.” Given the complexities and problems of arbitration, conducting swift and targeted research of the counterparties, arbitrator, and the circumstances underlying the claim is essential.