The past two decades have seen an increase in the number of contractual agreements containing arbitration clauses or other provisions that provide for dispute resolution outside a courtroom. Such provisions are most prevalent in agreements with credit card issuers, mortgage lenders for loans not sold to Fannie Mae or Freddie Mac, and auto finance companies. Thanks to this upsurge in arbitration provisions, a new phenomenon is slowly emerging—the class action in arbitration.

On the plus side, arbitration is thought to provide more expedient and less expensive dispute resolution than a traditional lawsuit. Arbitration also avoids the risk of a runaway jury verdict, particularly in cases that involve claims brought by consumers or claims requesting punitive damages. Further, because it takes place outside of the public eye, arbitration provides a mechanism to keep disputes and the information generated from them confidential.

On the flip side, arbitration has several drawbacks, including significant filing fees and hearing costs. There is also the risk that an arbitrator will "split the baby" without providing any justifications for an award. To make matters worse, the parties involved in an arbitration are severely limited in their ability to appeal an award.

Two of the major organizations administering arbitration proceedings—the American Arbitration Association and JAMS—each have specific rules governing how a class action is to be handled. Their criteria for certifying a class, which track with those set forth in the Federal Rules of Civil Procedure, present some notable disadvantages to defendants. Unlike the court system, arbitration rules do not provide for the opportunity to take discovery regarding the existence of a class. The option of discovery is left entirely to the arbitrator's discretion or the terms of any pertinent agreement between the parties.

Class action defendants in arbitration may face another hurdle—the inability to appeal. In all likelihood, errors of judgment or the misapplication of the class certification criteria by an arbitrator would not provide a basis to vacate a class certification award. On the other hand, judges in the court system are at least bound by precedent. There is also a defined mechanism by which class certification decisions can be reviewed, often prior to resolution of the dispute.

What should a business do to minimize risk in light of this emerging trend? The key to avoiding class action arbitration lies in the drafting of the arbitration agreement. If your contracts include an arbitration clause, it is important to incorporate language regarding class disputes. Moreover, if a contract is meant to prevent class actions entirely, such exclusions should be written in plain, understandable English and highlighted prominently.

These simple precautionary measures will help avoid the pitfalls of arbitration and may, in fact, contribute to a successful outcome for you and your company.