Cannabis Litigation 101: Arbitration

This is the second post in a series on various aspects of cannabis litigation. The title is admittedly a bit misleading, as arbitration isn’t really the same thing as litigation. That said, the two can intersect, and so understanding what arbitration is and is not, is important for cannabis businesses. After all, many contracts in the cannabis industry can include arbitration clauses.

Arbitration is, essentially, a trial before a private entity (this post only describes private arbitration and not judicial arbitration, which is different). Typically, arbitration cannot occur unless the parties have agreed to it in a contract; for example, an LLC operating agreement, sales contract, distributor agreement, intellectual property license, or any other kind of contract. The parties can use this contract to dictate the terms of the arbitration and how it will proceed. That said, below are a few of the features that are common to almost any arbitration:

Who Presides: In private arbitration, there are no juries. Instead, the parties pay a private arbitrator or arbitration company. Arbitrations are presided over by at least one arbitrator, who is generally a former judge or attorney. In some cases, there can be a panel of arbitrators who decide a dispute. Arbitrators are almost always neutral, meaning that the parties cannot communicate with them outside the presence of the other parties (there are some cases in which some of the arbitrators can be “party” arbitrators).

Anyone who has spent significant time in a court room knows that judges have intense caseloads—sometimes hundreds of active cases at any given time. On the other hand, arbitrators typically have less-intensive caseloads. This means both that arbitration can proceed more quickly and that the arbitrator(s) can devote more time to and gain more understanding of each case.

Arbitration Setting: In private arbitration, there is no court room. Instead, arbitration hearings take place in private facilities provided by the arbitrator or arbitration company. It’s not uncommon for an arbitration to occur in something that looks more like a classroom or board room than a court room. While an arbitration can feel a bit less formal, it is key to remember that arbitration is still an adjudicative and adversarial proceeding.

Private Nature: Arbitration is, again, private. This is very different from litigation, where almost every facet of a case is published or can be made public unless there is an order of the court to “seal” certain records. Parties to arbitrations don’t necessarily need to keep things confidential—it’s just that way by design. That said, they certainly can agree to strict confidentiality provisions above and beyond the non-public nature of arbitration.

Procedural and Evidentiary Rules: In court litigation, there are rules of procedure and evidence set forth in a number of different places. For example, in federal litigation, the process is governed by the Federal Rules of Civil Procedure, a district court’s local rules, and rules set forth by the individual judge. Evidence is received according to the Federal Rules of Evidence. In state court, there are typically a number of different evidentiary and procedural rules that will govern any proceeding.

Unlike in court proceedings, the procedural rules and rules of evidence are slimmer. Arbitration forums often have their own rules, which will generally apply by default unless the parties elect to follow the federal or state rules in their arbitration contract. Arbitration rules are generally much more compact than federal or state rules, and based on the private nature of arbitration, there are usually no cases discussing how those rules are to be applied. The result of this process is that arbitration proceedings can seem less formal.

Arbitration is not Mediation: One common misconception is that arbitration is or is similar to mediation, when the two are in fact very different. Mediation is a typically non-binding process in which parties come together in front of a third-party neutral (the mediator) to discuss their case with the intention of settling it. Arbitration is similar to a trial, and if it proceeds to the end, will result in an award to one party (which can be filed in court), rather than a settlement. The only important similarities are the presence of a neutral, and the fact that many arbitration companies employ arbitrators and mediators (often, the same people do both kinds of work).

This all sounds great, right? You may be asking why would someone would ever want to litigate, when they could just arbitrate faster, with less-intense rules, in front of a focused neutral who could devote more time to the dispute? It may come as a surprise that parties in a dispute often seek to avoid arbitration. One of the chief concerns is cost—because arbitration is private, parties need to pay the arbitrators, on top of their attorneys. This additional cost can be overly burdensome for some private litigants and is likely a major concern for smaller businesses. Another concern may be the private nature of arbitration. There may be a host of reasons why one party to an arbitration wants the dispute to not be kept private. And finally, there are generally no options for appealing an unfavorable arbitration decision. These are just a few of the reasons that parties may want to avoid arbitration.

As mentioned in the beginning of this post, arbitration and litigation can overlap. Parties to disputes sometimes file cases in court in spite of arbitration provisions. In such circumstances, the other party may file what’s called a “motion to compel arbitration”, and the other party could resist arbitration by arguing that the arbitration agreement is void, or that the dispute at issue is outside the scope of the arbitration clause. In California, for example, we have an additional law that permits a court to delay or even avoid arbitration if there are parties to a court case and a separate arbitration, if there would be a risk of an inconsistent outcome or factual finding. This is a very powerful tool for a party who wants to resist arbitration in multi-party disputes and, in many cases, it is available unless disclaimed in the arbitration clause.

In sum, what an arbitration clause says is powerful and will dictate how any dispute is resolved. When negotiating any contract, the dispute resolution procedures may be an afterthought for some, which can end up costing the parties later down the road. That’s why its critical to put serious thought into arbitration clauses and engage counsel who is experienced in drafting and reviewing such clauses.

For more on cannabis litigation, see our series here.