Think Twice About Including an Arbitration Clause in Your Inspection Agreement

by Nick Gromicko, CMI® and the InterNACHI® Legal Team

An InterNACHI member emailed us yesterday and asked why InterNACHI’s standard inspection agreement does not include an arbitration clause. Because other members may have the same question, we decided to write this article.

An arbitration clause precludes your disgruntled client from filing suit against you or your company. Instead, the unhappy client must commence an arbitration action with the arbitrator specified in the agreement, often the American Arbitration Association (AAA). The client must pay a fee to the AAA to begin the arbitration.

The theory behind including an arbitration clause in your agreement is that by removing a client’s right to sue and forcing the client to initiate costly arbitration, you will deter clients from pursuing claims against you. In our view, an arbitration clause may deter some very small claims, but it won’t deter a client claiming $100,000 in damages.

So, what happens if your client commences arbitration against you? You may not like the answers.

Here are some important disadvantages to using arbitration:

1.   If your contract requires arbitration through the AAA, you will be stuck with an arbitrator selected by process of elimination from a list provided by the AAA. Some AAA arbitrators are not lawyers and may not understand the language in the contract intended to protect you. On the other hand, judges in civil suits are all lawyers, normally appointed by the governor after a screening process to make certain they are competent. Because your defense is likely to hinge on language in the contract that protects you, you want the person deciding your case to understand contract law.

2.   Arbitrators normally charge about $300 per hour, with you and your client each paying half of the arbitrator’s fees.  In addition, you also pay a fee to the AAA for its administration of the case.

(Download this PDF of the AAA's complete Fee Schedule.)

The AAA charges more than the filing fee of a civil suit.  Judges, on the other hand, are paid by tax dollars.  Once you pay a filing fee, if any, you do not have to pay any additional money to the court.

3.   You generally do not get to conduct discovery in arbitration. This means your lawyer can’t take depositions and may not even be able to subpoena documents without the arbitrator’s consent. Some lawyers think this benefits the inspector because the inspector’s legal fees will be less.  That may be true, but it means you will go into your arbitration hearing blind, with little information about what evidence the client (and his alleged expert) intend to present.  However, if your client instead files a civil suit against you, your lawyer can depose the client and his alleged expert.  Often, your lawyer can use these depositions to convince the court to dismiss the lawsuit on a motion for summary judgment.

4.   The arbitrator’s decision is final. There is no appeal. Even if the arbitrator gets it wrong on the law or facts, you are stuck with the decision. Arbitrators know this and sometimes try to do what they think is fair rather than what the law requires. In a civil suit, the judge knows that if he or she makes an error, you can appeal the decision.

5.   If your contract requires you to use the AAA, you will have to use the AAA’s arbitration rules. These rules are just as complex as the rules of civil procedure that you hoped to avoid by requiring arbitration.

You can read them by downloading this PFD of the AAA’s "Commercial Arbitration Rules and Mediation Procedures."

6. An arbitration clause works both ways. Suppose your client bounces a check to you. You are not going to start an arbitration to recover such a small amount. Without the arbitration clause, you could file suit in small claims court, and, in many states you could get treble damages plus attorney’s fees. Or, suppose your unhappy client goes online and posts false statements about you. If your contract includes an arbitration clause, you would be unable to sue the client for defamation and potentially also for punitive damages. The arbitration clause would bind you.

7. There is no "right" way to draft an arbitration demand. If an unhappy client prepares a one-paragraph letter demanding arbitration and pays the required filing fee, the AAA will open a case. Moreover, the rules of evidence applicable in civil cases do not apply in an arbitration. For these reasons, an unhappy client may choose to avoid the expense of hiring a lawyer and attempt to represent himself in an arbitration. On the other hand, a client contemplating a civil suit against you for any significant amount of money will, as a practical matter, have to retain counsel to draft a complaint, prepare it for trial, and try the case if the case goes to trial. The expense of hiring a lawyer may deter some clients from pursuing claims against inspectors that they might pursue if their contracts required arbitration.

Taking all this into account, we decided not to include an arbitration clause in InterNACHI's standard contract. Instead, InterNACHI’s contract contains a two-step process for resolving disputes. First, paragraph 8 of the plain English agreement states:

If you believe you have a claim against us, you agree to provide us with the following: (1) written notification of adverse conditions within seven days of discovery; and (2) immediate access to the premises. Failure to comply with these conditions releases us from liability.

If the client notifies you of a claim, you then have the opportunity to consider it and to try to resolve it with your client. If the client fails to notify you and files a suit against you, your lawyer will be able to file a motion asking the court to dismiss the lawsuit and for attorney’s fees.

If the client notifies you of a claim and you are unable to resolve the issue, the client may sue you, but the InterNACHI Client-Inspector Agreement provides that the client waives trial by jury, meaning that a judge will decide your case. It also provides that if you prevail in the lawsuit, the client must pay your attorney’s fees and costs.

It is possible to insert a middle step that requires the client to participate in non-binding mediation before filing suit. Many states require non-binding mediation when a person files a civil suit, so the InterNACHI contract does not include a mediation provision. (We felt it was important to limit InterNACHI’s contract to one page so that it does not scare your prospective clients.)

If you still want an arbitration clause in your contract, don’t just cut and paste one from the Internet. And don’t let your lawyer do that, either. Consider specifying the name of the arbitrator right in the contract. That way, you pick the arbitrator in advance and you can be sure he or she is competent. You do not have to use the AAA. You may use any person willing to serve as an arbitrator and avoid the AAA’s administrative charges. Also, consider limiting the arbitration clause to claims in excess of a specified amount. That way, if your client bounces a check to you, you will still have the ability file suit in small claims court.

We put a great deal of research into InterNACHI’s standard contract and Online Agreement System. The contract is also available in Spanish and French. And last year, we created a plain English version of the contract. Click here to download MS Word and PDF versions.

There is a reason for each provision in InterNACHI’s contract. InterNACHI has the resources to assist you and your lawyer if your client challenges the validity of any provision in the InterNACHI contract. Before you accept your lawyer’s statement that a clause is not enforceable in your jurisdiction, encourage him or her to contact InterNACHI; we may have court decisions upholding the validity of InterNACHI’s clauses.

Only you can decide whether to include an arbitration clause in your contract. InterNACHI hopes you find this article helpful in making your decision.