Any lawyer considering a hotel-related agreement such as a hotel management agreements or a franchise agreement knows that mediation, expert resolution and arbitration are among the means employed to resolve owner/manager disputes. These alternative dispute resolution mechanisms are not unique to hotel–related agreements and are seen generally in contract disputes as a way to avoid costly litigation and the time consumed by having to await one’s place on the judge’s calendar.

Mediation

Mediation means the intervention of a person chosen by agreement of the parties in conflict to promote reconciliation, settlement or compromise. Most people are familiar with mediation in a marital context. It applies with equal efficacy to commercial disputes as a means to bring the parties ‘into the same room, face-to-face’ so that, with the assistance of a trusted and sometimestrained/certified mediator, the parties can craft a resolution themselves.

For a summary of mediator certification requirements state-by-state, go to: http://www.mediationworks.com/medcert3/staterequirements.htm

A mediator assists the parties to find common ground and, where the parties disagree, to make concessions in the interest of a compromised solution. Mediation techniques include separate meetings with each party, developing a statement of the parties’ exact differences to avoid having the dispute expand in the heat of disagreement and drafting a memorandum of understanding to capture the ‘deal’. This memorandum may be enough for the parties, or it may in some cases go to the lawyers to become a more formal contract or contract amendment.

Primary Benefits of Mediation

• The parties control the process from the selection of the mediator, the timing of the sessions and the outcome; the mediator is not the “decider”, just a facilitator.
• The obvious advantage is that mediation, properly conducted for parties honestly willing to find some middle ground in order to move on, can be fast and cost effective.
• Mediation tends to be somewhat “friendly” in that by its nature it plays down the adversarial nature of the dispute as the mediator seeks to find common ground for agreement; the relationship between the parties is left intact.

Disadvantages of Mediation

• Mediation can serve as uncontrolled or undisciplined discovery of a party’s position where the party is forthcoming during the process in the hope of reaching a compromise and that information is later used in an arbitration or litigation.
• Mediation can come apart in the “memorialization” phase wherein the lawyers attempt to embody the mediated settlement in a legal document; sometimes the devil in the details emerges, details that may not have been considered in friendly mediation.

Mediation may consume time and expense and delay the inevitable hostile or adversarial proceeding, such as arbitration or litigation, where the parties are far apart or one is or both are unwilling to compromise.

Expert Determination

If parties disagree on technical matters (as opposed to more legally-centered issues such as allegations of mismanagement or failure to comply with brand standards), they may decide either in advance by having ‘expert determination’ drafted into their contract or in an ‘ad hoc’ manner to jointly appoint a professional with appropriate credentials to the matter in controversy to serve as an “expert” and render a binding opinion on the matter.

This expert should be someone with specific and extensive knowledge in the technical subject matter, such as a CPA in respect of financial accounting matters or an engineer in respect of a matter involving the need to upgrade HVAC systems. The question to be decided should be carefully crafted by the parties as should the degree of latitude that the expert may exercise in reaching a decision.

If the dispute is monetary, the parties may also agree to ‘baseball arbitration’ whereby the expert is required to choose the position of one of the parties as correct and is not free on his or her own to determine some other remunerative value. In any case, the parties should agree either in the contract calling for expert resolution or in their subsequent agreement that the expert’s decision is binding and is not appealable, except for ‘manifest error’.

Obviously, this expert should have no preexisting relationship so that all judgments are objective and impartial.

Expert determination can involve many different types of disputes including:

• Calculation of fees such as the license fee, the management fees or the amount of the owner’s priority (if relevant)
• Calculation, withholding and payment of taxes whereby a tax lawyer or CPA is likely to be considered as the expert
• Necessary working capital
• Calculation or payment of disputed central service charges
• Approval of necessary expenditures in excess of the approved budget
• Application of the Uniform System and whether or not proposed expenses are operating expenses or capital expenses
• Termination for failure of the performance test or composition of the competitive set
• Whether or not capital expenditures are needed to meet a brand standard, an emergency or a legal requirement
• Whether or not proposed salary levels for key personnel are reasonable

Primary Benefits of Expert Determination

• Expert determination is likely to ensure the technical accuracy and appropriateness of the solution.
• Expert determination is likely to reinforce party autonomy as the parties themselves can control the process and freely appoint the expert as well as define the expert’s mission and tasks.
• Expert determination is likely to ensure confidentiality as the opinion will very rarely be made publicly available.

Disadvantages of Expert Resolution

• Non-lawyers may not be sensitive to evidentiary issues or contract nuances that are screened in judicial setting.
• It isn’t clear if a court will enforce the decision, but the contract wherein expert resolution is provided can make it clear that the decision is final, binding and non-appealable.

Arbitration

In ascending order in terms of “severity” of the matter in dispute, the next alternative for resolving disputes is arbitration. By “severity”, I am referring to the either the complexity of the question to be resolved where legal interpretations, document discovery and witness testimony, even expert witness testimony, may be utilized by the parties to present their side of the dispute. In short, the matter to be arbitrated typically is not unlike matters over which parties go to court, but for reasons we will explore, arbitration may be preferable.

As with expert resolution, in arbitration, a neutral third party, or, more commonly, a panel of three parties, the “arbitrators”, are called upon to control the process and resolve the issue, rendering a written, reasoned binding decision, as a judge might render, after a process that is similar to a court proceeding.

The question to be decided should be carefully crafted by the parties by means of an agreed “terms of reference” submitted to the arbitrators. The parties in their agreement to arbitrate may empower the arbitrators to make pre-decision orders (interim relief) as a court would do by issuing an injunction whereby the parties are ordered to do or refrain from doing certain acts pending the outcome of the arbitration.

In the early stages of the arbitration, the parties may request that the arbitrators make decisions about the scheduling of witness depositions, the production of documents and the details (time, place) of the arbitration hearing before the arbitrators, much as a judge would do in the pre-trial phase of a lawsuit.

If the dispute is monetary, the parties may also agree to ‘baseball arbitration’ as in an expert determination.

Selecting the Arbitrator(s)

Obviously, the arbitrators should have no preexisting relationship so that all judgments are objective and impartial.

Arbitrators may be chosen from a list of arbitrators who have been certified by arbitration-sponsoring organizations.

The question of how many arbitrators is worthy of careful consideration. While the perception is that a panel of three arbitrators will likely result in a decision that is more balanced and not subject to an individual’s whim, the process of selecting the three arbitrators can dilute this advantage. In many arbitration agreements, each party appoints an arbitrator, typically after each party interviews its own candidates, and then the two party-appointed arbitrators select the third or “neutral” arbitrator. That word “neutral” may have more meaning than is intended because there may be a tendency on the part of the party-appointed arbitrators, if not to advocate for the party that appointed them, at least they may be a bit biased toward that party. In addition, having three arbitrators, typically experienced lawyers with expertise in the field or retired judges, who are paid handsome hourly rates, can be very expensive for the parties who must also pay their own legal counsel. Two-to-one decisions by the arbitrators may indicate that in their closed sessions, the winning party’s appointed arbitrator may have been more persuasive toward the neutral arbitrator than was the losing party’s appointed arbitrator. Instead, the optimum goal in theory is that the three arbitrators will avoid the temptation of any bias toward either party.

Administrative Organizations

While arbitration may be conducted by the parties in accordance with their own agreed rules or available rules of recognized bodies such as the United Nations Commission on International Trade Law (“UNCITRAL”) and arbitrators may be selected without any particular “certification” or other qualification except as the parties may impose, there are many agencies that facilitate arbitration through the publication of rules, the qualification of arbitrators, management of scheduling and other services, these agencies also charge a fee, typically based upon the amount in controversy. The two agencies frequently chosen in hotel-related agreements are the American Arbitration Association (“AAA”) and the International Court of Arbitration established by the International Chamber of Commerce (“ICC”).

Types of Hotel Industry Disputes Suitable for Arbitration

Arbitration can involve many different types of disputes in the hotel industry, but the following are typical of disputes involving the degree of “severity” for which arbitration is suitable as an alternative to expert determination (discussed in a prior article) and judicial resolution:

• The scope and validity of a significant agreement;
• Claims of wrongful termination of a significant agreement;
• Owner claims of mismanagement by the management company;
• Owner-contractor disputes regarding the construction of a new hotel;
• Interpretation of collective bargaining agreements;
• Franchisor claims that the hotel fails to comply with mandated standards.

Primary Benefits of Arbitration

There are numerous advantages to arbitration as a way to resolve a case.

• The parties to the dispute usually agree on the arbitrator, so the arbitrator will be someone that both sides have confidence will be impartial and fair.
• The dispute will normally be resolved much sooner, as a date for the arbitration hearing can usually be arrived at a lot faster than a court date.
• Arbitration is usually less expensive than litigation (or is supposed to be!). Partly that is because the fee paid the arbitrator is a lot less than the expense of paying expert witnesses to come and testify at trial. (Most of the time the parties to arbitration split the arbitrator’s fee equally). There are also lower costs in preparing for the arbitration than there are in for preparing for a trial. Partly this is due to the fact that the rules of evidence are often more relaxed than in a trial, so that documents can be submitted in lieu of having a witness come to trial and testify. For instance, if a claimant has several doctors who are out-of-state, the cost of bringing them to trial or going out-of-state to take their depositions may be prohibitive for trial, but in arbitration you can usually use just their records and reports.
• Arbitration is faster than litigation (or is supposed to be!) because the parties are not subject to the court calendar.
• Unlike a trial, arbitration is essentially a private procedure, so that if the parties desire privacy then the dispute and the resolution can be kept confidential.
• If arbitration is binding, there are very limited opportunities for either side to appeal, so the arbitration will be the end of the dispute. That gives finality to the arbitration award that is not often present with a trial decision.
• Arbitration is appropriate where the parties are in different countries – i.e., in an “international dispute” – and none of the parties is willing to submit to the jurisdiction of the courts of another party’s country.

Disadvantages of Arbitration

There are, however, also some disadvantages to arbitration as a method of resolving a dispute.

• If arbitration is binding, both sides give up their right to an appeal. That means there is no real opportunity to correct what one party may feel is an erroneous arbitration decision.
• If the matter is complicated but the amount of money involved is modest, then the arbitrator’s fee may make arbitration uneconomical. Remember that the parties may be paying fees of an administrative agency, hourly rates of each of three arbitrators, their own counsel fees and expert witness fees.
• Costly experts may be used in arbitration to the same extent as in litigation.
• Rules of evidence may prevent some evidence from being considered by a judge or a jury, but an arbitrator may consider that evidence. Thus, an arbitrator’s decision may be based on information that a judge or jury would not consider at trial.
• If certain information from a witness is presented by documents, then there is no opportunity to cross-examine the testimony of that witness.
• Discovery may be more limited with arbitration. In litigation, discovery is the process of requiring the opposing party — or even a person or business entity who is not a party to the case – to provide certain information or documents. As a result, many times arbitration is not agreed to until after the parties are already in litigation and discovery is completed. By that time, the opportunity to avoid costs by using arbitration may be diminished.
• If arbitration is mandatory or required by a contract, then the parties do not have the flexibility to choose arbitration only when both parties so agree. Mandatory arbitration allows one party to force the other party to use arbitration, leverage that may favor the party with the deeper pocket.
• The standards used by an arbitrator are not clear, although generally the arbitrator is required to follow the law. However, sometimes arbitrators may consider the “apparent fairness” of the respective parties’ positions instead of strictly following the law, which could result in a less favorable outcome for the party who is favored by a strict reading of the law. This consideration is often overlooked in evaluating the applicability of arbitration.
• Where the losing party pays the prevailing party’s legal fees and the cost of the arbitrator(s), the fees and costs to be reimbursed may be huge, even larger than the award. The party who sees victory on the horizon as the process moves forward can engage in a certain largesse in its use of legal counsel.
• Arbitration may be more expensive than litigation. The judge is paid by the taxpayers; arbitrators are paid by the parties.
• Arbitration can be as slow as litigation. Parties may delay the proceeding and the increasing formality of arbitration proceedings – see the AAA Rules of Commercial Arbitration – can result in a slow process.
• Party-selected arbitrators may have loyalty to the appointing party. When a panel of three arbitrators is chosen so that each party chooses one and then the two choose the third arbitrator “neutral”, if the party-appointed arbitrators are reluctant or even hesitant about holding against the party that appointed her, then the proceeding devolves to the decision of the “neutral”.

Sample Arbitration Clause for Inclusion in a Contract

“All claims and disputes arising under or relating to this Agreement are to be settled by binding arbitration in [insert place where parties agree to arbitrate] or another location mutually agreeable to the parties. The arbitration shall be conducted on a confidential basis pursuant to the Commercial Arbitration Rules of the American Arbitration Association. Any decision or award as a result of any such arbitration proceeding shall be in writing and shall provide an explanation for all conclusions of law and fact and shall include the assessment of costs, expenses, and reasonable attorneys’ fees. Any such arbitration shall be conducted by an arbitrator experienced in [insert industry or legal experience required for arbitrator] and shall include a written record of the arbitration hearing. The parties reserve the right to object to any individual who shall be employed by or affiliated with a competing organization or entity. An award of arbitration may be confirmed in a court of competent jurisdiction. Each party shall be responsible for its fees and costs associated with the arbitration and the parties shall bear equally the costs of the arbitrators and other arbitration expenses.”

Case Illustration (Based Upon an Actual Case).

Owner claims that Management Company has mismanaged the hotel for the past X years resulting in losses to Owner of $Y; moreover Management Company has failed the performance test. Owner has terminated the management agreement based on the alleged mismanagement and the performace test failure and seeks $Y from Management Company as damages. Manager claims that Owner has refused to make required capital expenditures to comply with brand standards and has repeatedly interfered with Management Company’s right to exclusive operational control by issuing its orders to hotel personnel and seeks $Z for damages resulting from wrongful termination, recognizing that under the “agency theory” overlaying management contracts, Management Company cannot be reinstated. The matter is well-suited for three arbitrators, all lawyers, experienced in the hotel industry to read the correspondence that went back and forth between the parties about the many allegations, hear witness testimony and cross examination and issue a reasoned opinion (a written opinion setting forth the arbitrators’ reasons) as to the monetary damage claims of both parties. The decision may be enforced in court and is not appealable (1).

Bob has studied the rules of various arbitration providers. He knows an effective advocate chooses the arbitration forum that offers the rules best suited for the particular controversy. So, for instance, “If you want depositions, why not pick an arbitration forum whose rules expressly allow depositions?” Always the riddler, Bob put this question on his office wall.

Bob soon had a chance to put words into action. His client was involved in a messy business dispute that spilled over into a contentious litigation. Using his code words—more expeditious, more cost-effective, and confidential—Bob convinced the other side to arbitrate the dispute. The parties asked the court to enter an agreed order sending the case to arbitration.

Bob needed a couple depositions to prove his case. He drafted an arbitration agreement that identified ABC Arbitration Co. as the arbitration provider: “The parties agree that all disputes at issue in the current litigation shall be settled by arbitration administered exclusively by ABC Arbitration Co. Judgment on the award rendered by the arbitrator may be entered in any court having jurisdiction thereof.”

Why ABC? Because its rules stated, “Each party may take two depositions of an adverse party.” Deposition problem solved. Another example of brilliant drafting that anticipated and resolved a potential snare.

There was one problem: ABC Arbitration did not exist. Bob and his adversary could not find ABC’s offices, website or anything having to do with ABC. “No matter,” Bob assured his client. “The parties can select another arbitration provider and can proceed with the desired arbitration.”

Except that Bob two days later received his adversary’s motion to vacate the stipulation and order that directed the parties to arbitration in the first place. His adversary’s argument was simple. The arbitration provision identifies ABC as the arbitral forum; ABC does not exist and cannot arbitrate the dispute; consequently, the parties cannot arbitrate their dispute in accordance with the arbitration clause.

Must the parties now return to court or can Bob salvage the arbitration?

Section 5 of the Federal Arbitration Act states: “If in the agreement provision be made for a method of naming or appointing an arbitrator or arbitrators or an umpire, such method shall be followed; but if no method be provided therein, or if a method be provided and any party thereto shall fail to avail himself of such method, or if for any other reason there shall be a lapse in the naming of an arbitrator or arbitrators or umpire, or in filling a vacancy, then upon the application of either party to the controversy the court shall designate and appoint an arbitrator or arbitrators or umpire, as the case may require, who shall act under the said agreement with the same force and effect as if he or they had been specifically named therein; and unless otherwise provided in the agreement the arbitration shall be by a single arbitrator.”

How do courts determine whether the process for naming an arbitrator “lapses”? If the provision says the designated forum is the “exclusive” arbitral forum, there is a lapse and the court will not enforce the arbitration provision.

“If a designated arbitrator is unavailable, Section 5 of the FAA permits a court to appoint a substitute arbitrator in certain circumstances. Our court of appeals has not addressed the precise set of circumstances in which a court may appoint a substitute arbitrator, but other federal courts have held that Section 5 of the FAA generally permits a court to appoint a substitute arbitrator where the chosen arbitrator is unavailable, unless the selection of an arbitrator is ‘integral’ to the arbitration agreement, as opposed to an ‘ancillary logistical concern,'” the court wrote in Clerk v. Cash Central of Utah LLC, 2011 U.S. Dist. LEXIS 95494, at *13-*14 (E.D. Pa. Aug. 25, 2011).

How does one determine if the selection of the arbitrator is “integral” to the arbitration agreement? The court in Clerk said, “An arbitral forum is an integral part of an arbitration agreement if the agreement includes an express statement designating a particular arbitral forum to administer arbitration.” The Pennsylvania Superior Court agreed in Stewart v. GGNSC-Canonsburg, 9 A.3d 215, 219 (Pa. Super. 2010): “At a minimum, for the selection of an arbitrator to be deemed ‘integral,’ the arbitration clause must include an ‘express statement’ designating a specific arbitrator.” In Khan v. Dell, 669 F.3d 350 (3d Cir. 2012), however, the U.S. Court of Appeals for the Third Circuit reversed the rule. It said the choice of forum is an integral part of the agreement to arbitrate only if “the parties … have unambiguously expressed their intent not to arbitrate their disputes in the event that the designated arbitral forum is unavailable.” So what is an arbitration-contract drafter to do?

• The drafter should decide whether this is an “all or nothing” situation. Is the chosen arbitral forum the only acceptable forum? If so, the drafter should expressly say the forum is “exclusive.” Did Bob consider this issue? No. Would a forum other than ABC Arbitration have worked for Bob? Probably. Did Bob’s arbitration provision achieve his avowed goal? No.
• If another provider can substitute for the chosen arbitral provider, the drafter should make sure to avoid saying—expressly or impliedly—that the chosen provider is “exclusive.” Did Bob say the chosen provider was “exclusive”? Yes: “The arbitration [must be] administered exclusively by ABC Arbitration Co.” Did Bob really mean that? Nope. Did he consider the consequences of this language? Nope.

Could Bob have gotten his cake and eaten it too by ensuring that the parties go to and stay in arbitration even if the designated provider is not available? You bet. As Bob often tells anyone who will listen, “You first have to decide what you want to achieve in arbitration; you then use the language to get there.” Bob failed on both fronts. He is not going “there.”