The process of arbitration.
Clogged courts and escalating litigation costs have made arbitration as a solution for civil disputes and claims of conflict more necessary than ever before. Arbitration is a process by which a dispute is settled by an impartial, disinterested person or group who is authorized to render a decision that is legal, final, and binding. Arbitration is used as an alternative to litigation because it provides for an expeditious and inexpensive resolution of disputes by arbitrators having expert knowledge within a particular field, who act in an informal process that maintains the privacy of business transactions.
What triggers an arbitration instead of litigation? In litigation one party sues another, which is then forced to defend itself. An arbitration is brought about by an agreement between parties to resolve either a yet-to-occur dispute or one that is before the parties already. For years parties have written arbitration clauses into deeds, leases, and other legal contractual agreements to set the guidelines and framework for proceeding toward resolution of a disagreement. It is particularly common for disputes within the field of real estate to be resolved by arbitration.
Typically, in a case involving real estate the professional parties to the proceeding are an appraiser and a consultant or an attorney. Various witnesses who possess expertise in related professions, possibly including a sales broker, a leasing broker, a mortgage broker, a mortgage banker, an engineer, an architect, a developer, an economist, and an accountant may also be involved.
REASONS FOR ARBITRATION
Some examples of real estate disputes that may be resolved through arbitration include:
1. The value of a parcel of land needed
to determine an economic land rent.
2. The economic value of space (e.g.,
office, retail, residential) required
to determine rent during the re-
newal or option period of a lease.
3. The appropriateness or fairness of
a management fee between land-
lord and tenant where the tenant
reimburses operating expenses via
a passthrough clause in the lease.
4. The fair market value of an entire
property, including land and im-
provements, needed to determine
an acquisition or disposition price
subject to a purchase option clause
in a lease.
5. The fair market value of a frac-
tional interest in a parcel of real es-
tate required to determine the
"buyout" value of a partner's in-
terest or a family member's interest.
6. Other situations requiring arbitra-
tion may include tax appeal (i.e.,
certiorari); eminent domain (i.e.,
condemnation); commissions; sales
contracts; landlord and tenant
evictions; and the fair, reasonable,
and equitable nature of contracts.
The American Arbitration Association (AAA) provides guidance on how to conduct an arbitration procedure. The AAA recommends the insertion of a simple clause into contracts and agreements such as:
Any real estate valuation or related con-
troversy or claim arising out of or relating
to this contract, or the breach thereof, shall
be settled by arbitration in accordance with
the real estate valuation arbitration rules
of the American Arbitration Association
and judgment upon the award rendered
by the arbitrator(s) may be entered in any
court having jurisdiction thereof.(1)
Should the need for arbitration arise, the AAA will choose an impartial arbitrator from carefully selected lists of arbitrators having expertise within this specialized field. An arbitrator must have no conflicts of interest and the parties must agree to the chosen arbitrator. One type of arbitration takes place at the local or nearest offices of the AAA. A reporter may be present to record proceedings, lawyers for each side may present their clients' cases, and witnesses may even be called and exhibits presented. A variation of this procedure is to simply have both parties to the dispute present their cases to the arbitrator without attorneys, exhibits, or witnesses. There may be further variant procedures as well.
Some arbitration clauses may call for the rules and procedures of the AAA to be followed but leave the parties free to choose their own arbitrators and hold the meetings at places of their own choosing. Still other arbitration clauses make no reference to the AAA at all, but rather spell out the procedure for choosing arbitrators and leave it to them to determine the procedure. Other clauses contain the provision that in the event the two parties don't agree, each one shall choose an arbitrator or, often, a real estate appraiser. In this case specific qualifications may be stipulated, such as membership in a certain professional organization with a specific number of years' experience in appraising the particular type of property in the locale in question, or service as a broker for a specific number of years.
A typical clause of this kind might state, "In the event the two parties cannot agree, each shall choose an arbitrator who will be a real estate broker for a minimum of ten years and shall have experience in performing transactions of the same type of property as the subject." Often, the clause requires each party to choose "a real estate appraiser who is a duly designated member of the Appraisal Institute and who has a minimum of ten years experience in appraising the same type of property as the subject."
When both parties choose their own arbitrators, the two arbitrators may be unable to agree on a suitable decision. As a matter of fact, the only thing on which they may agree is to disagree. What happens when the two arbitrators fail to agree? A proper arbitration clause will direct the two arbitrators to choose a third arbitrator in the event the first two cannot agree on a resolution. Most of the time the agreement of two of the three will resolve the dispute. Alternatively, the clause may require all three to be in agreement, a difficult task.
A variant solution, called the "baseball" method, requires the third, or central, arbitrator to choose the conclusion or value of either one or the other arbitrators or appraisers. Some see this as a faster procedure that takes a great burden off the central arbitrator because the conclusion is always one value or the other but never something in between. In addition, it could be argued that this method of determination causes appraisers to be more objective than subjective.
COMPENSATION FOR ARBITRATION
Most often, each arbitrator is paid by the party who hired him or her, with both parties paying one-half of the fee of the third arbitrator. In some cases, the fees of all the arbitrators are paid equally by both parties.
Arbitrators' fees typically include a base amount and an hourly fee. Arbitrators are paid to initially meet with the party or parties, read the lease or document, listen to the presentation of the case by both sides, read all other related documents (e.g., appraisals, leases, deeds, exhibits, stenographic transcripts), deliberate, and finally, render a decision.
WRITING ARBITRATION DECISIONS
In rendering a decision, an arbitrator should write it in a short, one- or two-line statement that spells out the amount of the award, rent, or price. The AAA recommends that reasons and support not be given in an arbitration decision because they will furnish additional ground for opposing sides to attack should the decision be appealed. A sample of a suitable statement is:
In the matter of Acme Development Co. v.
Fifth Avenue Cooperative Owners Corpora-
tion, pursuant to their lease dated January
1, 1965, we find that the land value as of
December 31, 1989, is $20,000,000, reflect-
ing annual net land rent with no expense
offsets equal to 6% of that land value, or
$1,200,000 per year, from January 1, 1990,
to December 31, 1999.
Arbitration decisions are usually signed; when two arbitrators agree, they both sign to reflect agreement. If a third arbitrator is chosen and the final decision is based on a majority of the arbitrators, at the very least the two composing the majority sign the decision. In the baseball method, only the central arbitrator need sign the decision. A decision is made stronger when all the arbitrators sign the decision in assent. There are times, however, when an arbitrator may not agree with the decision and choose to dissent. He or she may sign as a dissenting arbitrator, or may write a dissenting opinion, which some attorneys feel makes their case stronger in an appeal process.
Decisions reached through arbitration are seldom successfully appealed. Courts are wary about upsetting arbitration decisions; however, if a decision is irrational a court may overturn it. Other reasons for vacating an award are: 1) corruption or misconduct in procuring the award; 2) partiality of an arbitrator appointed as neutral; 3) an arbitrator exceeding his or her authority; 4) a valid agreement to arbitrate not being made; or 5) the agreement to arbitrate not being complied with. There are also grounds for modifying an award, which include a miscalculation of figures; a mistake in the description of a property referred to in an award; or an award decided on a matter not submitted to the arbitrators. Upon vacating an award, a court may order a rehearing of all or any of the issues either before the same arbitrator or before a new arbitrator.
PLANNING THE PROCEDURE
Ideally, arbitration resolves a dispute in an expeditious and cost-effective manner. When there is one arbitrator and two disputing parties, the proceeding may be short because it is easy to assemble the small number of people, perhaps in the arbitrator's office. When the arbitration proceeding becomes a full "dog and pony show," however, with several attorneys on each side, appraisers, witnesses, exhibits, and a stenographer, it becomes more difficult to assemble all the parties at one time. In some cases it has taken years to accomplish just 30 days of actual meeting time.
For arbitration to work, the proper arbitration process must be conceived and well planned upon the execution of the original document. Even when this is accomplished, an overriding factor, referred to as the "spirit of the contract," may determine the outcome.
In real estate arbitration there are common points of weakness or controversy that may require much time to be spent in the arbitration process. For instance, in the arbitration of a rental to be decided for an option or renewal period, the instruction to value the land under the improvement on which the rental is based may be interpreted differently from the way it was originally intended. Was the land supposed to be valued:
1. Vacant and unimproved of all
2. Vacant and unencumbered?
3. Vacant, unimproved, but subject
to the lease?
Is each of these options different? Do any mean the same thing?
Other questions of interpretation may arise as well. In the determination of rent during an option or renewal period, does it make a difference whether the lease states fair market rent or fair rental value? Does the former term refer to a fair rent at the market level of other comparable rents for similar properties in the area, and does the latter term refer to a rent that is fair to both sides, but not necessarily at market?
If fair rental value means a rent that is most fair to both sides, regardless of the market level, should it make a difference to the arbitrator that one side can't elicit any more rent from an apartment building, because of rent control or rent-stabilized rentals, to pay more than a certain level of underlying lease rent, even though that rent level is less than what may be deemed a market rental? Is it fair to entirely wipe out a tenant's position by allowing the underlying rental to more than equal the apartment building's rental income? Questions such as these commonly face arbitrators in many proceedings.
DUTIES OF AN ARBITRATOR
Before the arbitration proceeding itself an arbitrator should read the document that contains the arbitration clause, meet with the parties to understand their positions, and discuss the ground rules of the procedure. Upon commencing the process, the ground rules and procedure should be openly stated for the record as well as for the understanding of all concerned and in attendance. Topics covered should include the oath of the arbitrators or panel, the swearing in of witnesses, the procedure for documentation of exhibits, and the formality or informality of the arbitration. It is an arbitrator's role to listen to the presentations of both sides, to hear and rule on objections, to consider and accept evidence in the form of exhibits, and generally to move the arbitration process along with speed and dispatch while being fair and equitable to both sides. A good arbitrator does not lose control of the procedure to one of the parties or their attorneys or become intimidated by them. If this happens one party will surely feel aggrieved--even during the arbitration process.
It is important to note that an arbitrator brings more than merely fair judgment to the proceeding. He or she brings an expertise from a specialized field that serves both parties better than they would have been served had the matter simply gone to court, where the judge may know little about the area of specialization in question. Many arbitrators believe that such expertise is a prime reason for choosing the arbitration process.
Arbitrators continue to face dilemmas during the procedure itself. For instance, an arbitrator may have more knowledge of leases, rentals, sales, and transactions than any appraiser or witness for either side has presented. Should that be considered? Or, during the arbitration process, is it fair and proper for a party-appointed arbitrator to communicate with his client? And if so, who should initiate contact? Should certain topics not be discussed, such as the opinions of the other arbitrators, until that point? Some clients attempt to use communication with their appointed arbitrator as a window into the confidential discussions of the panel to fine tune their presentation as they proceed. Where does one draw the line? A party-appointed arbitrator is a representative of the party who hired him and comes to a proceeding with a different agenda than the third or central arbitrator, a situation recognized by the courts. Canon III of the Code of Ethics for Arbitrators in Commercial Disputes states that "Unless otherwise provided in applicable arbitration rules or in agreement of the parties, arbitrators should not discuss a case with any party in the absence of each other party, except ... (3) if all parties request or consent that such discussions take place."(2) While it is important for party-appointed arbitrators to fairly represent their clients, care and thought should be given to just how much the arbitrators will allow themselves to be directed by their clients. The third or central arbitrator, however, truly plays the part of a judge and should thus have no biases.
Realistically, economic conditions play a large role in determining whether an issue will be arbitrated. During recessionary periods when values are in the trough, tenants are more likely to press for arbitration because it is an ideal time to set a low rent for the future period. Of course, because the real estate market is cyclical in nature, when values are at their peak landlords may press for the exercise of the arbitration clause.
One caveat: an arbitrator should not be hired to appraise, and an appraiser should not be hired to arbitrate. The arbitrator who also serves as his own appraiser becomes an advocate and the decision could be overturned.
Finally, it has often been said that the fairest decision is one that gives greatest weight to neither side yet satisfies both. The arbitration process no longer calls for a Solomon, but does require one to be fair, equitable, and just, while moving the process along with dispatch in a cost-efficient manner.
A truly successful arbitrator continues to be asked to perform this service by clients from both sides. Paramount to success is a thorough and working understanding of the arbitration process and its Code of Ethics.
(1.)American Arbitration Association, Real Estate Valuation Arbitration Rules (New York: American Arbitration Association, 1992), 3.
(2.)American Arbitration Association, Code of Ethics for Arbitrators in Commecial Disputes (New York: American Arbitration Association, 1977), 8.
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|Author:||Block, Jerome N.|
|Date:||Apr 1, 1993|
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