Forced Arbitration in Tech Contracts: Brendan Ballou on Vendor Accountability Risks

[00:00:00] Every contract you sign with a vendor, your RMM, your PSA, the hyperscalers, might have a clause you've probably never read that strips you of your right to sue them in court. If something goes wrong, you don't get a judge, you get an arbiter that they're paying for. Consumers win 89% of the time in small claims court in forced arbitration that drops to somewhere between 20 and 30%. At one arbitration provider, it was 0.2%. It's not a broken system, it's working.

[00:00:30] Exactly as designed. I'm Dave Sobel and this is the Business of Tech. Today I'm talking with Brendan Ballou, founder of the Public Integrity Project, formal federal prosecutor and author of When Companies Run the Courts. He's a speaker at our upcoming SMB online conference. Today we're going to talk about how forced arbitration became the invisible infrastructure that lets big companies operate beyond the reach of the law and what that means for MSPs who are caught on both sides of the table.

[00:01:00] Brendan Ballou, you are the founder of the Public Integrity Project, former federal prosecutor and author of When Companies Run the Courts. Welcome to the Business of Tech. Thank you for having me. Well, and you're a frequent flyer. This is your second appearance and you'll be coming up as a speaker at our upcoming SMB online conference. Really excited to talk to you again. I want to start with something that grabs people immediately because the story is really good. The Disney World case.

[00:01:28] A man's wife dies from an allergic reaction at a Disney restaurant and Disney's legal response is to invoke a forced arbitration clause because he once signed up for Disney Plus. So that's the opening opening framework. Tell me what that case illustrates about forced arbitration and where we've reached at this point.

[00:01:49] Yeah, I think what it tells you is that there is essentially a private secret justice system in the United States that very few people know about, but that binds almost all of us. You know, the fact that one man could be legally compelled into arbitration because he had signed a Disney Plus account four years ago and then had to arbitrate the death of his wife, I think speaks to the power that this system has to compel us into it.

[00:02:15] And yet I think the vast majority of people have almost no idea what forced arbitration even is. So now Disney backed down because of the public pressure, right? And you know that the law was actually on their side in this case. So like how often does public pressure not work and what happens in the 999 other cases that don't make the news?

[00:02:40] Yeah, well, you know, unfortunately, the very next example we had in the book was a graphic illustration of that, which is one woman was a employee on a cruise ship. She was allegedly raped by her coworker. And when she complained to the cruise ship company and tried to sue for essentially having an extraordinarily dangerous workplace environment, they were able to compel her into forced arbitration.

[00:03:07] And in fact, to do so in the Philippines, in our home country, where obviously we have no idea what the outcome of that arbitration was. You know, those were facts arguably even more horrible than Disney's. But and I'm paraphrasing the judge in that case only slightly here. The judge said something to the effect of, you know, horrible alleged facts don't change the underlying law here. And the underlying law is clear that if you sign one of these agreements, you can be compelled into forced arbitration.

[00:03:37] So, again, just a set of baseline of what we're talking about here, a private justice system where instead of your case being decided by a judge, it's decided by a private, what we'll call it, arbitrator. So often a retired judge or a lawyer in private practice. And that decision is just as binding as a regular judges and yet can almost never be appealed and usually occurs in secret. So there's no way to know what the outcome is.

[00:04:04] So, you know, what these cases illustrate is that, you know, you can be bound into this system, whether you intended to be or not, whether even you knew you could be or not. But these agreements will be enforced. Now, we talk a lot about agreements and it's worth getting back like to the to the why of here. Now, you trace back like kind of what's happened here to Anton Scalia's decision in 2011, but that dates all the way back to 1925 and the Federal Arbitration Act, like what it said.

[00:04:34] I think it's worth saying, like, let's set the premise here of like, what is arbitration? Why was it established? And then how did it get skewed in 2011 to become what it is now? A great question. So, you know, you reference 1925. That's when Congress passed what was called the Federal Arbitration Act. And the Federal Arbitration Act was meant to do something very different than what arbitration does now.

[00:04:56] It was meant to allow sophisticated power parties of roughly equal bargaining power to enter into an informal alternative to the to the justice system. You know, the idea is, you know, we can all imagine, you know, going to court is expensive. You often have to hire a lawyer. It can take a long time. All that if you can resolve your dispute more informally and both sides agree to it, that can be a great thing. And can and can work in a lot of different circumstances.

[00:05:22] But what was really important was that the Federal Arbitration Act was never meant to apply to disputes between, for instance, companies and their customers or companies and their employees. And it certainly wasn't meant to apply to what lawyers would call contracts of adhesion or, you know, what you might know is the sort of click to accept contracts that you sign every day when you go to a website or you get a new cell phone or you open a bank account. The kinds of contracts that you don't have the ability to negotiate over.

[00:05:52] Over time, the Supreme Court expanded the Federal Arbitration Act really beyond what what the legislative history said it should be beyond what even the text that it should be to encompass all of those things. So now arbitration can bind you if you're a customer, if you're an employee or if you're signing those click to accept contracts. And again, one of the big challenges that you have is all of those arbitration proceedings are going to happen in secret and they basically cannot be appealed. We'll be right back after this message.

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[00:07:16] That's M-O-O-V-I-L-A dot com slash MSP Radio to learn more. And we're back. Now, you've said something that I want to put a pin in there because the original intention we're going to loop back to in terms of equal size parties and the kinds of disputes. So listeners, pin that. Because right now I want to talk a little bit about some of the issues where it went wrong. Like I want to talk, there was, litigation was exploding in the 80s, right?

[00:07:44] And there was a lot of real kind of issues of volume and some of the class actions that get abused. Walk me through like the problem that Scalia was responding to and what caused the situation that we're having now. Yeah. So, you know, there has been this sort of meme in American history, this idea of a litigation explosion.

[00:08:05] And I'll actually, I'll offer sort of counter history to some of that, which is it's absolutely true that in the 1980s, litigation did increase in the United States. So, but what kind of litigation increase actually is very different from what I think most of us expect. So there was this really interesting study looking at litigation from, I think, 1978 to 1984, which is sort of the core period of when we start talking about the explosion of cases in the courts. And indeed, cases did rise in the federal court system.

[00:08:35] But a lot of the increase was due not to people suing companies, but actually the government suing people. So there was a huge push by the federal government to start suing Social Security beneficiaries and veterans who they believed were getting too many benefits and to try to take them away. Cases that companies really cared about, so securities cases, antitrust cases, and so forth, actually declined over that period of time.

[00:09:02] And, you know, to the extent that there was an increase in cases against companies, it was overwhelmingly about one specific industry, which was asbestos. So, you know, I think there's a really deep belief in America that there is this sort of tidal wave of frivolous litigation. I'm not sure that the data actually backs that up. And I would encourage people to think about their own sort of personal experiences.

[00:09:28] Like how many times have they sort of experienced frivolous litigation? Probably not that often as compared to how many times has a company or an employer treated you badly and there was no legal recourse actually is pretty, pretty common.

[00:09:43] The last thing that I'll just say about this is, you know, there really was an enormous, you know, while the litigation explosion may or may not have existed to the degree that people thought or in the way that people thought, an enormous amount of money was spent to kind of create the idea that it was. And so beginning in the 1990s, for instance, you have all these stories about, you know, the woman who spilled, you know, coffee on her lap at McDonald's and stuff like that.

[00:10:07] Turns out that woman got third degree burns in her thighs and vagina and tried to settle for $50,000, only sued because McDonald's refused to settle. And then it turned out that McDonald's had had seven or 800 similar complaints that they didn't disclose and actually had a company policy of heating their coffee up to 105 degrees. Water boils at 120. So I'm not trying to change people's opinions forever about lawyers and litigation in America.

[00:10:33] But I will say, I think the story is a little a lot more nuanced than the public sort of understanding often is. But the Supreme Court didn't respond to nuance. They responded to the popular history. And in the belief that there was a litigation explosion took a number of steps to make it much harder for people to sue when they're hurt by companies or when they're hurt by their employers. Now, you've done a great job of laying it out.

[00:10:56] And the nuance is where we're going to dance a little bit now, because I think what's interesting is, is we've got our audience, managed service providers, IT service companies actually have both sides of this problem. And I want to talk about the first part together, the piece that reflects what you've been working on here. So IT service providers, MSPs are going to sign contracts with their RMM platform, their PSA, the hyperscalers. They are resellers of Microsoft 365, Azure Web Services, Azure, Google Workspace.

[00:11:26] Like these are pieces where they are going to be signing contracts where they likely have limited at best ability to make changes to those contracts. So walk me through what a typical vendor arbitration clause requires of them and what they're giving up in terms of their rights. So an arbitration clause is probably going to say that if a dispute arises between you and the supplier, you cannot sue them in state or federal court.

[00:11:53] Instead, you will have to choose from, you know, one or a couple of arbitration providers. You know, the largest ones are called AAA and JAMS. Good chance that you'll be required to arbitrate there. In arbitration, you'll have some ability to choose who your arbitrator is and then potentially some sort of procedural protections around sort of what sort of discovery you can get, whether or not you can depose somebody and stuff like that. But the arbitrator's decision is going to be binding here.

[00:12:19] And one of the challenges that you might have as a comparatively smaller supplier against a really large tech behemoth is those tech behemoths appear in arbitration all the time. And you probably don't. And because arbitrators have to get chosen by both parties and are often paid for by the larger party, they, whether they want to or not, have a financial incentive to rule for one side.

[00:12:45] And so, unfortunately, you might be in a system that is systematically a little stacked against you. I'll just to give you some statistics. You know, it's not in the B2B context, but, you know, in consumer arbitration, you know, consumers win about 89% of the time in small claims court. In arbitration, they win 20 to 30% of the time. If they don't have a lawyer, it might be less than 10% of the time.

[00:13:09] So, you know, that speaks to even when arbitrators are trying to do the right thing, the financial incentives sort of push them in one direction, unfortunately. Well, I think that expertise is the area that I kind of want to understand a little bit more about. Like, so you have an issue. It's got, let's say, it's gotten to that level. You know, you're in this space where you don't have the same level of information. There's that asymmetry of information. Like, how is, are there things that smaller businesses can do to close the gap? Is it completely structural?

[00:13:40] Like, what can they do in those situations to make that better? Yeah, you know, it's tricky. I mean, part of it is if you've got some negotiating leverage at the outset to change this. What you really want, and I think this has been a theme in our conversation so far, is that arbitration by itself is not a bad thing. You know, arbitration can make a lot of sense in certain kinds of disputes.

[00:14:04] You know, if you, you know, have, again, have roughly equal bargaining power, you want to just kind of avoid the hassle of court and try to get to a resolution quickly. Arbitration can make a lot of sense. And so if you can negotiate a term that says after a dispute arises, the parties have a choice to engage in arbitration. That can make a lot of sense because once there's a fight, you can decide, well, is it going to be faster for me to arbitrate this?

[00:14:30] Or is it going to be something that really makes more sense to do in court? I think to the extent that, that, you know, if you can't sort of negotiate ex ante, if these are essentially click to accept contracts, the thing that you might be thinking about is, are there some power in numbers here? So forced arbitration is usually trying to kill a class action. It makes it impossible for you to sort of everybody just share one lawyer and bring one dispute.

[00:14:57] But even so, you have some leverage if you bring what's called a mass arbitration. So everybody who's similarly situated bringing an arbitration all at once. It gives you some negotiating power. So if you are in a situation where you've been harmed by one of these big suppliers and you're forced into arbitration, doing a little bit of outreach to some of your peers to see if they're experiencing the same thing and also want to pursue arbitration might give you a little bit of power. We'll be right back after this message.

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[00:15:49] For MSPs building a more automation driven operation, Halo PSA is one of the platforms increasingly showing up in those conversations. Learn more at usehalo.com. And we're back. Let's differentiate a little bit here because we've now hit on the piece that I think is important. On the other side, right, we've got the places where it makes sense. I'm going to give you a scenario and we'll talk it out a little bit.

[00:16:17] Like so an MSP has a $45,000 collections dispute with a client who's claiming service failures, right? This is this is that gray zone there. Small claims won't hear it's too big for that. $45,000 sounds like a lot of money until you start thinking about the cost of litigation, because it's quite likely that litigation is going to cost more than the recovery. Like walk me through what properly designed arbitration looks like in that context.

[00:16:45] Yeah, you know, and it's tough because, you know, I understand it as a small business owner. You know, you get one of these things and $45,000 can, you know, can be a lot to, you know, your bottom line. And the cost are the, you know, the, frankly, the scariness of having to litigate something can be really, really anxiety producing. And, you know, whenever somebody gets sued, you know, the other side is always bringing for false litigation. So, you know, you always sort of see things through your own lens.

[00:17:14] I would caution your audience to not immediately jump to the idea of including a forced arbitration clause in your contract ex ante. I think it may make a lot of sense for you to mutually agree on arbitration after the fact. You know, you have a collections dispute.

[00:17:35] You say, I am prepared to sue, but I think it is going to be in everybody's interest to pursue this through arbitration or mediation, which is like arbitration, but the outcome is non-binding. But I think it makes sense for us to pursue this in arbitration and to get consent to do that. But the reason why I don't think ultimately it is in your interest to have a forced arbitration agreement with all of your customers is I think it ultimately creates really bad incentives for your business.

[00:18:03] You think about the businesses or the industries that use forced arbitration the most, and it's the industries that you hate the most. It's, you know, it's your, you know, it's consumer finance, it's credit cards, it's cell phones, it's nursing homes. It's the industries that are hardest to deal with and most dangerous.

[00:18:24] And I think that there's a little bit of causation there, which is when a company or when an industry really doesn't have to deal with, you know, actual problems from their consumers and employees and know that they're functionally beyond the reach of the law. It really encourages terrible customer service, terrible customer relations and creates a sort of manipulative, extractive relationship with your customer. So I would encourage you to pursue arbitration or to encourage arbitration.

[00:18:54] But I think for the health and kind of for the soul of your business, I discourage you from forcing arbitration. There's the key unlock, the difference between forced and misogynist. My own attorney who I work with always says contract saves friendships. It's always because the intention is to write down. So what I kind of want to get is your book lays out some reform agenda, right? And this is obviously intended for the idea of those forced arbitration, things like transparent decisions, arbiter statistics, discovery rights and written outcomes.

[00:19:23] I'm curious, like, so if a listener right now, an MSP or an IT service company is drafting their master services agreement right now and they want to include dispute resolution clauses with this statement. I know you this is not legal counsel advice, but let's give them some guidance. Right. Which of those features that you outline in the book make it like legitimate and are the right spirit of things? And which are the ones to watch out for that could be weaponized? Yeah. Yeah.

[00:19:50] So, you know, the main thing, if you're drafting or if you're signing, the main thing to be thinking about is who is your arbitration provider going to be? So, you know, some are more reputable than others. You know, AAA and Jams are sort of the main ones. I have some concerns with how they've structured things, but by and large, they're sort of the fairest in the field. When you start seeing people, you know, turn to much smaller arbitration companies, those rules start to become very skewed.

[00:20:17] And so when you're on the signing side, be careful when you start to see those less reputable or less known arbitration providers out there. When you're on the drafting side, I think it's I ultimately think it's probably not in your company's long term interest to pursue that, you know, to use those. I think it ultimately hurts the sort of soul of your company. I will say to the extent that you want to consider alternative dispute resolution and you really want to include it ex ante.

[00:20:46] You know, one thing that you might want to do is think if rather than arbitration, think about mediation, which is, you know, the same procedures, but the outcome is not binding. And that's a good thing because you might not like the outcome of arbitration. You know, just as it's a little arbitrary for the other side, it can be arbitrary for you. And just like it's not appealable for them, it's not appealable for you. And I will say, you know, people have different experiences in mediation.

[00:21:15] But oftentimes it can get to essentially the same results as avoiding litigation entirely because it helps the parties come together informally and share some information and understand what's the real possibility of a resolution here. So non-binding mediation might be a way to save money, to save on those legal fees, but without locking either side into a system that might be a little arbitrary and that might not be fair for either side.

[00:21:43] Brendan Ballou is the founder of the Public Integrity Project and a former federal prosecutor who spent years in the DOJ's antitrust division. He's the author of two books, Plunder in 2023, an investigation into private equity's extraction from the American institutions, including nursing homes, newspapers and prisons, and When Companies Run the Courts this year. A deep examination of how forced arbitration became the legal infrastructure that allows larger corporations to operate largely beyond judicial accountability.

[00:22:12] He is also a speaker at the SMB Online Conference, where he presents on the themes from Plunder. His work has spanned legal scholarship, policy advocacy, and public accountability. Brendan, it is always great to have you on. Where can people find the book and where should they go to follow the work you're doing at the Public Integrity Project? Yeah, so when companies run the courts, it's available wherever you buy a book. And as for the Public Integrity Project, you can follow what we're doing. You can support the work at publicintegrityproject.org.

[00:22:39] And I know you'll be back to talk about private equity a little bit at our SMB Online Conference. Listeners can register at smbonlineconference.com. Brendan, always a pleasure to see you. Thanks again for joining me. Thank you. Want more from the Business of Tech? Join Business of Tech Plus for ad-free episodes, early interviews, extended cuts, subscriber-only shows, and exclusive member perks and analysis. Sign up at businessof.tech slash plus.

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