Construction & Public Contract Law Section Blog: Arbitration vs. Litigation: Binding Dispute Resolution Clauses in Construction Contracts:

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  • Construction & Public Contract Law Section Blog
    September
    25
    2018

    Arbitration vs. Litigation: Binding Dispute Resolution Clauses in Construction Contracts

    James M. Dash

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    When drafting construction contracts, it's good to pay attention to how disputes may be resolved. But how can you possibly know at the time of contracting which dispute resolution method is best? James Dash discusses what to consider when writing binding dispute resolution clauses.
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    Whether we like it or not, it seems to be human nature to have occasional disputes with one another.1 The construction world is a microcosm of humanity in this respect – disputes happen from time to time.

    Of course, disputes often run counter to the goal of running a profitable business, and the dispute resolution process frequently can be costlier in time, money, and effort than the object of the dispute. Accordingly, the most cost-effective solution very often is to settle the dispute between the parties before getting into a formal dispute resolution proceeding.

    Yet, for as many reasons as there are people and situations, some disputes are not resolved by agreement of the parties before the commencement of a such a proceeding. And because some proceedings are better, faster, and cheaper than others, it pays to give attention to the manner in which disputes will be resolved at the time of contracting.

    A Contract’s Arbitration Provision is Binding Unless Waived by All Parties

    Most form construction contracts contain options for binding dispute resolution via “litigation in a court of competent jurisdiction” or “arbitration under the rules of [the organization’s name].”

    James M. Dash com jdash carlsondash James M. Dash, Houston 1985, is a founding equity member with Carlson Dash LLC in Pleasant Prairie, with more than 30 years of practice experience in construction law.

    The most widely used standard form construction contract documents, the American Institute of Architects (AIA) documents, used to provide that all disputes would be resolved under the Construction Industry Arbitration Rules of the American Arbitration Association.2

    Accordingly, the contracting parties had to affirmatively edit the document to choose otherwise. The 2007 updates of the AIA documents changed the default dispute resolution method from arbitration to litigation, but contained open and obvious blank boxes to allow the parties choose arbitration, rather than simply abide by the default option.3 This remains the case in the 2017 version of the AIA documents, as well.4

    Wisconsin law is clear that an upfront written agreement to arbitrate is enforceable against the parties signing it.5 So, once a party signs a contract containing an agreement to arbitrate, it generally will be bound to arbitrate with the other signatory6 any dispute within the scope of the arbitration clause.

    ‘Big Rocks’ in Choosing Litigation versus Arbitration

    Herein lies one of the big issues with dispute resolution: how can one possibly know, at the time of contracting, which method of dispute resolution will be the “best” for any or all of the parties?

    Of course, this is a rhetorical question. Unless you have a working crystal ball (and if you do, there probably are better ways to spend your time than thinking about this), there is no way to know what the subject matter of a future dispute might be and who might be involved.

    So how does one decide?

    Quality of the Neutral

    Among the top factors to consider is the likely quality of the neutral. In the case of litigation, this means the judge(s) who are in the pool likely to hear potential litigation.

    In more populated counties, there usually are more judges – meaning that judicial assignments generally are narrower in scope, allowing individual judges to develop some experience – and expertise – in certain substantive areas of law.

    On the other hand, less populated counties generally have fewer judges, each of whom must hear a wider variety of matters and may not see a lot of construction cases. I recall one judge in a case in a smaller county involving a 1.2 million square-foot warehouse telling the assembled group of about 10 attorneys that he had not dealt with a construction lien case in 20 years. This did not inspire confidence.

    Meanwhile, every vendor of arbitration services will tell you that it has cherry-picked the best retired judges and practitioners to act as its neutrals. Sometimes you might agree; sometimes you might not.

    Depending on how you feel about the local bench versus the available pool of arbitrators, this could be a major influencing factor on the arbitration/litigation decision. Further, while you cannot assign a specific judge to a future case, you can agree to specify the names of arbitrators from whom the parties may choose at a later date and agree to litigate if none of the chosen are willing and able to arbitrate the dispute.

    Risk of Multiple Proceedings

    Another big concern is what I think of as a “multifront war,” where three or more parties are involved in a dispute and at least one of them is not bound to arbitrate.

    Take, for example, a design-bid-build project, where there is an alleged defect and a dispute over whether the cause is the design or the construction of the project. The owner might look at the architect and the contractor and say, “I neither designed nor built this, so it couldn’t have been me; it must have been one of you.”

    The architect and the contractor, meanwhile, each contend that it was the other that caused the defect. Complicating matters, the architect could claim that, even if the design was the problem, it was a hired consultant’s fault. For its part, the contractor may assert that, even if the construction was the cause of the problem, it was a subcontractor that was at fault

    And, of course, sureties, lenders and others may need to be joined in order to resolve a controversy completely for all involved parties. In short, it doesn’t take long for lots of parties to get involved in the dispute.

    Unless each of the involved parties has: (i) an arbitration agreement of sufficient scope to capture the dispute; and (ii) a consolidation provision that compels each party to participate in a single dispute resolution proceeding, parties up and down the chain run the risk of becoming involved in multiple proceedings to decide the very same question.

    Not only can this be exceedingly costly, but different decision-makers can reach different results on the same question – both against you or your client.

    The risk of multiple proceedings is considerably lower with litigation because, so long as personal jurisdiction exists, any party can be brought before a court without its consent. An arbitrator’s authority, on the other hand, is limited by the agreement(s) to arbitrate.

    Accordingly, if you agree to arbitrate up front, you may want to consider two things:

    1. a strong mandatory consolidation clause; and

    2. a limitation on the arbitrator’s authority to decide any dispute that reasonably requires parties who have not agreed to be subject to the proceeding to resolve the entire dispute.

    Recommendations

    In my experience, arbitration most often is faster than litigation in almost any court but, depending on how the neutral handles discovery and the hearing, is not necessarily less expensive.

    Because arbitration is faster, the costs are more compressed in time. And arbitrators must be paid by the parties, whereas the taxpayers pay the judge.

    The arbitrator’s fees often are not de minimis, and I have seen an arbitrator refuse to act when he did not receive the scheduled compensation before the decision was rendered – likely because one party did not prefer the expected decision. The arbitrator’s refusal to act landed the parties in court despite the arbitration clause.7 There is little risk of that happening with a judge.

    If we are starting from a clean slate, I generally prefer not to agree to arbitrate upfront because there are too many unknowns – and parties are always free to agree to arbitrate once the parameters of the dispute are known. Without an upfront arbitration agreement, there is minimal risk of becoming involved in multiple proceedings with the attendant cost and possible inconsistent decisions.

    If, once the dispute and parties are known, the parties can agree to arbitrate before a specific arbitrator – and perhaps to limit the scope of the arbitrator’s authority with the particular dispute in mind – they can likely get the most benefit from the arbitration.

    But sometimes the slate is not clean. We have represented parties who, consciously or not, have entered into an initial contract, say an owner-architect agreement, that contains an arbitration agreement and then ask us to help with the next relevant contract, say an owner-contractor agreement.

    In that event, our advice might be to enter into an arbitration agreement in the new contract to minimize the risk of multiple proceedings. And sometimes, although rarely in our experience, a counter-party will demand an arbitration clause or there is no deal. Few I know would walk away from a project on account of a dispute that has not yet occurred.

    If an agreement to arbitrate is included in the contract, I would consider requesting/demanding a strong consolidation clause (section 15.4.4 of the AIA A201-2017 is a good starting point) – and would limit the arbitrator’s authority to decide any dispute that reasonably requires to resolve the entire dispute the joinder of a party who has not agreed to be bound by the proceeding.

    Unlike some jurisdictions, Wisconsin courts have held that the question of substantive arbitrability generally is a question of law for the court absent an agreement to the contrary.8

    I recommend making it clear that the arbitrator has no authority to determine whether a dispute is within the scope of the arbitration clause. For one thing, forum disputes are about as wasteful as one can get.

    Further, as much as I admire my arbitrator friends, it is a fact that they will earn a fee if they find that a case is arbitrable and will not earn a fee if they find that the case is not arbitrable. Albeit not of their own making, that appears to be a conflict of interest. Letting a judge without a financial stake in the outcome make the decision of arbitrability is generally a better process.

    Arbitration Clause Considerations

    For these reasons, when drafting the initial contract for a project, I generally prefer not to have the parties agree to arbitration up front, but will look for opportunities once a dispute arises.

    If the parties are set on an arbitration clause, there are certain agreements that also should be made, including:

    1. a strong consolidation clause,

    2. sending the parties to litigation if a party reasonably joined cannot be compelled to arbitrate, and

    3. making clear that the court, and not any arbitrator, retains all authority to decide the issue of arbitrability.

    There is more to the art of drafting arbitration clauses than is covered here. Hopefully, this piece will give some guidance on whether and when the risk is worth taking and how to frame some of that risk.

    The Construction and Public Contract and Labor and Employment Law sections are co-producing the CLE presentation “Redefining Leadership in Construction: How a Diverse Team Gets Better Results” 3-5:40 p.m. Nov. 14 in Pewaukee. For more information, visit Redefining Leadership on WisBar's Marketplace.

    This article was originally published on the State Bar of Wisconsin’s Construction and Public Contract Law Section Blog. Visit the State Bar sections or the Construction and Public Contract Law Section web pages to learn more about the benefits of section membership.

    Endnotes

    1 This article is not intended to address other potential avenues to resolution that may be placed into a contract, i.e., via the “initial decision maker” or mediation.

    2 See AIA Form A201-1997, section 4.6.2.

    3 In 2007, the dispute resolution provisions of the AIA contract documents were moved from the “General Conditions” (i.e., AIA Form A201-1997) to the “Standard Form of Agreement” (i.e., AIA Form A101-2007, sec. 6.2).

    4 See AIA Form A101-2017, sec. 6.2.

    5 See Wis. Stat. § 788.01, et seq.

    6 Whether a non-signatory can be bound to an agreement to arbitrate is beyond the scope of this article.

    7 To be fair, the parties could have agreed that the failure to pay fees would result in an award against the party not paying its share, which likely would have avoided the fate suffered.

    8 See, e.g., Kimberly Area School Dist. v. Zdanovec, 222 Wis. 2d 27, 586 N.W.2d 41 (Ct. App. 1998).





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