Large-Scale Construction Projects: To Arbitrate, or not to Arbitrate – That is the Question

Robert B. Garner, David Kiefer and Gregg Jacobson | King & Spalding | March 8, 2019

Owners and contractors involved in large-scale energy and manufacturing projects face unique challenges in bringing projects to fruition. One challenge is negotiating and drafting a contract that places the parties in a fair position if problems arise during the project. In construction contracts for large-scale projects, multiple areas can be vitally important, such as intellectual property, change order rights, limitations of liability, liquidated damages and insurance. Somewhat overlooked, however, is the dispute resolution clause.

Through a dispute resolution clause, the parties decide in advance how disputes will be handled. The owner usually leads this discussion and develops a dispute resolution strategy early in contract negotiations, carefully considering the various parties (contractors, suppliers, and engineers) involved in the project, their typical requirements and expectations, and its own needs. The most basic question in developing a dispute resolution clause is whether arbitrators or a judge should decide the outcome of the case (and in the latter case, whether or not to permit a jury to have a role in the decision process). Both arbitration and litigation have advantages and disadvantages based on the circumstances.

Once that decision is made, the next issue is drafting the provision. If arbitration is chosen, one significant drafting concern is what law applies – the federal arbitration act or a state arbitration act. Even if the state arbitration act applies, drafters need to keep in mind that the federal act may govern in certain, specific situations. A well-drafted, customized dispute resolution clause will help ensure that the process goes smoothly, protecting against risk and potentially saving untold amounts of time and money.

To Arbitrate . . .

Enforcing a Foreign Judgment

Many sophisticated parties prefer arbitration in their agreements. One significant reason is that it can be much easier to enforce an arbitration award against a foreign party than a court judgment. This is due to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, also known as the “New York Convention.” Judgments from U.S. courts can be enforced overseas, but it is often a difficult and drawn-out process involving the Hague Convention. And of course, the longer the process to enforce the judgment, the more expensive it can be and the greater the opportunity for potential assets to slip away.

On the other hand, if a foreign country is a signatory to the New York Convention (and over 150 countries are), that arbitration judgment is directly enforceable in that country, barring a few narrow exceptions. Thus, owners of large-scale construction projects who envision using foreign contractors or suppliers, or contractors dealing with foreign ownership, will almost always find it easier in a foreign country to enforce a U.S. arbitration judgment than one issued by a judge.

Confidentiality

Another potential advantage to arbitration is the confidentiality of the arbitration process. Unlike litigation, which is presumptively public, arbitration proceedings are confidential. This means that whatever the allegations, you are unlikely to read about them in the press. This could be especially useful to owners who may be accused of various safety and environmental violations. However, it is also useful to contractors who are concerned about future clients learning about the number of claims they have made in past projects. However frivolous the lawsuit, if it is in court, it is public, and ripe fodder for the many legal websites following newly-filed litigation. If it is in arbitration, it is private.

Evidence

Construction cases are notorious for involving an extraordinary number of documents. Courts have strict evidentiary rules regarding documents – each one must be authenticated, and each one must have an adequate foundation to meet an exception to the rule against hearsay. These requirements can be a large burden for both sides. For example, if there is no witness to testify as to the date a photograph was taken, a court may exclude that evidence due to lack of authentication. Arbitrators, on the other hand, are likely to consider such evidence and determine on their own how much weight to give it. Thus, parties will face less procedural scrutiny to getting their evidence considered in arbitration than they would in a court.

Experienced Arbitrators

Another arbitration “plus” is the experience of the arbitrators themselves. Arbitrations are products of contract – the arbitration only exists because the parties agreed to arbitrate. Thus, the parties can agree to certain requirements. For example, the contract can state that three arbitrators shall hear the case, and that each party may choose one of the arbitrators (with those two choosing the third member of the panel). This gives flexibility to tailor the arbitrator to the dispute. If the claim involves intellectual property, an IP lawyer can be designated. If the disagreement covers specifications or scope, it could be a construction lawyer, or even an engineer or architect. If the main claim concerns delay, it could be a scheduling expert. Ensuring that certain expertise is on the panel can be extremely beneficial.

Enforceability of Choice of Law and Choice of Venue

Finally, one last arbitration advantage is the likelihood that choice of venue and choice of law provisions are upheld. Many states across the nation have statutes that invalidate choice of venue provisions if the provisions require that the parties resolve disputes outside the state where the project is located. These state laws not only invalidate choice of venue provisions, but often restrict choice of law clauses as well. However, an advantage of arbitration is that there is ample precedent indicating that the Federal Arbitration Act preempts these laws with respect to venue and choice of law restrictions. In those cases, the parties are free to determine the location of where the disputes will be handled and the law governing the parties’ agreement.

. . . or Not to Arbitrate . . .

Neutrality

While there are many advantages to arbitration, litigation also has its benefits. One advantage is the neutrality of the judges. While using experienced arbitrators can be an advantage for complex disputes, one must keep in mind that along with experience comes biases and pre-conceived notions. That experienced arbitrator who looks wonderful on paper may harbor a hidden animosity against one party due to a lifetime defending owners or contractors. Or, he may deem unenforceable any clause that he would not have agreed to himself. Most construction dispute arbitrators will be current or former construction litigators who have, throughout their career, primarily represented one type of party. A judge, on the other hand, is unlikely to have presided over many construction cases in his career. He or she is a blank slate, waiting to be informed. Savvy lawyers can use this to their advantage.

Dispositive Motions

Another benefit to litigation is the strict rule of law found in courtrooms, particularly regarding dispositive motions. A dispositive motion (typically a summary judgment motion) is a motion that decides part or all of a case just on the written motion – no testimony or hearings needed. Those with well-written, customized contracts hold a huge advantage here if the contract requirements are clear and unambiguous. These summary judgment motions are much more likely to be granted in litigation than in arbitration. One reason, as stated above, is that a judge is truly neutral – he or she typically does not care about the case itself, and is happy to make the docket lighter if part or all of a case can be dismissed on summary judgment. Conversely, an arbitrator has a financial disincentive to grant a dispositive motion. Arbitrators get paid by the hour and by the day, and any motion that removes part of a case cuts down on that work. Arbitrators will say that this disincentive does not come into play, and for most arbitrators it does not. At the least, however, that disincentivising undercurrent exists.

Another reason is the general informality of the arbitration process. Arbitrators prefer a less formal hearing than a trial, and generally allow the parties to put on all relevant evidence. Then, the arbitrators decide for themselves what weight to give that evidence. Courts, on the other hand, strictly follow the rule of law. If the contract is clear and unambiguous, the court can decide a dispute for itself – no hearing or trial needed. Thus, while an arbitrator is more likely to allow the evidence to be heard and then decide whether it affects the outcome, a judge will pare down the dispute as he or she can. Here, customized and clear contracts hold the advantage.

Discovery

Construction projects, perhaps more than any other type of case, involve a huge number of documents. Depending on the arbitration, the rules may restrict discovery so that it is difficult for either side to get all the information it wants. For example, international arbitrations typically rely on the IBA Rules on the Taking of Evidence and do not allow for pre-trial depositions. A court is much more likely to allow for broad discovery.

Further, any dispute will likely involve a third-party – someone not directly involved in the dispute, but someone who has important, perhaps even dispositive, information. Information from a third-party is much easier to obtain in court than in arbitration. In court, the process is relatively easy. The court (or even just the lawyers themselves) issues a subpoena, and the third-party is obligated under law to produce documents. The process may be a bit more complex for out-of-state parties, and more so for foreign parties, but it is still a straightforward process. Third-party discovery in an arbitration, conversely, is anything but straightforward. To obtain discovery in arbitration, you would need to specify that discovery is permitted in the contract itself, and that depositions may be held.

If the discovery rules for the arbitration are not clearly set out in the contract, you have to figure out whether third-party discovery before the hearing is even permitted. Currently, there is a circuit split in the courts as to when third-party discovery is allowed. The Federal Arbitration Act states that arbitrators can summon any third-party to come before the arbitrators and bring any documents. Some courts interpret this as only allowing certain discovery on the day of the hearing (trial), while others allow discovery in line with the federal courts. In court, those rules are already set.

Right to Appeal

Finally, the automatic right to appeal a court’s decision is a benefit to choosing litigation over arbitration. If you are dissatisfied with the court’s judgment, you have the right to appeal that decision to the state or federal Court of Appeals, and you can even try to have the case heard by the applicable Supreme Court. Conversely, you can only appeal an arbitration decision in a very few, narrow circumstances. The American Arbitration Association does allow for an appeal process, but it is optional. Therefore, contract drafters need to remember to put the appeal process in the contract if that option is desired. If it is not there, even if you did not know about it, you cannot use it.

What to cite

Once the decision to arbitrate is made, the next issue is knowing exactly what to say in the contract itself. Arbitration clauses, especially for large, complex projects, can be extremely detailed. Provisions regarding the number of arbitrators (which may change depending on the size of the claim), the arbitrators’ experience, the process through which the arbitrators are chosen, and the governing law, among other things, must be set out. It is especially important to set out what arbitration law applies. Many agreements, especially on large projects such as power projects, choose the Federal Arbitration Act (“FAA”). The FAA is federal law and can be used throughout the United States.

The FAA states that “[a] written provision in any . . . contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract . . . shall be valid, irrevocable, and enforceable.” Thus, for the FAA to control, the agreement must “involve[e] commerce.” A contract involves commerce to the same extent that Congress has power over interstate commerce under the Constitution. Congress’ interstate commerce power is extremely broad, and all agreements involving international parties should be covered. However, for domestic contracts involving local parties, the answer might not be so clear-cut – make sure to check with counsel.

Therefore, if the parties agree to arbitrate, the contract involves interstate commerce, and the FAA is cited, the FAA will control. On the other hand, if the parties decide that they would prefer to use a state arbitration act, they may do so as long as they cite it in the agreement. The FAA will only step in and govern over that state arbitration act if the state act renders the arbitration clause unenforceable. For example, even in an international construction project, the parties might agree to have a state arbitration act apply. Perhaps the project is in South Carolina, and through negotiation, the parties agreed to use the South Carolina arbitration act. That act states that notice of the arbitration clause must be proximately displayed on the very first page of the contract. Even if the notice is on the second page, the arbitration clause is unenforceable. If the agreement is rendered unenforceable due to the state arbitration act, and the agreement involves interstate commerce, one argument is that the FAA preempts, and controls on that issue. Federal law holds that in such a case, even though the state arbitration act holds otherwise, the arbitration agreement will likely be found enforceable.

. . . that is the Question.

There are numerous reasons to choose arbitration over litigation, and many reasons to do the opposite. Project owners and contractors in large-scale construction projects should consider the specifics of each project, and, with the advice of counsel, determine what best fits each endeavor. Some agreements may even use both arbitration and litigation, stating that only claims under a certain amount use one method, while all other claims use the other. Further, if the parties do agree to arbitrate, the agreement must be written so that the right arbitration act controls.

Though not as flashy as a negotiation over payment terms and scope of work, the time used on the dispute resolution clause will be well-spent if issues arise during the project. Thus, it is important to determine what is right for each development project, and to write each contract accordingly.

“Just What Was Needed”: Another Way to Waive a Right to Arbitrate

Gilbert A. Samberg | Mintz | February 25, 2019

Want to give up a contractual right to arbitrate? Easy. Don’t seek to enforce it. For example, just litigate for awhile and don’t mention your arbitration clause. The court has no obligation sua sponte to raise or enforce your contractual right if you choose not to. Or do nothing at all. At least two New York State trial courts tell us that your unexcused default in responding to a summons and complaint can be deemed a waiver of a contractual right to arbitrate. SeeCrowdpay US Inc. v. Midnight Gaming Corp. (a/k/a McGraw Inc.), 2019 N.Y. Misc. LEXIS 389 (Sup. Ct. N.Y. Co. Jan. 23, 2019); Charming Shoppes, Inc. v. Oberling Constr. Inc., 186 Misc.2d 293, 297, 717 N.Y.S.2d 860, 2000 N.Y. Misc. LEXIS 471 (Sup. Ct. Monroe Co. 2000). Those courts granted default judgments on contract claims in such circumstances notwithstanding that the contracts in question contained arbitration clauses.[1]

An agreement to arbitrate can be enforced in a court by, e.g., a motion to compel arbitration or to stay litigation. But what if a contracting party fails to appear to seek that enforcement?

In Crowdpay, the plaintiff brought suit for a breach of a license agreement. The defendant failed to respond to the complaint and the plaintiff sought a default judgment under N.Y. CPLR §3215 (“default judgment”).

The court noted that the contract in question “contained a provision requiring that disputes arising under the contract ‘shall’ be arbitrated,” 2019 N.Y. Misc. LEXIS 389 at *1-*2, and that plaintiff had argued that the defendant “waived” any right to arbitration due to its default, albeit without citing any supporting authority. The court, however, later found such authority in the Charming Shoppes decision. There, the court had held that “the Defendant effectively waived its right to enforce the arbitration clause when it failed to answer in response to the summons and complaint under circumstances where there was no reasonable excuse for such default.” 2000 N.Y. Misc. LEXIS 471 at *7-*8.

In Crowdpay, the court granted the plaintiff’s motion for a default judgment but deferred ruling on whether the defendant had waived its right to arbitrate “unless and until defendant makes a motion to vacate the default judgment and asserts a right to arbitrate the dispute.” 2019 N.Y. Misc. LEXIS 389 *2-*3. (The court allowed that the defendant might successfully seek vacatur of the default judgement if he could satisfy the relevant requirements of N.Y. CPLR § 5015 or some other relevant law. (Id. at *3.))

The Charming Shoppes decision presented a more complex situation and a less satisfying analysis. There, the plaintiff brought suit for breach of contract, seeking specific performance, and sought a default judgment when the defendant failed to answer the summons and complaint. Weeks after that, defendant’s counsel contacted plaintiff’s counsel, and continuances were eventually granted to allow the parties to try to negotiate a settlement. Those negotiations failed after several months, and defendant then filed a “cross-motion” seeking to compel arbitration among other things. The court granted plaintiff’s motion and denied defendant’s cross-motion, holding that the defendant had waived any right to compel arbitration by failing to answer the complaint, by delaying the progress of the suit, and by participating in settlement conferences and negotiations.

The court opined that in general “a defendant may waive any right to submit issues to arbitration by his actions.” 2000 N.Y. Misc. LEXIS 471 at *8 (“a defendant may ‘waive[] any right to stay the action [based on an arbitration clause] by its affirmative use of the judicial proceedings’”), citing DeSapio v. Kohlmeyer, 35 N.Y.2d 402, 405 (1974). It also opined that

“[t]hough arbitration clauses are generally enforceable, they cannot be used to bypass the statutory provisions requiring that pleadings be answered or to thwart a proper motion for a default judgment.” Id. at *7.

The Charming Shoppes court too allowed that such a waiver could be “set aside” if the defendant demonstrated that a default judgment was not warranted. Id. at *8. However, the court found that the defendant there had failed to demonstrate a basis for denying a default judgment.

The Charming Shoppes court also opined that the defendant’s participation in a lawsuit could manifest an “affirmative acceptance of the judicial forum,” which would be inconsistent with a later claim that only the arbitral forum is satisfactory. Id. at *9. A bit less satisfyingly, however, the court found such “participation” in defendant’s (i) failure to answer the summons and complaint, id. at *9 n.2; (ii) participation in settlement conferences and its agreement to a settlement in principle, id. at *12; (iii) requests for adjournment of the default judgment motion, id.; (iv) eliciting of relevant information concerning the issues in the case from the plaintiff during settlement discussions, id.; and (v) delay of a default judgment for approximately three months, id. at *12. This justification seems questionable.

But it illustrates the perils of failing to make a timely response to the commencement of suit by an adversary, even if that initiation of litigation was contrary to an applicable arbitration agreement.

Supreme Court Settles Age-Old Arbitrability Debate

William G. Geisen | Stites & Harbison | February 20, 2019

Many construction contracts designate arbitration as the means to adjudicate disputes which are not resolved through executive negotiation, mediation or some alternate method. Occasionally, a question arises whether the claim falls within the scope of the arbitration clause. In other words, the parties debate whether the dispute is arbitrable under the contract. Examples of such arbitrability disagreements include claims for negligence, misrepresentation, fraud, interference in business relationships or other non-contractual claims. One of the parties might file a lawsuit and request the court to decide the issue of arbitrability of the claim. For many years, legal scholars have debated whether the court or the arbitrator should decide the threshold arbitrability question.

On January 8, 2019, the U.S. Supreme Court answered the age-old question regarding arbitrability. In Henry Schein, Inc., et al. v. Archer & White Sales, Inc., the Supreme Court ruled that, when the parties’ contract delegates the arbitrability question to an arbitrator, the court cannot meddle in the parties’ contract; and, therefore, the arbitrator must decide the issue of arbitrability. The Schein decision marked Justice Kavanaugh’s first Supreme Court opinion, which he wrote for the unanimous Court.

The Schein case involved a dispute between a dental equipment distributor and a dental equipment manufacturer. The parties’ contract contained a straightforward arbitration provision which excluded actions for injunctive relief and disputes related to trademark, trade secrets or other intellectual property of the manufacturer. The arbitration clause also incorporated the Rules of the American Arbitration Association (“AAA”). Interestingly, the AAA rules provide that arbitrators have the power to resolve arbitrability questions.

In Schein, the distributor claimed that the manufacturer violated federal and state antitrust laws and filed suit in federal court in Texas. The manufacturer invoked the Federal Arbitration Act (“FAA”) and requested that the court refer the antitrust disputes to arbitration in accordance with the parties’ contract. The question then became who decides the threshold question whether the antitrust dispute is subject to arbitration…the court or the arbitrator.

Both the trial court and the Court of Appeals determined that the manufacturer’s arbitrability challenge was “wholly groundless” and ruled that the court could determine the arbitrability issue. The Supreme Court disagreed and held that the “wholly groundless” argument was inconsistent with the FAA and Supreme Court precedent. The Court held that when the parties’ contract delegates the arbitrability question to an arbitrator, a court cannot override a parties’ contract. Justice Kavanaugh wrote that, in such circumstances, a court possesses no power to decide the arbitrability issue, even when the court thinks that the challenge to the scope of the arbitration provision is “wholly groundless.”

In Schein, the Supreme Court was careful not to express a view on whether the contract between the manufacturer and the distributor, in fact, delegated the arbitrability question to an arbitrator, because the Court of Appeals did not decide that issue. Under Supreme Court precedent, courts “should not assume that the parties agreed to arbitrate arbitrability unless there is clear and unmistakable evidence that they did so.”

Although Schein is not a construction case, its holding clearly applies to arbitrability issues which arise under a construction contract. Notably, Rule R-9 of the AAA’s Construction Industry Arbitration Rules provides that the arbitrator has the authority to decide arbitrability of claims. Similarly, Rule 11 of the JAMS Engineering and Construction Arbitration Rules provides that the arbitrator has such authority to decide the threshold arbitrability question. Therefore, if a construction contract incorporates the AAA or JAMS Arbitration Rules, the parties agree to delegate the arbitrability question to the arbitrator.

If a construction professional is concerned about giving the arbitrator the authority to decide arbitrability of claims, it can do one of at least three things. First, specify in the construction contract that any issue relating to arbitrability of the claim or dispute will be decided by the court, not the arbitrator. Second, review the arbitration rules which are incorporated into the arbitration provision to determine whether the arbitrability question is delegated to the arbitrator by the rules. Third, carefully craft the arbitration clause to exclude specific construction claims which are not covered by the arbitration provision.

The recent Schein decision regarding arbitrability of claims extends well beyond manufacturer-distributor disputes and clearly relates to claims arising under a construction contract containing an arbitration provision. In Schein, the Supreme Court settled the age-old debate whether the court or arbitrator decides the threshold arbitrability question by holding that the arbitrator makes such determination when the parties’ contract delegates such authority to the arbitrator. You can read the short and concise Schein opinion HERE.

Supreme Court Rejects “Wholly Groundless” Exception to Question of Arbitrability

Justin Fortescue | White and Williams LLP | January 9, 2019

In newly appointed Supreme Court Justice Brett Kavanaugh’s first opinion, the United States Supreme Court held that the “wholly groundless” exception to arbitrability, which some federal courts had relied on as justification to decide questions of arbitrability over the express terms of a contract, was inconsistent with the Federal Arbitration Act and Supreme Court precedent. Based on this decision, where a contract delegates the question of arbitrability to an arbitrator, courts must respect the parties’ contract and refer the question to the arbitrator. Schein v. Archer & White, 586 U.S. __ (2019).

In Schein, Archer & White brought a lawsuit against Henry Schein alleging violations of federal and state antitrust laws and seeking both monetary damages and injunctive relief. The relevant contract between the parties contained an arbitration provision that provided:

“Any dispute arising under or related to this Agreement (except for actions seeking injunctive relief . . .) shall be resolved by binding arbitration in accordance with the arbitration rules of the American Arbitration Association.”

Based on the arbitration provision, Schein invoked the Federal Arbitration Act and asked the District Court to refer the parties’ dispute to arbitration. Archer & White objected, arguing that because the complaint sought injunctive relief, the dispute was not subject to arbitration. Thus, the question for the court was who decides the question of whether the dispute was arbitrable, an arbitration panel or the court. Relying on Fifth Circuit precedent, the District Court held that because Schein’s argument for arbitration was “wholly groundless” the court could decide the threshold question of arbitrability even if the parties had agreed an arbitrator would decide such arbitrability questions. The Fifth Circuit thereafter affirmed the District Court’s decision.

Holding that the “wholly groundless” exception was inconsistent with the Federal Arbitration Act and Supreme Court precedent, the Court vacated the Fifth Circuit’s decision. In support, the Court held that it must “interpret the [Federal Arbitration] Act as written, and the Act in turn requires that [the Court] interpret the contract as written.” Relying on prior Supreme Court precedent, the Court held that where parties delegate the question of arbitrability to an arbitrator, a court possesses no authority to decide the arbitrability issue. Going further, the Court held this to be the case “even if the court thinks that the argument that the arbitration agreement applies to a particular dispute is wholly groundless.”

Notably, while the Court vacated the Fifth Circuit’s decision, the Court did not decide whether the contract at issue actually delegated the arbitrability question to an arbitrator. Rather, the Court remanded the case to the Fifth Circuit to decide, noting that courts “should not assume that the parties agreed to arbitrate arbitrability unless there is clear and unmistakable evidence that they did so.”

This case is significant as it will ensure that an arbitrator, and not the courts, will decide questions of arbitrability where parties have contracted for such a result. Importantly, this will be the case regardless of whether the reviewing court believes the argument for submitting the dispute to arbitration is “wholly groundless.”

Arbitration Is an Increasing Trend Found Within Property Insurance Policies, and Arbitration is Not Appraisal

Chip Merlin | Property Insurance Coverage Law Blog | January 15, 2019

The photograph above depicts the Merlin Law Group “War Room” during a week-long arbitration last week. Michael Duffy, Ian Dankelman, Eric Dickey, and Kelly Kubiak were the winning Merlin Law Group team obtaining a $3.1 million award on Saturday. What a way to start off the year!

Arbitration is not appraisal. We have had policyholders and inexperienced lawyers from other law firms bring cases to us asking us to fix their bad arbitration awards because they treated the requirement of an arbitration like an appraisal.

Arbitrations require attorneys. It is almost like an informal trial. Evidence is presented after swearing in witnesses. It almost feels as if the proceeding is in a trial court. The proceedings are adversarial, and policyholders deserve to have excellent trial attorneys make the presentation because it is a lot more legally technical than an appraisal where the attorney’s trial skills do not matter.

The point of this post is to alert policyholders and public adjusters to determine whether the property insurance contract contains an arbitration provision versus an appraisal provision. We are finding more arbitration clauses within property insurance policies—especially commercial policies issued by surplus lines insurance companies. If the property insurance policy contains an arbitration clause, the proceeding differs vastly from appraisal and the case must be prepared as if it were going to trial rather than an informal appraisal.