You Cannot Arbitrate Claims Not Covered By The Arbitration Agreement

David Adelstein | Florida Construction Legal Updates

Regardless of the type of contract you are dealing with, “[a]rbitration provisions are contractual in nature, and therefore, construction of such provisions and the contracts in which they appear is a matter of contract interpretation.”  Wiener v. Taylor Morrison Services, Inc., 44 Fla. L. Weekly D3012f (Fla. 1st DCA 2019).   This means if you want to preserve your right to arbitrate claims you want to make sure your contract unambiguously expresses this right.  Taking this one step further, if you want to make sure an arbitrator, and not the court, determines whether the claim is arbitrable if a dispute arises, you want to make sure that right is expressly contained in the arbitration provision.

For example, in Wiener, a homeowner sued a home-builder for violation of the building code – a fairly common claim in a construction defect action.  The homeowner’s claim dealt with a violation of building code  as to exterior stucco deficiencies.   The home-builder moved to compel the lawsuit to arbitration based on a structural warranty it provided to the homeowner that contained an arbitration provision.   The structural warranty, however, was limited and did not apply to non-load-bearing elements which, per the warranty, were not deemed to have the potential for a major structural defect (e.g., a structural defect to load-bearing elements that would cause the home to be unsafe or inhabitable).  The trial court compelled the dispute to arbitration pursuant to the arbitration provision in the structural warranty.

But, the First District Court of Appeal held the trial court was wrong to compel the dispute to arbitration.  Why?  The homeowner did not sue the home-builder for a breach of the structural warranty.  Even if the homeowner was trying to navigate around the structural warranty, the warranty was limited in nature and would NOT apply to a claim dealing with defective stucco, which is not a load-bearing issue, to say the least.  See Wiener, supra (“[C]onsidering the plain meaning of the structural warranty agreement, the [plaintiff’s] complaint does not raise claims subject to arbitration under that agreement.”).  The home-builder could not have its cake and eat it too — it could not exclude claims from the warranty and then try to arbitrate those very excluded claims per an arbitration provision in the warranty.

Here, the issue of whether the claim was arbitrable (subject to arbitration), was decided by the court, as it typically is.  The arbitrability of a claim is typically a question for the court.  Wiener, supra. This does not mean that it needs to be that way.   Parties can clearly include in their arbitration provision that the determination of the arbitrability of a claim is a determination for an arbitrator, and not the court.

Ensuring Efficient Arbitration of Construction Disputes Involving Mechanic’s Liens

Robert G. Campbell and Trevor B. Potter | Construction Executive

There may be tension between the enforcement of statutory mechanic’s lien claims when a contractual dispute resolution provision calls for arbitration. Once the parties are in arbitration, it may not be clear whether the arbitrator has authority to make factual determinations regarding amount and validity of mechanic’s liens, and whether courts are bound by these determinations. This uncertainty stems from the fact that in most states a mechanic’s lien can only be enforced by a court of competent jurisdiction. Indeed, many mechanic’s liens statutes define foreclosure as a “judicial process,” and courts generally have exclusive jurisdiction to issue orders foreclosing on real property1.  

The risk for contractors and owners is that they will spend time and money re-litigating factual issues related to proving elements of a mechanic’s lien claim, including the proper lien amount, timeliness and other prerequisites. Without a clear understanding of what issues and elements are arbitrable, the parties run the risk that an arbitrator will rule on certain elements only to find out during post-arbitration lien foreclosure proceedings that the arbitrator lacked authority to make determinations on those elements. Questions therefore arise whether a court will enforce the arbitrator’s determinations and whether the parties must relitigate mechanic’s lien issues creating a further risk of inconsistent rulings. 

These risks can be minimized through arbitration provisions which address these issues, express requests in arbitration demands and by ensuring that arbitration awards contain explicit determinations of mechanic’s liens issues.

The resolution of any mechanic’s lien claim requires factual determinations regarding the amount and validity of a lien. The appropriate amount of a mechanic’s lien is generally the same as the contract balance owed2.  Since construction disputes usually involve breach of contract claims for unpaid amounts, arbitrators will necessarily determine the contract balance owed to a lien claimant during arbitration. It is therefore efficient for arbitrators to determine the appropriate amount of mechanic’s lien claims. 

Lien “validity” refers to whether a lien claimant strictly complied with state law requirements to perfect its mechanic’s lien. Some of those prerequisites include:

  • providing timely pre-lien notice (in California this is referred to as a Preliminary Notice) and post-recordation notice of the lien in proper form with all required information;
  • proper service of the pre-lien notice on all required persons;
  • timely recording of the lien; and 
  • timely filing of a lawsuit to foreclose on the lien. 

As with the amount of mechanic’s liens, much of the evidence relevant to lien validity, including the date work commenced, the date of notice, the project completion date and the timing of any lien foreclosure actions, etc. will likely be presented at arbitration. Since arbitrators typically consider significant evidence relevant to the amount and validity of mechanic’s liens in the normal course of a construction arbitration, it is efficient and proper for arbitrators to determine these elements in arbitration. 

In order to reduce the uncertainty regarding the arbitrator’s authority to make factual determinations regarding the amount and validity of mechanic’s liens, parties should first ensure that the arbitration provision in their construction agreements is broadly worded to encompass “all disputes” related to the project. The scope of arbitrator authority in the AIA A201 General Conditions is tied to the resolution of “Claims”, which include “…any demand or assertion by one of the parties seeking, as a matter of right, payment of money, a change in the Contract Time, or other relief with respect to the terms of the Contract…[and] other disputes and matters in question between the Owner and Contractor arising out of or relating to the Contract.” 

This language arguably empowers the arbitrator to determine the amount and validity of mechanic’s liens, but on its own, it may be insufficient to resolve uncertainty with respect to the arbitrator’s authority. To remedy this, Parties should consider including language in their arbitration provisions which expressly states “To the fullest extent permitted by law, the arbitrator shall determine factual issues concerning the amount and validity of any mechanic’s lien claims asserted by the parties3.”  This language clarifies the parties’ intent for the arbitrator to make factual determinations related to mechanic’s liens in arbitration, and provides courts with a justification to enforce these determinations in a subsequent foreclosure proceeding. 

Addressing uncertainty regarding the arbitrator’s authority to make factual determinations regarding the amount and validity of mechanic’s liens is an important step, but there are other practical steps owners and contractors should take to ensure courts accept and enforce those determinations. 

First, parties should expressly request determinations concerning the validity and amount of mechanic’s liens in their arbitration demands and responsive submissions. If the arbitrator has apparent contractual authority to determine the amount and validity of mechanic’s liens, but the parties do not expressly request these determinations from the arbitrator, the arbitration award may not contain them and issues may later arise in the trial court when proceedings ensue to foreclose on the lien. The parties may be forced to relitigate them in a subsequent lien foreclosure action. 

Second, if the award does not include the requested factual determinations concerning the amount and validity of mechanic’s liens, the parties should move to correct/modify the arbitration award immediately. Courts are very deferential to arbitration awards as a matter of public policy, but the parties must ensure that the award contains all of the mechanic’s lien determinations requested from the arbitrator in order for a court to enforce them. Following these recommendations will minimize the risk of having to relitigate mechanic’s lien issues in post-arbitration lien foreclosure proceedings. 

To be sure, there are aspects of arbitrating mechanic’s lien claims that remain problematic. Since arbitration is a creature of contract, non-parties to the arbitration agreement cannot be compelled to participate in arbitration and may justifiably argue they are not bound by arbitrator determinations. This problem crops up in lien foreclosure proceedings where the priority of the lien vis-à-vis junior liens and other interests in the property will be determined by the court. There is little parties can do to eliminate this phenomenon given that foreclosure of mechanic’s liens and lien priority, as noted above, is typically within the exclusive province of the courts.

Nevertheless, uncertainty regarding the scope of arbitrator authority to determine factual issues concerning the amount and validity of mechanic’s liens and the potential inefficiency associated with that uncertainty can be minimized through express language in arbitration provisions, explicit requests for a determination of these issues in arbitration demands and ensuring that arbitration awards include the requested determinations. Litigating a mechanic’s lien once is painful enough, litigating it twice should be avoided as much as possible.

The Shifting Sands of Alternative Dispute Resolution

Tim Scully | Porter Law Group

In California there are few tools which work to protect the employer, and California employers may have just lost another one. On October 10, 2019, Governor Gavin Newson signed into law AB 51, which bans the use of mandatory arbitration agreements in employment contracts.

More specifically, AB 51 adds Section 432.6 to the California Labor Code, making it unlawful to require a prospective employee, or current employee, to waive any right, forum, or procedure for a violation of any provision of the California Fair Employment and Housing Act  (“FEHA”)(Part 2.8 (commencing with Section 12900) of Division 3 of Title 2 of the Government Code) or the California Labor Code, starting January 1, 2020. Additionally, an employer is also prohibited from threatening, retaliating or discriminating against, or terminating any applicant or employee who may choose not to sign a voluntary arbitration agreement.

Previously, an employer was able to require employees and prospective employees to agree to arbitration to resolve almost any and all disputes between the employee and the employer as a term of their employment. These terms were often the bulk of employers’ written contracts. Employers could have employees waive the right to a jury trial, the right to court costs, and other expenses, provided that the employer paid for the expenses of the alternative dispute resolution. The injured employees right to recover attorney’s fees was always a non-waivable right under the Labor Code. There were only a few actions which could not be arbitrated, the most prominent exception being the right to seek recovery under the Private Attorney’s General Action (PAGA).

It is hard to understate the loss California employers will have under AB 51. The vast majority of employee/employer disputes are centered around alleged Labor Code and FEHA violations. Under AB 51, the few remaining subjects still allowed to be covered by an arbitration agreement will be torts and contract disputes, subjects which are very rarely litigated between these two parties.

This change is important for several reasons; employers will now be liable for more expenses related to dispute resolution, may be subject to additional criminal liability and be subject to more aggressive litigation from employees.

With arbitration agreements in place, employers were allowed to control many of the cost aspects of the dispute resolution. Litigation is very expensive, and the requirement to pay filing fees, jury fees, expert fees, and other court costs, often adds a significant expense to this course of resolution. Cases that are handled in arbitration often get a resolution at a fraction of cost of litigation, as arbitrators are usually more attentive to the immediate case at hand, and the case is not bound by the clutter of an overworked judicial system. As a by-product, cases which are resolved faster, tend to resolve for smaller sums as there is less opportunity for attorneys’ fees to swell as in a stagnating case. While not inexpensive, arbitration generally did not disadvantage employees, but did allow employers to mitigate costs and expenses if they were found to be liable for the employees claims.

It is a little-known fact, but many wage and contracting violations under the Labor Code are misdemeanors. AB 51 inserting Labor Code 432.6 under Article 3, “Contracts and Applications for Employment,” expands criminal liability to employers who violate the terms of Article 3, as described by Labor Code 433. Employers who continue the practice of including arbitration agreements in new, or renewed employment contracts after January 1, 2020 may now find themselves criminally prosecutable. While it is usually the place of the Department of Industrial Relations (DIR) Division of Labor Standards Enforcement (DLSE) or private counsel to prosecute violations of the Labor Code and FEHA, it has been a growing trend in the state for local District Attorneys (DA) to prosecute Labor Code compliance against less desirable employers as the office can collect state mandated fees from non-compliant employers. The additions of AB 51 will provide more liability and leverage against employers in the future.

Finally, it is predicted that employers will face new allegations of discrimination and retaliation. Disgruntled ex-employees will now have new grounds to allege disparate treatment. If the employer treats or is perceived to treat employees who volunteered for an arbitration agreement any differently from employees who did not volunteer for an arbitration agreement, that employer may now be liable under Labor Code 432.6(b). It will be the responsibility of every employer to educate their managing workers about the status of the new protected class, as even off handed comments by supervisors or shift leaders are enough to create liability for the employer in any discrimination or retaliation allegation.

AB51 has a very uncertain future. While the legislature has included language facially to avoid conflict with the Federal Arbitration Act (FAA), which expressly creates and protects an employer’s right to use arbitration clauses, it is believed that AB 51 greatly diminishes an employer’s right under the FAA. In previous years, Governor Brown vetoed nearly identical bills, like AB 3080, because the law was believed to be in direct conflict with, and preempted by, the Federal Arbitration Act, which is created by the supremacy clause of the United States Constitution. The constitutional conflict created by AB51 will likely land the law in years long litigation as it makes its ways through the appellate courts.

Regardless of the future of AB51, employers acting now to safeguard their businesses against future litigation must choose between several underwhelming options. Since, AB51 was signed into law without an explicit retro-active effect like the one described in AB5 (the codification of the Dynamex Operations West, Inc. v. Superior Court of Los Angeles decision), there is a strong legal argument that contracts entered into prior to January 1, 2020 with arbitration clauses should be honored to their full terms and effects, unless the contract is entered into, modified, or extended after the January deadline. Employers who chose to continue their arbitration clause practices may be more protected if AB51 is struck down in the courts, but run the chance of being found in violation of AB51 and criminally liable in the meantime while the courts decide Ab51’s ultimate fate.

While AB51 removes the ability to require arbitration of the most common causes of action for an employee to bring against an employer, i.e. Labor Code and FEHA violations, it still allows employers to have arbitration agreements for causes of action regarding tort, contract, and property disputes. While significantly rarer, there is still a benefit to binding arbitration clauses which resolve these disputes between the parties. Arbitration agreements narrowly tailored to avoid the protected subjects can still provide some protections to an employer. Narrowed agreements will provide the most protection for employers who retain performance-based employees, such as graphic designers, artists, musicians, and sales persons, as these relationships are more likely to regard contract and property disputes.

Employers may also choose to simply stop implementing arbitration clauses in their employment contracts after January 1, 2020. While this option relinquishes the rights previously described above, it may be the safest way to proceed. If AB 51 is struck down in the future, it is still an employer’s right to update and alter an at-will contract as the business requires. This right will allow employers to reinstate arbitration clauses when there is more certainty as to their enforceability and less liability for employers.

Employers who already have written employee contracts are encouraged to audit their contracts in the next two months and determine what is the best course of action for their business. No two employers face the same circumstances, and an assessment of the risks and benefits should be made on an individual level. If you are feeling confused or overwhelmed by the constantly changing burdens of California employers, you should have a conversation with competent employment counsel for guidance and advice on how to best protect your business.

Who Gets To Decide Whether Class Arbitration Is Available? It Just Might Be The Arbitrator

Philip Mohr | Womble Bond Dickinson

Where an agreement provides that “any dispute… arising out of the agreement” would be settled by binding arbitration in accordance with “the Rules of the American Arbitration Association,” such language provides “clear and unmistakable evidence” of the parties’ agreement to delegate certain substantive issues—like the availability of class arbitration—to the arbitrator. Rickenbaugh v. Power Home Solar, LLC, 2019 NCBC 79 (J. Bledsoe). As such, when agreements incorporate AAA’s Rules, the Business Court will compel arbitration but leave it to the arbitrator to determine whether class wide arbitration is available.

Plaintiffs are North Carolina homeowners. Defendant Power Home Solar, LLC (“Power Home”), a nation-wide solar installation company, contacted Plaintiffs to discuss Power Home’s “standard energy savings package.” Power Home’s representative allegedly promised Plaintiffs savings in excess of 90% on their energy bills if they purchased its energy package. Based upon these representations, Plaintiffs entered into an agreement with Power Home to purchase the energy package and have it installed (“Agreement”). The Agreement contained an arbitration provision that stated, “[A]ny dispute arising out of …any aspect of this agreement…shall be settled by binding arbitration in accordance with the Construction Industry Rules of the American Arbitration Association…” Power Home installed the energy package, but Plaintiffs did not experience the drop in energy bills they were expecting. Plaintiffs filed a putative class action against Power Home in Mecklenburg County Superior Court on behalf of themselves and other Power Home customers. Power Home filed a motion to dismiss or, in the alternative, to compel bilateral arbitration (thereby effectively precluding class-wide arbitration). In its Motion, Power Home argued that the Agreement clearly required Plaintiffs to arbitrate their claims and, because the Agreement had no clear language permitting class wide arbitration, the Court should determine whether Plaintiffs could maintain a class wide arbitration. Plaintiffs disagreed and contended, at a minimum, the inclusion of AAA’s Rules meant that the arbitrator, and not the Court, had to decide whether the Agreement allowed for class wide arbitration.

In its decision, the Business Court compelled Plaintiffs to arbitrate, but agreed with Plaintiffs that the arbitrator—and not the Court—would decide whether class wide arbitration was permitted. While a court typically decides questions of “substantive arbitrability” (e.g., whether the parties are bound by a given arbitration clause, whether the arbitration clause applies to a particular type of controversy, etc.), the Business Court recognized that the parties can delegate “substantive arbitrability” questions to the arbitrator so long as there is “clear and unmistakable evidence” of an agreement to so delegate. Because AAA’s Construction Rules empower the arbitrator to determine the “scope” of the arbitration agreement, the Business Court followed numerous federal court decisions and held the Agreement’s incorporation of AAA’s Rules provided “clear and unmistakable evidence” that Plaintiffs and Power Home had delegated the issue of the arbitrability of their personal claims to the arbitrator. (Opinion, ¶¶21,31,32). However, the Business Court also recognized whether the inclusion of AAA’s Rules constituted “clear and unmistakable evidence” that the parties’ had agreed to delegate the question of class wide arbitration to the arbitrator was an issue that had divided federal circuit courts and had not been definitively answered by the U.S. Supreme Court. (Id., ¶¶25,27,28). Acknowledging the “fundamental difference” between class arbitration and bilateral arbitration, as well as the potential due process concerns for allowing an arbitrator to determine the existence of a class (Id., ¶¶23,27), the Business Court nonetheless sided with those federal circuit courts that have concluded the incorporation of AAA’s Rules constitutes “clear and unmistakable evidence” to delegate the question of class wide arbitration to the arbitrator. (Id., ¶33). As a result, the arbitrator—and not the Business Court—would determine the availability of class wide arbitration. (Id., ¶34).

Based upon this decision, a business which incorporates any of the Rules of the American Arbitration Association into its arbitration agreements should understand that it is agreeing that an arbitrator—and not a judge—will decide whether an agreement permits class wide arbitration and, correspondingly, whether a class can be certified, whether a class action can be maintained, etc. All such decisions will be made with limited opportunity for judicial review. In order to avoid such a result, a business would be well served to provided explicit language in its arbitration agreements that requires any issue about the availability of class wide arbitration to remain with the court.

Additional legal points from this decision:

  • Although the agreement at issue in this case involved AAA’s Construction Rules, the same language involving the expansive “scope” of the arbitrator’s power that is contained in the Construction Rules (and which the Business Court relied on in reaching its decision that “clear and unmistakable evidence” existed) is the same language used in AAA’s Commercial Arbitration Rules and AAA’s Consumer Arbitration Rules. See American Arbitration Association Commercial Arbitration Rules and Mediation Procedures, §R-7(a); American Arbitration Association Consumer Arbitration Rules, §R-14(a). As such, the Business Court’s reasoning would likely apply regardless of which AAA Rules are employed.
  • Although the rules for AAA do not contain class arbitration procedures, class arbitration procedures are provided for in AAA’s Supplementary Rules for Class Arbitration which, by their own terms, are incorporated into “any of the rules of [AAA] where a party submits a dispute to arbitration…” (Opinion, ¶31).

California Appellate Court Holds Additional Insured Is Contractually Required to Arbitrate Coverage Dispute

Robert Dennison | Traub Lieberman Straus & Shrewsberry

In Philadelphia Indemnity Insurance Company v. SMG Holdings, Inc., the Third Appellate District Court of Appeal in Sacramento, California held that an additional insured was bound by an arbitration clause in the general liability insurance policy as to a coverage dispute between it and the insurance carrier.

The underlying civil action involved injuries suffered by an attendee at a Future Farmers of America (“Future Farmers”) event at the Fresno Convention Center in Fresno, California. The person stepped in a pothole in the parking lot and allegedly suffered serious injuries.

Future Farmers was required by contract to name site operator SMG Holdings, Inc. (“SMG”) as an additional insured on its general liability insurance coverage. Future Farmers obtained coverage with Philadelphia which added as insureds managers, lessors and landlords of property, as well as those “required by contract.” Philadelphia denied SMG’s tender of the injury action (on grounds the additional insured coverage did not include claims involving the parking lot) then, after two years of arguments about the coverage, filed a petition with the Superior Court to compel arbitration of the dispute per the arbitration clause. The Superior Court denied the petition, finding SMG as a non-signatory to the contract was not bound by the arbitration provision and that Philadelphia was equitably estopped from asserting the clause.

On appeal, the court of appeal found that SMG was a third-party beneficiary of the insurance contract and so was bound by the arbitration clause in it. The court also found that SMG was equitably estopped from asserting otherwise, saying that SMG’s tender was a “knowing claim of contract benefits,” so SMG was “estopped from disclaiming applicable contract burdens such as the arbitration clause.”

The appellate court held that the scope of the arbitration clause included the instant dispute because its use of “the insured” in the clause applied to an additional insured such as SMG. Finally, it also held that Philadelphia was not equitably estopped from asserting the arbitration clause by reason of its denial of the tender of defense and indemnity. The court reasoned that Philadelphia did not deny that SMG had coverage under the policy, rather it denied that the coverage granted to SMG included the injury claim.