Watch Your Stipulation! Award Confirmed Despite Arbitrator Exceeding Contractual Scope of Authority

Jim Archibald, Amandeep S. Kahlon & Luke D. Martin | Buildsmart

Once parties agree to arbitrate, courts generally defer to the arbitrator’s judgment regarding resolution of a dispute. The prevailing approach in many states is to not set aside an arbitration award unless the arbitrator clearly exceeded his or her authority and to exercise every reasonable assumption in favor of the validity of an award. The Minnesota Court of Appeals recently confirmed this view in Faith Technologies, Inc. v. Aurora Distributed Solar LLC.

In that case, the court upheld the arbitrator’s award for equitable relief, despite the parties’ contract prohibiting the arbitrator from providing any equitable remedy. The court found the parties’ stipulation to arbitrate all disputes effectively waived the contractual prohibition on equitable relief, especially where the equitable claim for abandonment was pled and not objected to until after the final award.

In 2016, Aurora hired Biosar to design and construct solar-power generators for a project in Minnesota. Biosar hired Faith Technologies to provide labor, materials, and services for the project. The EPC contract between Aurora and Biosar permitted arbitration to resolve disputes arising out of the contract but prohibited the arbitrator from “awarding nonmonetary, injunctive, or equitable relief.”

In 2017, disputes arose on the project. Aurora and Biosar commenced arbitration against one another, and Biosar separately filed an arbitration demand against Faith. In 2018, the three parties agreed to, and filed with the local district court, a stipulation to stay litigation and submit their claims to binding arbitration under the JAMS rules (a private arbitration service) “to finally and expeditiously resolve all their claims against each []other in one forum.”

The arbitrator entered an award in favor of Biosar and Faith finding Aurora abandoned and rescinded the terms of the parties’ EPC contract. Faith was awarded nearly $30 million in damages and fees on its quantum meruit claim, and Biosar was awarded approximately $3 million in attorneys’ fees. In the award, the arbitrator referred to both the stipulation and the EPC contract as sources for his jurisdiction over the dispute.

Biosar and Faith then sought to enforce the award in the district court. The district court affirmed the arbitrator’s award finding (1) the parties’ stipulation supplanted the EPC agreement arbitration clause, allowing for equitable relief, (2) any ambiguity in the stipulation should be resolved in favor of arbitration of equitable claims, and (3) the arbitrator determined the parties intended to arbitrate all claims, including those for equitable relief, a decision to which the district court must defer under the Federal Arbitration Act.

On appeal, Aurora argued the district court erred because the arbitrator exceeded the scope of his authority by granting equitable relief to Faith and Biosar and attorneys’ fees to Biosar. The court of appeals agreed with the district court that Aurora waived the prohibition on equitable relief in its contract by entering the stipulation and, also, by failing to object to arbitrating the abandonment claim until after final award.

The court relied on the JAMS rules for its analysis of whether Aurora’s failure to object to the abandonment claim constituted waiver. Under the JAMS rules, jurisdictional challenges are deemed waived unless raised in a demand or counterclaim or promptly thereafter, when circumstances first suggest the issue of arbitrability. Had the stipulation not included incorporation of the JAMS rules to the parties’ disputes, the court suggested it may have performed a different waiver analysis. Nevertheless, given the stipulation that the JAMS rules applied, Aurora’s failure to object to the abandonment claim in its initial pleadings, or promptly thereafter, meant it waived the contract prohibition on associated relief.

Aurora also argued that the arbitrator erred in granting Biosar attorneys’ fees because, having been awarded no monetary damages, it did not qualify as a “prevailing party” under the EPC contract. The court of appeals deferred to the arbitrator’s award, which determined the party that prevails on the underlying merits, regardless of whether the party receives compensation, is the “prevailing party” as defined in the EPC contract.

Lessons from Faith Technologies

Parties agreeing to arbitrate disputes should appreciate the finality courts associate with such awards. When arbitrators’ written support for their awards is confusing or appears to get the contract, facts, or applicable case law wrong, it can be tempting to challenge the enforcement of an award. However, unlike traditional trial court judgments, the options for judicial review of arbitration awards are limited. Because courts defer to arbitrators and treat arbitration awards as presumptively reasonable, they are unlikely to overturn an award, absent egregious conduct by the arbitrator or evidence that the arbitrator clearly exceeded the scope of his or her powers.

In Faith Technologies, had Aurora worded the stipulation more carefully and/or objected from the start of the proceeding to arbitrating any equitable claims, it might have had a strong argument that the arbitrator clearly exceeded his authority to resolve disputes under the arbitration provision of the parties’ contract. But, Aurora’s decision to arbitrate the abandonment claim fully, without objection, probably doomed its post-award effort to enforce the contract’s prohibition on an arbitrator awarding equitable relief.

Contractor Prevailing Against Subcontractor on Common Law Indemnity Claim

David Adelstein | Florida Construction Legal Updates

Common law indemnity is not an easy claim to prove as the one seeking common law indemnity MUST be without fault:

Indemnity is a right which inures to one who discharges a duty owed by him, but which, as between himself and another, should have been discharged by the other and is allowable only where the whole fault is in the one against whom indemnity is sought. It shifts the entire loss from one who, although without active negligence or fault, has been obligated to pay, because of some vicarious, constructive, derivative, or technical liability, to another who should bear the costs because it was the latter’s wrongdoing for which the former is held liable.

Brother’s Painting & Pressure Cleaning Corp. v. Curry-Dixon Construction, LLC, 45 Fla. L. Weekly D259b (Fla. 3d DCA 2020) quoting Houdaille Industries, Inc. v. Edwards, 374 So.2d 490, 492-93 (Fla. 1979).

Not only must the one seeking common law indemnity be without fault, but there also needs to be a special relationship between the parties (indemnitee and common law indemnitor) for common law indemnification to exist.  Brother’s Painting & Pressure Cleaning Corp., supra (citation omitted).  A special relationship has been found to exist between a general contractor and its subcontractors.  Id. at n.2.

Brother’s Painting & Pressure Cleaning Corp. exemplifies the rare application of a common law indemnity scenario.

In this case, a fire occurred in a renovated condominium unit.  The evidence revealed that that painters left rags with an oil-based product in a plastic bin overnight in the living room. The oil-based rags were not supposed to be left in the unit.  The next morning it was discovered a fire started in the plastic bin where the painters left the oil-based rags. The determination was that the oil-based rags spontaneously ignited.

The unit owner sued the contractor and the painter and the contractor asserted a cross-claim against the painter for common law indemnity.  The painter settled with the owner and, subsequently, the contractor settled with the owner. The contractor then pursued its common law indemnity claim against the painter seeking to recover the amount of its settlement against the painter. The trial court granted summary judgment in favor of the contractor for common law indemnity against the painter (that included the amount of the contractor’s settlement with the owner) and the painter appealed.  The appellate court affirmed.

The evidence revealed that the fire and corresponding damages “were caused by [the painter’s] sole negligent act of leaving an oil-soaked rag in the plastic garbage bin that was in the condominium unit.”  Brothers Painting & Pressure Cleaning Corp., supra.   The painter argued that common law indemnity should not apply because the operative complaint alleged that the contractor was also at fault for its failure to supervise.  The appellate court dismissed this argument explaining that allegations in a complaint do not control over the actual facts and “[t]he undisputed facts demonstrate that the fire was caused solely because [a painter’s] employee left a rag soaked in an oil-based stain in the condominium.” Brother’s Painting & Pressure Cleaning Corp., supra.

Lastly, the painter argued that the contractor’s settlement with the owner should preclude the common law indemnity claim.  This argument was also dismissed by the appellate court.  The settlement does not prevent the contractor from prevailing on a common law indemnity claim.  Moreover, the painter was on notice of the claim and of the settlement amount prior to the settlement being formalized.  Brother’s Painting & Pressure Cleaning Corp., supra,  (“Once a legal obligation has been established in the underlying action on the part of the indemnitee, the indemnitor will become bound by a settlement agreement in a suit against the indemnitee if the indemnitor was given notice of the claim and was afforded an opportunity to appear and defend the claim, as long as the settlement was not the result of fraud or collusion.”) (quoting Heapy Eng’g, LLP v. Pure Lodging, Ltd., 849 So.2d 424, 425 (Fla. 1st DCA 2003)).

While the contractor was able to prevail on a common law indemnity claim, a better claim would have been a contractual indemnification claim.  However, while not discussed, the subcontract evidently did not contain an indemnification provision.  This should serve as a reminder that all subcontracts should include a contractual indemnification provision.

Will Subcontractor Default Insurance Still Have Value in the Recovering Economy?

Nicole Lentini and Rebecca Clawson Juhl | Construction Law Blog

The COVID-19 pandemic has burdened subcontractors with workforce shortages, supply chain issues, and financial difficulties. Therefore, as states lift their stay-at-home orders issued to limit the spread of COVID-19 and construction projects resume, subcontractors’ ability to complete demanding, time-sensitive projects might be impacted. Subcontractor default is already a common and costly problem for general contractors. When subcontractors fail to complete their contractual obligations, a general contractor’s profitability and reputation are greatly impacted. Effectively managing the risk of subcontractor default will be increasingly important for general contractors in the post-pandemic economy.

Subcontractor Default Insurance (“SDI”) is a non-traditional insurance product which can minimize a general contractor’s damages resulting from a subcontractor’s default. It is a two-party indemnity agreement between a general contractor and insurer. It was created as an alternative to surety bonds, with the idea that the general contractor controls the default process and remedy to help keep projects on time and within budget. Under a SDI policy, a general contractor enrolls prequalified subcontractors for either a specific project or policy term. Then, the general contractor is indemnified by the insurance company for any covered costs incurred if one of the subcontractors defaults. Typically, SDI claims stem from labor, work delay and quality issues, as well as financial-related defaults, which are not covered under general liability insurance policies.

In addition to direct costs, SDI coverage usually includes indirect expenses such as liquidated damages, acceleration of other subcontracts, increased overhead and the like. The insurer shares the risk with the general contractor through a deductible and co-pay; the general contractor absorbs some of the costs associated with a subcontractor’s default, usually up the deductible amount. SDI coverage extends to the limits of the individual policy rather than being limited to the value of the subcontract.

In order to lessen their risk, SDI carriers require general contractors to prequalify subcontractors before they can be enrolled on the policy. General contractors are in charge of this process. In order to evaluate a subcontractor both operationally and financially, subcontractors must submit the following types of information: financial statements, proof of available lines of credit, safety record, and history of claims and litigation. For subcontractors, the prequalification process is not different than that for surety bonds, except that it is executed by the general contractor instead of a professional surety underwriter.

After the COVID-19 pandemic, insurance carriers will necessarily adjust their outlook on subcontractors due to the increased risk of loss. Therefore, it will likely be more difficult for general contractors to find subcontractors able to prequalify for SDI policies and, in any event, the process will become more tedious. In addition to the aforementioned information, general contractors will probably be interested in subcontractors’ business continuity plans and specific plans to mitigate impacts like loss of employees and/or project shutdowns.

General contractors must be large and sophisticated enough to have the resources necessary to properly pre-qualify subcontractors, including assessing the financial risks of accepting subcontractors, and monitor their schedules and performance for the duration of the project. While the pre-qualification process is necessary, it is insufficient to thoroughly manage the risk. Even a subcontractor who is prequalified at the outset of a project must be managed throughout the entire course of work. A general contractor’s oversight of subcontractor performance will be even more critical in the post COVID-19 economy as subcontractors are more likely to be operationally and financially stretched thin.

In order to even qualify for SDI insurance, a general contractor typically needs minimum annual subcontractor volume in the $50-$100 million range. In fact, for SDI to be cost-effective, carriers say that annual subcontracted values must exceed $75 million. This is because SDI is expensive, usually ranging from 0.4 to 0.85 percent of total subcontract values.

Given the increased risk of subcontractor default, SDI policies will likely be even more expensive as the economy recovers from the COVID-19 pandemic. Deductibles, which are already high, are likely to increase. Currently, it is not unusual for a deductible to be in the $500,000 range. In addition to that, SDI policies have a co-pay which is paid up the retention aggregate—often three to five times the deductible. That said, SDI will still have value and provide cost savings under the right circumstances. For very large jobs, it would be worth taking on part of the financial risk of default for general contractors to accept SDI’s high deductibles because it would cost much less (now typically 50% less) than subcontractors bonding and passing along costs within their bid. Another consideration is whether the costs can be absorbed by the project. General contractors can also strategically utilize SDI to target high-risk subcontractors.

Cost will not be the only determinative factor in evaluating SDI’s value after the pandemic. It is possible insurers will write more exclusions into policies to manage their own risk associated with impacts associated with mandated shutdowns similar to what the United States recently experienced. Accordingly, subcontractor default stemming from such a shutdown (including impacts like workforce shortages and supply chain backlogs) would unlikely be covered. SDI policies also generally do not cover defaults, which result from the following: misrepresentation, fraud, defaults occurring prior to the policy period, material breach of warranty by the contractor, contracts acquired from other entities, war and losses arising from providing professional services.

To determine whether or not SDI is a worthy investment, a general contractor must separately evaluate each project, and carefully weigh the cost, potential savings and risk involved.

Questions To Ask When Changing Your Arbitration Clause

Jay Ramsey and Abby Meyer | Class Action Defense Strategy Blog

In a prior post (here), we highlighted some questions that companies may want to ask when evaluating whether their arbitration clauses are enforceable.  If changes need to be made to those clauses, then companies should consider how to implement those changes so as to ensure those are enforceable too.  The following is what you should be thinking about and asking.

If an agreement needs to be amended to add or modify an arbitration clause, you should strongly consider having customers re-agree to a contract or set of terms and conditions with the new arbitration clause.  This could be done a number of ways, including by having customers agree to an entirely new contract or having them agree to just a replacement arbitration clause.  For companies who engage their customers online or through mobile applications, this may be as simple as requiring customers to re-register or log-on in a way that confirms their assent to the new agreement.

In some cases, the original agreement may have a provision that permits the company to amend or modify the agreement unilaterally.  These provisions generally require that the company post the amended terms to its website or in some other location and indicate that a customer’s continued use of the company’s services constitutes agreement to the amended terms.  The provision may also require that the company provide its customers with some type of notice of the amended terms.

The law permitting unilateral amendments in accordance with these types of modification provisions is still developing.  Some courts have permitted unilateral amendments if the company follows the terms of the modification provision, even if notice of the amended terms is not separately provided.  See Miracle-Pond v. Shutterfly, Inc., No. 19 cv 04722 (N.D. Ill. May 15, 2020).  Other courts have rejected modifications if notice was not provided. See, e.g.Douglas v. U.S. District Court, 495 F.3d 1062 (9th Cir. 2007).  What constitutes adequate notice is often up for debate.

In light of this mixed law, if you are considering modifying a set of terms without requiring a new agreement from your customers, you should consider at least the following:

  1. Does the original agreement permit modifications?  If so, are you complying with the modification provision?
  2. Does the modification provision require that a particular notice be sent to the customer regarding the amended terms?  Should you provide that notice even if the provision does not require it?
  3. Does any notice that you are sending out clearly indicate that changes are being made to the terms?  What does the subject line of the email notification say?  If changes are mailed, do the documents make clear that your company’s terms are changing?  Is there anything on the envelope indicating that changes to the terms are included inside?
  4. Does any notice that you are sending not only provide the amended terms or access to them, but also describe any material changes to the terms?  Does the notice clearly indicate that the customer agrees to the amended terms by continuing to use the company’s services?
  5. Is the notice being sent to the best, most up-to-date contact information for the customer?

As we noted in our last post (here), the above questions may not cover everything that you and your company should consider when updating your agreements or terms and conditions, particularly when adding or modifying an arbitration provision.  Crafting a solution for each company, while satisfying the concerns and desires of the legal department, the marketing department, and the business teams can sometimes be challenging, but it should be done.  There is no reason to risk unnecessary exposure to consumer class actions.

Contract Provisions That Help Manage Risk on Long-Term Projects

Jason Lambert | Construction Executive

Few things can dampen the thrill and promise of a newly closed construction deal than the realization that it could quickly become a losing proposition for the contractor depending on economic and other conditions. In an era of instant information, constantly adjusting markets and political extremes, projects that start under one set of assumptions or conditions can occur or conclude under much different ones. While no one has a crystal ball, there are contractual provisions that can provide clear guidance in the face of many “what ifs” that can arise in construction. 

One of the chief concerns a contractor should have in a project lasting more than a few months is what impact price increases will have on the profitability of the job. On a true cost-plus project, this may be of little concern, but on any project with a limitation on costs or a guaranteed maximum price, contractors should insist on a procedure to revisit the limitation or price if certain conditions change. 

This can be as simple as allowing the contractor to receive an upward adjustment in the price if costs increase by more than a certain percentage. It can be as complicated as requiring multiple new bids and disclosures to the property owner, architect or project manager and allowing approval of new suppliers or subcontractors to limit cost increases to the cheapest increase. The protection—and certainty—to the contractor though, comes from having a process in the contract to address cost increases, whether it is simple or complex. 

In a similar vein, if seeking cost increases is not feasible or preferable, then it may make sense to include a provision that allows the contractor to terminate the contract if costs increase beyond a certain amount or certain percentage. Again, this may require a certain amount of disclosure to property owners or other third-parties to justify termination, but it may be preferable to exit a project at a break-even point or mild profitability rather than take it to conclusion and lose money. This option does not exist though, unless a contract between the parties expressly allows it. 

Shifting away from cost-focused provisions, another unpredictable problem can involve owner-caused delays. Typically, property owners have material selections to make or approve, change orders to authorize and other input to provide on the project. While eliminating delays entirely may be impossible, the best way to address them can be to incentivize timely performance, by, for example, providing for liquidated damages in the event the owner does not meet required deadlines. Another option could be to allow cost increases to be charged if they are the result of delays, and still a third option would be to allow the contractor to make the decision for the owner in the absence of timely input. Again, the specific method of allowing for additional costs or time in response to delays is less critical than having a procedure to do so that eliminate uncertainty from the future.

Another type of delay can arise from third-parties or events external to the project. Contracts commonly alleviate contractors from delays caused by natural disasters, strikes, war, etc., but most do not go the extra step of determining how the risk of those events are to be allocated among the parties or how the contractor is to be reimbursed for the consequences of them. One way to avoid this issue is to provide more specificity, especially in the face of known issues. 

A great example of this is hurricanes. Many projects along the U.S. Gulf Coast and Eastern Seaboard face the threat of hurricanes impacting the project sometime during the summer months, whether a hurricane actually strikes the project or simply strikes a manufacturing facility 100 miles away. Contracts for these projects should include specific hurricane mobilization and demobilization provisions, allocate the costs and delays associated with the same, and allow contractors to seek cost increases if material or subcontractor prices go up due to demand or scarcity. While the hurricane may never impact the project, if it does, the contractor will be able to rely on those provisions to protect its ability to perform the project or terminate it if necessary. 

Finally, contracts should require that contractors, subcontractors and material suppliers exercise their rights under relevant lien laws. This means ensuring the pre-lien notices or any pre-project notices are sent at the beginning of the project, even when things are going well and everyone is performing their contractual obligations timely. This is the only way to ensure that lien and other rights are preserved in the event of any “what ifs” that come to fruition. 

While these are only a few specific types of issues that can arise in the future and can be mitigated through contractual risk allocation, contractors can think through common problems that occur for their business or their region and craft contractual provisions that address what the contractor wants to happen if some foreseeable event in the future. While this may not prevent problems from arising, it certainly will keep those problems from derailing a project or company.