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.

Eight Things You Need to Know About the AAA’s New Construction Arbitration Rules

Garret Murai | California Construction Law Blog | August 5, 2015

I just finished a construction arbitration this past week, which also explains my sporadic posts as of late, sorry.

Coincidentally, on July 1, 2015, the American Arbitration Association (“AAA”) implemented their newly revised Construction Industry Arbitration and Mediation Procedures.

For those of you who follow our blog, you know I’m not a big fan of arbitration, which, from my experience, doesn’t deliver on its promise of better, faster, or cheaper, and ends up being pretty much the same thing as trial without the benefit of discovery, the rules of evidence, or appealability.

The AAA is trying to change all of that though and in a news release announced that its new “Rules” “directly address preferences of users for a more streamlined, cost-effective, and tightly managed arbitration process that avoids the high costs of litigation.” Which makes you wonder whether they had to survey their “users” to come to this realization. But I digress.

With the AAA’s new Rules come eight new changes, as follows:

Fast Track Procedures: Newly revised Rule F-1 now applies to two-party cases where no party’s claim or counterclaim exceeds $100,000. Under old Rule F-1 the monetary cap was $75,000.

Consolidation and Joinder: Newly revised Rule R-7 now requires that requests for consolidation (of other arbitrations) or joinder (of parties) be submitted prior to the appointment of an arbitrator, or within 90 days of the date that the AAA determines that all administrative filing requirements have been satisfied, whichever is later.  Under old Rule R-7 there was no deadline for requests for consolidation or joinder.

Preliminary Management Hearing: Newly revised Rule R-23 provides that the timing of a preliminary management hearing is “[a]t the discretion of the arbitrator” although it “should be scheduled as soon as practicable after the arbitrary has been appointed,” and provides that at the hearing “the parties and arbitrator should be prepared to discuss and establish a procedure for the conduct of the arbitration” and refers to new Rules P-1 (General) and P-2 (Checklist) for specific issues to be considered. New Rules P-1 and P-2 modify the issues to be considered under old Rule R-23.

Emergency Measures of Protection: New Rule R-39 allows a party to apply for emergency relief such as a temporary restraining order, requires the AAA to appoint a single emergency arbitrator within one (1) business day of receipt of the application, and requires the emergency arbitrator to establish a schedule for consideration of the arbitrator within two (2) business days of appointment.

Pre-Hearing Exchange and Production of Information: Newly revised Rule R-24 provides that an arbitrator “on application of a party or on the arbitrator’s own initiative” may: (a) Require the parties to exchange documents on which they intend to rely at the hearing; (b) Require the parties to update their exchanges as such documents become known to them; (c) Require the parties, in response to reasonable document requests, to make their documents available to the other party; and (d) Require the parties, when documents are maintained in electronic form, to make such documents available in the form most convenient and economical for the party producing those documents unless the arbitrator orders otherwise. Old Rule R-24 simply provided that at the request of any party or at the discretion of the arbitrator the arbitrator could direct the production of documents and other information and the identification of any witnesses to be called.

Mediation: Newly revised Rule R-10 provides that, in all cases where a claim or counterclaim exceeds $100,000, the parties shall mediate their dispute, subject to a party’s ability to “opt out” of mediation unless their agreement requires mandatory mediation. Under old Rule R-10 mediation was voluntary by the parties.

Dispositive Motions: New Rule R-34 permits an arbitrator, upon prior written application, to consider motions that dispose all or part of a claim, or narrow the issues in a case.

Sanctions: New Rule R-60 permits an arbitrator, upon a party’s request, to order appropriate sanctions if a party fails to comply with its obligations under the Rules or with an order of the arbitrator.

Want to learn more? AAA’s new Rules can be found here.

via Eight Things You Need to Know About the AAA’s New Construction Arbitration Rules | California Construction Law Blog | Wendel Rosen.

The Only Four Good Reasons to put Arbitration in Your Contract

Liz Kramer – January 4, 2013

Let’s say you are considering updating your form contract, or you are in the midst of negotiating a new contract with someone. Should you include mandatory arbitration for resolving any disputes? Assuming you have the choice, my view is you should only include arbitration if at least one of these four factors are present:

Having a knowledgeable industry professional decide the dispute is very important (an architect, engineer, doctor, reinsurance expert, etc), instead of a judge or jury without that expertise, because disputes are likely to be very technical.

Keeping the proceedings confidential (and not publicly available in court filings) is very important to you. (Although, if either party moves to vacate, much of your arbitration proceeding could become part of a court record.)

You do not want class actions. (They can be precluded in an arbitration agreement; it is less clear whether they can be precluded without an arbitration agreement.)

You want to arbitrate because other parties on the same project or deal have arbitration provisions. (For example, if the owner and general contractor on a construction project are bound to arbitrate, the owner and architect may also want to agree to arbitrate in case the architect is implicated in claims between the owner and general.)

It is a relatively short list. But, in my view, these are the only four bases on which arbitration has a significant advantage over litigation. You will note that speed of resolution is not on the list (unless parties opt for expedited proceedings, arbitrations generally take about as long as court proceedings — the median case valued between 1 and $10 million dollars administered by the AAA took 414 days to get to an award). You will also note that cost is not on the list (in my experience on complicated commercial matters, there is no cost saving to arbitration and I found a recent study supporting my anecdotal evidence). Speed and cost used to be the primary reasons people chose arbitration.

There are other potential reasons to choose arbitration that I am also discounting. For example, the risk of an illogical jury verdict is not significantly greater in my mind than the risk of an illogical arbitration award. I also do not see any advantage to the greater informality and looser rules in arbitration, or find it less adversarial. And, although you can make someone conduct the arbitration hearing in the basement of your building, you could just as easily have a forum selection clause choosing your home town courthouse in most circumstances, so I do not count that as a big advantage for arbitration.

It’s the start of a new year and a great time to step back and revisit our reasons for inserting arbitration in our contracts.

via The only four good reasons to put arbitration in your contract – Lexology.