Firms Should Reconsider Using Arbitration for Resolutions
It is time for the construction industry to reject the notion that arbitration is the best way to resolve all construction disputes. It is not. Arbitration, when appropriate, must be tailored to the specific project. In other instances, it should be avoided.
This rejection of the cognitive bias towards arbitration may inflame those who financially benefit from its use. But it is time to break old habits and impress upon the contractor, the contractor’s attorney or whomever drafts and negotiates the construction contract that arbitration is not a one-size-fits all solution. The consideration and negotiation of dispute resolution provisions should be as important as any other construction contract provision.
The dispute resolution provision rarely takes center stage during contract negotiations. Accordingly, the provision itself may become an afterthought. If it is included at all, it may look something like this:
• All claims and disputes arising under or relating to this agreement are to be settled by binding arbitration. An award of arbitration may be confirmed in a court of competent jurisdiction.
Fortunately for most projects, that is the last time anyone gives a thought to resolving a dispute. But when a problem does arise, and the parties cannot resolve it, they look to the dispute resolution provision. It is at this very moment when the inadequacy of the dispute resolution provision becomes apparent. The boilerplate provision does not speak to time, cost or scope. From hence forward whomever becomes the arbitrator (or arbitrators) drives the pace of the dispute, dictates the cost of the dispute and becomes the judge, jury and executioner.
Arbitration Fails to Deliver
The main reason the construction industry prefers arbitration is the perception that the legal system is expensive, public, time-consuming and unpredictable. It was these often-valid criticisms of the legal system that drove the construction industry to adopt arbitration as the preferred way to adjudicate a dispute. They believed it would be cheaper, faster and more predictable.
However, decades later many of the promises of arbitration did not come true. Moreover, arbitration has become an industry unto itself. From full-time arbitrators charging $500/hour to the American Arbitration Association, arbitration proceedings have essentially become privatized lawsuits. Before proscribing this “cure,” let’s debunk some myths:
• Arbitration is Cheaper Than Lawsuits – Arbitrators charge by the hour. When you have a three-arbitrator-panel, that’s three professionals who will be working on your clock. For arbitrators who charge $500, you are looking at $1,500 per hour. Now compare that to a judge for whom the parties pay nothing. The secondary argument is that the parties pay less in the long run because the arbitration is faster and therefore less time is spent by the parties. That too is a myth.
• Arbitration is Faster Than Lawsuits – Despite popular perception, arbitration is not demonstrably faster than lawsuits, especially when the parties are subject to expedited trial settings and streamlined discovery, and have waived the right to a trial by jury. Moreover, the courts have every incentive to move cases off their dockets. Additionally, a multi-party arbitration requires the parties to juggle the schedule of attorneys, parties and the three arbitrators, all of which typically results in an arbitration with a 12-month time horizon, not including continuances.
• Arbitration is More Predictable – The resolution of commercial disputes is never “predictable.” If it was, there would be no need for litigation or arbitration. It is important to remember that arbitrators do not have to follow the Rules of Civil Procedure that governs the litigation process. Moreover, they have no appellate scrutiny except in rare occasions. This lack of oversight and accountability has led arbitrators to “go rogue” on discovery orders or arbitration awards.
What’s the Alternative to the Boilerplate Arbitration Provision?
There are three viable alternatives to the standard boilerplate arbitration provision to consider: (1) a project-specific arbitration provision; (2) a bench trial; and (3) trial by jury. To determine which of these options to incorporate, begin with a project-specific assessment – where is the project located? Who are the parties? What is the size and scope of the project? With those factors in mind, it frequently is clear how to proceed.
Project-Specific Arbitration Provision
The first alternative is one that addresses the weaknesses of arbitration. By providing guidance and structure tailored to the unique needs of a specific project, the parties can improve the arbitration experience. Here are areas to focus on:
• Who will administer the arbitration?
• Number of arbitrators
• Identity of arbitrators
• Scope of discovery
• Multiple parties
• Duration and scheduling of arbitration
• Location of arbitration
By addressing each of those topics, the parties can better control the proceedings and prevent it from “going off the rails.”
The first issue is to decide whether it shall be administered by an established alternative dispute resolution (ADR) provider like the American Arbitration Association (AAA) or Judicial Arbitration and Mediation Services (JAMS), or by the arbitrator. The provider will argue that its more efficient to use it, but cost savings are to be had if it’s done ad hoc. The concern, of course, is whether the ad hoc has the resources to properly administer the proceeding.
The second issue is the number of arbitrators. Under default AAA rules, any matter over $1 million requires a three-arbitrator panel. The parties can agree to change that to one arbitrator or increase the dollar amount threshold for a three-panel arbitration. Remember, the more arbitrators on board the more the parties are paying in fees.
The third issue is the identity of the arbitrator. If the parties cannot agree on an arbitrator, the ADR provider will provide a list, and the parties will have a period of time to rank their favorites and strike the three most objectionable candidates. This process eats up time, sometimes as much as a month or more, so there is value in agreeing upon a list and inserting those names into the arbitration provision.
The fourth issue is multiple parties. Multijurisdictional case law addresses who is and who is not a signatory to an agreement, and who can be joined in an arbitration. To prevent this issue from becoming a case within a case, the agreement should address whether third parties can be joined. For efficiency purposes, it makes sense. But make sure the provision provides for it and the parties pass along those contractual obligations to the third parties.
The fifth issue is the duration and scheduling of the arbitration. To reduce cost, require that the arbitration adheres to an agreed-upon schedule. By requiring the final arbitration hearing be heard in a specific period, and the award issued in a specific period, it prevents the arbitrator and one of the parties from using litigation to draw out the resolution. This is especially important for a small contractor that doesn’t have the same resources of a larger contractor.
The final issue is location. Specify where the arbitration is to occur. The parties can agree to arbitrate in a larger metropolitan area versus a remote venue even if the project was in the remote venue. Addressing these topics within the arbitration provision will take additional time, but the cost savings is immense if a dispute erupts.
Contractors are wary of juries. Typically, they consist of 12 residents of a specific county. The educational and vocational background of the jury will vary, and there is no guarantee that anyone on the jury will understand the complicated facts, expert testimony and industry-specific issues inherent to construction disputes. There is also the possibility that the jury will render a “runaway verdict.” As a result, a bench trial provides many advantages over an arbitration and a jury trial.
First, typically a judge is more educated than the average jury and can understand complicated concepts. Second, a bench trial is typically shorter than a jury trial and those cases are reached faster. The logistics of a jury trial are cumbersome and slow down the presentation of evidence. Third, a judge is free unlike an arbitrator.
Fourth, the judge is limited by the rules of evidence and the rules of civil procedure. Fifth, the judge is more likely to rule on a dispositive motion than an arbitrator. Sixth, a judge is subject to appellate review if he or she gets it wrong. Finally, a bench trial is a great compromise for one party that wants an arbitrator and the other party that wants a jury.
Contrary to popular belief, some parties in the construction industry favor jury trials. The classic example is a large company that has spent millions of dollars on advertising and philanthropy. That company has created enormous goodwill in the community, and it would rather have 12 members of that community weigh the evidence than have a construction-industry arbitrator or a judge decide. The contractor, meanwhile, should be careful. If the project is in a “judicial hell hole” where the verdicts and judgments often favor the local company, the contractor should fight hard for arbitration or even consider passing on the project.
The next time you are negotiating a construction contract, ask yourself: is this the right dispute resolution provision for this project? Breaking old habits is hard. And deviating from approved contract language is scary. But a party can save itself time, money and heartburn by eliminating the boilerplate arbitration provision.
Co-founder of the Houston-based West Mermis law firm, Joshua Mermis’s practice focuses on construction, energy and product liability litigation. He is a former chairman of the Houston Bar Association’s Construction Law Section.