To Arbitrate or Not, That Is the Question

The decision of any player in a commercial construction project to agree to submit all disputes to binding arbitration as opposed to litigation in court is a significant business decision which should never be made lightly. 

While the construction industry has traditionally used binding arbitration clauses, with the recent trend towards making arbitration more like litigation, as well as other criticism, there are significant disagreements and debates in both the construction and legal communities about the pros and cons of binding arbitration.

There are many construction lawyers who detest arbitration and strike such provisions from every contract. There are also some who recommend arbitration to every single client for every single project. There simply is no hard and fast rule. Arbitration is a contract clause. At the beginning of any project there should be a comprehensive review of any proposed binding dispute resolution clause (but frequently there is not because in the beginning, everyone is one big happy project team).

This article does not touch on the pros and cons of mandatory mediation as a condition to invoking arbitration or litigation. Instead, the issue should be met head on for every single project: What method of binding dispute resolution is best for the company? Even then, there is no way to know in advance if it is the right decision, because many of the key considerations are double-edged swords.

1. The Decision Maker

Most who argue for binding arbitration cite this as the primary reason to arbitrate disputes over litigation. The arbitrators (there can be one or a panel of three) will either be experienced construction lawyers or non-lawyer commercial construction professionals (engineers, architects, developers, etc.). They are familiar with the language and the types of sometimes very complicated disputes that can arise (defects, delay claims). As a result, arbitrators can more quickly get to the heart of the matter and ignore all the red herrings that lawyers may throw at them. Decisions are more predictable, which lends itself to a better evaluation of potential settlement. There is also limited “home cooking” when the other side is local and there is an elected judge or local jury.

In litigation, the judge or jury may not know a change order from a pay application. How they expect to understand in just a few days of a trial multiple detailed change order disputes or understand the concept of a “critical path” delay analysis? There are many instances where one side has put an expert on the stand in a trial who has absolutely no idea of what they are talking about but can be dressed up and presented to a judge or jury on the topic on what is the “standard” in the industry no matter how absurd the argument.

A party may have their own expert to rebut, but with a lay judge or jury, who is to be believed? An experienced arbitrator should know about industry standards. Putting a complicated “bet the business” construction dispute before a judge or jury is pure legalized gambling. One contrary argument is that arbitrators always “split the baby” in their decisions or do not follow the “law.” There is no question that many times arbitrators try to come to the right decision and may not consider a non-negotiated clause in a 50-page contract. There are many studies which refute this argument, and it is also foolish to believe that judges and juries do not do the same. 

2. The Time to Get a Final Hearing

These days courts, both state and federal, are clogged up with cases. In some jurisdictions, judges will not set a case for trial until the long “discovery” process has been fully completed. And even when that time comes, the available trial dates, especially when multiple days (and sometimes weeks or month) are needed and are years away. Sometimes, especially in federal court, criminal trials can take priority over the scheduling of civil trials and at the last second, cases are continued.

By way of contrast, even though there are exceptions, even multi-million-dollar, multi-day arbitrations can be set for final hearings within a year of the filing of an arbitration demand. In 2018, the author was involved as counsel in a $100M construction dispute. There was no arbitration clause. The local judge said that at best, a three-week trial could be scheduled in 2021. The parties then decided to arbitrate the disputes and a hearing was set in less than a year. For smaller arbitrations, hearings can happen in less than six months. It is a rare occurrence where it is not an advantage to both parties to have disputes resolved as quickly and efficiently as possible: time is money. 

3. Discovery, Legal Fees and Expenses

In litigation, unless closely controlled by a judge, parties are free to issue multiple subpoenas, take multiple depositions and embark on a costly “fishing” expedition. There can be multiple motions filed which require significant lawyer time to respond, even if filed in bad faith. Third parties who are not a part of the contract can be brought into the case and cause further delays. Key customers may have to submit to depositions or produce documents.

The fact is that a construction dispute is the most expensive type of civil dispute because most of the time there are multiple issues to be resolved. By way of example, each disputed change order has its own story. In arbitration, the general rule is that unless there is a contrary provision in the arbitration clause, written pre-hearing discovery is very limited. There may not be any depositions allowed. The ability to bring in other third parties is severely limited. For instance, a contractor may not be allowed to bring into an arbitration, as it may be able to do in litigation, 10 different subcontractors, which can delay any hearing for an owner for years.

For the most part, legal fees are reduced in arbitration, as well as the time involvement of key employees. There is also a consensus that what can be done in one full day of arbitration can be accomplished in three days in court. However, while filing a lawsuit is inexpensive and a judge is “free,” it is not so in arbitration. Filing an arbitration (such as through the American Arbitration Association) can require a significant filing fee. Arbitrators normally charge an hourly rate which, while split by the parties, can be very expensive, especially if there is a panel of three arbitrators. If each arbitrator charges $450 an hour, for a week-long hearing, each party would have to pay (in advance) an amount more than $20,000, just for the arbitrators. In the arbitration mentioned above, the required prepayment was $75,000 per party. The costs can add up quickly. 

4. Finality

This factor is frequently cited by opponents of binding arbitration. After a trial, either side normally has the absolute right to appeal any unexpected decision to an appeals court, usually because of a claimed error of law. If an appeals court decides that there was an error of law, the decision can be vacated or sent back for another trial.

Sometimes appeals can take years, and by that time, one party may not even be in existence and the winning company simply cannot continue to exist without collecting the money that it has been awarded. By contrast, in arbitration, finality is the rule rather than the exception. There are limited exceptions, but for the most part, it is virtually impossible to have a trial or appeals court reverse an arbitration award, even if it is found that the arbitrator made a horrible decision such as ignoring a contract clause or misapplying the law. This factor is a textbook example of a double-edged sword. Even with a bad result, the arbitration is over and a losing party can move on. However, for those risk-averse companies, when a bad decision can end a company’s existence, it may be that litigation, not arbitration, is the best option to preserve all appeal rights. 

5. Privacy

Any court filings are normally open to public scrutiny. While protective orders can be entered by a judge, if there are issues about profit margins, employment agreements, embarrassing text messages, etc., all of these come out in a public trial. If it is a large dispute with a large local employer, anything that may have an appeal to the public (or to competitors), there can be publicity, either online or through traditional media. No one likes dirty laundry aired in public. Claimed and unproven allegations of fraud or mismanagement may get the headlines, but when those claims are later proven to be false, there are never published retractions. By contrast, arbitration is private and confidential. No other third party can attend an arbitration hearing. Arbitration awards are only sent to the parties. 

6. Location of the Hearing

In litigation, the parties normally do not have control over where the final hearing will take place. If the project is in Texas, but the parties are located on the East and West coast, with both lawyers in the Midwest, the hearing will normally be in Texas—and with that comes the possibility of home cooking from a local judge or jury. In arbitration, the parties can agree on the most convenient location for any final hearing. 

7. The Actual Hearing: Rules of Evidence

In an arbitration, the normal “rules of “evidence do not apply. The arbitrator is counted on to sift through what is and what is not relevant and material. This can save time and money. If a document is what it says it is, it comes into a hearing. If a key witness is unable to attend a hearing, with arbitration, that witness can testify via skype or phone. In a trial, there may be significant limitations on what can and cannot be admitted at trial, or requirements to have to go out and take expensive pre-hearing depositions to authenticate documents or preserve the testimony of a key witness.

8. What About Making the Decision Up to One Party?

In many instances, a company may not know until a dispute occurs whether that dispute would be best heard in court or arbitration. That is why many times companies try to put in the contract that the decision to arbitrate or litigate is an option solely in the discretion of one party. While this provision may not be enforceable in a consumer context, it should be in a commercial contract. Having the ability to choose either can be a significant advantage because each dispute can be different. 

9. Drafting Arbitration Clauses to Reduce the Cons of Arbitration

Arbitration is a matter of contract. It is a contract clause. If the concern about arbitration is the decision-maker, a clause can be added to the contract on required arbitrator qualifications. If there are concerns about a solo arbitrator going wild, then mandate a panel of three arbitrators (but that can get expensive). Other negotiable requirements include ensuring that the rules of evidence apply or that at least a few pre-hearing depositions are allowed and whether third parties are allowed to join in the arbitration if there is a common question of fact.

The bottom line is that any party to a construction contract should think long and hard about where and under what circumstances any dispute in a proposed project will be finally resolved. While 98% of all projects do not generate claims, those 2% can suck up much of the profit on the other projects, and that does not count the time of employees. While all disputes cannot be anticipated, and there is no clear cut “yes or “no” on choosing arbitration vs litigation, these factors and considerations should be helpful for those that have to make such decisions. 

Republished from Construction Executive, Dec. 12, 2019, a publication of Associated Builders and Contractors. Copyright 2019. All rights reserved.