Many construction contracts used in the industry include clauses mandating that any disputes be decided by binding arbitration rather than a jury or bench trial. The standard AIA forms provide the parties with the option of court or arbitration. Trial courts, overwhelmed by a flood of cases and supported with strong caselaw and statutory precedent, regularly enforce arbitration clauses. Yet the decision to choosearbitration over litigation is a major business decision when drafting and negotiating contracts that should not be made lightly.
Many construction lawyers vehemently disagree on the merits of arbitration versus litigation for construction disputes, and this debate will likely continue. When evaluating this choice, lawyers, and business decisionmakers must know in advance what a party will likely get—and not get—by choosing to arbitrate or litigate a construction dispute to best make this decision.
Problems with Courtroom Litigation
The primary reason for the preference of arbitration is often the perception of the legal system’s defects. Few companies that have been through a lawsuit, even one resolved in its favor, would wish to endure it again. Why? Some common problems are inherent to litigation:
Cost. Litigation is time-consuming and expensive. More to the point, while approximately 95% of civil cases settle before trial, settlement often takes place on the courthouse steps after the parties have incurred most of their expenses. Construction disputes in particular can take longer and be more expensive to resolve than other commercial disputes as they are highly fact intensive and deal with large amounts of information. Out-of-pocket costs for attorneys, expert witnesses, depositions, electronic-discovery consultants (those tasked with gathering every pertinent email) and other discovery expenses are considerable.
In most U.S. jurisdictions, unless the contract contains a provision for attorneys’ fees, such costs are not recoverable even by the victorious party. A company may “win” its case only to realize that after subtracting lawyer fees and other items, its bottom line is a net-zero “recovery.” Even when a party wins, it faces the question of whether the judgment is collectible. A judgment against a bankrupt or marginally solvent defendant might not be worth the paper on which it’s printed. While the same is true of a bankrupt party after arbitration, it remains that litigation generally is more expensive than arbitration such that the overall out of pocket costs are lower and the result is usually obtained more quickly in arbitration.
Litigation also produces substantial soft costs. Time is money. In any suit, management and other key employees must devote considerable time to the dispute even if a project has been completed for many years; forced attention paid to a past job detracts from one’s focus on current jobs and new clients. Key employees may have moved on and may be uncooperative. It also affects the morale of any staffers who feel “tainted” by the whole process.
Publicity and public filings. Lawsuits can damage reputations and boost one’s competitors. Court filings are public records. Even if frivolous, the mere filing of a lawsuit may make the front page of the local news or be featured in a trade journal, a prominent email chain or an industry blog—whereas the successful defense or dismissal of the claim, sometimes years later, might not get reported at all.
Court filings and trial testimony, meanwhile, are generally open to any competitor. In a case involving a claim for lost profits, for instance, the business making the claim may be required to open its tax records to prevail. The parties can agree on protective orders, but even if they do, once such documents are produced, they’re out there for any interested outside party to potentially discover.
Time. Lawsuits can take years just to get to trial. After which, of course, the losing party has an automatic right to appeal . . . which might consume years more (and will be expensive). The right to appeal an adverse ruling is a point in favor of litigation—and that right, while time-consuming, can make litigation more predictable in the long run at least in terms of legal issues. But a competent lawyer can delay payments of a judgment with those same rights to appeal. And an otherwise solvent defendant might be able to delay a final judgment, and by the time that judgment is rendered, that company’s assets are gone, or it has filed for bankruptcy.
Less predictable initial results. In any courtroom, there is no way to guarantee what an elected judge (yes, the phenomenon of “home cooking” does exist) or the jury might do. If the case involves complicated facts, expert testimony, or industry-specific issues, it’s quite possible that the jury—or even the judge—will get confused and fail to focus on the topics of primary importance, leading to an incorrect, inexplicable result. As stated above, while choosing to litigate provides more pathways to appeal which helps with the predictability issues, the need for such appellant rights is arguably lower in arbitration.
Pros and Cons of Binding Arbitration
Predictability. Most arbitrations are heard and decided by a neutral third party (or panel of them), generally experienced construction lawyers. Arbitrators do not have to be lawyers but can be (for example) engineers, bankers, or developers trained in arbitration. This can minimize some of the concerns above and reduce the time required to educate a judge or jury about the nuances of a dispute. Properly selected arbitrators are more likely to understand and focus on the key material issues and are typically not as easily swayed by lawyers’ emotional arguments or “expert” witnesses that might lose people in technical minutia.
Time. Because there’s no crowded court docket competing for attention, arbitration hearings can often be scheduled within months, not years. Even when millions of dollars are at stake, hearings can commence more quickly than in court, where criminal trials take priority over civil ones, especially in federal court. In general, one day of an arbitration hearing equals two or three days of trial. Grounds for appealing an arbitration award usually are also circumscribed as discussed above, so finality is the rule rather than the exception. In many arbitration fora, the arbitrator(s) is (are) required to issue a ruling within 30 days, unlike state or federal court without no such definitive deadlines.
Arbitration is also less formal; the applicable rules of evidence and procedure might not be as strictly followed. This fact cuts both ways. While it often makes the proceeding smoother with less time spent fighting over, for example, the admissibility of a fact or document or opinion, it also means more information is likely to get in front of the arbitrator (whether that information is considered or not may be a different story).
Costs. Arbitration is generally less expensive than litigation, which is often criticized for the time and expense of pretrial discovery. As such, it’s significant that with a few exceptions, arbitration limits discovery. The lack of multiple pre-hearing motions and limited pre-hearing depositions, as well as the finality of the award, substantially reduce attorneys’ fees and overall costs. But of course, without knowing at the time of entering a construction contract, you may ultimately wish you had the ability to take those extra depositions, which an arbitrator may not allow to occur. Parties often in arbitration are stuck to some extent rolling the dice with what a witness may say in arbitration. A risk much less common in trial.
One additional caveat: Unlike in court, the parties must pay for arbitration. There are initial filing fees based on the amount of the claim, and arbitrators typically charge hourly rates that must be paid in full prior to any hearing. This adds up: Do the math on $550 an hour for three arbitrators over 10 days of hearings.
Privacy. Unlike courtroom litigation, arbitration is private and confidential. The proceedings are not public records; arbitrators maintain the privacy of the hearings unless some statute mandates to the contrary.
Arbitrating construction disputes is not a panacea, nor is it always the right choice. All its “pros” come paired with “cons.” And while this author thinks there is good reason for the predominance of arbitration agreements in this industry, if a loss in a dispute might put the business under, sticking to litigation (with the right to conduct full-blown discovery and the right to appeal) may be the better choice.
The bottom line: If the dispute can be resolved through arbitration in most instances the proceedings will be faster, more predictable, confidential, and less expensive than a trip to court. But parties opting to arbitrate are in most circumstances giving up their right to appeal, and while saving money on discovery, they may ultimately wish they had the ability to spend that money. Reasonable minds can differ on the best choice, but it is one that should not be entered blindly.