The inadvertent waiver of mandatory construction arbitration clauses.

• Author: Lesser, Steven B.

In 1996, the American Arbitration Association received more than 4,000 requests to resolve construction-related disputes involving in excess of $900 million dollars.[1] As construction industry groups continue to include arbitration provisions in their form documents, it is anticipated that the use of arbitration will continue to increase.[2] Nationally, arbitration is recognized as an expedient, low cost mechanism to resolve construction disputes.[3] Although gaining economy, informality, and privacy, those electing to arbitrate surrender the right to appeal which may ultimately lead to disaster.[4] Once a controversy arises, a party may opt to waive arbitration and pursue litigation. This alternative is advantageous when a legal defense asserted at an early pretrial hearing may dispose of the entire claim.

Construction practitioners seeking to reap the benefits of mandatory arbitration should be mindful of those activities that constitute an inadvertent waiver of this right. This article will explore the current state of the law regarding waiver of mandatory arbitration provisions. At the outset, the benefits and detriments of mandatory arbitration will be discussed to provide counsel with an overall perspective as to the arbitration process.

Benefits of Arbitration

It may be beneficial to pursue arbitration to resolve disputes in an economical, private, and confidential setting especially when proof may involve disclosure of trade secrets or bidding strategy and also, to avoid publicity based upon allegations of improper conduct.[5] Arbitration is often attractive to out-of-town litigants and "deep pocket" corporations seeking to avoid local judge or jury prejudice. Likewise, parties often prefer knowledgeable, qualified professionals ruling on issues involving confusing delay claims as opposed to fact finders unfamiliar with complex construction issues. As the formal rules of evidence do not apply, hearsay evidence is admissible and this often reduces the cost of the proceeding.[6] Finally, parties often favor limited appellate rights associated with mandatory arbitration, recognizing that potential disputes will be resolved with finality.

Detriments of Arbitration

Parties elect to waive arbitration for a variety of reasons. First, legal issues may prompt a summary judgment in your favor which may resolve the entire case. Absent an agreement to the contrary, summary judgment is not available thereby requiring the arbitration panel to consider all evidence before rendering its award.

Second, limited rights of appeal exist from an arbitration award. Generally, a right of appeal exists only for corruption, fraud, evidence of partiality or misconduct, exceeding jurisdiction, refusing to postpone a hearing for a good cause, or refusing to hear evidence.[7] Recent decisions provide arbitrators with wide latitude relative to awarding punitive damages,[8] attorneys' fees,[9] and determining liability based upon statutory racketeering claims.[10] The sweeping decision-making power of an arbitration panel often creates high levels of anxiety among participants when an appointed arbitrator, as opposed to a judge or jury, will decide entitlement to an award of punitive damages when limited rights of appeal exist.

Third, as arbitration is a creature of contract,[11] nonjoinder clauses often preclude other parties such as design professionals, subcontractors, engineers, and sureties from participating in arbitration. Consequently, claims for in demnification or contribution against other responsible parties would require resolution by a separate proceeding as opposed to a single lawsuit.

Fourth, from a strategic standpoint, outspending the opposition through litigation where extensive, burdensome discovery is available may be preferred as opposed to arbitration.[12] Considering congested court dockets, litigating a complex construction dispute coupled with the exercise of appellate rights could realistically consume the better part of a decade.

Fifth, when the stakes are high and your opposition is likely to encounter problems with proof, the rules of evidence will bar potential evidence from consideration by the fact finder.

Sixth, although viewed as expedient, loopholes exist in arbitration to frustrate the process and delay resolution. For example, a party may simply refuse to pay its share of arbitration fees resulting in a postponement.[13]

Finally, in Bowles Financial Group, Inc. v. Stifel, Nicolaus & Company, Inc., 22 F.3d 1010 (10th Cir. 1994), the Tenth Circuit U.S. Court of Appeals ruled that an offer of settlement disclosed during an arbitration proceeding will not serve as grounds to vacate an arbitration award. The court held that since the rules of evidence barring the admissibility of settlement negotiations do not apply to arbitration, arbitrators are free to decide what evidence should be considered.[14] This decision highlights another pitfall associated with arbitration, namely that settlement offers may be introduced at arbitration unless precautionary measures are undertaken by counsel. As noted by the court, counsel would be derelict in advising a client to make a settlement offer knowing the offer may potentially be communicated to the arbitrators.[15]

Based upon the potential adverse impact associated with the intentional or inadvertent waiver of arbitration, any action that may constitute a waiver of a party's right to arbitration must be avoided. Should a waiver occur, the benefits of arbitration may be forever lost.

Compelling Arbitration

By initiating litigation, a party waives its right to arbitration.[16] Upon being served with a lawsuit, a party seeking to enforce its right to arbitrate should promptly file a motion to compel arbitration and stay litigation[17] or a motion to dismiss.[18] Generally motions to compel arbitration require at least three elements to be alleged:[19] a valid agreement requiring arbitration; the existence of arbitrable issues; and the absence of any waiver of the right to arbitrate.

* Valid Agreement to Arbitrate[20]

The right to arbitration exists only where a valid agreement demonstrates that the parties intended to arbitrate a dispute.[21] In certain circumstances, however, a party may still be required to arbitrate notwithstanding a failure to execute an agreement containing an arbitration clause.[22] Generally, several theories exist to require a nonsignatory to arbitrate including agency,[23] veil piercing,[24] estoppel[25] and, most importantly, incorporation by reference.[26]

In a construction context, the use of prime contract form documents from the American Institute of Architects (AIA) between the owner and general contractor often results in the use of companion AIA documents between the general contractor and its subcontractors.[27] When parties specifically agree to incorporate the prime agreement into their own contract, subcontractors become bound by the arbitration clause contained in the prime agreement.[28] Based upon these principles, when an AIA form construction contract references the AIA Document A201 "General Conditions of Contract for Construction" (which includes an arbitration clause), AIA Document A201 will be incorporated by reference into the construction contract and the parties will be obligated to arbitrate.[29]

There is also authority, however, that an arbitration clause will not be incorporated by reference when it represents an extraneous part of the documents being incorporated. In Omega Construction Co., Inc. v. Altman, 382 N.W.2d 839 (Mich. Ct. App. 1985), the contract stated that it was "being signed based upon plans and drawings prepared by the Architect." The plans and specifications were contained in a "project manual" with the title page signed by the parties. The project manual stated that the AIA Document 201 "General Conditions Of Contract For Construction" (which require arbitration) were part of the specifications. A dispute arose when the defendants claimed it never intended for...