Construction Arbitration v. Litigation – Which is right for you?

Construction Arbitration or Construction Litigation?

Recent developments have cast doubt on the prior concepts that made construction arbitration so popular. Many Builders say arbitration is faster and cheaper than litigation. But homeowner and consumer groups, including Consumers Union, the publisher of Consumer Reports, say arbitration panels may be stacked in favor of industry and deprive citizens of their constitutional right to a jury trial. The outcomes may also be sealed, meaning the public cannot learn about serious issues.

It is common sense that the best approach to winning a dispute is to avoid it in the first place. Easier said than done. Most, if not all building and construction contracts today include an “arbitration clause” for use if the inevitable dispute arises. This clause generally sets forth that if a dispute arises, both sides agree to submit the matter for arbitration before the American Arbitration Association (“AAA”), according to the AAA established rules and costs. Each party waives their right to proceed in a court of law on all matters, including mechanic liens. The arbitration or “hearing” is in reality a “mini trial” where each side presents its evidence and witnesses before an arbitrator that is jointly selected by the opposing sides from a panel of approved arbitrators.

The premise behind mediation and arbitration is a speedy cost-effective resolution. While some attorneys generally favor arbitration over litigation, there are factors that should be considered prior to selection of the “arbitration clause”. Unfortunately, the acceptance or demand for an arbitration clause may be an unwary, time consuming and expensive trap for the unfamiliar.

The Arbitration Clause

Many private work construction contracts today contain mandatory arbitration clauses, such as the typical AIA contract. Most Public contracts do not contain arbitration clauses as such would violate most state and local laws that prohibit a public entity from.  In addition, arbitration clauses in home improvement contracts in New York are voidable at the homeowner’s discretion.

The arbitration clause should be written so that the arbitration is held in the locality where the project was constructed and is governed by a specific organization, such as the American Arbitration Association or JAMS. It is important to watch out for arbitration clauses from out of state companies, suppliers, vendors, etc that place arbitration in other venues.  In certain instances such provisions are void in New York and an out of state contractor or supplier cannot force you to litigate or arbitrate outside of New York.

Arbitration clauses may be waived. If a party avails themselves of the court system, recent case law has held that the party may lose its right to elect to seek arbitration. If an adversary serves a summons and complaint, yet the contract contains an arbitration clause, be careful in how you respond. It is suggested that you either move to dismiss or answer the complaint, but put the other side on notice that you request the withdrawal of the lawsuit based upon the arbitration clause. If you do not wish to utilize the arbitration process, simply proceed with defending the lawsuit.

Conditions Precedent to Construction ARbitration

The typical AIA arbitration clause mandates that any dispute must first go to the project architect and then to formal mediation. Many architects are able to efficiently resolve disputes. However, in some instances, the architect is non-cooperative or unjustly favors one side. In those instances, if a response is not received from the architect, proceed with the next step-mediation. In many instances, mediation is great. Both sides sit down with an independent mediator who is skilled in dispute resolution. The only downside is that the process can be costly. The AAA may charge thousands of dollars for the mediators time and in administering the process. On one hand, spending a few thousand dollars to save the cost of arbitration, attorneys fees and down time is certainly worth the effort and expense. However, if one side is not participating in good faith and obviously just wants to go through the motions of mediation to get to the arbitration stage, suggest that the parties agree to waive the mediation process.

Contract Based Claim Time Requirements

Do not forget to honor the contract based time requirements. The typical AIA contract mandates that any claim must be presented within 21 days from the time one becomes aware of the claim or dispute. Also, many contracts contain clauses that limit the time period in which a party may seek arbitration. Carefully review the governing contract to make sure the time periods are not waived and lost. Courts have recently upheld the waiver of claims if they are not presented within the specified time periods. While courts have been lenient in the past, strict construction is now the rule.

The Mechanics Lien Claim in Construction ARbitration

Remember that filing a Demand for Arbitration is not the same as filing a Mechanics Lien and vice versa. This seems obvious but many claims are lost due to the failure to timely file. File the Mechanics lien on time and enforce it on time or obtain extensions. The enforcement efforts will be stayed pending the outcome of the arbitration. Failure to timely file, extend and foreclose the mechanics lien may provide an empty arbitration victory-the payment security is lost.  A popular misconception is that filing a mechanic’s lien voids an arbitration clause or that when there is an arbitration clause there is no right to file a mechanic’s lien.   As you can read here, that is simply not the case.

Placement of the Arbitration Clause in all Contracts

If an arbitration clause is selected in the prime contract, it is better to include an arbitration clause in all subcontracts and other project related contracts. It is obviously problematic, duplicative and costly if an owner is arbitrating with the general contractor, the owner is litigating with the construction manager and the subcontractors are litigating with the general contractor. Most arbitration clauses permit joinder of arbitrations to streamline the arbitration process. Additionally, liquidating agreements whereby the general contractor submits the subcontractors claim to the owner also help streamline the arbitration process.

The Construction ARbitration Process

To begin an AAA proceeding, a Demand for Arbitration claim form must be submitted to the AAA Arbitration tribunal along with a copy of the contract arbitration clause and the AAA administrative fees. The fee structure and forms are available on the AAA’s web site at http://www.adr.org./ The Responding party must file an answer and if applicable, should file a counterclaim and the corresponding fee.

The Arbitrator

One of the advantages of construction arbitration over litigation is that the arbitrators available via the AAA are experienced in the construction industry and consist of architects, construction attorneys, contractors, construction managers, and engineers. They are knowledgeable in the field of construction, daily operation, work sequencing and quality, and in the actual obstacles, and foreseeable and non-foreseeable problems – the work “reality”. However, these seasoned construction individuals may not be trained in the law, may disregard legal arguments, do not have to follow the rules of evidence and may consider evidence that would be inadmissible in court. This may lengthen and complicate the hearing process and make the arbitration dangerously less predictable.

The Cost of Construction ARbitration

It is an incorrect, yet widely held belief, that the arbitration process is always less expensive than litigation. The AAA requires a case filing fee from $500 to $10,000+, a case service fee from $500+ and arbitrators charge close to $1,000 per hour.

Attorneys fees may be somewhat reduced in construction arbitration but are often very similar to those incurred in construction litigation.

In litigation, there is the pre-trial and trial phase. In the pre-trial phase, the attorneys exchange pertinent documents, conduct depositions of parties and witnesses, argue over principles of law in “motions”, and attend numerous court conferences. The pre-trial phase can be costly and time consuming and may represent over 60% of the litigation costs. The trial phase is akin to the arbitration “hearing”, and thus it appears that a savings of all pre-trial costs is attained with arbitration. This is not the case. An attorney must still review the entire project file, request and review documents and evidence, prepare a submission called an “arbitration brief”, submit all proposed exhibits in “arbitration binders”, and prepare witnesses for the hearing. In arbitration you lose the right to depose your adversary and their witnesses before the trial/hearing. While the pre-trial process in litigation is often time consuming and expensive, it is often well worth the avoidance of being ambushed in the arbitration and may actually lead towards an early resolution.

The Time it Takes to Complete Construction Arbitration

In matters up to $75,000, the AAA utilizes a fast track procedure, where there is very limited discovery, the hearing date is set for no more than 30 days from the date the arbitrator is selected and is conducted in only one hearing day, with limited exceptions. The arbitrator provides a decision in 14 days and generally charges less for their time. You cannot beat the speed, but you must construct a strong well organized case in a limited time. A standard arbitration usually takes 6-8 months from start to conclusion, the arbitration itself takes 5-10 working days( to upwards of 25 days) and an arbitrators decision is rendered in thirty days.

There is no Absolute Right to Appeal a Decision in Construction ARbitration

It is extremely difficult to appeal an arbitrators decision which may not be set-aside based upon errors of law or mistakes of fact. In fact, an arbitrator does not have to give any reason for a decision. If a party obtains new evidence that could impact the result of the decision, such will not be considered, although such new evidence may be considered if the matter was in a court of law.

Award Enforcement

After an arbitrators award is rendered, if it is not paid, the winner must still commence a court action to “confirm” the arbitrators award and convert it to an enforceable judgment, which takes weeks, if not months. The enforcement procedure is a trap for the unwary as the failure to continue a lien or other security while confirming the award, could leave you with a judgement which is as good as wallpaper.

What to do: arbitrate or litigate?

This decision is usually based on the size of the project: the bigger and more complex a project, litigation is generally more cost-effective and advantageous based on the right to conduct extensive pre-trial discovery and depositions.

Again, the best approach is dispute avoidance: 1) memorialize conversations in a joint memo/log signed by all parties, 2) have site meetings, 3) utilize a detailed scope of work and realistic completion dates, 4) carefully define general conditions, 5) memorialize every change-order and extra in writing signed by all parties, 6) assign permit and C/O obligations in the contract, 7) create detailed punch lists with remediation recommendations signed off by both parties, 8) be consistent in your contract administration and payment requisition process, and 9) remove employees that constantly create conflict.

So what’s the bottom line? Originally, Construction and commercial arbitration envisioned the use of construction experts to decide disputes in a stream-lined cost effective manner. In recent years, construction arbitration has become a mirror image of litigation. The main differences being that in arbitration: 1) Litigants must pay fees for the use of the facility, for administration and for the arbitrators, 2) in arbitration the process is private, not open to the public and rarely results in a published decision; 3) the decision is generally not appealable; and 4) the parties are able to mutually select the arbitrator.

Referring a litigation matter to the Commercial Parts of the New York State Court System may be an alternative. In 1993, the Supreme Court, Civil Branch, New York County established four Commercial Parts on an experimental basis. The aim was to concentrate commercial litigation in that court in those Parts. The reaction of commercial practitioners to the Parts was very favorable. In January 1995, a task force of the Commercial and Federal Litigation Section of the New York State Bar Association recommended that the Commercial Parts be expanded. Specifically, it was proposed that a Commercial Division of the Supreme Court be established in areas of the State in which significant commercial litigation is prosecuted. In November 1995, the Commercial Division was established in Monroe County (Rochester) and in New York County, beginning with one Justice in the former and four in the latter. Branches of the Division were established in Erie, Nassau, and Westchester Counties in 1999 and in Albany, Kings and Suffolk Counties in 2002.

The Commercial Parts regularly handle construction disputes. A particularly noteworthy item is the use of technology. The Courtroom for the New Millennium in Supreme Court, New York is equipped with state-of-the-art technology, such as flat-screen computer monitors in the jury box, on the witness stand, and at the counsel table; an electronic blackboard; real time court reporting; an electronic projector; computer docking stations for counsel; video capability, and the like. Similar courtrooms are due to be introduced in other venues across the State.

An Alternative Dispute Resolution Program (“ADR”) was established in New York County in early 1996. Pursuant to the rules of this program, cases are referred by the Justices for mediation or any other form of ADR the parties might wish to undergo. Volunteer neutrals, of whom there are some 250, handle the ADR proceedings. The Rules provide for deadlines for the process. A similar program is in place in Westchester County and is being studied in other jurisdictions

In short, there is no “right” answer to the question whether to arbitrate or litigate. The only right answer is that careful analysis of the items mentioned in this article should be addressed in reaching the best decision.

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