The construction industry has been a leader in the use of arbitration to resolve disputes. In the past 30 years, it is fair to say that arbitration has outpaced litigation as the dominant method of dispute resolution. The protracted time for a construction case to get to trial and the attendant cost and expense has led the construction bar away from the courthouse and into the arbitration room. It not unusual for a lawyer bringing a construction case to court to receive a frosty reception from the judge, whose first remark is often akin to “why are you not in arbitration?” In other words, sitting through a construction trial is not among the court’s favorite pastimes.
The decision to arbitrate is made most typically, although not exclusively, by the parties’ agreement. The American Institute of Architects’ templates of construction agreements include an arbitration option wherein the parties agree that all disputes arising out of the agreement shall be determined in an arbitration to be administered pursuant to the Construction Industry Rules of the American Arbitration Association. These rules, well known to construction lawyers, provide for the orderly administration of an arbitration. Most construction lawyers, out of either lassitude or ignorance, pay scant, if any, attention to the arbitration clause. This is a mistake, perhaps a significant one, that can affect the outcome of the arbitration in numerous ways that cannot be predicted when the underlying contract is signed.
The arbitration clause is not a holy scripture that came down from Mount Sinai and cannot be altered or amended. Arbitration clauses get amended all the time, and it is up to you to decide how best to modify the standard arbitration agreement.
In addition to my law practice at Pepper Hamilton LLP, I have served as an arbitrator for the American Arbitration Association since 1987 and have presided over numerous cases both as a sole arbitrator and a member or chair of an arbitration panel. My experience has taught me that the prudent negotiation of an arbitration clause is as important to an arbitration as jury selection and jury charges are to litigation. Here is some advice:
- Who can demand arbitration? The standard arbitration clause allows either party to initiate an arbitration. If that is not what you want, the arbitration clause should be amended. For example, an owner may want to have an exclusive option on whether a dispute will be arbitrated or arbitration will only be allowed for disputes under a particular dollar threshold.
- Who will the parties be? The American Institute of Architects’ templates, not surprisingly, protect architects from being joined as parties to arbitrations unless they consent. This protection often leads to a situation where the owner and general contractor are in one arbitration and the owner and architect are in a separate arbitration. This arrangement frequently results in inconsistent results and very unhappy owners. If the thought of this keeps you or your client awake at night, modify your arbitration clause to allow for liberal consolidation so that all disputes arising from one project are determined in one arbitration.
- Who will be the arbitrator(s)? Unless your arbitration clause addresses this issue, your arbitrator will be selected by mutual agreement of the parties or, failing that, by administrative appointment. Too frequently, arbitration panels consist of all lawyers. Before the contract is signed, ensure that one arbitrator will be a contractor or design professional — or you may exclude lawyers altogether. If your adversary is very well-known in town and you or your client are less well-known or not known at all, you should require that none of the arbitrators can be from the local jurisdiction. It is appropriate to require that arbitrator(s) have a minimum number of years of experience in their specialty.
- How many arbitrators? Absent express agreement, the number of arbitrators who will hear your case is determined by the entity that administers the arbitration. The American Arbitration Association uses a $1 million threshold. If the claim is equal or less than the threshold, one arbitrator is assigned; if greater, three arbitrators are assigned. Why should you be concerned? A few reasons: given the arbitrator’s extremely wide latitude in his/her management of the case, casting your lot with one arbitrator can be an extremely risky proposition. If you or your client successfully alienates a solo arbitrator, your case is in deep trouble. For that reason, many counsel insist on three-member panels. On the other hand, the costs of a three-member panel can easily surpass $10,000 per day, excluding the arbitrators’ incidental expenses, which can include meals and lodging in a swanky hotel.
- Where will the arbitration be held? Arbitration clauses are often silent on this issue. Do not leave this point to the discretion of the administering agency. Clearly state where the arbitration must be held. Remember that requiring your arbitration to be held in New York City could have you traveling to Staten Island. You are better to state the venue as New York County.
- How much discovery will be permitted? One of the perceived advantages to arbitration is that the money-burning discovery so common in litigation is nowhere to be seen. Discovery in litigation can take too long and can be too expensive. However, are you certain that your case would not benefit from modest discovery? For example, allowing each side to take two fact witness depositions and a deposition of each expert witness, where each deposition does not exceed seven hours, may be a prudent use of resources.
- What rules of evidence will govern? One of the nasty surprises that may await a party in arbitration is the haphazard application of the rules of evidence. The American Arbitration Association encourages arbitrators to accept evidence that will foster an understanding of the dispute. Unfortunately, some arbitrators allow everything into the record with the refrain of “I’ll take it for what it’s worth,” while other arbitrators are far more restrictive.
The arbitration clause is the place to take control of this issue. For example, the clause could read, “the Rules of Evidence shall be as set forth in the Federal Rules of Civil Procedure except that hearsay testimony may be admitted but the absence of the opportunity to cross-examine the declarant shall be considered in determining the weight to be afforded to the proposed testimony or document.” In reading the rules of the American Arbitration Association, it is surprising that arbitrators are not required to exclude evidence on the grounds of privilege, e.g., attorney-client or settlement discussions. The risk of having an adverse inference drawn against your case because of your justified refusal to produce a privileged document can easily be dealt with in the arbitration clause.
- How long will the arbitration take? Clients are often disappointed or outright angry over the length of time to complete an arbitration. After all, one of the major selling points of this form of dispute resolution is its relative speed compared to litigation. Unfortunately, due to scheduling conflicts, especially with a panel of three arbitrators, arbitrations seldom proceed from start to finish in consecutive days. Rather, there are often gaps between hearing days lasting days, weeks or, in some cases, months. The arbitration clause is a good place to set express deadlines. For example, the clause could state that “the parties agree that the Arbitration shall be completed in not more than ## days measured from the appointment of the arbitrator(s).” This clause will assist the administering entity in selecting arbitrator(s) who can meet this commitment.
- Attorney’s Fees and Costs. Absent an agreement to the contrary or controlling statute, the “American Rule” provides that each side bears its own legal fees. The arbitration clause is a good place to provide for a mandatory award of attorney’s fees in favor of the prevailing party. Of course, if you or your client is likely to be the respondent in the arbitration, you may wish to omit this clause. As for the costs of the arbitration — which may well include arbitrator compensation (which in complex cases can run into the six figures) — I often include the provision that “The costs and fees of the arbitration, including arbitrator compensation shall be borne as incurred and the arbitrator(s) are without power to apportion them.”
- Modification of Award. The rules of the American Arbitration Association only allow an arbitrator to modify the award if there is a computational error or other similar imperfection. The arbitrator may not revisit any of his/her substantive conclusions. You could allow a party to request the arbitrator to revisit the merits of the award, especially where the arbitration is conducted before one arbitrator who may simply have swung and missed. The clause should include a tight time frame for this request and, to avoid having the other side incur needless legal fees, that party should not be required to respond to the modification request unless the arbitrator directs it.
The above ten points are far from exhaustive, but they should encourage you or your attorney to pay closer attention to boilerplate arbitration clauses.