Designing an Effective Arbitration Clause Claims and disputes arising from construction projects are often costly and time consuming to resolve. While it is best to avoid construction claims and disputes from the beginning of a project, it is important to resolve them quickly and efficiently once they arise. The efficient resolution of claims and disputes is often crucial to the economic success of a project. Charles W. Surasky Senior Counsel Atlanta, Georgia T: 404.582.8022 E: cwsurasky@smithcurrie.com For many years, arbitration was the construction industry s preferred method of dispute resolution. The goal of arbitration is to achieve a just, efficient, and cost-effective resolution of a dispute. Arbitration allows disputes to be resolved privately by an arbitrator or arbitrators with knowledge of the construction industry. This removes the risks associated with presenting technically and factually complex cases to lay jurors and local jury bias. Arbitration also allows the contracting parties to tailor the dispute resolution process to their individual needs and preferences. Doing so can avoid the lengthy and expensive discovery and hearing processes that are typical in litigation. Regrettably, for many in the construction industry, the distinct benefits of arbitration speed, cost, and efficiency have proved to be illusory because arbitration has evolved into a process which too closely resembles litigation. Complex arbitrations routinely involve lengthy and expensive pre-hearing discovery proceedings. Lengthy arbitration proceedings are common as well. These lengthy proceedings are expensive and divert resources and supervisory attention away from the parties business objectives. Arbitration still has the potential to be less expensive, less time consuming, and less destructive of business relationships. Contracting parties have a much greater ability to tailor the dispute resolution process to their needs. The prospect of overly litigious arbitration can be avoided by thoughtful drafting of an arbitration clause. The following checklist of considerations can be used to create an effective arbitration clause. Consider incorporating the standard rules of an arbitral institution in the arbitration provision. As discussed in a previous article in this series, there are several organizations with experienced practitioners that specialize in resolving construction disputes. These organizations include the American Arbitration Association, Judicial Arbitration and Mediation Service or JAMS, and International Institute for Conflict Prevention and Resolution. Each of these organizations have their own standard rules, which can be adopted by contracting parties when drafting arbitration provisions. The most popular arbitration agency serving the construction industry is the American Arbitration Association. The AAA Construction Industry Arbitration Rules and Mediation Procedures have been frequently amended over the years to address the concerns of industry professionals. Most recently, the AAA released its Supplementary Rules for Fixed Time and Cost Arbitration. The goal of these supplementary rules is to provide an arbitration process that is more predictable in time and cost to the contracting parties. The standard rules of any arbitral institution address many of the considerations discussed in this article. Still, it
is critically important to carefully review these standard rules to determine if they are appropriate for your project before incorporating them into any contract. Remember that the beauty of arbitration is the process can be tailored to your specific needs, so these standard rules may be limited or altered. Pre-select the hearing locale in the arbitration provision. If you can, specify a location for the hearing that will be convenient for you and any key witnesses that will need to be present in the event of a dispute being arbitrated. By selecting a favorable location for the hearing, you can also reduce the risk of having an arbitrator or panel of arbitrators selected from your opposition s home turf. Once an arbitrator is selected, the parties can mutually agree to have the hearing conducted in a different location if it makes more sense to do so. Consider including an election to arbitrate clause. In many jurisdictions, it is permissible to structure your arbitration clause to allow one party to unilaterally elect arbitration, as opposed to litigation or some alternative dispute resolution process, after the dispute has arisen. By reserving the right to elect or reject arbitration after the dispute has arisen, you can judge the suitability of the dispute for arbitration versus litigation after all the elements of the dispute are known. Before including an election to arbitrate clause in your contract, you should check the law governing your contract and the law in the locale of the project itself. If your election to arbitrate clause is not valid and enforceable under the controlling law, your opponent may argue that the entire arbitration provision is unenforceable. Consider specifying a contractual time limitation for initiating a claim or demand for arbitration. Statutes of limitations on demands for arbitration differ from state to state. This can cause uncertainty for those seeking closure of disputes. Be sure to check the law governing your contract and the law in the locale of the project itself. It may be advisable to specify a time limitation for initiating a claim or demand for arbitration in the arbitration clause itself. It may also be helpful to consider specifying a time when arbitration must occur, such as after the completion of the project. This can help avoid supervisory time and resources being diverted to arbitration proceedings and pre-hearing discovery before the conclusion of the project. Limit pre-hearing discovery. Because arbitration has evolved into a process that closely resembles litigation, many arbitrations experience lengthy and expensive pre-hearing discovery. Contracting parties can dramatically reduce these costs by limiting discovery on the front end. For example, the arbitration clause might provide that there will be no pre-hearing discovery at all or that pre-hearing discovery will be limited to only an exchange of relevant documents that each party intends to use as hearing exhibits. The parties may also choose to limit pre-hearing depositions in number, duration, and scope. Establish a protocol for pre-hearing discovery and exchange of
any electronically stored information. Electronically stored information (ESI), such as email communications and project scheduling files, may be critical to the resolution of a construction claim or dispute. Addressing how to exchange ESI from the outset will help ensure that the pre-hearing discovery runs smoothly. Consider whether information should be exchanged in native file format as opposed to paper or PDF format. Also, consider requiring that any paper documents be exchanged in separate, searchable PDF files. Finally, consider requiring the production of metadata with regards to electronically stored information to avoid discovery disputes. Differentiate between complex and small disputes. An arbitration clause can provide separate sets of rules and procedures depending on the size and complexity of the dispute. For particularly small disputes, it may make sense to streamline the arbitration process by agreeing to waive the right to any hearing before the arbitrator and to submit the dispute to the arbitrator in writing, with appropriate page limitations for each side s argument. In the case of more complex disputes, where a hearing is to be allowed, it may still be advisable to limit the time in which each side must present its case to the arbitrator to a specific number of days or hours. Specify the arbitrator selection process. One distinct advantage that arbitration has over litigation is the ability to have your dispute resolved by an arbitrator who has general or specialized knowledge of the construction industry. Your arbitration clause can specify the manner in which the arbitrator is to be selected, so if you wish to require that the arbitrator possess certain qualifications, then you can specify such qualifications in the arbitration agreement. If, for example, you are an owner who does not want a contractor as an arbitrator, you can contractually agree that your arbitrator must be an architect or have some experience as an owner s representative. You may also choose to pre-select and name a selected or mutually agreeable arbitrator in the arbitration clause. Specify the number of arbitrators. Not only can you specify the manner in which your arbitrators are selected in an arbitration clause, but you can also limit the number of arbitrators to be selected. For small disputes, the appointment of one arbitrator is the norm. Larger, more complex disputes typically use a panel of three arbitrators. For example, the AAA Construction Arbitration Rules and Mediation Procedures provides for the appointment of a panel of three arbitrators where the disclosed claim or counterclaim of any party is at least $1,000,000. Consider your desired number of arbitrators up front and expressly address this issue in your arbitration clause. Empower the arbitrator to allocate or award attorneys fees. Absent specific statutory authorization or agreement by the parties, the law is unsettled regarding whether arbitrators have the authority to award attorneys fees. While there is no such prohibition in the Federal Arbitration Act, some states forbid arbitrators to award
attorneys fees unless specifically empowered to do so by the parties agreement. Thus, it is critical that the arbitration clause itself expressly authorizes the arbitrator to include an allocation of attorneys fees in the award. By way of example, the AAA Construction Arbitration Rules and Mediation Procedures permits an arbitrator to award attorneys fees (1) if all parties have requested an award of attorneys fees, (2) if an award of attorneys fees is authorized by the parties arbitration agreement, or (3) if an award of attorneys fees is authorized by law. Provide for consecutive hearing days. Arbitrations typically grow in length when hearings are not scheduled to begin and conclude on consecutive days. With each break in the arbitration process, the parties will typically find more witnesses, documents, or questions which must be presented when the hearings resume. The extended duration caused by non-consecutive hearings can dramatically increase the cost of the arbitration with no offsetting benefit. One way to control the overall length of the arbitration is to require the arbitration hearing to be scheduled to start and conclude on consecutive hearing days. Another way is to impose outside time limits on each party s presentation of its case. Consider requiring the arbitrator to strictly enforce contract terms and adhere to legal principles. Some in the construction industry feel that contractual and legal principles can be lost to an arbitrator s desire to do the right thing. To these critics, the resulting compromises are frustrating and dissatisfying. Consider drafting the arbitration clause to require that the arbitrator strictly follow the contract terms and/or established legal principles in making a final decision and that the arbitrator s failure to do so will be grounds for an appeal. But think carefully before adding such a requirement. By making it easier to appeal an award, you will lose the benefit of finality that many consider to be one of the major advantages of arbitration. Consider a mandate for reasoned opinions accompanying the arbitrator s award. If your arbitration clause allows an appeal in the event of an arbitrator s failure to enforce contract terms or adhere to legal principles, it is of little effect if it is not accompanied by a requirement that the arbitrator issue a reasoned opinion that explains his or her decision. Unless the parties request or require otherwise, there is no requirement that an arbitrator provide the parties with a specific form of the award. Thus, you may wish to require the arbitrator to write a reasoned opinion explaining the award and the specific manner in which each claim and counterclaim was decided. This requirement may also include findings of fact and conclusions of law on specific issues presented in the case. It is important to note that this requirement may significantly increase the cost of the arbitration to the parties. When faced with this requirement, the arbitrator will usually request that each party submit their own proposed findings of fact and conclusions of law for the arbitrator s consideration. If the submission is made after the conclusion of the evidentiary hearing, the arbitrator will not officially close the hearing until after the submission is made. This will delay the publication of the final arbitration award if the publication deadline runs from the date that
the hearing is officially closed. Identify conditions precedent to arbitration. It may be wise to require the parties to participate in a non-binding process, such as a structured negotiation between principals or mediation, as a condition precedent to either party s resort to the arbitration process. Even the most cost-effective and efficient arbitration proceeding can distract from the parties business objectives and damage the parties business relationship. The early involvement of an experienced mediator or a structured settlement meeting between the principals of the opposing parties may resolve the dispute much more quickly and effectively than an arbitration proceeding. Provide for consolidation and joinder of other parties. Construction claims and disputes often involve multiple parties. If your contracts are not carefully drafted, you face the risk of being involved in multiple arbitration proceedings or simultaneous arbitration and litigation. If you are concerned that other parties may be involved in a construction claim or dispute, be proactive and preserve your right to join those parties in the arbitration based solely on your determination of the likely involvement or interest of the other party in an arbitration proceeding. You may also consider drafting your arbitration clause to allow you to invite others to participate in an arbitration and be bound by its result. Be sure to include a similar consolidation and joinder provision in all downstream subcontracts and purchase orders so that you can join lower-tier subcontractors and suppliers in the arbitration. An effective consolidation and joinder provision in your arbitration clause is important to obtaining full and final resolution of claims and disputes. Thanks to University of Georgia law student Matt Porter for his help with this article.