Implied Waiver of Arbitration Clause Through Active Litigation -- Tuscan Builders Case Summary

Courts applying the Federal Arbitration Act and the state arbitration acts routinely impose a strong presumption against finding waiver of an agreement to arbitrate. 

In the case of Tuscan Builders, LP v. 1437 SH6 LLC, No. 01-13-00685-CV (Tex.App. [1st Dist.] Jan. 30, 2014), the appellate court affirmed the denial of a motion to compel arbitration finding that the moving party's "motion to compel more consistent with a late-game tactical decision than an intent to preserve the right to arbitrate." 

Here at Division 1, we are all familiar with this issue.  It particularly occurs where we represent clients in matters, such as mechanic's lien actions, that are required to be filed in court -- not through arbitration.  We know that the question of implied waiver of the arbitration provision is one for the Court to decide and it will turn on the particular facts and procedural history of the case.  The question always is: how much is too much? 

We thought a summary of this case would be a helpful refresher. 

The Facts

Plaintiff in the original action was the Owner of a new commercial building that was going to provide health related services. 

Owner contracted with Designer to design the building.  Owner and Designer signed a modified B141-1997 that excluded the mediation and arbitration provisions in favor of state court litigation.

Owner contracted with Contractor to construct the building.  Contractor provided the Owner with the A101-1997 agreement.  No modifications were made to the incorporated A201-1997 agreement thereby selecting mediation and arbitration as the dispute resolution mechanism.  Owner claimed it was never provided a copy of the A201 General Conditions. 

Owner sued Designer and Contractor.  Contractor answered without asserting the right to arbitrate.  Contractor also asserted third party actions against its subcontractors. 

The litigation ensued with written discovery, an inspection of the building demanded by the third party defendants, and a consented-to extension of the trial schedule. 

After the passage of one year and the closure of discovery, Contractor moved to compel arbitration.  Owner claimed that it never knew of the arbitration provision in the A201 and, even if the arbitration provision was binding and enforceable, Contractor waived its right to compel through its active involvement in the litigation. 

The trial court agreed with Owner and denied Contractor's motion.

Factors Considered For Implied Waiver of Arbitration Clause

The Tuscan Builders Court applied a five-factor test (the Perry Homes Factors): "In determining whether a party waived an arbitration clause, the courts can consider, among other factors,

1. whether the movant for arbitration was the plaintiff (who chose to file in court) or the defendant (who merely responded),
2. when the movant learned of the arbitration clause and how long the movant delayed before seeking arbitration,
3. the amount of the movant's pretrial activity related to the merits rather than arbitrability or jurisdiction,
4. the amount of discovery conducted, and
5. whether the movant sought judgment on the merits."

In applying these factors, the Court considers the moving party's conduct in the litigation and determines if it portrays the "kind of 'aggressive litigation strategy' that substantially invokes the litigation process." 

Under the facts of Tuscan Builders, the appellate court agreed Contractor had waived its right to enforce the A201 arbitration clause.  The facts most relied upon by the Court which caused the strong presumption against waiver to be overcome were:

• No mention (or reservation) of the arbitration agreement.
• Lapse of Time - 1 year.
• Contractor was presumed to be familiar with the arbitration provision because it presented the AIA form agreement to Owner.
• Perceived tactical strategy to use the tools of litigation and then go to arbitration. 
• Prejudice to Owner, Designer, and Court for piecemeal, inefficient proceedings. 

In this context, the court explained that the "[p]rejudice refers to the inherent unfairness caused by 'a party's attempt to have it both ways by switching between litigation and arbitration to its own advantage.'"

Division 1 Members, please feel free share similar cases you are aware of or your personal experience on the issue of how far can you go in litigation until impliedly waiving arbitration . . .

Division 1 Cocktail Party at House of Blues (4/10 after Welcome Reception)

 

Join Division 1 for a cash bar cocktail reception at the House of Blues after the welcome reception on April 10. 

 

Where: House of Blues, Third Floor (The Prayer Room is reserved for us), 225 Decatur Street, New Orleans, LA 70130

 

When: April 10 around 8:00PM (after the Welcome Reception)

 

More Info: Contact Division 1 Chair, Luis Prats (LPrats@cfjblaw.com)

Division 1 Supports ACE Mentor Program

SO YOU THINK YOU CAN NEGOTIATE A CONSTRUCTION CONTRACT DISPUTE?

Division 1 is teaming up with the Young Lawyers Division and Divisions 2, 3, 5, 6, 7 and 9 at the Forum's Annual Meeting to present live demonstrations of the ACE Construction Contract Negotiation activity module the YLD and ACE jointly created. 

The student negotiators attend the McDonogh #35 Senior High School in the historic Treme neighborhood.  They have participated in the ACE program for two years and receive school credit for their involvement in ACE. 




WHEN: Friday, April 11, 2014, 12:30-1:30pm, Division Lunches

WHERE: The Roosevelt Hotel - New Orleans

Utilizing a Pre-Construction Contract Review to Minimize the Potential for Construction Billing Disputes

In Division 1, many of us tend to focus on how to resolve disputes after they have come to light.  This article, written by Curt Plyler, CFA, CCA of Fort Hill Associates, identifies a method for our clients to avoid disputes later in the game by doing the key legwork before construction even begins.  

Curt and I met at the meeting in Nassau, and he was kind enough to forward this article to me for our use in the Dispute Resolver.  Thank you, Curt!

Here's the article:

As a project moves from an idea towards construction inception, the Owner, Contractor, and their attorneys work together to create a construction contract designed to meet their mutual interests. Much effort and expense goes into this process, which is necessary given the potential risk exposures. However, once the Contract is set for execution, an essential step to minimizing future disputes is often omitted. A Pre-Construction Contract Review assists in identifying and mitigating many issues often arising from the Contractor’s billing practices.

Why Conduct a Pre-Construction Contract Review?

A Pre-Construction Contract Review enhances the efforts of the Owner’s representatives, attorneys, architects, and project managers in ensuring the underlying financial intent of the Contract is met. The additional intelligence provided by this review maximizes cost transparency, and as a result, the Owner’s fiscal responsibility. Most importantly, a Pre-Construction Contract Review establishes the proper expectations at project inception. A Contractor will seek to be compensated appropriately to complete a project not fully defined under a fixed price contract. 

As a result, Guaranteed Maximum Price (GMP) contracts are often utilized by Owners to get a better price on this type of construction project. The Contractor is normally paid the Cost of the Work plus a fee. Defining ‘cost’ is paramount. Assuming no language to the contrary, if the Contractor charges the Owner anything other than the cost incurred for labor, leased equipment, insurance, information technology, and etc., the underlying intent of the Contract has been changed. The Contractor can still utilize predefined rates to bill certain elements of project cost. However, the Pre-Construction Contract Review will validate the rates to be utilized to charge the project are representative of the actual cost incurred.

Step 1: Auditor Review of Contract Language

Ideally, a Pre-Construction Contract Review is done prior to Contract execution. The Contract is designed to eliminate ambiguities, but the complexities of a large construction project often leave the various parties with different understandings and assumptions related to project billings. The Auditor’s work complements the work done by both group’s attorneys. The attorneys are focused on a Contract to minimize their respective party’s risk, and the Owner’s Auditor (external or internal) seeks to minimize the potential for future billing disputes. These disputes often involve billing methodologies that alter or differ from the intent of the Contract. In most instances, the first step normally entails the Auditor reviewing the draft Contract language and identifying areas of concern.

Step 2: Review Labor Billing Methodology

Labor is the largest component of General Conditions and can be easily manipulated in the Contractor’s favor. The Contractor is entitled to recover the cost of payroll taxes, insurance, and customary benefits. These costs are often recovered through a labor burden billing based on the base wages. Since these costs will vary depending on who is assigned to the job, an estimated labor burden is often billed to the project. The Contractor’s estimate tends to be conservative, and each of the labor burden components is normally slightly overstated as a result. 

A Pre-Construction Contract Review proactively examines the proposed job roster and reviews employee payroll records. This review ensures the base wages billed are the actual wages paid to the employees. Additionally, the labor burden is reviewed to ensure it is representative of actual cost for both regular and overtime hours worked (many labor burden components are not applicable to overtime hours) for the Contractor’s hourly and salaried workforce. 

Other Contractors utilize labor billing rates, inclusive of base wages and labor burden, to charge the project. These billing rates may or may not be representative of actual Contractor cost. The Contractor’s payroll records should be reviewed during the Pre-Construction Contract Review to ensure these rates are representative of actual cost incurred.

Step 3: Review Contractor-Owned Equipment Rates

Many Contractors lease various pieces of their own equipment to the project. During the Pre-Construction Contract Review, the following items should be determined and/or validated:

• Fair market value of each item of equipment upon arrival on the project site
• A derivation of the components of the rate to be charged for each item of equipment
• The aggregate amount allowed to be charged for each item of equipment
• Any other charges to be billed separately and directly for equipment

It is recommended these rates be indexed to a respected industry source (for example, the AED Green Book). Additionally, the aggregate rental payments should not exceed a Predefined percentage of each item’s fair market value.

Step 4: Review Defined Rates for Other Items

Contractors will often insert Contract language allowing insurance to be charged at a stated rate, or they will bill the coverage at a rate despite Contract language stating only the premiums directly related to the project are allowed. As with the leased equipment and labor billing rates, it is very important to understand and validate the items comprising the insurance rate. It is not uncommon to find excess coverage and ‘home office’ insurance costs included in the rate.

Similar to insurance, many Contractors attempt to insert Contract language specifying a rate (a predefined percentage or an amount per labor hour of work) for information technology (IT), or they will charge a rate despite Contract language specifying actual cost incurred for direct project-related expenses. Any IT billing method utilizing a rate needs to be reviewed to ensure the components comprising this rate are reimbursable
pursuant to the underlying Contract. These IT components should not be billed directly if included in a predefined rate. Additionally, any rate based on a charge per work hour should be restricted to regular time wages only. 

Other items, including document reproduction and document retention, are often charged to the project with pre-defined rates. The Auditor should request the Contractor provide a list of all rates to be utilized in lieu of actual cost during the Pre-Construction Contract Review. All of these rates should be reviewed to ensure they are representative of actual cost incurred.

Step 5: Define a Budget for Daily/Interim Cleaning

Daily or interim cleaning charges can create issues of contention as a project progresses. In most Subcontracts, the Subcontractor is responsible for maintaining a clean job site. Thus, if the Contractor is not self-performing work on the project, the Owner may perceive a duplicate billing when daily/interim cleaning charges are billed to the project (if the Contractor is self-performing work, keeping that portion of the job site clean should be within their scope). The responsible Subcontractor should be back charged for any further cleaning required as a result of their work. 

In reality, though, it is nearly impossible to determine the responsible party for cleaning in all instances, especially given the common areas used by multiple Subcontractors. During the Pre-Construction Contract Review, it is recommended the daily/interim cleaning budget be reviewed and agreed-upon. This budget should be capped to prevent abuse.

Step 6: Defining the Required Documentation

The Pre-Construction Contract Review is the ideal time to specify the documentation required to approve Owner Change Orders, payment applications, and allowance/contingency usage.

• Change Orders should be fully supported, including templates specifying allowable markups for labor, equipment, and materials.
• Allowance and contingency expenditures should be reviewed with the Owner prior to the incurrence of these costs. Utilizing a ‘no cost’ Change Order to track usage provides the proper transparency to the Owner.
• Each payment application should be fully supported with Subcontractor payment applications, invoices for all expenditures above a predefined threshold, and a job cost report inclusive of a reconciliation for that month’s billing. 
• Monthly labor and leased equipment reports are also recommended to ensure visibility is provided for individuals and equipment moving to and from the project. 

Interim/Closeout Construction Reviews

The Pre-Construction Contract Review validates the basis for a Contractor’s billings to the Owner at project inception. On larger projects, periodic audit reviews are recommended every six to nine months of activity after project inception and the Pre-Construction Contract Review. These reviews are done for two reasons. First, it should be determined whether the Contractor has billed in a manner compliant with any understandings reached during the Pre-Construction Contract Review. Second, staff turnover -- both with the Contractor’s and the Owner’s project management teams -- often leads to misunderstandings regarding the agreed-upon billing methodologies. The findings in an interim or closeout audit should be minimal in the absence of large clerical errors. 

Conclusion

From the Owner’s perspective, eliminating billing issues upfront eliminates negotiating for a partial credit later on in the project for a ‘difference of interpretation’. From the Contractor’s perspective, the upfront review eliminates the bad feelings that can arise if the Owner calls in to question the Contractor’s billing methodologies later in the project. Thus, the ‘rules’ by which the game will be played are clarified. The Pre-Construction Contract Review is fair for both parties, and successful financial oversight of the project will be significantly enhanced when these reviews are employed. 

Curt Plyler is a Principal with Fort Hill Associates, LLC. Fort Hill is a consultancy specializing in construction contract audits and pre-construction reviews with offices in Raleigh, NC and Greenville, SC.

Texas Jury Sentences General Contractor to Three Years in Prison for Fraudulent Nonpayment of Subcontractors

The Dallas Morning News reports that a jury in Fort Worth, Texas recently gave the principal of a general contractor a three-year prison sentence for fraud in connection with his failure to pay amounts due to subcontractors for work performed on the construction of a car dealership. According to the article, the Tarrant County District Attorney's Office stated that the criminal conviction, which came after a week-long trial, was the first of its kind in the country.

The press release from the Tarrant County District Attorney's Office offers some additional details about the case. It states that the general contractor had submitted payment applications to the owner claiming all subcontractors were being paid. This turned out not to be the case, as subcontractors filed seven liens totaling about $100,000 against the owner's property. The owner filed a complaint against the general contractor's principal with the Tarrant County District Attorney's Office. The principal was then indicted, arrested, and tried on a felony charge of making a false statement to obtain property or credit.

The defendant had no prior felony convictions, and therefore faced punishment ranging from probation to ten years in prison. During the punishment phase, prosecutors presented evidence of prior civil lawsuits against the defendant filed by subcontractors, as well as repeated bankruptcy filings to avoid liability. After considering this evidence, the jury sentenced the defendant to three years in prison with a $10,000 fine.

As civil defense attorneys, we often view potential liability for nonpayment on construction projects in civil, rather than criminal terms. Has anyone else experienced situations where criminal charges were asserted? Is this the type of conduct that merits criminal punishment rather than civil liability for damages?

Score One For the Contractors - Federal Circuit Rejects “Specific Targeting” Requirement In Good Faith and Fair Dealing Claims Against the Government

In Metcalf Construction Co., Inc. v. United States, 2014 WL 51956 (Fed. Cir. 2014), the U.S. Court of Appeals for the Federal Circuit considered the scope of the federal government’s duty of good faith and fair dealing to a private contractor engaged to design and build military housing.  The case involved claims by the contractor against the government for differing site conditions and associated delays and the government’s assessment of liquidated damages against the contractor.  In addition to claiming the government’s material breach of specific contract provisions, the contractor claimed that the government’s actions breached the government’s implied duty of good faith and fair dealing under the contract.

Interpreting the Federal Circuit’s prior decision in Precision Pine & Timber, Inc. v. United States, 596 F.3d 817 (Fed. Cir. 2010), the trial court had held that a breach of the government’s duty of good faith and fair dealing could only be established by a showing that the government “specifically designed to reappropriate the benefits [that] the other party expected to obtain from the transaction, thereby abrogating the government’s obligations under the contract” - in short, “specific targeted action” against the contractor, regardless of any incompetence and/or failure to cooperate or accommodate a contractor’s requests.  The Federal Circuit, however, held that the trial court’s view of its Precision Pine decision was “unduly narrow” and that the trial court had misread the decision.  The Court clarified that its prior decision in Precision Pine did not purport to define the scope of good faith and fair dealing claims for all cases, let alone alter prior standards, and that the Precision Pine decision did not hold that the absence of specific targeting, by itself, would defeat a claim of breach of the implied duty.  Instead, the Court stated that the “specific targeting” language of the Precision Pine decision on which the trial court relied only meant that the implied duty of good faith and fair dealing depends on the parties’ bargain in the particular contract at issue.

Accordingly, the Metcalf decision clarifies that the government’s duties of good faith and fair dealing should be analyzed on a case-by-case basis and in the context of the contract - particularly, according to whether the government’s actions rise to the level of denying the contractor its benefits of the parties’ bargain in the contract.

Iowa Supreme Court - Waiver of Sovereign Immunity on Public Projects Involving "Targeted Small Businesses"

The Iowa Supreme Court recently issued a decision which requires the Iowa Department of Transportation (DOT) to pay three subcontractors after they completed work on state projects but were never paid by the general contractor, effectively implementing a waiver of sovereign immunity for claims by “Targeted Small Businesses”(TSB).

The case, Star Equipment v. State of Iowa (2014 WL 346521), involved improvements made to highway rest stops. The DOT hired the general contractor, Universal Concrete, which in turn hired some subcontractors. The general contractor was classified by the State of Iowa as a TSB, meaning it is minority-owned and exempted from the requirement of posting a surety bond to secure payments on the project. Thus, there was no surety bond from which the subcontractors could seek payment if the general contractor failed to pay them (Iowa Code Chapter 573 is Iowa’s counterpart to the Federal Miller Act). After the general contractor failed to pay the subcontractors, they sued both the general contractor and the Iowa DOT.

The trial court ruled that state law did not require the DOT to pay on the general contractor’s obligations. The Supreme Court reversed, finding that subcontractors of state-hired TSB general contractors can seek payment from the state if the general contractor fails to pay. In reaching this conclusion, the Supreme Court reasoned that Iowa Code Section 573.2 acts as a waiver of sovereign immunity when the requirement of a bond is waived (such as when a TSB is hired as a general contractor), thereby allowing the subcontractors to recover the balance owing directly from the DOT.

Do you agree with the decision? Are you aware of any other states that have similar statutes to protect targeted small businesses?

Check out this post from Skanska on project team collaboration and communication

Skanska blog - http://blog.usa.skanska.com/why-collaboration-and-communication-are-essential-to-project-success/.

George McLaughlin wrote a series of articles on this topic in the Dispute Resolver last year.