Unbalanced Arbitration Clauses: Are They Enforceable?

A Tenth Circuit case from earlier this year in a non-construction context raises an important question in every context in which arbitration clauses are used.  Generally, construction arbitration agreements are structured in a way which allows either party to the relationship to compel arbitration.  Similarly, most construction arbitration agreements do not limit the types of actions which can be pursued in an arbitration.  In THI of New Mexico at Hobbs Center, LLC, v. Patton, 741 F.3d 1162 (10th Cir. 2014), however, the Tenth Circuit considered the enforceability of an arbitration clause requiring a nursing home patient to arbitrate all of her claims but allowing the nursing home to file suit on certain limited claims -- here, small claims under $2,500, or claims related to guardianship, collections, or evictions.

The arbitration clause in question was upheld initially by the U.S. District Court.  Then, the New Mexico Court of Appeals held an identical arbitration agreement to be unconscionable under New Mexico law.  See Figueroa v. THI of N.M. at Casa Arena Blanca, LLC, 306 P.3d 480 (N.M. Ct. App. 2012).  The question before the Tenth Circuit then became whether an arbitration provision which was unenforceable under state law could nonetheless be enforced under the Federal Arbitration Act.  741 F.3d at 1165.  The Tenth Circuit determined that the decision of the New Mexico Court of Appeals was based on the notion that arbitration as a dispute-resolution process was inferior to litigation.  As a result, the Tenth Circuit held that the FAA would enforce the arbitration provision and, further, would preempt the state court decision on the issue.

How does this relate to construction?  In many large-project contracts and especially for international projects, arbitration clauses allowing one party the right to choose whether it pursues its claims in arbitration or litigation are becoming more common.  Based on case law as it appears currently, it is likely that the United States would enforce such provisions.

A recent article by Alexandra Douglas published by CPR raised the issue as to whether a rule of law similar to would be followed in other countries.  As with many issues in the law, the answer is, "it depends."  In cases from both Russia and France, unilateral arbitration clauses which allow only one party to the agreement to choose litigation or arbitration are unenforceable.  On the other hand, it appears that Spanish courts would be more likely to enforce such unilateral clauses.

As a lawyer, if you are involved with international arbitration and, in particular, with drafting arbitration provisions in international construction contracts, it is important to keep these decisions in mind when advising your clients.

8th Circuit: Arbitrator Decides Whether Non-Signatory to Contract can Compel Arbitration if Contract incorporates AAA Arbitration Rules

In a recent decision, Eckert/Wordell Architects, Inc v. FJM Properties of Willmar, LLC, the 8th Circuit reviewed a Minnesota federal court's order compelling the parties to submit - to an arbitrator - the question of whether a non-signatory party to the contract (FJM Properties) could compel arbitration. The parties' contract incorporated the AAA Rules requiring arbitration. As such, the 8th Ciruit found that the contract provided a "clear and unmistakable indication" that the parties intended for the arbitrator to decide the threshold question of arbitrability; therefore, the 8th Circuit affirmed the Minnesota district court's decision that the issue was to be resolved by the arbitrator, not by a court.

This case is in line with the U.S. Supreme Court decision in Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79 (2002), in which the Supreme Court found that a contract incorporating the NASD (National Association of Security Dealers) arbitration rules was a "clear and unmistakable indication" the parties intended for the arbitrator to decide threshold questions of arbitrability.

Partial Disclosure of a Source of Potential Bias Justifies Vacating an Arbitration Award in Texas

When compared with traditional litigation judgments, it is much harder to vacate arbitration awards after they are issued. The Texas Supreme Court recently addressed the standard by which an award can be vacated due to inadequate disclosures by the arbitrator.  In particular, the Court had to evaluate whether an award should be vacated due to an arbitrator’s partial disclosure of a source of potential bias or conflict. Tenaska Energy, Inc. v. Ponderosa Pine Energy, LLC, 57 Tex. Sup. J. 617 (Tex. 2014).

The AAA Commercial Arbitration Rules require that “any person appointed or to be appointed as an arbitrator shall disclose…any circumstance likely to give rise to justifiable doubt as to the arbitrator’s impartiality or independence, including any bias or any financial or personal interest in the result of the arbitration or any past or present relationship with the parties or their representatives.” 

The underlying arbitration proceedings were based on a contract dispute between Tenaska and Ponderosa.  The parties’ arbitration agreement provided for a panel of several arbitrators. Lawyers from Nixon Peabody represented Ponderosa and selected Samuel Stern as their arbitrator.  After his selection Stern disclosed the following information to the parties regarding his relationship with Ponderosa and Nixon Peabody: (1) Nixon Peabody had designated him as an arbitrator in three other proceedings, (2) Stern, on behalf of a company named LexSite, had discussions with Nixon Peabody about outsourcing litigation discovery tasks to LexSite, and (3) “Nixon Peabody and LexSite have done no business, and it is not clear that Nixon Peabody would ever have any business to give LexSite.”  Stern, as part of a divided panel, eventually awarded $125 million to Ponderosa.

Tenaska moved to vacate the award in state court, arguing Stern was neither impartial nor free from bias.  The parties conducted extensive discovery on the issue prior to the hearings on the opposing motions. Ultimately, the trial court vacated the arbitration award based on Stern’s failure to disclose that his only contacts at Nixon Peabody were the two lawyers representing Ponderosa, he owned stock in the litigation services company that was pursuing business from Nixon Peabody, he served as president of the company’s U.S. subsidiary, he conducted significant marketing for the company, he had additional meetings and contact with the Nixon Peabody lawyers to solicit business from the firm, and he allowed one of the Nixon Peabody lawyers to edit his disclosures to downplay the relationship with the firm. The court of appeals reversed, holding that Stern’s disclosures were sufficient to put Tenaska on notice of a potential conflict. 

The Texas Supreme Court ultimately upheld the trial court’s vacation of the arbitration award, reasoning that Stern’s failure to disclose the extent of his relationship with LexSite and his attempts to solicit business from Nixon Peabody demonstrated evident partiality and supported vacating the award.  The Federal Arbitration Act allows a court to set aside an arbitration award “where there was evident partiality.” 9 U.S.C. § 10(a)(2).  The U.S. Supreme Court has interpreted the statute to impose a requirement on arbitrators to “disclose to the parties any dealings that might create an impression of possible bias.”  Commonwealth Coatings Corp. v. Cont’l Cas. Co., 393 U.S. 145, 147 (1968). Moreover, the Texas Supreme Court had previously held that “if the arbitrator does not disclose facts which might, to an objective observer, create a reasonable impression of the arbitrator’s partiality,” then the arbitrator exhibits evident partiality. 

Based upon these cases, the Texas Supreme Court held an arbitration award can be vacated if an arbitrator fails to disclose facts which might, to an objective observer, create a reasonable impression of the arbitrator’s partiality. However, information that is trivial will not rise to this level and need not be disclosed.  Looking at the facts regarding Stern’s business relationship, his potential financial gain from procuring Nixon Peabody’s business, and his decision to allow Ponderosa’s attorneys to downplay their relationship, the Court held that the information was not trivial and might have conveyed an impression of partiality toward Nixon Peabody’s client to a reasonable person. Accordingly, the failure to disclose the information demonstrated evident partiality, and the trial court properly vacated the award. 

While this case was decided under Texas law, the Texas Supreme Court’s interpretation of the Federal Arbitration Act suggests that its reasoning could be applied more broadly to cases across the country. In particular, the Court’s decision to evaluate the extent to which a partial disclosure could be misleading could give rise to more challenges to arbitration awards based on disclosure issues.

Thanks to J.P. Neyland at Griffith Davison & Shurtleff, P.C. for assistance with preparing this post.

Standards of Proof for Quantum Meruit Actions: Process Engineers & Constructors, Inc. v. DiGregorio, Inc., (R.I., July 1, 2014)

In Process Engineers & Constructors, Inc. v. DiGregorio, Inc., No. 2013-87 (July 1, 2014), the Rhode Island Supreme Court affirmed a judgment awarded to a sub-subcontractor following a bench trial. 

The case is helpful because it provides standards of proof under Rhode Island law for quantum meruit claims often brought in construction disputes.  The two points are:

1. A plaintiff need only prove it was not at fault for the changed condition (not need to prove cause).
2. No expert testimony is required to prove the costs incurred were "fair and reasonable."  Proof of the value of the services is sufficient.

At trial, the sub-subcontractor plaintiff sought to recover against the party with whom it contracted (the subcontractor) $316,000 based upon extra work performed.  Plaintiff brought breach of contract and quantum meruit causes of action.  The trial justice found that the plaintiff did not satisfy its burden of proof on the breach of contract claims for failure to follow the change order requirements of the contract. 

On its quantum meruit recovery, plaintiff sought to recover for three categories: (1) change order work, (2) increased bond premium charged due to increased contract amount, and (3) additional costs due to replacing a pipe caused by wet insulation. 

As to the first item (unallocated change order work), the trial justice held that the plaintiff failed to meet its burden of showing that a benefit was conferred on defendant and that the defendant accepted the benefit.

The trial justice found in the plaintiff's favor as to the increased bond premium and wet insulation extra work item.  Specifically regarding the wet insulation item, the trial court found that the loss was not due to the sub-subcontractor's action because it was not responsible to dewater the trenches that became wet. 

In its appeal, defendant contended  the evidence presented by the plaintiff was insufficient because the plaintiff did not prove defendant was responsible for the wet insulation.  The Supreme Court framed the issue and its holding as follows:

Whether [plaintiff] only had to prove that it was not responsible for the loss or whether [plaintiff] also had to prove what caused the loss. We hold that [plaintiff] was required to prove only that it was not at fault for the loss; it did not need to prove who was at fault." Emphasis added.

The second issue on appeal concerned the requisite proof that services rendered were "fair and reasonable" for quantum meruit recovery.  Here, the Court shifted the burden on the defendant to establish the claimed charges and costs were unreasonable.  Citing Bruner & O'Connor, the Supreme Court stated:

For purposes of the prima facie case, a plaintiff need only submit evidence of the value of the services; the factfinder is permitted to infer that the charges are fair and reasonable. A plaintiff is not required to put forth expert testimony on the reasonableness of the value of the services during his or her prima facie case. If a defendant wishes to contest the fairness or reasonableness of the value asserted by a plaintiff, the burden shifts to the defendant to prove that the charges were unreasonable. Emphasis added.

The Supreme Court did not explain what level of proof is required for a defendant to establish charges were not "fair and reasonable" or whether expert testimony would be required.  On the specific facts of the case, the Court found that the defendant simply failed to challenge the reasonableness of the costs .  It stated, "[defendant] did not challenge the hourly rates, the number of hours worked, the costs of materials, or the charges for equipment."