Agreements to Arbitrate Are Simple, Right?

Ira M. Schulman, Partner, Pepper Hamilton LLP

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:

1. 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.

2. 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. 

3. 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.

4. 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.

5. 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.

6. 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.

7. 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.

8. 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.

9. 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.”

10. 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.

Article originally posted March 31, 2016 on Constructlaw, an update and discussion of recent trends in construction law and construction, maintained and edited by Pepper Hamilton's Construction Law Practice Group. 

Amount in Controversy Not a Barrier to Federal Court Review of Arbitration Award

In Pershing, LLC v. Kiebach, 2016 WL 1375874 (5th Cir. April 6, 2016), the 5th Circuit considered an interlocutory appeal whether the district court properly exercised jurisdiction over a case that involved an arbitration award of only $10,000.  The 5th Circuit "adopting the better reasoned approach" concluded yes.

The underlying matter concerned an alleged Ponzi scheme.  Investors (Kiebach and others) claimed that a clearing broker agent of Pershing failed to disclose adverse financial information causing them $80 million in damages.  After a two week hearing, a Financial Industry Regulatory Authority ("FINRA") panel found against the investors' claims, but awarded them $10,000 in compensation for "certain arbitration-related expenses." Pershing filed a motion to confirm the arbitration award in federal court pursuant to the Federal Arbitration Act ("FAA").  The investors moved to dismiss because, although the parties were diverse, the amount in controversy was only $10,000, not the threshold amount of greater than $75,000.

Noting that federal courts diverge, the 5th Circuit observed that the "courts that have confronted this issue generally follow one of two approaches—the award approach or the demand approach."  As the name would suggest, the "award approach" determines the amount in controversy based on the "underlying arbitration award regardless of the amount sought."  In contrast, the "demand approach" ties the amount in controversy to "amount sought in the underlying arbitration." Based on the Investors' arbitration demand of $80 million, the district court had decided that the $75,000 amount in controversy was met.  The 5th Circuit agreed.

The 5th Circuit's rationale relied three points.  "First, the demand approach recognizes the true scope of the controversy between the parties."  The Court observed that the Investors were likely opposing the confirmation of the award because they were not satisfied with $10,000 on their original $80 million claim.  Second, "the demand approach avoids the application of two conflicting jurisdictional tests for the same controversy." Essentially using the award approach would result in two different jurisdictional outcomes at the beginning of the arbitration and at the end.  In other words, a motion to compel arbitration, based on the amount claimed (if more than $75,000), could be heard by the court.  But then, for the exact same case, the motion to confirm the later arbitration award (if ultimately less than $75,000) could not be heard by the court.  This dichotomy is irrational and would possibly promote "gamesmanship" of filing motions for arbitration at the start of the case in order to "to preserve their right to a federal forum for review of the eventual award."  The third rationale for using demand approach was that the jurisdictional outcome would be the same had the case been arbitrated or litigated. 

The concurring opinion pointed out that while the demand approach was appropriate in this case, it was not "necessary or advisable to adopt any such general approach" for all cases going forward.  Rather the concurring judge believed the better approach was to take each matter on a case-by-case basis on its facts.

You’re Holding Me Up: My Week Spent Back on a Jobsite

“Who’s this guy?”

That’s the look I got from some folks and it’s a look I knew all too well. I flashed it many times as an onsite project engineer and project manager.  On one particular jobsite I was on, we would joke about the starched white shirt/pressed jeans guys who would be posted up in the trailer conference room occasionally for matters that were above our pay grade.  For the first time a few weeks ago, I was one of those guys as I spent my first prolonged period of time on a large jobsite since becoming an attorney. 

I was sent to the South to a large industrial project that was just reaching critical mass of construction operations with over 700 tradesmen onsite and multiple shifts running 7 days a week.  As I walked onsite and into the trailer complex, the intensity and buzz of the site was palpable, and it surprised me how much I missed that aspect of construction.  My role for the week was to simply begin compiling facts in order to status certain contracts for the owner.  I did this through collecting documents and interviews with the owner’s supervisory field staff.  At first, I had some difficulty in my new role as a passive observer rather than a proactive participant in the actual building operations. I found myself at times having to suppress the construction manager remnants of my brain when process and future operational concerns were being discussed.  I reminded myself that I was no longer a field guy and in my current capacity, I needed  to dial it back to stick to the task at hand of information gathering, not getting into fervent discussions of panel attachment details and efficient trade sequencing.

Through the contract document review I conducted prior to arriving onsite, I knew the contractual relationships and who might be in trouble.  The office I was placed in was located next to the large general conference room where marathon coordination meetings were taking place and I worked with the door open in order to better understand the project.  Knowing who was in the crosshairs, there were times when I winced at things said from an owner standpoint, and at other times when subcontractors were speaking I wanted to yell out the door, ‘SOMEONE WRITE THAT DOWN! WE’LL NEED THAT LATER!”

By the end of the week, I had slipped back into the comfortable rhythm of a jobsite, something that is missing in an office environment.  There are times of the day that have certain feels to them; the sacrosanct coffee break, the quiet, almost peaceful lull of lunch, and wrap up time in the late afternoon as the shadows get longer.  A few days, I found myself out on the deck watching the tradesmen file out of the gate and thought wistfully of my time spent onsite and how I might want to get back into it.  Then I would snap back with the reality of the monumental task and the crushing and all-consuming pressure this team would experience over the next year in order to complete the project on time. Accordingly, I quickly remembered why I made the decision to go to law school.  I found that jobsites and their intensity are a nice place to visit, but me and my starched shirts had a plane to catch to get back to the office to start reviewing documents and begin writing.

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The author, Brendan Carter, is a contributor to The Dispute Resolver and a former Student Division Liaison to the Forum on Construction Law.  He is an attorney and a Senior Consultant with Navigant’s Global Construction Practice based out of Boston, MA.  He may be contacted at 617.748.8311 or brendan.carter@navigant.com.

Guest Post: Schedule Errors -- To Correct or Not to Correct? by Fritz T. Marth, PE, CFCC, Senior Managing Consultant at GREYHAWK

The Dispute Resolver is proud to offer the following guest post by Fritz T. Marth, PE, CFCC, Senior Managing Consultant at GREYHAWK.  We are grateful to Fritz for his contribution and insightful post.  Please click here to learn more about Fritz and GREYHAWK.

Schedule Errors – To Correct or Not to Correct?

By Fritz T. Marth, PE, CFCC

Senior Managing Consultant at GREYHAWK

The forensic analysis of critical path delays to project milestones, as part of claims and litigation, initially involves the assessment of the baseline schedule.  While there is often a temptation to “correct” critical path method schedules prior to or during the schedule analysis process, one should always think twice before doing so.  It is best to remember the old adage that, “no good deed goes unpunished.”  No matter how genuine the desire to perform an accurate and objective analysis may be, that genuineness will be challenged anytime changes to contemporaneous project documents, including schedules, are made after the fact.  That is not to say that there are not very legitimate reasons for corrections to a schedule, or any other project document for that matter; however, many times these corrections can be addressed by way of explanation rather than by way of change.

For example, when clear cases of improper sequencing occur, such as a schedule indicating a wall being constructed before its footing is placed, the temptation to correct exists.  This makes sense, especially if the original critical path progresses through the wall, and then moves into something other than the scheduled footing.  In that case, a good argument could be made that that critical path is in error, and would actually be increased in duration since proper sequencing would require footing placement before wall construction.  At this point in the analysis however, the analyst should stop and ask themselves some questions, such as:

• Going forward in time on the project (taking advantage of the benefit of hindsight), was the critical path, or the actual work, in fact influenced as a result of this sequencing error?

• Will addressing this sequencing error as simply resulting in a de facto schedule impact provide a more understandable and accurate analysis than making an upfront change to the schedule which could affect the schedule “downstream,” in a way that would never have occurred?

If the answer to the first question is “no” or the answer to the second question “yes,” the error is likely better addressed by explanation than by change.  In doing so, full acknowledgement of the error is made, the effect of the error accounted for, and any arguments about the credibility of “making changes to the plan after the fact” avoided.  The more objective the analysis is the more credible the analysis is, and any changes made by an analyst necessarily introduce subjectivity.  Finally, one should always be mindful that when performing a schedule analysis without the benefit of having access to the scheduler, what may appear as an obvious error, may in fact not be one.