Waiver of Arbitration by Litigation Conduct – Who Decides (Court or Arbitrator)? by Tom Dunn*

Common Fact Scenario: Defendant is sued in state or federal court.  Plaintiff and Defendant signed an arbitration agreement.  After participating in the litigation for some period of time, Defendant moves to compel arbitration.  Plaintiff objects asserting, in part, that Defendant waived the right to compel arbitration through participating in the litigation and/or delaying the demand of arbitration. 

Typical Outcome: The question of waiver by litigation conduct is a case by case analysis with no bright lines.  “Thus, ‘a party may waive an agreement to arbitrate by engaging in two courses of conduct: (1) taking actions that are completely inconsistent with any reliance on an arbitration agreement; and (2) “delaying its assertion to such an extent that the opposing party incurs actual prejudice.”’” Shalabyv. Arctic Sand Technologies, Inc., et al., MICV2014-03621, Slip. Op. (Mass.Sup. Ct. 12/15/2014), quoting  Johnson Assocs. Corp. v. HL Operating Corp., 680 F.3d 713 (6th Cir. 2012), quoting in turn Hurley v. Deutsche Bank Trust Co. Ams., 610 F.3d 334, 338 (6th cir. 2010), quoting in turn O.J. Distrib., Inc. v. Hornell Brewing Co., 340 F.3d 345, 356 (6th Cir. 2003).  In general, as a defendant engages in affirmative conduct that involves the exercise of the power and authority of the court, and through the lapse of time, the likelihood that such conduct will be regarded as a waiver increases.  In Shalaby, for example, the defendant filed a Rule 12(b)(6) motion to dismiss, engaged in contentious e-discovery disputes, and requested the Court to issue a discovery protective order. Only after the lapse of six months and partial denial of its dispositive motion did Defendant first assert the affirmative defense of arbitration and/or a right to compel arbitration.  Under these facts, the Court found defendant waived arbitration. Defendant acted completely inconsistent with its rights to arbitration and caused prejudice to plaintiff through a “deliberate and tactical delay six month delay” that caused plaintiff to incur greater expense while also denying her the opportunity for an expeditious alternative to litigation. 

While this result is not that surprising, I found the Court’s discussion on “who” should make the determination of waiver based upon litigation conduct interesting. 

Who should decide waiver by litigation conduct: Court or Arbitrator? The Shalaby court addressed this question under the Federal Arbitration Act and federal case law.  It found the issue “more nuanced” than Massachusetts law, which presumes that questions of arbitrability are issues to be decided by a judge. See O’Brien v. Hanover Ins. Co., 427 Mass. 194, 199 (1998). Two lines of federal case law are relevant:

·       First Options: “Under the [FAA], ‘[c]ourts should not assume that the parties agreed to arbitrate arbitrability unless there is “clea[r] and unmistakabl[e]” evidence that they did so.” Shalaby at p. 2, quoting First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 944 (1995), quoting in turn AT&T Technologies, Inc. v. Communications Wkrs. of America, 475 U.S. 643, 649 (1986).

·       Howsam: “[T]he Supreme Court moved the line drawn in First Options by deciding that under federal law ‘the presumption is that the arbitrator should decide “allegation[s] of waiver, delay, or a like defense to arbitrability.”’” Shalaby at p. 2, quoting Howsamv. Dean Witter Reynolds, Inc., 537 U.S. 79, 85 (2002), quoting in turn Moses H. Cone Mem. Hospital v. Mercury Constr. Corp., 460 U.S. 1, 24-25 (1983); see also BG Group, PLC v. Republic of Argentina, 134 S.Ct. 1198, 1207-1210 (2014); Green Tree Financial Corp. v. Bazzle, 539 U.S. 444, 452-453 (2003).  In these cases, the Supreme Court has found that the questions of waiver are “‘issues of procedural arbitrabillty’ concerning ‘conditions precedent to an obligation to arbitrate’ that presumptively should be decided by an arbitrator, not for the judge. Howsam, 537 U.S. at 85.   

The Supreme Court has not answered whether the Howsam standard applies to waiver by litigation conduct.  Which standard applies: First Options [court decides] or Howsam [arbitrator decides]? The Shalaby Court stated the “consensus view” amongst “virtually every appellate court” is that “‘the Supreme Court in Howsam and Green Tree did not intend to disturb the traditional rule that waiver by conduct, at least where due to litigation-related activity, is presumptively an issue for the court,’ and not for the arbitrator, to decide.” Shalaby at p. 2, quoting Marie v. Allied Home Mortgage Corp., 402 F.3d 1, 14 (1st Cir. 2005).  The rationale is that the conduct that formulates the claim of waiver through litigation conduct primarily occurs before the the court and the court is in the best position to identify abuses and forum shopping.    

After finding that the First Options rule applies to waiver by litigation conduct, the Shalaby Court inquired whether under the facts of the case there was “‘clear and unmistakable evidence’ of such an intent in the arbitration agreement [or in arbitration rules adopted by contract].”  In Shalaby, the agreement cited the JAMS employment arbitration rules which provide that the arbitrator will decide any “Jurisdictional and arbitrability disputes, including disputes over the formation, existence, validity, interpretation or scope of the agreement under which Arbitration is sought[.]” Shalaby at p. 3, citing to JAMS Employment Arbitration Rule 11.  The Court found the rule insufficient to overcome the First Options presumption.

·       Reason #1: “Federal law appears to render ineffective any contract provision purporting to delegate the issue of litigation-conduct waiver to an arbitrator.” The explanation here is that “waiver” constitutes a “default” by a party seeking to enforce an arbitration clause and Section 3 of the FAA (9 U.S.C. § 3) restricts a court from issuing a stay pending arbitration where there is no default.  [Question: wouldn’t the same reasoning apply to the Howsam line of cases?]  The court continued its analysis even if such an agreement were enforceable.

·       Reason #2: The arbitration rules at issue in the case could not overcome the First Options presumption. The Court stated: “The JAMS rule does not clearly and unmistakably provide that an arbitrator must decide the parties’ dispute as to whether [the moving party’s] conduct in this civil action constitutes a waiver of its right to compel arbitration. While the JAMS rule makes clear that the parties agreed to arbitrate ‘the gateway question of whether the underlying substantive dispute between [the parties] is arbitrable,’ nothing in this rule ‘similarly evidences a clear and unmistakable intent to have an arbitrator decide’ whether [the moving party] waived arbitration by ‘actively litigating the underlying dispute in court. There are no references to waiver of arbitration in this or any other provision of the’ JAMS rules.” Shalaby at p. 4, quoting Ehleiter v. Grapetree Shores, Inc., 482 F.3d 207, 221 (3d Cir. 2007).

Takeaways: Courts are likely to keep the issue of “waiver by litigation conduct” until the U.S. Supreme Court extends its “procedural arbitrability” rule to this specific form of waiver.  While the Shalaby Court does not expressly say so, it is clear that the Court did not wish to reward the perceived purposeful litigation tactics of the employer moving party.  For example, the Court commented:

[Defendant] was happy to litigate Plaintiff’s claims in the Superior Court so long as it thought that it could obtain a quick judgment in its favor on the merits. It only moved to compel arbitration after its motion to dismiss on the merits was denied in part, in a 16-page memorandum of decision dated September 3, 2014. In essence, [Defendant] ‘“wanted to play heads I win, tails you lose,” which “is the worst possible reason” for failing to move for arbitration sooner than it did.’

Shalaby at p. 5 (internal citations omitted) (emphasis added). 

For those arbitration advocates that believe all issues of arbitrability including waiver from litigation conduct should be decided by an arbitrator, not a court, add language to your client’s arbitration agreement that the issue of waiver of arbitration, including but not limited to waiver from litigation conduct shall be exclusively decided by the Arbitrator through the arbitration process.”  This added language would present the issue squarely for the next court that addresses this issue. 

 

* Tom is a member of the steering committee  for Division 1: Litigation and Dispute Resolution of the ABA Forum on Construction Law.  Tom also helps manage The Dispute Resolver Blog.  In his life away from Division 1, Tom is a Partner at Pierce Atwood, LLP.  He practices construction law and business dispute resolution in Massachusetts and Rhode Island.  If you are interested in submitting an article to The Dispute Resolver or to learn more about FCL or Division 1, feel free to contact Tom at rtdunn@PierceAtwood.com. 

Sixth Circuit Allows Lawsuit Against Indirect Parties Following Consolidated Arbitration

Jones Day recently posted an interesting article about a case allowing a subcontractor to proceed with a lawsuit against design professionals, even though the subcontractor, the design professionals, and others had previously participated in a consolidated arbitration.

Arbitration for One is Not Arbitration for All: Sixth Circuit Allows Lawsuit Against Indirect Parties Following Consolidated Arbitration

Recently, the U.S. Court of Appeals for the Sixth Circuit allowed a subcontractor's lawsuit against design professionals to proceed even though all parties had previously participated in a consolidated arbitration proceeding over the same issues. W.J. O'Neil Co. v. Shepley, Bulfinch, Richardson & Abbott, Inc., No. 12-2320, 2014 U.S. App. LEXIS 16607 (6thCir. Aug. 28, 2014). The design professionals were brought into the arbitration via indemnification claims by the owner, and there was no arbitration agreement between the subcontractor and the design professionals. Given this, the court found that the subcontractor's claims against the designers were not a part of the arbitration and not barred byres judicata. The court applied a technical approach to res judicata based on the principle that a party cannot be forced to arbitrate a claim against another party with whom it has not agreed to arbitrate.

The O'Neil decision is potentially significant for any consolidated construction arbitrations involving additional parties added through indemnification claims. Whether a contractor, project manager, or design professional, O'Neil holds that arbitration is binding and final only as to the parties who agreed to arbitrate the claims that are subject to arbitration. The result highlights the fact that the same claims may have to be relitigated in their entirety in a second proceeding—depriving everyone of a sense of finality. The risk of multiple proceedings and increased costs should be considered in determining how to proceed in a consolidated arbitration proceeding and how to draft arbitration clauses to minimize the risk of repeatedly litigating the same claims.

[...]

Here are links to the article's authors:

Scott W. Cowan

Kent W. Lindsay

Andrew D. Ness

Stephen V. O'Neal

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.

Scope of Federal Arbitration Act Allows Contractor to Compel Arbitration

In August, the Supreme Court of South Carolina addressed the reach of the interstate-commerce requirement of the Federal Arbitration Act (FAA). Cape Romain Contractors v. Wando E., LLC, 747 S.E. 2d 461 (S.C. 2013).  It also addressed whether an Owner could compel arbitration of a lien-foreclosure action filed by a subcontractor.

Wando E. owns property along the Wando River. It hired Sean Barnes as its general contractor to build a marina along the river.  Barnes then subcontracted with Cape Romain Contractors to install pilings and a prefabricated, manufactured dock. 

A dispute arose between Barnes and Cape Romain after the project engineer refused to certify further payments due to problems with Cape Romain's work, including angled pilings and misaligned dock sections. Cape Romain insisted its work was correct and argued that the manufacturer was at fault.  The dispute could not be resolved, so Cape Romain filed a $158,413.14 lien on Wando E.'s property.

Cape Romain filed a lawsuit against Barnes and Wando E., alleging breach of contract and seeking to foreclose on the lien.The subcontract between Barnes and Cape Romain was an AIA form contract that required arbitration of disputes.  Thus, Barnes sought to compel arbitration and dismissal of the court case.  For its part, Wando E. wanted to tag along with Barnes to arbitration.  

The trial court, however, refused to compel arbitration. That court found that the contract between Barnes and Cape Romain did not impact interstate commerce sufficiently to "justify or trigger" application of the FAA.  The court also found that Wando E. could not compel arbitration with Cape Romain because they had not agreed to arbitrate and did not have a "special relationship" that justified applying the arbitration provision in the subcontract with Barnes.

The Supreme Court of South Carolina reversed on both issues.  To determine whether the FAA applied, the Court looked to decisions defining the extent of the Commerce Clause under the U.S. Constitution.  For commerce to be "interstate," the commerce either must use the "channels" of interstate commerce, use the "instrumentalities" of interstate commerce, or have a "substantial relation" to interstate commerce.  In this case, the Court held that all three prongs were satisfied -- the marina included raw materials originating in Ohio, Cape Romain used barges to bring materials up the Wando River through the Charleston Harbor (see the map, above), and the project was constructed in navigable waterways of the United States under a permit issued by the U.S. Army Corps of Engineers.  

As to Wando E.'s attempt to compel arbitration, the court declined to reach the question as to whether the attempt was valid on its own.  Instead, the court pointed to Section 21.6 of the Barnes/Cape Romain contract, which allows for, "joinder [of] persons or entities substantially involved in a common question of law or fact whose presence is required if complete relief is to be accorded in an arbitration" so long as that other party consents to joinder.  Since Wando E. consented to joinder, the South Carolina Supreme Court held that Cape Romain could not preclude  Wando E. from joining.  The case was then remanded with a stay imposed in the litigation below.