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Arbitration Clauses: Pros and Cons

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Whether a contractor enters into a direct agreement with a customer or is acting as a subcontractor and is required to sign a subcontractor agreement, the document will most likely contain a dispute resolution clause.  The clause might simply state where disputes will be heard (i.e. “all disputes and claims shall be governed by Minnesota law and venued in Hennepin County, Minnesota”), or it might require a specific form of dispute resolution (i.e. “any controversy or claim arising out of or relating to this Agreement shall be settled by binding arbitration in accordance with the Construction Industry Rules of the American Arbitration Association.”)  Parties often simply sign the agreement without reviewing or weighing the advantages or disadvantages involved with the chosen dispute resolution method.  However, all contractors should have a basic understanding of the potential pros and cons associated with arbitrating a dispute instead of litigating it in court.

 

PROS:

Speed:  An arbitration proceeding can be faster than a district court lawsuit.  Lawsuits in court often take twelve months to reach a trial.  If a court case is appealed to a higher court this generally adds another year to the process.  In contrast, certain arbitration hearings can occur in as little as forty-five days.  For example, under the rules of the American Arbitration Association (“AAA”), a construction arbitration involving claims of $75,000 or less can be handled as a “fast track” proceeding, where the hearing occurs within forty-five days after the case is filed and a decision is rendered no more than fourteen days after the hearing is completed.

Potential for Reduced Costs:  Since many arbitrations take less time than a court action, it stands to follow that they might be less expensive.  The attorneys simply would not have as much time to litigate and charge time.  Further, many arbitration proceedings provide for limited “discovery,” the process of investigating the claims and defenses and seeking information from the other parties.  With less ability for the attorneys to take depositions, serve interrogatories, and review voluminous amounts of documents, the client’s legal bill should be less than that typically associated with a court suit.  But see below regarding “Potential for Increased Costs.”

Experienced Decision MakerDistrict court judges sometimes know little about construction projects and how they work, which can make it difficult to effectively present a case.  In contrast, arbitrators in construction cases are generally selected from a list of attorneys or other industry professionals who are very familiar with construction law and construction projects.  This can be of great benefit when complex issues, terminology and industry trade practices are involved.

 

CONS:

Lack of Discovery:  While limited discovery may help keep costs down, it can also make it more difficult to win your case.  Attorneys are best able to achieve a good result for their clients when they have as much relevant information as possible.  Some “fast-track” arbitrations can resemble small claims court hearings, where the parties exchange some documents shortly before the hearing, show up and “shoot from the hip.”  The inability to analyze claims and information, or even the existence of information, can work to a party’s detriment.

Potential Increased Costs:  While the attorneys’ fees for a shorter arbitration with limited discovery might be less expensive, the filing fees for resolving disputes through the AAA or similar organizations are often much higher than court filing fees.  For example, for claims under $10,000 dollars AAA would charge fees of nearly $1,000 compared to a small claims court filing fee that would typically be less than $100.  Arbitration filing fees for larger claims can range from $1,275 to $18,800 depending on the size of the claim, with claims over $10 million also imposing an additional fee of 1% of the claim amount (not to exceed $65,000).  Further, arbitration filing fees generally do not include paying the arbitrator his or her fees to hear the case, which could add many thousands of dollars.  In contrast, most court filings fees are less than $500 and include the judge’s time to hear the case (although courts do often charge additional fees along the way to file motions, request hearings, etc.).

In addition to increased filing fees and paying the arbitrator, complex arbitration cases often take as long and involve the same amount of discovery as a court case, with multiple depositions, motion hearings before the arbitrator, and other time consuming “lawyer activities.”  Combine these costs with the additional filing fees, and an arbitration proceeding has the potential to be more expensive than a court action for the same case.

While AAA is not the “only game in town” for pursuing and managing an arbitration proceeding and other similar organizations exist that might charge lower fees, those organizations might not match AAA’s level of service and experience in hearing construction disputes.  Parties may also agree to simply hire an arbitrator, set the ground rules, and conduct the case privately.  However, many construction contracts (often unwittingly) include a clause specifically requiring that the arbitration actually be administered by AAA.  Note that the sample phrase in the first paragraph above states only that the disputes will be “settled by binding arbitration in accordance with the Construction Industry Rules of the American Arbitration Association,” but does not require that the proceeding be administered through AAA.  In other words, the parties may conduct a private arbitration proceeding but have agreed to follow and be bound by AAA’s Construction Industry Rules.

No Right of AppealArbitration decisions generally may not be appealed to a higher authority because they are not decided as part of the court system.  The parties to an arbitration proceeding agree to be bound by the arbitrator’s decision and that decision will be final.  No appeal may be made alleging that the arbitrator made the wrong decision, misunderstood the facts, or even made a clear error in applying the law.  Under limited circumstances a party may petition a court to review an arbitrator’s decision, but generally only if it can be argued that the arbitrator exceeded his or her authority or that the decision was procured by fraud, corruption, or other undue means.  An allegation must be presented that, if true, would clearly demonstrate the award was rendered under these impermissible circumstances.  Also, since an arbitration is not a court proceeding, arbitrators are generally not required to follow or obey court rules.  For example, while a court judge might not allow certain testimony or documents to be used in the case because they violate the court rules of evidence, an arbitrator could be free to allow the evidence anyway.

Inability to Process All ClaimsArbitrators have limited jurisdiction and sometimes may not have the authority to decide all claims.  For example, construction or mechanic’s lien laws vary from state to state, but in general a lien claim must be adjudicated by a court in the county where the real property in question is located.  Therefore, the parties are often forced to participate in both a court action to resolve any mechanic’s liens and a separate arbitration action to resolve the other claims.  Procedurally, the lien claimant must first commence a court action to preserve its lien rights and prevent any statute of limitations from expiring, and then request that the court put the case on hold while the claimant pursues an arbitration action to decide who wins.   If the lien claimant wins it would then need to revive the court action to pursue its lien rights.  This often cumbersome process can increase the costs to pursue a dispute.

Arbitration is a standard method of dispute resolution in the construction industry and has a number of merits.  However, parties should understand the basic pros and cons of agreeing to arbitrate disputes so they may make an informed decision on what could later prove to be a critical contract clause.