Arbitration – It’s time to give it a second thought

The construction industry has used arbitration as the primary method for resolving disputes for many years. Builders routinely include a well-worn arbitration provision in their contracts. When disputes occur, however, builders are often surprised at certain limitations of the arbitration process. Therefore, it is worth giving that old arbitration clause a second thought and seeing if it can be improved.

Arbitration was created to provide a less expensive, quicker and more predictable method for resolving disputes. In Texas, the rise of arbitration in construction occurred at a time when many builders considered the courts to be risky and hostile venues. Builders were drawn to a dispute resolution process in which the decision maker had more construction knowledge and was less likely to award punitive damages than jurors. Nevertheless, time and experience have shown that the arbitration process has limits. Fortunately, some of these limitations can be solved through careful contract language.

One of the main limitations to arbitration is who can be forced to participate in an arbitration proceeding. Only parties that have signed an agreement to arbitrate, or otherwise voluntarily agreed to do so, can be parties to an arbitration. When a dispute arises, typically it is more efficient to have all the necessary parties in one proceeding rather than participating in multiple proceedings. For example, if an owner files an arbitration claim against the builder for a defect caused by a subcontractor who did not agree to arbitrate, the builder might be forced to wage war regarding the defect on two fronts – in an arbitration with the owner and a lawsuit against the subcontractor (“Sub”). This result can make it costlier for the builder to resolve the dispute, prevent the builder from forcing a global settlement, and limit certain defenses.

A builder can mitigate this limitation by requiring its Subs and vendors to sign an agreement in which they agree to arbitrate disputes and be joined as a party to any arbitration relating to the project. For many segments of the construction industry, a builder may find it a practical impossibility to enter into comprehensive contracts with all its Subs on every project. As a result, many builders have started using a comprehensive contract called a Master Service Agreement (“MSA”). An MSA is a contract that covers the general business terms of the relationship between the Subs and the builder for all future projects the Sub works on. Usually, the MSA contains an arbitration provision that covers disputes on all projects. Using an MSA in this way ensures the Subs can be forced to be in one proceeding and relieves the builder from the inconvenience of attempting to get a separate agreement on every project.

Another limitation is the surprising cost of arbitrating a dispute. Builders who participate in an arbitration for the first time are surprised by filing fees, administrative fees, payments to expensive arbitrators, and room rental fees. Arbitrators charge for their travel costs and high hourly rates for their time and effort, and proceedings are often in neutral sites that require rental fees. For disputes handled through the American Arbitration Association (“AAA”) fees are scalable and increase depending on the amount in controversy. By comparison, in a traditional lawsuit the judge and courtroom are paid for by the taxpayers.

Despite the high administrative costs of arbitration, typical cost shifting provisions in arbitration clauses only deal with attorneys’ fees and not the cost of arbitration. So, even though the builder wins the arbitration and recovers attorneys’ fees, it might be stuck with high arbitration fees. Therefore, it is important to consider including arbitration fees in the fee shifting clause.

Additionally, absent a contractual provision, an arbitration decision cannot be overturned even if the arbitrator misapplied the law. Texas courts have consistently held that even if the arbitrator did not follow the law, a Texas court will not correct the arbitrator’s decision. This is in contrast with the court system where the parties can seek appellate review for misapplication of law by the trial court.

Builders should also consider the locale of the arbitration when drafting an arbitration clause, especially if the builder has projects in multiple states. As you can see, there are many issues to consider when drafting an arbitration clause. So, before including the same well-worn arbitration clause, you should seek legal advice to see if there are any improvements needed to your arbitration clause.