Arbitration Fundamentals in Construction
Arbitration is a dispute resolution process where an independent third-party, the arbitrator, hears both parties’ evidence and arguments and renders an award or decision. This process carries over from the well-established practice in commercial contracts industry wide, and has been applied to the construction industry since as far back as 1600.
The reasons for including an arbitration clause in a construction contract are the same as with any other commercial agreement. Construction may seem like an especially fertile ground for arbitration , but in many respects this is really just reflective of the general commercial environment. These reasons include: The arbitration award is final and enforceable by order of the court. Replacement of litigation with arbitration does not practically change the positions of the parties, but it does provide a legally valid reason to enforce a final award without going through the added time and expense of litigation.
All that said, arbitration is not always suitable as a dispute resolution method in the construction industry. There have been instances before the Supreme Court of Canada where the construction industry’s longstanding preference for arbitration over litigation has come into conflict with the priority accorded statutory liens.
Arbitration Rules in Construction Contracts
The arbitration process is not a cookie-cutter process. The various arbitration rules, procedural requirements and venue considerations are integral to the proceeding and the ultimate outcome of the arbitration award. Accordingly, the parties’ agreement will dictate the manner in which the arbitration will proceed based on the broadly accepted arbitration rules. Common institutional rules include rules and guidelines promulgated by organizations such as the American Arbitration Association (hereinafter "AAA") and the International Institute for Conflict Prevention and Resolution (hereinafter "CPR"). In addition to these widely accepted rules, many parties rely on a version of the Federal Arbitration Act (hereinafter "FAA") to govern their arbitration process.
Of note, is that construction litigation also has several specialized rule systems that may apply to a contract dispute between a property owner and a contractor or subcontractor. Under a contract for a publicly funded project, the various statutes and administrative codes will provide the parameters and governing rules for arbitration when applicable. As well, the National Architectural Accrediting Board, Inc., the National Council of Architectural Registration Boards and the Design Professionals Insurance Company have recently adopted the AIA Contract Document Supplemental Conditions to the AIA Document A201. Under this document, the Architectural License Board can be the sole arbiter of specific types of construction contract disputes. As with many state and local government or quasi-governmental entities, individual states may also have their own rules of procedure that are specific to their local construction industry including the Dispute Review Board Manual for Federal Projects developed by the Federal Agencies Dispute Resolution Cooperative.
Just as construction contracts may incorporate a variety of rules, and statutes, which will govern the process for an arbitration proceeding, so too will the arbitration process itself focus on determining the individual arbitration rules that will guide the arbitration if a dispute arises during construction. Of note is that the AAA and CPR rules specifically exclude themselves if a conflict exists between the rules and the parties’ agreement. Accordingly, if you are entering into a contract where the language requires arbitration, your contract will likely dictate the rules of arbitration that the parties must follow if a dispute is raised during construction.
Arbitration Institutions in Construction Industry
An important aspect of arbitration practice involves the rules of the major arbitration institutions. These institutions develop comprehensive rules that govern the administration of the arbitration process. Understanding these rules can increase efficiency and guarantee that the process moves along smoothly. Major arbitration institutions often have specific construction industry rules, which we will cover here.
American Arbitration Association
The American Arbitration Association ("AAA") is a non-profit organization dedicated to the resolution of disputes through alternative dispute resolution techniques, notably, arbitration and mediation. In 1991, the AAA published the first Construction Industry Arbitration Rules. In 2000, the AAA revised these rules further, producing the current AAA Construction Industry Rules and Mediation Procedures. The current AAA rules apply to any arbitration agreement (between American entities or foreign entities) in which the parties have not excluded the Construction Industry Rules.
National Arbitration Forum
The National Arbitration Forum ("NAF") is a leader in the alternative dispute resolution field. It is a for-profit organization committed to innovative dispute resolution techniques and consumer protection. The NAF has adapted its Commercial Rules to develop specific arbitration rules for the Construction Industry. The NAF Construction Arbitration Rules apply to any arbitration agreement (between American entities or foreign entities) in which the parties have incorporated the NAF Construction Arbitration Rules.
JAMS
The Judicial Arbitration and Mediation Services ("JAMS") is an international not-for-profit organization that provides mediation, arbitration and other dispute resolution services. JAMS publishes Comprehensive Arbitration Rules and Policies which apply to a variegated group of disputes, including construction.
Stages of an Arbitration in Construction
There is no "standard" arbitration process, but the arbitration process in construction disputes usually involves some or all of the following six steps.
Step One – Filing and Serving the Demand for Arbitration or Responsive Filing
To initiate an arbitration in the AAA, one party must file and serve on the other a completed Demand for Arbitration form, which sets forth background information about the dispute as well as the parties to the dispute, the relief sought, and the arbitration rules and number of arbitrators requested. Simultaneously, the other party to the dispute must provide the first party with a completed Answer to the Demand for Arbitration form (which responds to the demand), as well as an applicable counterclaim form (if a claim is being made against the first party).
Step Two – Selection of Arbitrators
The AAA provides the parties with a list of arbitrators that are qualified to hear the parties’ claim. The parties alternately strike arbitrators from this list until one person (or a predetermined panel size, such as a panel of three) remains. If not, the AAA will appoint an arbitrator for any position not selected by the parties.
Step Three – The Hearing
The arbitration hearing is conducted similarly to a court trial, but generally more expeditiously. Although the process and rules vary depending on the arbitration, hearings normally include the presentation of:
After the hearing the arbitrator(s) will render a written award.
Step Four – Issuance of Final Award
In most cases, the award is made final and binding on the parties. However, in some cases one or both parties may challenge the award. The parties have the option of vacating the arbitration award (i.e., getting rid of it altogether).
Vacating an arbitration award can be relatively difficult. From the standpoint of a regular court proceeding, the rules for a "motion for new trial" or "grand jury indictment" are inapplicable to arbitration awards. In general, arbitration awards can only be vacated on very limited grounds. For example, the U.S. Supreme Court has stated that arbitration awards can be vacated only when there is a complete lack of arbitration provisions in the contract or "where there is fraud or corruption" in the decision.
Common Issues in Construction Arbitration
While construction arbitration offers many advantages, parties face a number of challenges when participating in the process. Following are some of the more common issues and ways to mitigate the consequences.
Selecting a Neutral Arbitrator
While the construction industry is not recession proof, an arbitrator selection process could be. Arbitration rules generally provide that if an arbitrator is unavailable due to a previous appointment, the next available arbitrator will replace the unavailable arbitrator. As a result, there have been many occasions where one arbitrator in the construction case has been selected by both parties, but then the second arbitrator has many months’ worth of cases previously scheduled. Rarely does this individual make an accommodation for an expedited construction arbitration, and as a result, the parties wait in somewhat of a "queue" for a year or more. This ends up negating one of the perceived benefits of arbitration: speed. In addition, if the parties have agreed to 3 arbitrators, one party could be left without any choice if there were a lack of good candidates for a 3 arbitrator panel.
The best way to deal with this is to try to select a well-respected and established arbitrator who will be responsive to the scheduling needs of the parties. It’s also a good idea to attempt to schedule the hearing as soon as possible after all of the arbitrators have been appointed, and then to compel compliance with that schedule.
Costs and Expenses
Cost is an issue that comes up frequently. The perception is there that arbitration is cheap in comparison to a court trial. In general, this is not true. The fees paid to arbitrators (in the form of hourly fees) often rival the daily rates of a circuit court judge, or perhaps even exceed them. The only real savings are in (1) scheduling control; and (2) the fact that there are no depositions (which is a very large part of the expense of preparing for litigation).
However , since arbitration involves a hearing, all of the costs of expert attendance apply: flights, hotel rooms, meals, etc. All of this can add up quickly.
Reading the fine print – and negotiating – can help. While there’s usually no way to avoid the arbitrator’s fees, there are usually some opportunities to limit the expense of the hearing itself (hotel rooms, airfare, etc.). Obtaining the right to video-tape the arbitration can help, although it’s not unusual for the parties to agree "no recordings" are permitted. The idea is to make sure the scope of the fees are clearly set out in the arbitration agreement before you sign on the dotted line, and to try to limit your exposure to those costs.
Complexity of Cases
Construction claims are complex. The contract is long. There are often more than 8 parties involved. The issues are numerous and technical. There are obvious reasons a homeowner disputes the cost of their $35,000 exposed aggregate patio, only to find out it was completed in accordance with the plans. What would normally be a small claim becomes an extended dispute over just how much concrete was required for the job.
At the other end of the spectrum, sophisticated owners will often have major defense use experts testifying to nonconforming design standards, water intrusion, and other issues they feel justify their refusal to pay. The problem is, those experts can cost $250,000 or more to prepare and defend against.
The best approach for these cases is to settle them early. Many claims that go to arbitration have a short list of difficult issues of liability and entitlement thereon. As a result, if the parties could get the case to arbitrate quickly (within a month or two), it’s likely that a neutral arbitrator’s opinion could result in an early settlement. If not, the parties will be in for a long, expensive arbitration.
Latest Developments in Construction Arbitration
Recent trends in construction arbitration are leveraging technology, and this is true for both traditional arbitration (i.e., one-t1o-one or small panel arbitration) and for institutional arbitration. The benefits are particularly clear when parties consider the use of digital evidence presentation in their cases. Instead of slogging through piles of paper, with copies of exhibits strewn around the table for the duration of a hearing, how much easier is it to use a digital exhibit presentation system? The use of the projector and screen has been around for some time, but today, parties are increasingly relying on digital presentations that facilitate easy sorting, searching, and sharing. The use of electronic evidence presentation systems allows for the means of electronically browsing and piecing together documents in a clear and visually effective format. This completely eliminates the need for piles of paper and makes the review process much easier for the Arbitrators.
A second trend in construction arbitration is the increase in the number of transnational (i.e., international) arbitrations in the sector. Recently, we assisted with an international arbitration proceeding in Vietnam. The volume of procedures for international construction disputes is growing steadily in Asia. One of the more popular forms of international arbitration in the construction industry is ICC, which is the International Chamber of Commerce, based in Paris.
The final trend that we are seeing in construction arbitration is the influence of the legal technology. More and more parties are utilizing technology to organize complex construction claims. This trend arises in two forms. First, parties are organizing the evidence — whether electronic or paper — on evidence management platforms. These platforms provide a means to organize large amounts of materials and speed up the review process. Second, parties are using software to help with analysis of construction claims. Construction lawyers are (ever so slowly?) adopting legal tech to organize, scrutinize, and analyze construction data that ultimately bolsters their arbitration presentation and arguments. In a recent international arbitration, the integrity of a pile of technical documentation was verified using legal technology, helping the party relying on the documents demonstrate the existence of the contractually required documents in the files. Other legal tech solutions are also being used in arbitration, such as speech-to-text transcription, intelligent search solutions, multi-lingual analysis, and even artificial intelligence assistance.
Conclusion: How Arbitration Works in the Construction Industry
Arbitration can be a useful, efficient, and effective means of resolving construction disputes. But, since arbitrators are essential to that success, selection of the proper arbitrator (or properly selecting arbitrators if a panel is requested) is crucial, and understanding the rules of the forum to which the arbitration is being submitted is equally important. The construction industry has several prominent arbitration forums, including AAA, JAMS, and ICC. The AAA and JAMS rules contain detailed provisions applicable to our industry. These rules, along with the specific agreement of the parties, can have a profound effect on the arbitration process.
Arbitration has many benefits. It is relatively inexpensive and private. Confidentiality can be assured if desired. It is also expeditious, especially when compared to litigation in the courts, and generally results in relatively shorter disputes. But, while arbitration has many benefits, it has downsides as well. As an example , discovery in arbitration tends to be limited-especially for single arbitrator panels. The parties may be limited to exchanging documents and interrogatories (although arbitration rules allow for more if agreed). Also, there will rarely be depositions, and cross examination is usually confined to the testimony of the opposing party or witnesses called by such parties. Any discovery beyond that is typically disfavored by the arbitrator and must either appear in a tribunal order or otherwise be allowed by the arbitrator.
It is clear that both construction professionals and their counsel should familiarize themselves with the applicable rules and know their way around the arbitration forum they may be involved with in the future. This includes understanding how the appointment of the arbitrator(s) takes place, the arbitrators’ powers, the conduct of the arbitration hearing, and how the arbitrator(s) make a final decision (e.g., by rendering an award).
