Arbitration v. Litigation: Binding Dispute Resolution Clauses in Construction Contracts

Whether we like it or not, it seems to be in the nature of human beings to have occasional disputes with one another.  The construction world is a microcosm of humanity in this respect; disputes happen from time to time.  Of course, disputes often run counter to the goal of running a profitable business – and the dispute resolution process frequently can be costlier in time, money and effort than the object of the dispute.  Accordingly, the most cost-effective solution very often is to settle the dispute between the parties before getting into a formal dispute resolution proceeding.  Yet, for as many reasons as there are people and situations, some disputes are not resolved by agreement of the parties before the commencement of a such a proceeding.  And because some proceedings are better, faster and cheaper than others, it pays to give attention to the manner in which disputes will be resolved at the time of contracting.

CHOOSING ARBITRATION IS BINDING UNLESS WAIVED BY ALL PARTIES

Most form construction contracts contain options for binding dispute resolution of “litigation in a court of competent jurisdiction” or “arbitration under the rules of [the organization’s name].”  Section 4.6.2 of AIA Form A201-1997 provided that all disputes would be resolved under the Construction Industry Arbitration Rules of the American Arbitration Association; the parties had to affirmatively edit the document to choose otherwise.[1]  Illinois law is clear that an upfront written agreement to arbitrate is enforceable against the parties signing it.^[2]  So once a party signs a contract containing an agreement to arbitrate, it generally will be bound to arbitrate with the other signatory[3] any dispute within the scope of the arbitration clause.

“BIG ROCKS” IN CHOOSING LITIGATION v. ARBITRATION

Herein lies one of the big issues with arbitration:  how can one possibly know, at the time of contracting, whether arbitration will be better than litigation in a court of competent jurisdiction as the method of resolving a particular dispute?  Of course, this is a rhetorical question; unless you have a working crystal ball (and if you do, there probably are better ways to spend your time than thinking about this), there is no way to know what the subject matter of a future dispute might be and who might be involved.  So how does one decide?

Quality of the Neutral

Among the top factors to consider is the likely quality of the neutral.  In the case of litigation, this means the judge(s) who are in the pool likely to hear potential litigation.  For disputes involving mechanic’s liens, in Cook County there is a section of judges who are dedicated to hearing such cases; in the collar counties and others with higher populations, most courts have at least one judge in the “Chancery Division” that hears most such cases.  On the other hand, less populated counties generally have fewer judges, each of whom must hear a wider variety of matters and who may not see a lot of construction cases, much less ones that involve our highly technical Mechanics Lien Act.  I recall one judge in a case in a smaller county involving a 1.2 million square-foot warehouse telling the assembled group of attorneys that “I haven’t read the Mechanics Lien Act for 20 years!”  This did not inspire confidence.

On the other hand, every vendor of arbitration services will tell you that it has cherry-picked the best retired judges and practitioners to act as their neutrals.  Sometimes you might agree; sometimes you might not.  Depending on how you feel about the local bench versus the available pool of arbitrators, this could be a major influencing factor on the arbitration/litigation decision.  Further, while you cannot assign a specific judge to a future case, you can specify the names of arbitrators from whom the parties may choose at a later date and, if none of the chosen are willing and able to serve, the parties would agree to litigate.

Risk of Multiple Proceedings

Another big concern is what I think of as a “multi-front war,” where three or more parties are involved in a dispute and at least one of which is not bound to arbitrate.  Say, in a design-bid-build project, there is an alleged defect and a dispute over whether the cause is the construction or the design.  The owner might look at the architect and the contractor and say “I neither designed nor built this, so it couldn’t have been me; it must have been one of you.”  The architect says it was the construction; the contractor replies that it was the design.  The architect could claim that, if it was the design, it was a hired consultant’s fault.  The contractor may point to a performing sub-trade if it turns out to be the construction.  Sub-trades might need to join one or more material suppliers.  Sureties, lenders and others may need to be joined in order to resolve a controversy completely.

Unless each and every one of the involved parties has: (i) an arbitration agreement of sufficient scope to capture the dispute; and (ii) a consolidation provision that compels each party to participate in a single dispute resolution proceeding, parties up and down the chain run the risk of becoming involved in multiple proceedings to decide the very same question.  Not only is this exceedingly costly, but different decision-makers can reach different results on the same question – both against you or your client.

The risk of multiple proceedings is considerably lower with litigation because, so long as personal jurisdiction exists, any party can be brought before a court without its consent.  Because an arbitrator’s authority is limited by the agreement to arbitrate, if you agree to arbitrate up front at all, you may want to consider two things: (i) a strong mandatory consolidation clause; and (ii) a carve out of the arbitrator’s authority to decide any matter where any party reasonably joined cannot be compelled to arbitrate in that proceeding.  And any time the scope of the arbitrator’s authority is limited, you run the risk of having an arbitrator getting to decide in the first instance whether the arbitration is the proper forum, which will be subject to an independent court decision, leading us to the following recommendations.

THE AUTHOR’S RECOMMENDATIONS

In my experience, arbitration most often is faster than litigation in almost any court but, depending on how the neutral handles discovery and the hearing, is not necessarily less expensive.  Because arbitration is faster, the costs are more compressed in time.  And arbitrators must be paid by the parties, whereas the taxpayers pay the judge (and there is little risk of the judge refusing to act because (s)he is not being paid).

If we are starting from a clean slate, I generally prefer not to agree to arbitrate upfront because there are too many unknowns – and parties are always free to agree to arbitrate once the parameters of the dispute are known (understanding that getting parties to agree to the time of day may be difficult once a construction dispute arises).  Without an upfront arbitration agreement, there is minimal risk of becoming involved in multiple proceedings with the attendant cost and possible inconsistent decisions.  If, once the dispute and parties are known, the parties can agree to arbitrate before (a) specific arbitrator(s) – and perhaps to limit the scope of the arbitrator’s authority with the particular dispute in mind – they can get the most benefit from the arbitration.

But sometimes the slate is not clean.  We have represented parties who, consciously or not, have entered into an initial contract that contains an arbitration agreement and then ask us to help with the next contract.  In that event, our advice might be to enter into an arbitration agreement in the new contract to minimize the risk of multiple proceedings.  And sometimes, although rarely in our experience, a counter-party will say that there must be an arbitration clause or there is no deal.  Few I know would walk away from a project on account of a dispute that has not yet occurred.

If an agreement to arbitrate is included in the contract, as mentioned above, I would consider requesting/demanding a strong consolidation clause – and if a party is reasonably joined for the complete resolution of a dispute cannot be compelled to arbitrate, the parties agree to litigate the matter in court.  Of course, this means that someone, either a judge or an arbitrator, will have to decide which is the proper forum in the event of a venue dispute.  Absent language limiting the arbitrator’s authority to decide the question, seemingly contrary to the express language of the statute [710 ILCS 5/2], Illinois courts have held in many cases that arbitrators, not the courts, have the authority to decide the question of arbitrability in the first instance.  As much as I admire my arbitrator friends, it is a fact that they will earn a fee if they find that a case is arbitrable and will not earn a fee if they find that the case is not arbitrable.  Albeit not of their own making, that appears to be a conflict of interest.

Going through an entire arbitration proceeding only to have a court hold later that the arbitrator exceeded his/her/their authority can be both maddening and expensive … and good luck seeking reimbursement of the arbitrator’s fees – not to mention the legal fees – expended in the arbitration that a court later rules the arbitrator did not have authority to adjudicate.  Limiting the arbitrator’s authority in the contract to decide the issue of arbitrability would give a judge without any financial stake in the outcome the ability to make a binding decision whether or not a case is arbitrable without having to go through an entire arbitration proceeding first.

CONCLUSION

For the reasons stated above, if drafting the initial contract for a project, I generally prefer not to have the parties agree to arbitration upfront but will look for opportunities once a dispute arises.  If the parties are set on an arbitration clause, there are certain agreements that also should be made, including: (i) a strong consolidation clause; (ii) sending the parties to litigation if a party reasonably joined cannot be compelled to arbitrate; and (iii) removing the authority of the arbitrator to decide the issue of arbitrability.

There is more to the art of drafting arbitration clauses than is covered here.  Hopefully, this piece will give some guidance on whether the risk is worth taking and how to mitigate some of that risk.

     [1] Dispute resolution was moved from the “General Conditions” to the “Standard Form of Agreement” (i.e., Form A101) in 2007.  Section 6.2 of A101-2007 changed the default option to litigation but contained open and obvious blank boxes to make it more likely that the parties would make an active choice rather than simply abide by the default option.  This remains the case in section 6.2 of the A101-2017.

     [2] See 710 ILCS 5/1 (regarding validity); Melena v. Anheuser-Busch, Inc., 219 Ill. 2d 75, 99 (2006) (regarding contract interpretation principles for arbitration clauses).

     [3]  Whether a non-signatory can be bound to an agreement to arbitrate is beyond the scope of this article.

This article is not intended to address other potential avenues for resolution that may be placed into a contract, i.e., the “initial decision maker” or mediation. This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.