Owners and contractors involved in large-scale energy and manufacturing projects face unique challenges in bringing projects to fruition. One challenge is negotiating and drafting a contract that places the parties in a fair position if problems arise during the project. In construction contracts for large-scale projects, multiple areas can be vitally important, such as intellectual property, change order rights, limitations of liability, liquidated damages and insurance. Somewhat overlooked, however, is the dispute resolution clause.
Through a dispute resolution clause, the parties decide in advance how disputes will be handled. The owner usually leads this discussion and develops a dispute resolution strategy early in contract negotiations, carefully considering the various parties (contractors, suppliers, and engineers) involved in the project, their typical requirements and expectations, and its own needs. The most basic question in developing a dispute resolution clause is whether arbitrators or a judge should decide the outcome of the case (and in the latter case, whether or not to permit a jury to have a role in the decision process). Both arbitration and litigation have advantages and disadvantages based on the circumstances.
Once that decision is made, the next issue is drafting the provision. If arbitration is chosen, one significant drafting concern is what law applies – the federal arbitration act or a state arbitration act. Even if the state arbitration act applies, drafters need to keep in mind that the federal act may govern in certain, specific situations. A well-drafted, customized dispute resolution clause will help ensure that the process goes smoothly, protecting against risk and potentially saving untold amounts of time and money.
To Arbitrate . . .
Enforcing a Foreign Judgment
Many sophisticated parties prefer arbitration in their agreements. One significant reason is that it can be much easier to enforce an arbitration award against a foreign party than a court judgment. This is due to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, also known as the “New York Convention.” Judgments from U.S. courts can be enforced overseas, but it is often a difficult and drawn-out process involving the Hague Convention. And of course, the longer the process to enforce the judgment, the more expensive it can be and the greater the opportunity for potential assets to slip away.
On the other hand, if a foreign country is a signatory to the New York Convention (and over 150 countries are), that arbitration judgment is directly enforceable in that country, barring a few narrow exceptions. Thus, owners of large-scale construction projects who envision using foreign contractors or suppliers, or contractors dealing with foreign ownership, will almost always find it easier in a foreign country to enforce a U.S. arbitration judgment than one issued by a judge.
Another potential advantage to arbitration is the confidentiality of the arbitration process. Unlike litigation, which is presumptively public, arbitration proceedings are confidential. This means that whatever the allegations, you are unlikely to read about them in the press. This could be especially useful to owners who may be accused of various safety and environmental violations. However, it is also useful to contractors who are concerned about future clients learning about the number of claims they have made in past projects. However frivolous the lawsuit, if it is in court, it is public, and ripe fodder for the many legal websites following newly-filed litigation. If it is in arbitration, it is private.
Construction cases are notorious for involving an extraordinary number of documents. Courts have strict evidentiary rules regarding documents – each one must be authenticated, and each one must have an adequate foundation to meet an exception to the rule against hearsay. These requirements can be a large burden for both sides. For example, if there is no witness to testify as to the date a photograph was taken, a court may exclude that evidence due to lack of authentication. Arbitrators, on the other hand, are likely to consider such evidence and determine on their own how much weight to give it. Thus, parties will face less procedural scrutiny to getting their evidence considered in arbitration than they would in a court.
Another arbitration “plus” is the experience of the arbitrators themselves. Arbitrations are products of contract – the arbitration only exists because the parties agreed to arbitrate. Thus, the parties can agree to certain requirements. For example, the contract can state that three arbitrators shall hear the case, and that each party may choose one of the arbitrators (with those two choosing the third member of the panel). This gives flexibility to tailor the arbitrator to the dispute. If the claim involves intellectual property, an IP lawyer can be designated. If the disagreement covers specifications or scope, it could be a construction lawyer, or even an engineer or architect. If the main claim concerns delay, it could be a scheduling expert. Ensuring that certain expertise is on the panel can be extremely beneficial.
Enforceability of Choice of Law and Choice of Venue
Finally, one last arbitration advantage is the likelihood that choice of venue and choice of law provisions are upheld. Many states across the nation have statutes that invalidate choice of venue provisions if the provisions require that the parties resolve disputes outside the state where the project is located. These state laws not only invalidate choice of venue provisions, but often restrict choice of law clauses as well. However, an advantage of arbitration is that there is ample precedent indicating that the Federal Arbitration Act preempts these laws with respect to venue and choice of law restrictions. In those cases, the parties are free to determine the location of where the disputes will be handled and the law governing the parties’ agreement.
. . . or Not to Arbitrate . . .
While there are many advantages to arbitration, litigation also has its benefits. One advantage is the neutrality of the judges. While using experienced arbitrators can be an advantage for complex disputes, one must keep in mind that along with experience comes biases and pre-conceived notions. That experienced arbitrator who looks wonderful on paper may harbor a hidden animosity against one party due to a lifetime defending owners or contractors. Or, he may deem unenforceable any clause that he would not have agreed to himself. Most construction dispute arbitrators will be current or former construction litigators who have, throughout their career, primarily represented one type of party. A judge, on the other hand, is unlikely to have presided over many construction cases in his career. He or she is a blank slate, waiting to be informed. Savvy lawyers can use this to their advantage.
Another benefit to litigation is the strict rule of law found in courtrooms, particularly regarding dispositive motions. A dispositive motion (typically a summary judgment motion) is a motion that decides part or all of a case just on the written motion – no testimony or hearings needed. Those with well-written, customized contracts hold a huge advantage here if the contract requirements are clear and unambiguous. These summary judgment motions are much more likely to be granted in litigation than in arbitration. One reason, as stated above, is that a judge is truly neutral – he or she typically does not care about the case itself, and is happy to make the docket lighter if part or all of a case can be dismissed on summary judgment. Conversely, an arbitrator has a financial disincentive to grant a dispositive motion. Arbitrators get paid by the hour and by the day, and any motion that removes part of a case cuts down on that work. Arbitrators will say that this disincentive does not come into play, and for most arbitrators it does not. At the least, however, that disincentivising undercurrent exists.
Another reason is the general informality of the arbitration process. Arbitrators prefer a less formal hearing than a trial, and generally allow the parties to put on all relevant evidence. Then, the arbitrators decide for themselves what weight to give that evidence. Courts, on the other hand, strictly follow the rule of law. If the contract is clear and unambiguous, the court can decide a dispute for itself – no hearing or trial needed. Thus, while an arbitrator is more likely to allow the evidence to be heard and then decide whether it affects the outcome, a judge will pare down the dispute as he or she can. Here, customized and clear contracts hold the advantage.
Construction projects, perhaps more than any other type of case, involve a huge number of documents. Depending on the arbitration, the rules may restrict discovery so that it is difficult for either side to get all the information it wants. For example, international arbitrations typically rely on the IBA Rules on the Taking of Evidence and do not allow for pre-trial depositions. A court is much more likely to allow for broad discovery.
Further, any dispute will likely involve a third-party – someone not directly involved in the dispute, but someone who has important, perhaps even dispositive, information. Information from a third-party is much easier to obtain in court than in arbitration. In court, the process is relatively easy. The court (or even just the lawyers themselves) issues a subpoena, and the third-party is obligated under law to produce documents. The process may be a bit more complex for out-of-state parties, and more so for foreign parties, but it is still a straightforward process. Third-party discovery in an arbitration, conversely, is anything but straightforward. To obtain discovery in arbitration, you would need to specify that discovery is permitted in the contract itself, and that depositions may be held.
If the discovery rules for the arbitration are not clearly set out in the contract, you have to figure out whether third-party discovery before the hearing is even permitted. Currently, there is a circuit split in the courts as to when third-party discovery is allowed. The Federal Arbitration Act states that arbitrators can summon any third-party to come before the arbitrators and bring any documents. Some courts interpret this as only allowing certain discovery on the day of the hearing (trial), while others allow discovery in line with the federal courts. In court, those rules are already set.
Right to Appeal
Finally, the automatic right to appeal a court’s decision is a benefit to choosing litigation over arbitration. If you are dissatisfied with the court’s judgment, you have the right to appeal that decision to the state or federal Court of Appeals, and you can even try to have the case heard by the applicable Supreme Court. Conversely, you can only appeal an arbitration decision in a very few, narrow circumstances. The American Arbitration Association does allow for an appeal process, but it is optional. Therefore, contract drafters need to remember to put the appeal process in the contract if that option is desired. If it is not there, even if you did not know about it, you cannot use it.
What to cite
Once the decision to arbitrate is made, the next issue is knowing exactly what to say in the contract itself. Arbitration clauses, especially for large, complex projects, can be extremely detailed. Provisions regarding the number of arbitrators (which may change depending on the size of the claim), the arbitrators’ experience, the process through which the arbitrators are chosen, and the governing law, among other things, must be set out. It is especially important to set out what arbitration law applies. Many agreements, especially on large projects such as power projects, choose the Federal Arbitration Act (“FAA”). The FAA is federal law and can be used throughout the United States.
The FAA states that “[a] written provision in any . . . contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract . . . shall be valid, irrevocable, and enforceable.” Thus, for the FAA to control, the agreement must “involve[e] commerce.” A contract involves commerce to the same extent that Congress has power over interstate commerce under the Constitution. Congress’ interstate commerce power is extremely broad, and all agreements involving international parties should be covered. However, for domestic contracts involving local parties, the answer might not be so clear-cut – make sure to check with counsel.
Therefore, if the parties agree to arbitrate, the contract involves interstate commerce, and the FAA is cited, the FAA will control. On the other hand, if the parties decide that they would prefer to use a state arbitration act, they may do so as long as they cite it in the agreement. The FAA will only step in and govern over that state arbitration act if the state act renders the arbitration clause unenforceable. For example, even in an international construction project, the parties might agree to have a state arbitration act apply. Perhaps the project is in South Carolina, and through negotiation, the parties agreed to use the South Carolina arbitration act. That act states that notice of the arbitration clause must be proximately displayed on the very first page of the contract. Even if the notice is on the second page, the arbitration clause is unenforceable. If the agreement is rendered unenforceable due to the state arbitration act, and the agreement involves interstate commerce, one argument is that the FAA preempts, and controls on that issue. Federal law holds that in such a case, even though the state arbitration act holds otherwise, the arbitration agreement will likely be found enforceable.
. . . that is the Question.
There are numerous reasons to choose arbitration over litigation, and many reasons to do the opposite. Project owners and contractors in large-scale construction projects should consider the specifics of each project, and, with the advice of counsel, determine what best fits each endeavor. Some agreements may even use both arbitration and litigation, stating that only claims under a certain amount use one method, while all other claims use the other. Further, if the parties do agree to arbitrate, the agreement must be written so that the right arbitration act controls.
Though not as flashy as a negotiation over payment terms and scope of work, the time used on the dispute resolution clause will be well-spent if issues arise during the project. Thus, it is important to determine what is right for each development project, and to write each contract accordingly.