Designing an Arbitration Clause

When first introduced to the construction industry, arbitration was hailed as a light at the end of the frequently long and dark litigation tunnel into which most serious construction disputes were directed. Litigated construction disputes were too expensive, lasted far too long, and were often seen as too complicated for the lay jurors who ultimately resolved the disputes. Many construction industry participants did not enjoy having their disputes resolved in public forums or in foreign courts where local prejudice and unanticipated laws were sometimes encountered with disastrous results. The litigation discovery which preceded any final dispute resolution consumed too much supervisory time and too large a share of the company profit margin.

With the advent of arbitration, a cure for many of the litigation ills was promised. Arbitration would be less expensive, less time consuming, and less destructive of business relationships. Arbitration would permit disputes to be decided privately, and the disputes would be resolved by an arbitrator or arbitrators with knowledge of the construction industry. There would be no string of endless appeals, no long and expensive discovery process, and no local jury bias. Arbitration became the preferred method of resolving construction disputes and found a permanent place in the disputes clauses of the ever-popular form contract documents distributed by the American Institute of Architects.

The Arbitration Reality

Has arbitration lived up to its promise? Although construction industry participants may differ in their opinions on this issue, many in the industry are quick to say that, except perhaps with respect to a small dispute involving limited issues and only two parties, arbitration has evolved into a process which too closely resembles the litigation process and all of its perceived problems.

Complex arbitrations routinely involve lengthy and expensive pre-hearing discovery proceedings. A number of factors (e.g., the process of scheduling hearings by agreement, arbitrator scheduling conflicts, scheduling nonconsecutive hearing days, and arbitrator inexperience in "pushing" a case to finality) frequently result in lengthy arbitration proceedings which are too expensive and which divert too much supervisory attention away from the company's business objectives. Some in the industry are convinced that arbitrators too often engage in "splitting the baby" compromises, and others complain that contractual and legal principles are lost in an arbitrator's desire to "do the right thing." Moreover, for many the absence of any articulated rationale in the arbitrator's typical one-line decision leaves too many questions unanswered. The list of criticisms of the arbitration process is long, and the level of disappointment among construction industry participants is high and rising.

Efforts to Fix the Arbitration Process

In April of 1996, the American Arbitration Association, still the most popular of the arbitration agencies serving the construction industry, amended its Construction Industry Arbitration Rules in an effort to address many of these growing complaints. Although these rule amendments and later AAA rule amendments in 1997 and 1999 have improved the process, the complaints have not stopped. Over the last several years, many in the industry abandoned arbitration as a disputes process resolution, and those disappointed at arbitration's apparent breach of its promises are not easily encouraged to return to the process.

Arbitration Clause Checklist

The purpose of this article is to suggest that those of you have given up on arbitration, or who are disappointed in the arbitration process, consider some self-help measures to make arbitration a more acceptable disputes procedure. An advantage of arbitration over litigation is that the contracting parties generally have greater ability to tailor the disputes process to their individual likes and needs. If there is an aspect of arbitration which you find disturbing or inadequate, a careful revision of your contract arbitration clause may supply the desired "fix." Consider, for example, the following checklist of ten drafting considerations which an owner, contractor, or subcontractor should observe in creating an effective arbitration clause in a contract with a lower tier contractor or subcontractor:

  • Select the Hearing Locale In order to make the arbitration proceeding less expensive, and to minimize the possibility of an arbitration panel selected from your opposition's home territory, pre-select the hearing locale in your arbitration provision.
  • Consider an Election to Arbitrate In many jurisdictions, it is permissible to structure your arbitration clause so as to allow one party to elect arbitration, as opposed to litigation or some other disputes procedure, after the dispute has arisen. By reserving that right to elect or reject arbitration, you then can judge the likely suitability of the dispute for arbitration after all of the elements of the dispute are known. (Note: Check the law in your state and the locale of the project to determine if this is a viable option.)
  • Limit Pre-Hearing Discovery Even if the arbitration clause adopts the standard rules of an arbitration service, such as the American Arbitration Association, the parties may contract to limit or alter those "standard" rules. For example, the arbitration clause might provide that there will be no pre-hearing discovery, that pre-hearing discovery will be limited to only an exchange of relevant documents, or that pre-hearing discovery will include only document inspection requests and no more than two four-hour depositions by each party.
  • Differentiate Between Complex and Small Disputes The arbitration clause may provide separate sets of rules and procedures (e.g., allowed discovery procedures) depending on the size and complexity of the arbitration dispute. If the dispute is particularly small, the arbitration clause might provide that the parties waive the right to any hearing before the arbitrator and that the parties agree to submit the dispute to the arbitrator in writing, with appropriate page limitations for each side's argument. Or, if a hearing is to be allowed in disputes of a certain size, the arbitration clause might limit the time in which each side must present its case to the arbitrator to a specific number of hours or days.
  • Specify the Arbitrator Selection Process The arbitration clause can limit the number of arbitrators, as well as specify the manner in which the arbitrator is to be selected. If, for example, you are an owner who does not want a contractor as an arbitrator, you can contractually agree that your arbitrator must have some experience as an owner representative or possess other defined qualifications. In the alternative, you might pre-select and name your selected arbitrator in the arbitration clause.
  • Provide for Consecutive Hearing Days Arbitrations typically "grow" in overall length when hearings are not scheduled to begin and conclude on consecutive days. With each break in the arbitration process, each party finds more witnesses, more documents, or more questions which must be presented when the hearings resume. Contractually agree that the arbitration hearing will be scheduled to start and conclude on consecutive hearing days. To control the overall length of the arbitration, you might also impose outside limits on the time allowed to each party for the presentation of its case.
  • Consider Required Adherence to Contract Terms and Legal Principles by Arbitrators If, for example, you are proud of the favorable contract terms you have negotiated, you might draft the arbitration clause to require that the arbitrator follow the contract and/or established legal principles in making a final decision and that the arbitrator's failure to do so will be grounds for an appeal. Such a requirement is of limited effect, however, unless accompanied by the arbitration clause suggested next.
  • Consider a Mandate for Reasoned Opinions Accompanying the Award If it is important to you to know why the arbitrator decided as he or she did, provide in the arbitration clause that the arbitrator will write a reasoned opinion explaining the award. This requirement might include a required set of "findings of fact" and "conclusions of law" on specific issues by the arbitrator or that the arbitrator specifically identify the manner in which each separate claim is decided.
  • Identify Conditions Precedent to Arbitration Consider the wisdom in requiring that the parties participate in some non-binding process--structured negotiations between principals, mediation, and so on--as a condition precedent to either party's resort to the arbitration process. Even a streamlined and carefully-tailored arbitration proceeding can be distracting and destructive of business relationships. More often that you might expect, an experienced mediator or a structured settlement meeting between principals may resolve, quicker and less expensively, difficult construction disputes.
  • Provide for Consolidation and Joinder If you are concerned that other parties may be involved in a construction dispute, preserve your right to join those parties in the arbitration based solely on your determination of the likely involvement or interest of the other party in an arbitration proceeding. In addition, your arbitration clause might allow you to invite others (e.g., subcontractors or sureties) to participate in an arbitration and be bound by its result, even if that third party is not made an official party to the arbitration proceeding.

Final Comment

The checklist above is not exhaustive, but it should begin to tell you that much can be done to improve on the "standard" arbitration clause. Look again at your standard contracts and subcontracts, and think about those aspects of arbitration that are important to your satisfaction with the arbitration process. Your ability to craft a workable arbitration provision is limited only by your degree of control over the contract drafting process.