Alternative Dispute Resolution Seminar

Arbitration is the referral of a dispute to one or more impartial persons for final and binding determination. Parties may agree in their contract in advance to arbitrate any dispute that arises, or they may agree later, after the dispute arises, to arbitrate. The parties may modify the arbitration process either by agreement in the arbitration portion of their contract or by separate agreement before the arbitration. Some modifications include the confidentiality of proprietary information, the rules of evidence, the number of arbitrators, where the arbitration will take place and the scope of the arbitration and expedited procedures. See American Arbitration Association, A Guide to Mediation and Arbitration for Business People, 1998.

Most people are familiar with the litigation process. Arbitration differs from court proceedings in many respects, a few of which are discussed below:

Jury. In court, the parties may elect to have their case decided by a jury. In arbitration, the arbitrator(s) decide the case. In complicated, technical cases this may be an advantage, since the parties may stipulate that a technical panel of experts shall hear the case.

Joinder. One drawback to arbitration is the lack of joinder. Generally, a court may compel only those parties who signed the agreement to participate in the arbitration. For example, A, an owner, has a contract with B, a general contractor, and the contract contains an arbitration clause. A and B have a falling out. A may compel B to litigate the dispute in arbitration. However, B may not compel C, B's subcontractor, to participate in the arbitration, unless the subcontract between B and C either includes its own arbitration provision, or it incorporates by reference the terms of the general contract between A and B (including the arbitration provision).⁽¹⁾ Thus, B will have to sue C in court in a separate proceeding.

In court proceedings, parties have the right to request joinder of all interested parties. For example, A can proceed against B, and B can proceed against C, in the same suit.

Finality. Arbitration offers the parties a finality of decision that court proceedings cannot. The circumstances under which a court may vacate or modify the arbitrator's award are very limited. Under the Texas General Arbitration Act, a district court may vacate an arbitrator's award where:

• The award was procured by corruption, fraud or other undue means;

• Evident partiality exists;

• The arbitrator exceeded his powers;

• The arbitrator prejudiced substantially the rights of a party, e.g., he refuses to postpone the hearing when a party shows sufficient cause, or refuses to hear evidence material to the controversy; or

• There was no arbitration agreement in the first place and the party raised the objection before participating in the arbitration hearing.

See 4 Tex. Civ. Prac. & Rem. Code Ann. §171.014 (Vernon 1997). A state district court may only modify or correct the award when the arbitrator has made an evident miscalculation of figures or erroneous description in the award; the award includes a matter not submitted to arbitration and deleting it will not affect the merits of the decision; or the award is imperfect in form, not in merit. See 4 Tex. Civ. Prac. & Rem. Code Ann. §171.015 (Vernon 1997). In court proceedings, the appellate courts have much broader discretion in reviewing the decisions of the trial court.

Time. Arbitration can also differ from court proceedings in the length of time it takes to resolve the dispute. A complex court proceeding may take several years before actually going to trial. In a relatively complex arbitration, the arbitrator's hearing will usually be held within nine (9) to twelve (12) months after the arbitration is filed. In many instances, special expedited rules exist for cases where the amount in controversy is smaller.

Cost. In many cases, arbitration can be less expensive, overall, than litigation. The abbreviated proceedings are one reason that arbitration can be less expensive than going to court. However, parties to an arbitration are required to pay the arbitrator(s)' fees and general arbitration expenses, including the cost of the room in which the hearing will be conducted, long distance telephone costs, travel expenses for the arbitrators, and copy, mail, and courier costs, in advance of the arbitration hearing (typically when the arbitration demand is filed, or very soon thereafter). In a large case, the fees paid to the arbitrators and/or organizations like the American Arbitration Association can run into the tens of thousands of dollars. These fees greatly exceed typical court filing fees of no more than a few hundred dollars. In the end, however, the parties can generally save money by litigating their disputes in arbitration rather than in a court of law.

Evidence. Another difference between arbitration and court proceedings is the absence of formal rules of evidence and rules of procedure. In arbitration, the type and amount of evidence presented and the weight the evidence is given is left to the discretion of the arbitrator. In litigation, the Judge controls the presentation of evidence pursuant to time-honored rules.

Confidentiality. Many parties agree to arbitration instead court proceedings because of the confidentiality afforded in arbitration proceedings. Although a court may seal its proceedings so that less information is made public, there is still greater potential for inadvertent leaks of information than in arbitration.

Arbitration promotes efficient dispute resolution by simplifying the procedural and substantive rules of litigation. To obtain efficiency, the arbitrator has broad discretion. However, the parties may agree to modify the arbitrator's discretion. Absent such an agreement, the discretion of the arbitrators may have positive and negative effects. Professor Martin Domke calls the arbitrator the "decisive element in any arbitration." Garylee Cox, The Selection Process and the Appointment of Arbitrators, Arb. J., June 1991, at 28. The courts increase the influence of the arbitrator by routinely upholding the arbitrator's decisions. The areas where the arbitrator's discretion may have the greatest impact follow:

• The arbitrator has wide discretion over the documents and information the parties will share with one another. See American Arbitration Assoc., Construction Industry Dispute Resolution Procedures, as amended and in effect Oct. 15, 1997 at R-26 [hereinafter Arbitration Rules]. In litigation, the parties routinely exchange this information under both the state and federal rules of civil procedure.

• To protect privacy, the arbitrator may limit attendance to parties who have a direct interest in the arbitration. See Arbitration Rules at R- 25.

• The arbitrator may also exclude any witness, other than a party or other essential person, during the testimony of any other witness. See id.

• The arbitrator may postpone any hearing for good cause. See Arbitration Rules at R-26.

• The arbitrator may determine the presentation of evidence and motions. See Arbitration Rules at R-29.

• The arbitrator may determine the outcome of dispositive motions in arbitration proceedings. See Arbitration Rules at R-29.

• The arbitrator may subpoena witnesses or documents and determine the weight and relevance of evidence. See Arbitration Rules at R-31.

• The arbitrator may choose to make an inspection in connection with the arbitration. See Arbitration Rules at R-33.

• The arbitrator may initiate interim measures that he or she deems necessary, such as conserving property that is the subject of the dispute. See Arbitration Rules at R-34.

• The arbitrator determines when the hearing is complete. See Arbitration Rules at R-35.

• Before making the award, the arbitrator may reopen the hearing. See Arbitration Rules at R-36.

• The arbitrator may grant any remedy or relief that he or she deems just and equitable and is within the scope of the agreement of the parties. See Arbitration Rules at R-43.

If a party has knowledge that the arbitrator has not complied with any provision of the arbitration rules, he must make a timely objection or he loses his ability to do so at a later time. This automatic waiver reinforces the wide discretion of the arbitrator. See Arbitration Rules at R-38.

Before entering arbitration, the parties have the power to alter the arbitrator's discretion. The parties may agree to modify the arbitrator's powers either in the initial contract that contains the arbitration agreement or by separate agreement before proceeding with the arbitration.

Arbitration offers a unique opportunity, unmatched in litigation, to select the decision maker. The wide discretion of the arbitrator and the finality of the arbitrator's decision makes this selection crucial. The parties might consider agreeing on an arbitrator before entering the contract and then designate that arbitrator in the contract, thereby agreeing that the arbitrator has the expertise or level of experience necessary to understand a dispute that may arise between the parties. If the parties designate a particular person to serve as arbitrator, they should select alternates in the event that the particular arbitrator is not available.

Biographical Information. Several steps may be taken to assure the best arbitrator possible. First, obtain biographical information. The American Arbitration Association maintains biographical information on each of its arbitrators. Also, check the professional and general press accounts. If the candidate has a high news profile this may influence the selection.

Writings. Second, read any books or articles by the candidate. These writings may reveal the candidate's views regarding his role as an arbitrator and/or his general position on issues crucial to a party's claim.

Recommendations. Third, ask around. Often, reliable third parties can provide anecdotal information regarding their experience with the candidate. This includes information relating to the candidate as an arbitrator, as well as relating to other professional dealings and organizations in which the candidate has participated.

In recent years the courts have played a more expansive role in examining the arbitration process as litigants continue to challenge or defend efforts to arbitrate disputes. The more common issues regarding arbitration which our courts routinely decide are as follows:

1. Whether or not an agreement to arbitrate exists;

2. Whether the Federal Arbitration Act (FAA) or the Texas General Arbitration Act (TGAA) governs the arbitration rights and procedures of the parties;

3. Whether the dispute is an issue within the scope of the arbitration agreement;
4. Even with an agreement to arbitrate, has the party waived its right to arbitrate; and
5. Under what circumstances can a court change or overturn an arbitrator's award.⁽²⁾

An agreement to arbitrate is usually required to be in writing and signed by both parties, absent special circumstances. Additionally, the agreement needs to be clear as to the intent of the parties. A typical arbitration provision, like the one used in the 1987 AIA-A201 General Conditions of the Contract for Construction, is as follows:

Any controversy or Claim arising out of or related to the Contract, or the breach thereof, shall be settled by arbitration in accordance with the Construction Industry Arbitration Rules of the American Arbitration Association, and judgment upon the award rendered by the arbitrator or arbitrators may be entered in any court having jurisdiction thereof, except controversies or Claims relating to aesthetic effect and except those waived as provided for in Subparagraph 4.3.5.

If an arbitration provision is not clearly worded like the one above, disputes can occur regarding whether the parties agreed to arbitrate and the scope of the agreement.

Employment Contracts. In Tenet Healthcare, Ltd. v. Cooper, 960 S.W.2d 386 (Tex. App.--Houston [14th Dist.] 1998, no writ), the appellate court considered whether an acknowledgment form attached to a new employee handbook was a sufficient agreement to arbitrate. The court found that a designated representative of the employer had not signed the form as required by the company's procedures. Additionally, the employee had never signed the form, the employee did not receive the form until thirteen years after she was hired, and the acknowledgment form had only one signature line so that the employee did not have the power to bargain for terms. Thus, the court held, the acknowledgment form was not a sufficient agreement to arbitrate.

In Circuit City Stores, Inc. v. Curry, 946 S.W.2d 486 (Tex. App.--Fort Worth 1997, no writ), the Court reached a different result where the parties used an "opt out" form. The opt out form allowed the employee to decline to participate in the company's arbitration process. The employee did not sign or return the card. After the employee's discharge, the employee requested arbitration. Arbitration proceedings began and the employee participated. Later, the employee pursued litigation in court. The court concluded that because the employee did not return the opt out form, and because the employee initially requested arbitration, an agreement to arbitrate existed.

Commercial Contracts. An agreement to arbitrate was also found in a commercial context where a signed writing did not exist. In Hardin Construction Group, Inc. v. Strictly Painting, 935 S.W.2d 308 (Tex. App.--San Antonio 1997, no writ), Hardin, a general contractor, and Strictly Painting, the subcontractor, entered into a subcontract. The terms of the subcontract were identical to the parties' previous smaller subcontracts, but this subcontract required a performance bond. Strictly Painting did not sign the subcontract. Instead it started performing and forwarded a letter to Hardin agreeing to all of the contracts' terms except the performance bond requirement. Before receiving the letter, Hardin made the first monthly payment. Hardin made no additional payments, though Strictly Painting substantially completed its work on the project.

Ultimately, Strictly Painting sued Hardin over Hardin's failure to make progress payments. In its answer, Hardin demanded arbitration. The court found that, under Texas contract law, the parties can enter a binding agreement upon certain contractual terms, leaving others to be negotiated in the future, if those left for negotiation are not essential. The court held that the performance bond requirement was not essential, and that because Strictly Painting substantially performed the work consistent with the subcontract, Strictly Painting agreed to the arbitration clause in the unexecuted subcontract.

In BDO Seidman v. Miller, 949 S.W.2d 858 (Tex. App.-- Austin 1997, writ dism'd w.o.j.), the court found that an arbitration agreement was invalid on its face. The partners in an accounting partnership named BDO Seidman signed a partnership agreement that included an arbitration provision and a covenant not to compete. Miller left the partnership, and then sued to have portions of the partnership agreement declared void. The partnership demanded arbitration and sought to enforce the covenant not to compete. The contract designated five arbitrators: three members of BDO Seidman's board of directors and two additional BDO Seidman partners. The court found that because the arbitration provision designated partners and members of the Board of Directors of BDO Seidman to be the "arbitrators," and because these "arbitrators" owed a fiduciary duty to BDO Seidman, the arbitration provision was inherently unfair, and was thus invalid. As a result, the court denied the request for arbitration.

In American Employers' Ins. Co. v. Aiken, 942 S.W.2d 156 (Tex. App.--Ft. Worth 1997, no writ), the Aiken Insurance Agency sued the insurer for wrongful termination of an agency agreement and tort claims. The contract between the agency and the insurer contained an arbitration clause. The court concluded that the agency may not avoid the responsibility to arbitrate a contract dispute by attempting to cast complaints in tort rather than contract, and that the claims were restatements of claims under the agency agreement, or were so interwoven as to be inseparable.

Similarly, in Hou-Scape, Inc. v. Lloyd, 945 S.W.2d 202 (Tex. App.--Houston [1st Dist.] 1997, no writ), the trial court found that the parties' contractual disputes were covered by an arbitration clause in their contract, but the tort claims should be heard in state court. On appeal, the court focused on the broad language of the arbitration clause, which required arbitration of all disputes "arising out of, or relating to the Contract Documents or the breach thereof." The court held that the claims regarding violations of the DTPA, libel, slander, tortious interference with a contract, negligence, gross negligence, and fraud all arose out of or related to the Contract Documents, and therefore all the claims were arbitrable.

The parties by their action may deliberately or inadvertently waive the right to arbitrate a disagreement. In prior years, Texas court decisions shifted the balance against finding a waiver of the right to arbitrate. However, three cases that addressed waiver in 1997 all found that waiver had occurred.⁽³⁾ In Viveo v. Cates, 953 S.W.2d 489 (Tex. App.--Austin 1997, n.w.h), the Austin Court of Appeals examined a dispute over management contracts where neither party had requested specific performance of the arbitration provision. The court construed the plaintiffs' filing of suit on "arbitrable claims" to be unconditional, and thus decided that such an act created for the defendant a right of "election" to insist or not insist upon arbitration. The court then ruled that because the defendant also pursued litigation, the parties mutually repudiated the arbitration covenant as a matter of law and waived any rights thereunder.

Turford v. The Honorable Olen Underwood, 952 S.W.2d 641 (Tex. App.--Beaumont 1997, n.w.h), is the second waiver case. In Turford, a former employee filed a declaratory judgment action in Montgomery County, Texas, to declare invalid a covenant not to compete. The employer answered the lawsuit. Within thirty days of filing its answer, the employer filed a suit for an injunction on the covenant not to compete and for damages for breach of contract in Oakland County, Michigan, pursuant to a forum selection clause. The employer then sought dismissal or compulsion of arbitration of the Texas lawsuit. The district court granted the motion to compel arbitration. The former employee petitioned for the appellate court to review the district court decision.

The appellate court concluded that because the employee filed the Texas lawsuit before the Michigan lawsuit, and because the former employer answered in Texas before suing in Michigan, the former employer's action was inconsistent with the arbitration agreement. The court found that the former employer had prejudiced the former employee by forcing him to arbitrate in Texas and litigate in Michigan, and thus concluded that there was a waiver of the right to arbitrate.

The final waiver case is Bruce Terminix Co. v. The Honorable Bob Carroll, 953 S.W.2d 537 (Tex. App.--Waco 1997, n.w.h). A consumer sued a termite exterminator. The termite exterminator answered the consumer's lawsuit and served written discovery requests. The consumer answered the discovery. A few months later the termite exterminator filed a motion to compel arbitration, which the consumer contested. The trial court orally granted the motion. No written order was ever signed by the district judge. Two years later, the trial court with a new judge presiding held a hearing on the consumer's motion to vacate the earlier order compelling arbitration. The judge never ruled on the motion. Several months later, a third judge granted the consumer's motion to abate arbitration. In upholding the trial judge's decision, the Court of Appeals held that once arbitration is ordered the parties must arbitrate the dispute in a timely manner. Since the exterminator's three year delay to initiate arbitration was not timely, the court ruled that the finding of waiver was appropriate.

After an arbitrator has made an award, the prevailing party requests a confirmation of the award from the district court. See 4 Tex. Civ. Prac. & Rem. Code Ann. § 171.087 (Vernon 1987). The losing party has the option of requesting the court to modify or to vacate the award. See 4 Tex. Civ. Prac. & Rem. Code Ann. §§ 171.089-.091 (Vernon 1987).

Courts have statutory and common law authorization to vacate an arbitrator's award. However, the parties also have the right to agree that the arbitration will be binding and not appealed. In Raffaelli v. Raffaelli, 946 S.W.2d 139 (Tex. App.--Texarkana 1997, no writ), the losing party alleged that the arbitrators exceeded their authority by exercising jurisdiction over real property not belonging to the parties. The Texarkana Court of Appeals noted that it has statutory and common law powers to vacate or modify an award. Because the parties agreed that the arbitration would be binding, the court concluded that it only has authority to review arbitration awards based on common law grounds of fraud, misconduct, and mistake. The court found that the applicable arbitration agreement stated that all property was to be included in the arbitration. The court, therefore, rejected the challenge to the award.

Additionally, courts may vacate an arbitration award if facts constituting an arbitrator's "evident partiality" are not disclosed to the parties prior to the arbitration hearing. A Texas Supreme Court decision was recently issued on this point, and it is discussed in further detail in the following "Hot Topics" section of this paper.

Whether a surety may be compelled to participate in an arbitration affects the claimant's ability to recover from the surety in a timely manner. If the surety is not a party to the arbitration, then the party trying to recover will have to institute a second court proceeding to recover its award. Although courts across the country have not been consistent in deciding this issue, the more recent trend favors compelling the surety to participate in arbitration.

A surety is typically not a signatory to the construction contract that contains an arbitration clause. However, the surety bond often incorporates the construction contract by reference. Courts are not in agreement as to whether, based on the incorporation of the construction contract which contains an arbitration clause, the payment and/or performance bond evidences a surety's consent to arbitrate disputes in which the surety is involved, such that the court may compel the surety to participate in the arbitration.

Most courts refusing to compel the surety to arbitrate hold that the courts cannot compel the surety to arbitrate absent its agreement to do so.See Transamerica Ins. Co. v. Yonkers Contr. Co. 1966); Episcopal Hous. Corp. v. Federal Ins. Co., 239 S.E.2d 647, 652 (S.C. 1977); United States v. Weiss Pollution Control Corp. 532 F.2d 1009, 1012-13 (5^th Cir. 1976). In those jurisdictions, the courts will not compel the surety to arbitrate unless it is a signatory to the agreement containing the arbitration clause. Even though the performance bond incorporates the contract by reference, the courts have held that the surety is not bound to arbitrate claims made against it on the bond.

The more recent trend, however, appears to favor courts granting motions to compel a surety to participate in arbitration. The Fifth Circuit has indicated a willingness to bind a subcontractor to the arbitration agreement between the contractor and owner where the subcontract incorporates by reference the original contract. See J.S.&H. Construction Co. v. Richmond County Hospital Authority, 473 F.2d 212 (5^th Cir. 1973).

Other courts have taken the "incorporation-by-reference" reasoning a step further and applied it to surety bonds. For example, in Exchange Mutual Ins. Co. v. Haskell Co., 742 F.2d 274 (6th Cir.1974), the federal court used the principle of incorporation-by-reference to link the arbitration clause to the bond and compel the surety to arbitrate. The case involved the construction of a shopping center parking lot, and the dispute was between a subcontractor and the prime contractor. The subcontract, which was incorporated into the performance bond, did not contain an arbitration clause. However, the subcontract incorporated the prime contract, which did contain an arbitration clause. Thus, the court held, the surety was bound to participate in the arbitration. Federal courts in Alabama, Maine, Georgia, New Jersey, Massachusetts, as well as state courts in New York, Florida, and California have all compelled sureties to arbitrate based on the incorporation by reference of an arbitration agreement.

Foreclosure of a mechanic's lien is not available as an award in arbitration. To foreclose a mechanic's lien, one must obtain a judgment from a court of competent jurisdiction foreclosing the lien and ordering the sale of the property subject to the lien. See Tex. Prop. Code Ann. § 53.154 (Vernon 1984).

In Hearthshire Braeswood Plaza Ltd. Partnership v. Bill Kelly Co., 849 S.W.2d 380 (Tex.App.--Houston [14 Dist.] 1993, writ denied), the Houston Fourteenth Court of Appeals held that while an arbitrator decides the underlying dispute, the suit to foreclose a lien is stayed. The court concluded that if the holder of the mechanics' lien prevails in arbitration, he or she can then sue to foreclose the lien. The court did not give the arbitrator the authority to include foreclosure of a lien in the arbitration award.

Under both the 1995 and 1997 versions of the Texas General Arbitration Act, courts may vacate an award because of the "evident partiality" of an arbitrator who was appointed as a neutral. See 4 Tex. Civ. Prac. & Rem. Code Ann. §171.04 (Vernon 1997); 4 Tex. Civ. Prac. & Rem. Code Ann. §171.088(a)(2)(A) (Vernon 1998). In Burlington Northern Railroad Co. v. Tuco, Inc., 960 S.W.2d 629 (Tex. 1997), the Texas Supreme Court interpreted the meaning of "evident partiality" for the first time. The Court held that if the parties select a neutral arbitrator and the arbitrator does not disclose facts which might create a reasonable impression of partiality in the mind of an objective observer, then the arbitrator exhibits evident partiality, and a court may vacate the award. The Court emphasized that evident partiality is established from the nondisclosure itself, not whether the nondisclosed information actually establishes partiality or bias. Thus, it is now essential that arbitrators disclose all prior relationships and other contacts and dealings which simply might give the impression of partiality, or else the losing party may be able to have the arbitrator(s)' award vacated.

In Weekley Homes, Inc. v. Jennings, 936 S.W.2d 16 (Tex. App.--San Antonio 1996, writ denied), the parties' construction contract provided for arbitration in accordance with the American Arbitration Association's construction industry rules, but required that mediation between the parties take place first. When one party filed an arbitration demand without first attempting to mediate the dispute, the court held that the party had waived its right to arbitrate. The decision was based upon the particular contractual provision involved. Thus, it appears that in Texas parties must be very careful to follow the dispute resolution procedures in their contracts to avoid waiving their arbitration rights. This case is quite significant because the 1997 Edition of the AIA-A201 General Conditions of the Contract for Construction requires mediation prior to arbitration. According to the Jennings case, then, skipping the mediation process could amount to a total waiver of the arbitration provision in the contract.

1. The concept and effects of "incorporation by reference" provisions are discussed in further detail in the "Hot Topics" section of this paper as they relate to compelling a surety to participate in arbitration against the surety's principal.

2. For a more detailed analysis see Lionel M. Schooler, Arbitration Developments in the Law, The Hous. Lawyer, March/April 1998, at 22.

3. Additionally, a very important 1996 waiver case, Weekley Homes, Inc. v. Jennings, 936 S.W.2d 16 (Tex. App.--San Antonio 1996, writ denied), involving mediation as a condition precedent to arbitration is discussed in the "Hot Topics" section of this paper.