May  26, 2000

Bulletin #36: The Arbitration

ZZZ Sheetmetal had been fortunate. Over the prior ten years, only a few projects had gone sour. It had been five years since ZZZ executives had found themselves in court and almost as long since their most recent arbitration. The ZZZ president realized that he could no longer remember the phone number of the company’s attorney. That realization made his day.

In the midst of this streak of good fortune, ZZZ responded to a bid request for the HVAC system on a new regional shopping mall. It would be a big job with a developer from outside of the area. ZZZ staff put the pricing together and the bid was accepted. The project was structured on a “direct bid” basis and the developer presented ZZZ with a contract. It was a printed document and looked a lot like an AIA form, although it was not identified as such. ZZZ management checked the price, signed the contract, and started ordering materials.

On page 22 of the contract was what appeared to be a standard arbitration clause. The provision read, in relevant part, as follows:

14.2. Arbitration. In the event of a dispute between the Owner and the Contractor, the matter shall be submitted to binding arbitration. Within forty-five (45) days of the Contractor’s submittal of the documentation necessary to substantiate its claim, the Owner shall designate a third party arbitrator and shall notify the Contractor of such designation. The arbitration hearing shall be held on a date mutually acceptable to the parties at a location designated by the arbitrator. The arbitrator shall render its decision within thirty (30) days following the arbitration hearing and the arbitrator’s decision shall be non-appealable and binding on both parties. The arbitrator shall also have authority to require the non-prevailing party to pay the prevailing party’s attorneys’ fees and the costs of arbitration.

Unfortunately, this project did not go smoothly. There were constant issues with the schedule, unforseen conditions, poorly defined and changing specifications, work coordination, and the re-design of components. The potential claims on the part of ZZZ rose by the week and had reached six figures within the first three months of the project. The developer then started withholding significant amounts from monthly draws based upon “unauthorized charges” and “disputed charges.” ZZZ management felt the need to act. It began to submit notices of its claims on a monthly basis as the various disputes gained momentum. The developer wrote back suggesting that the claims be held until the end of the job and resolved in one arbitration proceeding. ZZZ management agreed and continued work on the project.

By the completion of the job, the claims amounted to almost twenty-five percent of the original bid figure and the stakes in the arbitration would obviously be very high. ZZZ assembled documentation to support its claims and submitted the documents and a summary of its claims to the developer. It received no response. After numerous phone calls and certified letters, the developer wrote back stating that the contractor had not submitted documentation necessary to “substantiate its claims” under the arbitration clause. After another thirty days of delay (during which ZZZ duplicated and delivered most of its file on the project), a letter was finally received from the developer indicating that it had designated an attorney half-way across the country to act as arbitrator. A letter from the attorney arrived several weeks later indicating that the arbitration hearing would occur in the attorney’s offices, even though the project (and ZZZ’s offices) were 1,000 miles away. (Coincidentally, the headquarters of the developer were located in the same city as the arbitrator’s office). ZZZ protested, but to no avail. Sensing the difficulties that might lie ahead, the president of ZZZ dug through his drawer and found the phone number for the company’s attorney. The arbitration hearing was only four weeks away. The ZZZ attorney immediately demanded that the developer produce a lengthy list of documents to permit the contractor to prepare for the arbitration hearing. The ZZZ attorney also indicated that he wished to take sworn testimony from several developer executives. The developer refused to comply and ZZZ’s attorney appealed to the arbitrator for an order compelling release of the requested information and access to the developer personnel. The contractor and its attorney received a letter four days before the arbitration hearing stating that the arbitration clause did not provide for discovery and that the developer was not required to provide the requested materials or testimony. The arbitrator interpreted the arbitration clause as simply providing for each party’s presentation of its position based upon the information available to it. He would then render his decision.

Without the developer materials, the contractor found itself “flying blind” on some major issues and was unaware of the defenses that would be asserted. The company attorney suggested that ZZZ commence a lawsuit, asking the judge to postpone the hearing and order the arbitrator to compel discovery. However, the contractor was not looking to add the expense and aggravation of another legal proceeding to an already painful and expensive process. ZZZ decided to go forward with the arbitration. From the first, ZZZ knew that it was in trouble. The arbitrator was hostile in tone and impatient with the testimony of the contractor’s executives. He seemed fixated on the fact that the contractor had worked for over three months without complaint, even though it alleged that it was incurring damages throughout that period. The developer’s presentation went far more smoothly. It was obvious that the developer had been through this process many times. After three days, testimony ended and the arbitrator indicated that he would render his decision shortly.

The process had left ZZZ concerned about some technical points, but the executives were confident that fundamental fairness would drive a decision in their favor. They were wrong. A three sentence decision arrived ten days later giving the developer a net recovery of over $200,000 and requiring ZZZ to pay the developer’s attorneys’ fees. The president of the contracting firm sat at his desk dumbfounded. He could never have imagined such a result. Determined to appeal, he called his attorney (whose work and home phone numbers were now emblazoned in his memory). He would take the matter to the “highest court in the land.”

The final cold shower for ZZZ came when the attorney informed the company that arbitration awards were essentially non-appealable, unless the company could establish fraud or corruption by the arbitrator or that the arbitrator had exceeded his authority. There was no proof (although more than a little suspicion) as to the former and no issue as to the latter. Ultimately, the company saw itself as having no choice but to write the checks to the developer and its attorneys and to close its file.

The point of this scenario is not to diminish the importance or benefits of arbitration. A properly conducted arbitration proceeding (particularly when coupled with mediation) can save time and expense to both parties in a dispute. The arbitration clauses in the forms developed by the American Institute of Architects and the Associated General Contractors of America have been designed to give both parties a reasonable opportunity to present their cases. However, the contractor should pay particular attention to the arbitration clause in any proprietary contract form (or to modified AIA or AGC forms), keeping in mind the following questions:

1. Will the arbitrator be truly unbiased or handpicked by the other party?

2. Will the other side have to set out its claims and defenses before the hearing, so that the contractor will have a reasonable opportunity to respond?

3. Will the contractor have access to other parties and their files to minimize the likelihood of being “blind-sided” by some undiscovered information?

4. Is arbitration mandatory for both parties or only for the contractor? If the other party to the contract can pick the method of dispute resolution, it is likely that the choice made will work to the disadvantage of the contractor.

Improvements in dispute resolution have benefitted the entire industry as the “partnering” concept has continued to take hold. However, disputes still happen and the contractor needs to exercise care to make certain that the deck is not stacked against it from the first day of a job.


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