The Critical Path: Tools for Resolving Construction Disputes : California Construction Lawyer & Attorney for Dispute Resolution in Los Angeles, San Diego & the S.F. Bay Area

Even after twenty years, the so-called “McDonald’s coffee case” or “hot coffee case” is still the poster child of tort reform advocates and the rally cry of consumer attorneys. The former decry a legal system which permits such “frivolous” lawsuits while the latter complain that public relations firms distort the facts of the case to engender public sympathy for big business. Let’s pivot away from the politics of the case and, going back in time, look at the lawsuit from a neutral perspective-as people who want to resolve a dispute as efficiently and effectively as possible. Like a mediator.

The hot coffee case is reported in Wikipedia. Using the facts reported in the article, let’s consider what risks were involved in the case and identify some of the barriers to settlement. What was it about the settlement negotiations that made trial a better option for the parties than a settlement? In other words, using Fisher and Ury’s term from their national bestseller Getting to Yes, what was the BATNA-the best alternative to a negotiated agreement-for each party, and why was trial deemed to be a better option than the settlement terms that were offered? This is a question every litigant must consider in order to properly prepare for settlement negotiations.

Your BATNA becomes evident through rigorous risk analysis of the legal, economic, and emotional aspects of the dispute. You should also consider these things from your opponent's perspective. Unless you attempt to view the case from the other side’s perspective of the risks and rewards of the case, you may force your opponent to engage in a trial that no one really wants. Therefore the key to effective negotiations is finding a reasonable settlement range that takes into account the risks and rewards of trial for both sides. The plaintiff will not agree with the lowest number in the settlement range and the defendant won’t agree with the highest, but once both parties find themselves in the same settlement range, settlements almost always happen. It is the mediator’s job to help them get there. Unfortunately, it appears the parties in the hot coffee case were never in the same range until after the trial.

The Accident

• A 79-year-old woman ordered a 49-cent cup of coffee from a drive-in window at a McDonald’s restaurant. The cup had a warning label about the hot coffee.
• McDonald’s served coffee at 180-190 degrees. At that temperature, the coffee would cause third-degree burns in two to seven seconds.   
• While sitting in the passenger seat of a parked car, the woman placed the cup between her legs and pulled the lid toward her to remove it. In the process, she spilled the coffee on her lap.
• She suffered third-degree burns on six-percent of her skin and lesser burns over sixteen percent. She was hospitalized for eight days, underwent skin grafting, and spent the next two years receiving medical treatment.
• Her past medical expenses were $10,500; her future medical expenses were $2500; and her lost income was $5000 for a total of approximately $18,000.

 Pre-trial Settlement Negotiations

The plaintiff made a pre-lawsuit offer of settlement in the sum of $20,000. McDonald’s offered $800.  McDonald’s also rejected a pre-trial offer of $90,000, and then a $300,000 offer, and a final pre-trial mediator’s proposal of $225,000.

Trial, Verdict, and Post-Trial Settlement

At trial, the plaintiff introduced evidence of measures that could have been taken to reduce the risk of burning and evidence of 700 other burn victims. The jury returned a verdict that awarded the plaintiff $200,000 in compensatory damages and $2.7 million in punitive damages. The punitive damages were apparently based on plaintiff’s counsel’s argument that McDonald’s took in $1.35 million in coffee sales per day, and the jury awarded two days worth of sales as a punishment for what happened. The jury did find the plaintiff was 20% at fault, so the compensatory damages were reduced to $160,000. The judge reduced the punitive damages to three times the compensatory amount, for a total of $640,000.

Eventually the parties entered into a confidential settlement prior to the filing of an appeal, presumably in an amount that substantially exceeded McDonald’s initial offer of $800.

Observations

The settlement value of the hot coffee case must be analyzed from a pre-trial and post- verdict perspective.

Pre-trial: What were the chances the jury would find McDonald’s liable? Was the warning on the cup sufficient? Did the plaintiff have any comparative fault? McDonald’s pre-trial offer of $800 seems to indicate that it did not believe a jury would find the company liable under the facts of the case. In addition, the $800 was more than the $714 average settlement given to 700 other burn victims. The defense may have also factored in the high cost of litigation the plaintiff would face and expected a considerable discount from the plaintiff as a result.

The plaintiff though had real injuries and verifiable damages of $18,000. The plaintiff may have felt that the initial settlement offer of $20,000 was reasonable given her actual damages and considerable pain and suffering. Two-thousand dollars for pain and suffering would be more than fair and reasonable, plaintiff must have thought. But did the plaintiff factor in the possibility that a jury would not find McDonald’s liable? Did she really have a 100% chance of success? Could it have been a 75% chance, or some other number? Even if she was 100% certain that McDonald’s would be liable, did she consider that a jury might find that she was also at fault and that her damages could be reduced by some amount on a comparative fault basis?

McDonald’s turned down plaintiff’s pre-trial settlement offer of $90,000. Given the $160,000 of compensatory damages actually awarded by the jury, it seems the $90,000 offer was within a reasonable range. Without more information it is hard to tell the dynamics at this point, but it seems McDonald’s had a totally different view of the case, probably because the medical expenses were only $10,500. McDonald’s probably thought that even if it were found to be liable, an award for pain and suffering would not be more than 3 or 4 times the medical expenses, so the cap on the damages would be limited to no more than $52,000. Therefore, a settlement of $90,000 was unacceptable to McDonald’s because it represented a valuation that was almost two times the amount plaintiff was likely to get on her best day of trial.

McDonald’s then turned down plaintiff’s pre-trial settlement offer of $300,000 and the mediator’s settlement proposal of $225,000. Very interesting: generally the plaintiff would have attempted a compromise by going below her last number which was $90,000. Why did the next offer go up, and not down? Probably because the plaintiff uncovered evidence to support a claim for punitive damages, so the price of settlement went up. It is a funny thing though-most businesses do not want to settle a case based upon potential punitive damages. That is because the burden of proof is so high that it is hard to get punitive damages, so businesses adopt the attitude, “if you want punis you’re going to have to take them from me at trial.” It is a business risk they are often willing to take.

McDonald’s may have thought they could keep evidence of the other burn victims out of the trial by filing a motion to exclude such evidence. I noticed in the court docket numerous motions to exclude filed by McDonald’s, including a “Motion to Exclude Prior Deposition Testimony and Photographs of other Burn Injuries at Trial. (08/04/1994)” Apparently the motion was denied which then let the jury consider McDonald’s prior knowledge of the danger of the 190 degree coffee which apparently led to an award of punitive damages.

I recommend that every trial risk analysis include the possibility of favorable and unfavorable outcomes for law and motion matters. For example, what are the chances of excluding certain evidence and if the motion fails, could the potential damages increase? From the plaintiff’s side, a risk analysis may include the possibility of losing a motion for summary judgment or the impact on damages if a motion to exclude evidence is granted.

A final thought about punitive damages:  court’s have the authority to reduce awards for punitive damages if the amount is deemed to be excessive on constitutional grounds. Here, the trial court reduced punitive damages to three times the compensatory damages. The days of huge punitive damage awards of ten, fifteen, or a hundred times the amount of the compensatory damages are long gone. The U.S. Supreme Court opinion in the State Farm v. Campbell case (where the compensatory/punitive damages ratio was 145:1) a few years ago changed all of that. Plaintiffs need to account for that in their risk analysis and expectations. Trial courts seem to be limiting punitive damage awards in most cases to three or four times the compensatory damages, and if they don’t, an appellate court probably will.

Post-Verdict: at this stage the dynamics have shifted in plaintiff's favor. McDonald’s will have to pay $640,000 plus interest unless the verdict is reversed on appeal. Why then would plaintiff settle for an amount less than $640,000? Because there is a chance the she could lose on appeal. Then she would have to retry the case with a different jury which means an uncertain outcome and additional litigation expense. As a result, the parties settled the case.

Final Thoughts

There are other factors to consider when evaluating the settlement value of a case: the costs of litigation, the possibility of having to pay the other side’s costs and attorney fees if you do not prevail,  the time value of money, etc.. There are also other costs that are harder to gauge:  the emotional toll of participating in a trial, the time commitment, added pressures on family and business colleagues, and much, much more.

I am a great believer in the benefits of settling disputes prior to trial. It requires a realistic view of the facts and the law by both parties. That view must be shaped by realistic assumptions. You cannot compare the strongest parts of your case with the weakest parts of your opponent’s case and expect to have a meeting of the minds.

Disputes happen but reasonable people can usually find ways to resolve them in a cost-effective manner. When they cannot even agree on a possible settlement range, settlement is not possible and the dispute will spill into court. Who will wipe up the mess? A jury of your "peers"-strangers really-who may not even know what it is like to drink hot coffee.

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In construction defect cases there is often a dispute within the dispute: should the case be prosecuted in a court of law or proceed under the terms and conditions of an arbitration provision? There are rational reasons for selecting arbitration over a court or jury trial. Many believe that arbitrations are more cost effective than jury trials, for example. However, parties who arbitrate their disputes give up the constitutional right to a jury trial and their appellate rights are generally restricted, among other things.

Real estate developers often prefer arbitration over jury trials for various reasons, not the least of which is the belief that they would fair better in front of an experienced construction law arbitrator than they would in front of 12 jurors who probably have little or no understanding of the construction industry. As a result, developers will often include arbitration provisions in documents called conditions, covenants, and restrictions (referred to as CC&R's) which are akin to by-laws for corporations. CC&R's constitute the governing document for members of homeowner associations and tell  property owners what they can and cannot do within the development.

In California, the law on the issue of whether or not an arbitration provision in CC&R's is enforceable is unsettled. Yesterday, the California Supreme Court granted review in the Pinnacle Museum Tower Assn. v. Pinnacle Market Development (US) LLC case. Attorney Kathleen Carpenter of Luce Forward has provided a good summary of the relevant cases and issues which you can read by clicking here. You can read the Pinnacle case and two other cases, the Villa Vicenza case which is pending in the Fourth Appellate District, where the Court granted rehearing after holding that such provisions in CC&R's are not enforceable, and the Villa Moreno HOA case, the first California case to address the issue (in 2000) by clicking here, here, and here.

If you have a case involving the issue of the enforceability of an arbitration provision in CC&R's, you may have to wait awhile to get a definitive answer to that question. As Ms. Carpenter notes in her summary, it may take 12 -24 months before the California Supreme Court issues its opinion in the Pinnacle Museum Tower case, and the Fourth Appellate District's opinion in the Villa Vicenza case is not expected until January 2011. Meanwhile, she notes, it is likely the Supreme Court will grant review and stay other similar cases until it decides Pinnacle Museum Tower.

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The right to arbitrate a dispute can be waived. One way to waive arbitration rights is to sit on them, figuratively speaking, of course. By sit on them, I mean delay enforcement of the right or take steps that leads the other side to believe you do not intend to arbitrate the dispute. In a recent unpublished opinion (meaning, the case can't be cited in legal pleadings or used in oral argument as persuasive authority), the California Court of Appeal addressed the waiver issue. The case is important to the The Critical Path because the facts present a common set of circumstances that can result in a waiver. Therefore, even though the opinion is unpublished, it is instructive, and it is helpful in that it refers to most of the published California opinions on the subject. Click here to read the opinion.

Here's What Happened

Thompson Building Materials was a defendant in a construction defect case. The homeowners alleged the stone pavers provided by Thompson cracked and deteriorated due to latent defects, and that debris from the defective material damaged the pool filter and pump system. Thompson filed an answer to the complaint and participated in court-ordered proceedings, discovery, and a mediation. A week before the discovery cut-off and a month before trial, Thompson filed a motion to compel arbitration, claiming that it had recently discovered an arbitration provision on the back of the invoices for the sale of the building materials.Apparently, when the invoices were copied, only the front side was copied, leaving the backside boilerplate, including the arbitration provision, uncopied.

In support of the motion to compel arbitration, Thompson's counsel informed the trial court that

although he had-known of these invoices and had been-litigating these invoices for probably 20 years, his associate (to whom he had delegated the responsibility of responding to plaintiffs discovery) had not, and-she simply didn't know any better in terms of knowing there should have been a back side on [the invoice]. 

 Plaintiff homeowners opposed the motion to compel, arguing Thompson waived the arbitration provision by participating in the litigation for over a year and that plaintiffs were prejudiced by the fact that Thompson was attempting to compel arbitration of a case that was only a month away from trial. Plaintiffs also argued that they were prejudiced because Thompson obtained information in discovery that it would not have been able to obtain in arbitration.

 The trial court granted the motion to compel arbitration, and the homeowners filed a petition for writ of mandate. The Court of Appeal held the trial court's order was not supported by substantial evidence and granted the homeowners' petition. The court concluded Thompson had waived its arbitration rights:

Although there is no uniform test for determining whether a party‘s conduct amounts to a waiver of the right to arbitrate, the courts have formulated a list of factors that are relevant in making that determination. These include ‗―(1) whether the party‘s actions are inconsistent with the right to arbitrate; (2) whether ‗the litigation machinery has been substantially invoked‘ and the parties ‗were well into preparation of a lawsuit‘ before the party notified the opposing party of an intent to arbitrate; (3) whether a party either requested arbitration enforcement close to the trial date or delayed for a long period before seeking a stay; (4) whether a defendant seeking arbitration filed a counterclaim without asking for a stay of the proceedings; (5) ‗whether important intervening steps [e.g., taking advantage of judicial discovery procedures not available in arbitration] had taken place‘; and (6) whether the delay ‗affected, misled, or prejudiced‘ the opposing party.(St. Agnes Medical Center v. PacifiCare of California (2003) 31 Cal.4th 1187, 1196, quoting Sobremonte v. Superior Court (1998) 61 Cal.App.4th 980, 992.)

Thompson‘s conduct in this case satisfies virtually all of these factors and compels a finding of waiver. Thompson did not raise arbitration as an affirmative defense in its answer. (SeeGuess?, Inc. v. Superior Court, supra, 79 Cal.App.4th at pp. 557-558.) Thompson participated in the litigation for nearly a year. In opposition to Thompson‘s motion, plaintiffs‘ counsel submitted a declaration in which he listed 54 items plaintiffs considered to be ―significant litigation activities by the parties. Nearly half of these items are discovery propounded by Thompson. The parties designated expert witnesses; Thompson‘s expert inspected plaintiffs‘ property in June 2009 and March 2010. The parties also participated in a case management conference in September 2009 and court ordered mediation in February 2010. Suffice it to say, ―the litigation machinery has been substantially invoked and the parties ―were well into preparation of a lawsuit before Thompson notified plaintiffs that it would seek to compel arbitration.  

Lessons to be Learned

Usually, the decision to include an arbitration provision in a contract is the result of a deliberative decision making process. Therefore, when a claim arises, it would be wise to take steps to preserve that right, or at least, consider your options. You may want to create a checklist that could include one or more of the following points:                                                                                                                                                

• make sure there is  a written contract
• assume the contract has a dispute or claims clause and check to see if there is an arbitration provision
• decide if the arbitration provision should be enforced or waived, if it is believed that litigation would be more advantageous under the circumstances of the claim
• decide if there are mechanics lien rights, statute of limitations issues, or other equitable remedies that must be preserved by filing a lawsuit, then seek a stay of the action, and proceed with the parts of the claim that are subject to arbitration.                                                                                                                                                      

You might also want to be sure that both sides of documents are copied before providing them to your attorney or to the other side. You would be surprised how many times issues seem to disappear simply because both sides of documents are inadvertently not copied.

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Arbitration rules have increasingly come under scrutiny by various state legislatures and courts. Oftentimes changes in state arbitration laws intended for other parts of  the economy have found their way into the construction industry, with mixed results.  Last Friday Andrew Ness of Howrey LLP posted in the kluwerconstructionblog an insightful piece on a consumer protection bill recently proposed  in the House of Representatives.

 Rather suddenly, a substantial backlash against mandatory arbitration has appeared on the scene. One of the clearest indicators is the proposed Arbitration Fairness Act (H.R. 1020) that was introduced in the House of Representatives in February of 2009, and is still very much in play. While the anger is not directed at construction dispute arbitration, the concern is that commercial arbitration will end up being limited in important ways, as well as mandatory arbitration schemes where the use of arbitration is seen as one-sided and unfair.

The bill is intended to limit the reach of the Arbitration Act including the authority of arbitrators in situations where individuals are in unfair bargaining positions, e.g., employer-employee relations, personal credit issues, and individual real estate transactions. Mr. Ness expresses concern about the potential application of these limitations to the construction industry.

While the construction industry is not specifically targeted by the AFA, concerns have arisen that subcontractors and suppliers, for example, may attempt to claim unequal bargaining power when confronted with standard arbitration clauses contained in many form subcontracts. As a result, those concerned about cost effective and efficient dispute resolution in the construction industry, both within the U.S. and internationally, are following the AFA’s progress through Congress closely.

My thanks to Mr. Ness for making us aware of  the proposed Arbitration Fairness Act pending in Washington, D.C. and its potential impact on the construction industry. Arbitration provisions are bargained for rights in construction contracts.. They are intended to help parties resolve construction claims in an efficient manner. Legislation that potentially impacts contractual rights creates uncertainty which expands the risks associated with construction contracts. Therefore, I echo the warning of Mr. Ness's prescient post: those concerned with cost effective and efficient dispute resolution should follow this proposed legislation closely.

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