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

Arbitrator is defined in my dog-eared college dictionary as "one who is chosen to settle differences between two parties to a controversy." My Black's Law Dictionary, my desk-mate of thirty years, adds an important word-disinterested- to the meaning of "arbitrator," while expounding on the legal aspects of the word: "A private, disinterested person, chosen by the parties to a disputed question, for the purpose of hearing their contention, and giving judgment between them; to whose decision (award) the litigants submit themselves either voluntarily, or, in some cases, compulsorily."

In California, the Code of Civil Procedure refers to a "neutral arbitrator" (section 1280(d)). and while the word neutral is not expressly defined in the statute, Black's tells us the meaning of the word:

Indifferent;unbiased;impartial;not engaged on either side;not taking an active part with either of the contending sides.

Under California law, a neutral arbitrator "shall dislose all matters that could cause a person aware of the facts to reasonably entertain a doubt that the proposed neutral arbitrator would be able to be impartial," including the following:

• Any ground specified for disqualification of a judge.
• Any arrangement or discussion regarding employment or services as a dispute resolution neutral with a party to the proceeding.
• Any matter required to be disclosed by the ethics standards for neutral arbitrators.
• The names of the the parties and lawyers to all prior or pending collective bargaining cases.
• Prior attorney-client relationships with a party or lawyer in the arbitration proceeding.
• Any professional or significant personal relationship between the arbitrator or the spouse or minor child of the arbitrator and any party or lawyer in the arbitration.

Each state has similar disclosure laws to ensure arbitrators are, indeed, neutral, including Texas, where a $22 million arbitration award was thrown out last week by the Fifth District Court of Appeals because of undisclosed social contacts between the arbitrator and the lawyer representing the plaintiff. The same thing happened a few years ago in a California Fourth District Court of Appeals case where the arbitrator previously represented various entities in a complicated insurance syndicate that were connected to the defendant appearing before him in the arbitration. I invite you to read both of these cases, but for my purposes here I will only summarize the alleged conflicts of interests to illustrate the simple (the Texas case) and subtle (the California case) ways such conflicts can arise.

TEXAS CASE

The Texas Court considered the following facts regarding the relationship between the arbitrator and plaintiff's counsel:

• The relationship began in 1994 when the lawyer was a clerk to a judge in the courthouse where the arbitrator was serving as a magistrate judge.
• The arbitrator and the lawyer had a social relationship that included dinners, sporting events, Christmas gifts, numerous business calls and e-mails.
• The arbitrator and lawyer acted as "strangers" when they introduced themselves to each other at the arbitration.

CALIFORNIA CASE

 The arbitrator and his law firm represented "Protections and Indemnity Clubs" which provided insurance and other business services to shipowners and others involved in the maritime industry. The P&I Clubs  procured reinsurance support from syndicates of Lloyd's of London. The respondent in the arbitration proceedings was insured through Lloyd's syndicates, and a representative of Lloyd's was present during the arbitration.

Final Thoughts

In the Texas case, the arbitrator did not recall the extent of the social contacts over a 15 year relationship until his memory was refreshed by his wife after the arbitration was concluded. However, the standard for vacating an arbitration award in Texas is whether a party's rights were prejudiced by the "evident partiality" of the arbitrator. An arbitrator exhibits evident partiality if "he does not disclose facts that might, to an objective observer, create a reasonable impression of the arbitrator's partiality."  

In the California case, the arbitrator apparently did not realize that various insurance syndicates that he and his law firm represented had some kind of connection to a party to the arbitration. However, when a Lloyd's lawyer began to monitor the arbitration, the arbitrator did not make any inquiries to see if there were any conflicts with his existing client base. In the end the California Appellate Court felt that a reasonable person could doubt the impartiality of an arbitrator who provided legal services to an insurance group that may be responsible for paying some part of the potential arbitration award. 

There are any number of reasons for failing to disclose certain facts that have nothing to do with the moral character of the arbitrator, including time constraints, faulty memory, and staffing issues. However, these cases illustrate the caution proposed arbitrators must exhibit prior to the arbitration. From simple facts about social contacts to subtle facts about complicated business structures, arbitrators must spend sufficient time to discover and disclose facts that could affect the perception their impartiality. Once such facts are disclosed, the parties can make an informed decision about selecting the arbitrator. And oftentimes, the parties will select an arbitrator despite the disclosures because of the arbitrator's reputation for honesty, integrity, and fairness-the hallmarks of all good arbitrators. 

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Alternative dispute resolution procedures such as arbitration, mediation, and references to referees are often found in commercial contracts. A recurring issue in the ADR world is the enforceabilty of an arbitration provision when one side claims it is  unconscionable. A companion issue in California is the enforceabilty of provisions that require parties to submit their disputes to a court-appointed referee pursuant to Code of Civil Procedure 638 in the event the arbitration provision is found to be unenforceable.

In cases involving large groups such as tenants or members of home owner associations, a threshold issue is often whether some members of a group can be compelled to submit to the appointment of a referee when other members of the group do not have predispute reference provisions in their contracts for one reason or another. This was the situation in an opinion published last week by the California Supreme Court in a case called Tarrant Bell Property v. The Superior Court of California. 

Here's What Happened

 A couple of years ago, 120 lessees and residents of a mobile home park sued the owners of the park for failing to maintain the common areas and facilities and for otherwise subjecting the residents to substandard living conditions. The standard lease agreement provided that any landlord-tenant disputes would be resolved through arbitration but if the arbitration clause was deemed unenforceable the parties would submit their dispute to a court-appointed referee. However, the arbitration and reference provisions were found in only 100 of the 120 leases at issue.

In response to the lawsuit, the park owners filed a motion to compel arbitration, or, in the alternative, for an appointment of a referee. The tenants opposed the motion, arguing the arbitration and reference provisions were unenforceable and that, because some of the leases did not include the arbitration and  reference provisions, the motion should be denied to avoid the risk of conflicting rulings on common issues of law and fact.

The trial court denied the park owners' motion to compel arbitration on the grounds the arbitration agreement was unenforceable. The court also declined to enforce the predispute reference provision because of the possibility that the tenants could face inconsistent results even though they were experiencing the same problems at the mobile home park. In other words, the tenants with leases containing the reference provision would have there disputes reviewed by a referee in one proceeding while the other tenants who were not bound by the predispute provision would have their disputes resolved in court by a judge. This presents a question of fairness as the judge might not rule the same way as the referee on common questions of law and fact. Same problem; potentially different results. Unfair.

The park owners petitioned the Court of Appeal for a writ of mandate seeking to vacate the trial court's order denying their motion to appoint a referee. The Court of Appeal denied the writ, finding the trial court had the discretion to refuse to enforce the reference provision because of the possibility of conflicting rulings and other issues related to the efficient resolution of disputes.

The park owners appealed to the California Supreme Court. The Court affirmed the decisions of the lower courts, holding the legislative history of Code of Civil Procedure 638 establishes an intent to give trial courts the discretion to deny a request for the appointment of a referee when the potential for inconsistent findings is present. The Court also noted its disapproval of two appellate decisions to the contrary.

 Lessons Learned

 Some ADR provisions in commercial contracts are written with a belts and suspenders approach. Such contracts have arbitration as the first option for dispute resolution. If a court later finds that the arbitration provision is unenforceable, an alternative provision requires that the dispute be submitted to a court-appointed referee. 

Despite the careful drafting of such ADR provisions, disputes, like a baggy pair of pants, can fall to the ground when the most obvious details-like buckling and fastening-are not  considered. In California, you had better be sure the ADR provisions you spent so much time, effort and money preparing are actually found in the signed contracts of your opposition, especially when you are dealing with large groups of people such as tenants and home owner associations.

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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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