This feature is a part of "The Dotted Line" series, which takes an in-depth look at the complex legal landscape of the construction industry. To view the entire series, click here.
Many construction projects turn out just as all parties expect — the job gets finished on or near schedule, and everyone gets paid for the work they completed.
However, once in a while, there is a disagreement too contentious or too large in scope to be worked out during a few job site meetings. Without a firm dispute resolution process in place, these conflicts can quickly get out of hand. However, most standard forms of construction contracts outline the steps necessary to achieve a fair outcome.
There are typically three major types of dispute resolution procedures referenced in a contract — mediation, arbitration and litigation. All parties involved with a construction contract need to explore which option is right for them and the project, and also ensure their contract terms are as clear as possible to avoid potential problems down the road.
Mediation is usually the first contractual step in resolving a dispute. It is also required in most standard construction contracts before the parties can move on to arbitration or litigation. However, as far as non-binding procedures go, mediation is often successful in getting all parties to look at conflicts and come to an agreement before launching into the more expensive alternatives. In mediation, all sides choose a neutral party to take a look at the situation, hear arguments and then make a decision.
"The proliferation of mediation, both before and during the proceedings, has greatly affected the number of cases that proceed to court," said Kimberly Ashby, partner at Foley & Lardner in Orlando, FL. A qualified mediator will quantify the issues at hand and typically make one or more parties realize that they would not be making a smart business decision "by rolling the dice" and pushing for litigation, she said.
"The proliferation of mediation, both before and during the proceedings, has greatly affected the number of cases that proceed to court"
Partner at Foley & Lardner
However, not every case is suitable for mediation, according to John Patrick Curran, partner at Sive, Paget & Riesel in New York. "If the parties are so far apart that a compromise isn’t realistic, then mediation makes no sense," he said. Curran did agree with Ashby that mediation can often prod one or more parties into coming to grips with how realistic their chances are. "A mediator gives the clients, more than anything, a very frank assessment of the merits of their prospective cases," he said. "If the client doesn’t listen to his attorney, he might listen to the mediator."
Cost is also a factor in mediation’s success, according to Ashby, as the prospect of pricey arbitration and litigation expenses make those options less attractive. In addition to a fatter project bottom line — minus the flood of legal bills — mediation can also be the process by which both parties can, for example, demonstrate to major project stakeholders that they can resolve their issues, increasing the chance of future repeat business.
Arbitration vs. litigation
If mediation fails, then it's typical for arbitration or litigation to follow. These two are an "either-or" prospect, as the parties must typically choose one or the other when they sign the construction contract. "Arbitration and litigation are the two last chances," Curran said. "It would take the teeth out of arbitration if they could go to court after."
Arbitration comes in many forms, from one person to a panel of three or more arbitrators deciding the case, but no matter what the arbitration panel looks like, the decision is binding. Arbitrators can be lawyers, architects, engineers, general contractors — anyone qualified to understand the details of a construction dispute and come to a fair decision.
The contract will often specify that arbitrators come from organizations like the American Arbitration Association or JAMS (Judicial Arbitration and Mediation Services). These professional groups not only provide a list of arbitrators but can also handle the administration process, such as collecting fees, conducting conflict checks and making disbursements to the arbitrators.
"A mediator gives the clients, more than anything, a very frank assessment of the merits of their prospective cases"
John Patrick Curren
Partner at Sive, Paget & Riesel
So which should a construction firm choose? "Many believe that arbitration favors contractors," Curran said. First, he noted that approximately nine out of 10 disputes are payment related. Arbitration is a much faster process than a court proceeding, which means that if the contractor prevails, they get their money a lot faster.
Arbitrators also have a lot more leeway in making their rulings and don’t necessarily have to abide by prevailing law, Curran said, relying on what they consider fair. If a contractor believes the case will benefit from that flexibility, then arbitration could be the way to go.
In fact, Curran said that once an arbitrator has made a decision, a court of law cannot reverse it or modify it unless it finds the arbitrator acted in bad faith or was arbitrary in the decision-making process. On the other hand, in traditional litigation, an appeals court could decide if a lower court applied the law correctly.
Arbitration isn’t always the cheapest option, though. Each arbitrator — particularly if they are attorneys — typically bills at an hourly rate. If there are three or four arbitrators on the panel, all billing per hour for two or three weeks, that can add up to a significant amount of money.
Another question to be considered when deciding on litigation or arbitration as a final method of dispute resolution is whether a jury will be able to come to a reasoned decision if the members don’t have any construction experience or background, according to Ashby. If the issues at hand are nuanced, a court might not be the best place for a contractor to bring a dispute.
The importance of planning
There’s not much deviation between dispute resolution terms in standard contracts issued by organizations like the American institute of Architects or Design Build Institute of America, as most utilize the same stepped approach, but there are some clauses that should throw up red flags that are unenforceable.
For example, Curran said that in New York, it’s illegal to insist that dispute resolution take place in another state if the project is being constructed in New York. This stipulation varies from state to state. In addition, Curran said a "you can’t sue me for any reason" clause is unenforceable, partly because it would void lien rights under many state laws.
"The contract should provide specific answers and procedures to resolve typical questions that arise during construction"
Partner and leader of the construction planning practice group at Honigman Miller Schwartz and Cohn
Perhaps the most important aspect of dispute resolution is to minimize the chance of conflict before disagreements rise to the level of "disputes" or "claims," according to Margaret Greene, partner and leader of the construction planning practice group at Honigman Miller Schwartz and Cohn in Detroit.
The first step is careful project planning. Contractors should make an effort to identify potential problems in advance and come up with alternative solutions before they’re needed, Greene noted. Similar care needs to be taken with contracts as well. "The contract should provide specific answers and procedures to resolve typical questions that arise during construction," she said.
For example, Greene said that instead of using the term "reasonable" for items like markups and time limits, parties should be specific and identify exact markups and time limits. The goal here, she said, is to reduce the number of items over which parties can argue.
Greene also said it’s important to keep contract terms realistic. "A contract that is over-the-top and one-sided may not hold up during construction," she said. "This happens when the contract cannot be enforced in the field as a practical matter, and the owner and contractor representatives resolve issues by ignoring the contract and making up their own rules in the field." When a conflict does arise in this situation it’s difficult for the parties to know how to deal with it.
Greene added that "diligent contract administration" can also help to head off contract disputes. "Some disagreements — change orders, open issues, delays — morph into claims simply because they haven’t been resolved by the end of the project," she said.
Nevertheless, contractors need to be aware that dispute resolution clauses can vary from contract to contract, and enforceability can differ from state to state. "There is a danger of relying solely on form documents without taking into consideration the state law which will apply to that contract," Ashby said.
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