Arbitration Road Blocks and Detours

When you sign a contract to buy a car or a cellphone, or apply for a credit card, you’re probably agreeing to arbitrate disputes. Why? Because lawyers who write these contracts agree. Arbitration saves time and money. And sellers usually win in arbitration.

So why doesn’t every construction contract require arbitration? Easy question. An agreement to arbitrate is an agreement not to litigate – sue in a court of law. That’s giving up an important right.

There are two broad currents running here -- in opposite directions. One limits access to arbitration. Another encourages arbitration. I’ll explain.

The current running against arbitration flows through state legislatures. Eleven states (CA, IL, MD, MA, MO, NE, OR, PA, SC, TX and VT) void any arbitration clause in a construction contract if the agreement omits certain disclosures. For example, specific language has to be in a certain location or in bold type or in caps or be initialed by the owner. Make a mistake in the contract and your dispute is headed to court. Why all these restrictions? Simple. It’s consumer protection law. No one should give up the right to sue by accident.

A second current runs in the opposite direction. Judges favor arbitration. It reduces their workload. Any hint in the contract that the parties agreed to arbitrate will get a sympathetic hearing in court.

Case on Point

Here’s an example, the recent California case of Leeor Builders, Inc. v. Forehand. You decide if the court got it right.

Leeor Builders agreed to improve LeRoy and Elizabeth Forehand’s southern California home. Near the bottom of the first page of the contract was a box with the text:

"ARBITRATION OWNER: Initial this box if you agree to arbitration.” The box was large enough to fit only one set of initials. In the box was written "EF" for Elizabeth Forehand.

The arbitration notice required by California law (in 10-point bold type) was on another contract page:

WE HAVE READ AND UNDERSTAND THE FOREGOING AND AGREE TO SUBMIT DISPUTES ARISING OUT OF THE MATTERS INCLUDED IN THE 'ARBITRATION OF DISPUTES' PROVISION TO NEUTRAL ARBITRATION.

Initials of “Direct Contractor” and Elizabeth were beside that notice. LeRoy’s initials are missing. He signed the contract but never initialed the agreement to arbitrate.

Below the space for initials, the contract provided, "in the event that Contractor and Owner have not each initialed the arbitration provision above, then it shall be conclusively agreed without a subsequent written agreement by all parties, that neither party agrees to arbitrate and the arbitration of disputes provision shall not be deemed to be a part of this agreement."

No doubt about who the “Owner” is, both LeRoy and Elizabeth Forehand. If Elizabeth agreed to arbitrate and LeRoy didn’t, then the contract did not require arbitration.

You can guess what came next. The Forehand job had problems. Eventually LeRoy brought a demand for arbitration. Leeor Builders objected, insisting the arbitration agreement was invalid. The reason: LeRoy was an owner, just like Elizabeth. Le Roy never initialed the arbitration clause required by California law. When the arbitrator refused to halt the proceeding, Leeor filed a complaint in superior court, asking for an injunction to stop arbitration.

This wasn’t a trivial issue. The arbitrator’s award came to $902,749. Now the court had to decide, does California law require initials of all owners. Or is one owner enough. The court’s decision: Elizabeth's initials were enough. The arbitrator’s award was confirmed. Hard cases make bad law.

Now you see the current running two ways. State law throws up road blocks to arbitration. State courts favor arbitration.

This time, I think the court got it right. But next time? Suppose one owner really didn’t want to arbitrate and refused to initial the contract. What then? In my opinion, the California legislature wanted to protect all owners. Any owner should be able to object to arbitration. Just don’t initial the arbitration notice.

If You Decide to Arbitrate

Don’t take a chance. Get the details right. Comply exactly with the laws of your state.

• The contract has to be clear, “owner and contractor will submit all disputes related to this job to binding arbitration.”
• Identify the arbitrator. AAA, CDRS and JAMS provide arbitration services nationwide. Disputes under $10,000 can usually be settled by email or video conference.
• Identify the arbitration rules. AAA, CDRS and JAMS rules are considered both fair and comprehensive.
• Make the arbitrator’s decision final. The words are, “Judgment on the award may be entered in any court having jurisdiction.”

Construction Contract Writer will help get it right, no matter the type of work or job site. The trial version is free.