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May 2007
14
May 14, 2007

Arbitration Agreements in Construction Not Fail Safe

Arbitration agreements are common in the construction industry. But they may not keep you out of court when disputes arise on a project unless the agreements include some "magic" language required under Michigan law.

Arbitration clauses have been included in standard construction contracts for many years. The clauses typically apply to disputes between all parties involved in a construction project. The rationale behind the broad use of arbitration provisions is that arbitration is a faster, cheaper and less business-disrupting alternative for resolving disputes than traditional litigation in the courts.

In Michigan, the courts recognize two kinds of arbitration agreements: "common-law," an agreement revocable by either party, and "statutory," an agreement binding on both parties. While most standard-form construction contracts include enforceable "statutory" arbitration clauses, some of the terms of those contracts may be deleted or changed during contract negotiations. And in some cases non-standard contracts are used. It is in these situations that understanding the distinction between common-law and statutory arbitration may be important.

The parties to a construction contract generally agree in writing that disputes arising from the work will be submitted to arbitration rather than the courts. (In fact an oral agreement to arbitrate disputes is also enforceable, but only as a "common-law," revocable agreement.) To be a "statutory" arbitration agreement, the clause must specifically state that "a judgment of any circuit court may be rendered upon the (arbitration) award made pursuant to such agreement." Then neither party has the power to revoke the agreement without the consent of the other party. (The referenced Michigan statute is The Michigan Arbitration Act, at MCL 600.5001 et seq.) If the arbitration provision does not include this "magic" language then it is a "common-law" arbitration agreement. And as held by the Michigan Supreme Court as recently as May 4, 2006 (in Wold Architects and Engineers v Thomas Strat, et al), "common-law" arbitration agreements may be revoked unilaterally by either party up to the time any final award is issued by an arbitrator.

Parties negotiating construction contracts without the benefit of advice by an attorney may be unhappily surprised to learn after a dispute has arisen that the other party can ignore a signed agreement to arbitrate all disputes and instead file suit in court, or force the other party to file a lawsuit to resolve the dispute. A party may spend substantial money and time preparing for and even going through an arbitration process only to have the arbitration agreement revoked before the arbitrator renders her decision.

On the other hand, knowledge of the difference between common-law and statutory arbitration agreements can give the knowledgeable party some options and perhaps a strategic advantage over another party to the contract who is not aware of the distinction. A party who understands this distinction may prefer to include only a common-law arbitration provision in the contract even if that party would generally prefer to arbitrate rather than litigate. The unaware party is likely to believe, incorrectly, that the arbitration clause is binding and any disputes will be decided by arbitration rather than litigation. But by using only the common-law form of arbitration provision, the more sophisticated party leaves itself the option of litigation. For example, a large general contractor with sufficient resources to fund expensive, protracted litigation might prefer to litigate, or threaten to litigate a dispute with a relatively small, poorly-funded subcontractor or supplier, knowing that the threat of expensive and lengthy litigation might cause the subcontractor to withdraw a claim or settle for less than it might have otherwise. By using only a "common-law" arbitration clause, the general contractor effectively gives him options. If on the other hand a party to a construction contract prefers certainty and predictability and believes that arbitration is always preferable to litigation, that party may want to ensure that the arbitration provision meets the statutory requirements to be deemed a "statutory arbitration," an agreement which cannot be revoked.

There are other issues and strategic implications involved in drafting and negotiating arbitration agreements, as well as the other provisions in construction contracts.

The take-home lesson here is that not all agreements to arbitrate really mean what they say.

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Rodrick W. Lewis, an attorney with Warner Norcross & Judd, specializes in litigation, business, construction and professional malpractice.

MiBiz West

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