Arbitration of Construction Disputes: Benefits and Drawbacks

Arbitration is an alternative dispute-resolution process that uses a neutral third party to make a binding decision. Disputes are inevitable in any business or partnership, but most do not expect future litigation against the other party. However, in the construction industry, the average value of disputes in North America increased by 42% in 2023, according to a report from Arcadis. And 70% of construction projects end up with claims.

Increased caseloads have created a backlog, delaying federal and state court dates and making it much harder for any party pursuing a claim to be heard in court. Awaiting trial could take years—especially in a post-pandemic world. While waiting for long periods of time, the party can lose money on the claim from lost operating funds, loss of use of money, costs from legal fees, and inflation. Construction projects are ending up in litigation at higher rates than ever before.

Alternative dispute resolutions (ADR), or external dispute resolutions have continued to grow in response to the difficulties of taking disputes to court. Arbitration of any construction dispute has become popular among owners, subcontractors or contractors for less costly methods of pursuing their claim or settling a dispute. The American Arbitration Association (AAA) has administered and resolved 54,226 cases this year between Jan. 1 to Feb. 5, which reflects turning away from judicial systems and favor in arbitration. “All parties in favor of arbitration to a construction contract should be aware that arbitration is an available alternative to traditional litigation of claims,” said Christopher Ng, managing partner at Gibbs Giden Locher Turner Senet & Wittbrodt LLP (Los Angeles, CA). “But at the same time, arbitration isn’t always the most ideal solution to all claim situations. A party may desire to litigate rather than arbitrate certain disputes.”

Unlike a court or jury trial, arbitration can consist of documentation only, but if both parties want to speak their arguments, attorneys must be present. So, before you decide to resolve your claim or dispute through arbitration, read to understand both its advantages and disadvantages:

Advantages

Impartiality. Both parties involved in the dispute can pick an arbitrator together ensuring confidence of unbiased and impartial judgement. Also, many arbitrators in construction claims are typically retired lawyers or judges who have expertise in the field of law that relates to your case. “A lawyer who has spent their career in the construction industry and has a basis of knowledge that is broader than a judge is very beneficial,” said Michael Murray, Esq., associate attorney at Lanak & Hanna, P.C. (Orange, CA). “It’s beneficial for you to the extent of having someone who’s knowledgeable in the area of law that encompasses your case.”

Timeliness. Arbitration cases are likely to be resolved in a shorter amount of time because legal rules of evidence and procedures do not apply to arbitration. This means both parties can save months, if not years on hearings. “If you’re engaged in the building of a large-scale or industrial complex, have to get it done in a certain time frame and you run into a problem, arbitration has the advantage of speed,” said Emory Potter, Esq., partner at Hays & Potter, LLP (Peachtree Corners, GA). “Speed is a main factor in arbitration. Crowded court calendars prevent most construction disputes from being heard until several years after the suit is filed mainly for disputes that require longer trials, like those involved in large, complex projects.”

Efficiency. Time saved is money earned. Arbitration can provide quick and inexpensive means to resolve construction disputes. It eliminates many of the prerequisites to a lawsuit, such as discovery and pleadings, which are costly to all parties in terms of both time and money, explained Ng. “Unlike litigation, arbitration doesn’t require pleadings, legal memoranda, or other costly trappings of a formal lawsuit,” Ng said. “Most of the time, attorneys and expert witnesses charge hourly or daily rates during trials that are way higher than their rates for trial preparations. But arbitration hearings are usually scheduled with the needs of both parties and the arbitrator in mind so that everyone’s daily professional lives can continue while the arbitration hearings are happening.”

Privacy. Trials are usually very public, but arbitration comes to a private resolution. Information in an arbitration dispute can be kept confidential and is beneficial for more well-known or public figures and clients in business disputes. All arguments, statements and evidence are kept private.

Disadvantages

Contract technicalities. One of the disadvantages to arbitration is some contractual preconditions. For example, a construction contract may require that the dispute be submitted to the architect before seeking arbitration. “The contractor will most likely be reluctant to do so if it believes that a favorable decision will not be received from the architect, who may be slow to act,” said Ng. “If the contractor proceeds to invoke arbitration, the owner may point to the contractor’s failure to submit the dispute to the architect as a reason why arbitration should not go forward.”

Cost. Most costs are determined by the amount of money sought in an arbitration dispute. High-quality arbitrators can demand loaded fees that wouldn’t necessarily apply in court. Also, contractors must pay the arbitrator’s fee in full. “As the amount of the controversy increases, the amount you pay the company increases, and the more money in the dispute, the more the arbitrator charges you for it versus one filing fee in a court system,” said Potter. “I think it can be more hurtful than helpful to credit professionals in construction because extra fees add up to hundreds of thousands and you don’t know for sure if you’ll collect.”

Unpredictability. One of the biggest drawbacks to arbitration is that arbitrators are not required to follow every word of the law—and arbitration awards are not reviewable by courts for errors of fact versus law. “If the parties by contract choose arbitration, then the grounds for appeal will be extremely limited,” said Ng. “It’s also not required to have participation of all parties needed to fully resolve a particular dispute. Some third parties will not have agreed to arbitration in a contract and, therefore, cannot ordinarily be compelled to participate. Another reason for choosing the court system over arbitration is the desire to defuse the opponent’s equitable arguments, which may be more appealing to a panel of arbitrators than to an experienced trial judge.”

To connect with experts in the construction industry, visit NACM’s Secured Transaction Services (STS) website, or email Chris Ring at ChrisR@nacm.org.