A construction contractor wins a $30 million contract to expand and upgrade a city’s wastewater treatment plant. During construction, weather, engineering issues, and other unforeseen problems cause the contractor to fall behind schedule, and the city terminates the contractor for default. The city contends that not only was the termination proper, but the contractor also owes the city almost $14 million for costs to complete the project. The parties agree to submit their dispute to arbitration, and eighteen months later, the arbitral tribunal issues an award agreeing with the city that the contractor’s termination was for cause, and that the contractor now owes the city nearly $15 million. The contractor demands that the tribunal modify the award, arguing that the arbitrators had not deducted the contract balance, but the tribunal denies the request, claiming that the award was not erroneous, and that the tribunal had no obligation to provide a detailed award.
The city then seeks to enforce the award in federal district court, and the contractor and surety move to vacate the award they see as obviously erroneous. The parties expend a great deal of time and money briefing the motions and eventually appealing, re-litigating much of the case in the process. After a decade of legal maneuvering set in motion by the termination, and four years after the parties agreed to settle their dispute via arbitration, the circuit court of appeals holds that the contractor has failed to show the award should be vacated, and the contractor is therefore liable. The contractor ends up paying $16.3 million to the city on top of hefty costs from years of litigation. Soon after, the contractor closes its doors.
Arbitration has become commonplace in the construction industry in recent years as owners, contractors, and others acted on arbitration’s reputation as less expensive and less risky than litigation in court. When everything functions smoothly, arbitration resembles a sleeker, streamlined version of litigation. Advantages include simplified procedures, limiting costly discovery and depositions, the availability of experienced arbitrators to render decisions (as opposed to unpredictable juries), and greater finality due to the extremely limited avenues for appeal of an arbitral award. However, as the above story – drawn from the facts of MCI Constructors, LLC v. City of Greensboro, 610 F.3d 849 (4th Cir. 2010) – illustrates, the streamlined and final nature of arbitration can turn from a blessing to a curse when the outcome of the arbitration is highly questionable.
In response to such concerns, the American Arbitration Association (AAA) and International Centre for Dispute Resolution (ICDR) recently released a new set of rules – dubbed the “Optional Appellate Arbitration Rules” – for use in AAA/ICDR arbitrations. These rules may prove useful in the complex realm of construction litigation as they will allow parties to seek meaningful, unbiased review of an award without the often insurmountably-high standard of review which courts apply to arbitration awards.
Determining whether the Optional Appellate Rules are suitable for your business and your projects requires carefully evaluating the potential risks and benefits of these Rules and their potential impact upon your litigation strategy. In this article, we will first examine why parties may wish to use the Optional Appellate Rules, and then consider features of the rules you should weigh when evaluating their potential use in future disputes.
The Problem: Federal Courts Provide Only Limited Review Of Arbitral Awards
The limited ability to appeal an arbitral award has long been a central feature of arbitration, making it particularly attractive to businesses and other parties that value finality and certainty. In this regard, the Federal Arbitration Act (FAA), 9 U.S.C. §§ 1-16, provides expedited methods for federal courts to confirm, modify, or vacate arbitral awards, but these methods do not provide for meaningful appellate review. Instead, after issuance of the award, the prevailing party may file a motion in federal district court to confirm the award. If the court grants the motion, the award becomes the subject of a judgment that may be enforced just as any other judgment issued by a federal court. 9 U.S.C. § 9. The procedure is simple, and the court must grant the motion unless grounds exist to vacate, modify, or correct the award. Id.
If a party to an arbitration believes the award to be inaccurate or incorrect, the party may request the court vacate or modify the award. Yet, the basis for vacating an award is limited to allegations of fraud, evident bias on the part of the arbitrator(s), procedural misconduct by the arbitrators, or instances where the tribunal exceeded its power under the arbitration agreement. 9 U.S.C. § 10. Similarly, a court may only modify an arbitral award to correct an obvious miscalculation or other superficial defect in form not affecting the merits of the dispute. 9 U.S.C. § 11.
Finally, some jurisdictions allow a court to vacate an award for a “manifest disregard” of the law. Generally speaking, to establish a manifest disregard for the law, the losing party must show that “(1) the applicable legal principle is clearly defined and not subject to reasonable debate; and (2) the arbitrator[ ] refused to heed that legal principle.” Wachovia Sec., LLC v. Brand, 671 F.3d 472, 481 (4th Cir. 2012);see also id. at 481 n. 7 (noting split among circuit courts regarding exclusivity of FAA, 9 U.S.C. §§ 10-11, as grounds to vacate arbitral award). Proving manifest disregard of the law in the context of construction litigation can be particularly challenging given that many jurisdictions lack “clearly defined” legal precedent that is “not subject to reasonable debate.” Thus, as MCI Constructors learned first-hand, vacating or modifying an arbitration award can be exceedingly difficult even if it the arbitration panel decided the matter incorrectly.
The AAA’s Solution: The Optional Appellate Arbitration Rules
The AAA’s Optional Appellate Rules create an alternative path for parties who are willing to sacrifice some finality in the interest of obtaining the “correct” outcome. The full text of the rules is available via the AAA’s website at http://go.adr.org/AppellateRules, but those in the construction industry should take note of certain features of the following new rules.
Using The Optional Appellate Rules
Just as with arbitration itself, all parties must consent to use of the appellate rules either by contract or stipulation. The AAA provides suggested contract language to invoke the Optional Appellate Rules, provided that a standard arbitration agreement is already in place. This language makes clear that any award issued by the arbitral tribunal does not become final until the time to pursue an appeal has elapsed. In effect, this prevents the prevailing party from immediately moving to confirm the award in court. Of course, parties may also elect to use the Optional Appellate Rules after the dispute has arisen by using similar language in a stipulated agreement. Without an agreement executed by all parties containing language specifically invoking the rules, the Optional Appellate Rules do not apply and all parties are limited to the narrow scope of review afforded by the federal courts.
Selecting The Appellate Arbitrators
The Optional Appellate Rules handle arbitrator selection in much the same way as the AAA’s arbitration rules. The parties are free to negotiate their own process for selecting arbitrators, and may also choose the size of the appellate tribunal. Otherwise, Rule A-5 states that, upon receipt of a Notice to Appeal, the AAA will send each party an identical list of ten potential arbitrators selected from AAA’s Appellate Panel, from which three appellate arbitrators will be appointed after the parties strike objectionable names and rank those remaining. If the parties have requested arbitrators with specific qualifications, the AAA will consider these preferences when creating the initial list of potential appellate arbitrators. Rule A-4 requires that any appellate arbitrators shall be selected from the AAA Appellate Panel, which the AAA states is comprised of former federal and state judges, plus neutrals with strong appellate backgrounds. Furthermore, Rule A-4 requires that nominated arbitrators disclose any circumstances that may create an appearance of bias or a conflict of interest.
As any party or attorney with AAA arbitration experience will be aware, selecting an arbitral tribunal is a critical first step that has the potential to affect the outcome of the arbitration itself: contractors often select arbitrators with experience working for and with other general contractors, and owners, subcontractors, and others proceed likewise. Depending on the makeup of the AAA’s panels, parties using the Optional Appellate Rules may engage in similar wrangling to achieve what appears to be a favorable appellate tribunal. Because the appeal process is initiated after the conclusion of the arbitration, the parties could find it difficult to reach agreement on an appellate tribunal due to the increased stakes at that stage. However, if the AAA panels are indeed composed of former judges and experienced neutrals, the consequences of a AAA-selected tribunal should be relatively limited.
Review Of An Arbitral Award
The Optional Appellate Rules do not displace other arbitration rules providing for the modification of awards, such as found in AAA’s Commercial Rules. If a party merely seeks to modify or correct a mistake in an award, that party must first pursue those remedies in the initial arbitration, though the party may appeal a tribunal’s denial of such a request. A party initiates an appeal by filing a Notice of Appeal with any AAA office, stating the relevant details of the initial arbitration, and noting the portions of the award being appealed and the errors alleged. Any other party may file a Cross-Appeal within seven days of filing of the Notice.
The appellate tribunal has the authority to review an award for material and prejudicial errors of law, or determinations of fact that are clearly erroneous, a standard of review similar to that applied by appellate courts. The tribunal bases its decision on the record on appeal, assembled mutually by the parties. In many arbitrations in the construction industry, the parties do not use a court reporter to transcribe the hearings—note that while the rules do not require the parties to submit a transcript of the arbitration, the tribunal may consider excerpts of any transcript as part of the record on appeal. A transcript may prove particularly useful when attempting to show an incorrect factual finding, and parties should consider using a stenographer in arbitration if an appeal via the Optional Appellate Rules is a possibility. Otherwise, the record on appeal consists of any expert reports, deposition transcripts, documentary evidence, briefs, or other materials presented at the arbitration. Just as in the court system, a party may not present an issue on appeal that was not raised at arbitration.
After the parties compile the record on appeal, the relevant parties file and serve an Initial Brief, an Answer Brief in response, and a Reply Brief, plus any additional briefing for Cross-Appeals. Pursuant to Rule A-15, appeals will normally be determined based only on the written materials compiled and filed by the parties. A party may request oral argument within thirty days of the Notice of Appeal, but the appellate tribunal has discretion to determine whether oral argument is necessary. If the tribunal grants a request for oral argument, the hearing must be scheduled to take place within thirty days of the last brief’s filing.
Once the appellate tribunal reviews the record and the parties’ briefs, Rule A-19 requires that the tribunal either adopt the original award, substitute a new award, or request additional information from the parties. The tribunal may, in effect, “affirm” the arbitral tribunal by adopting the original award. If the appellate tribunal finds that the original award is erroneous, the tribunal issues a new, substitute award that corrects any errors in the original, and adopts any portions of the original award that are not vacated. In either case, the prevailing party may then move a federal district court to confirm the now-final award. Decisions must be made by a majority of the appellate tribunal, and the rules expressly prohibit the tribunal from ordering a new arbitration hearing or remanding the case back to the original arbitral tribunal.
Timeline Of Appeal Process
In drafting the Optional Appellate Rules, the AAA obviously intended to preserve the significant advantage in speed that arbitration typically enjoys over the court system. Indeed, the AAA’s press release describing the rules notes that the appeal process can be completed in “about three months.” The rules impose twenty-one day filing deadlines for briefs, and a thirty page limit on opening and responsive briefs. Even the appellate tribunal faces deadlines, as it is required to either rule or request more information within thirty days of the last brief (though the tribunal has the option to delay its ruling by up to thirty days). If an appellate arbitration follows the schedule laid out in the rules, with no extra time and no cross-appeals, the appellate tribunal must issue a decision 103 days after the Notice of Appeal. Of course, if the parties agree to extend deadlines, the tribunal decides to hold oral arguments, or a party files a cross-appeal, this time frame will grow longer. We will not know how closely appellate tribunals will be able to follow this timeline until litigants test the waters, but the rules themselves appear designed to avoid drawn out delays after the conclusion of arbitration
Costs And Allocation Among Parties
Any party that wishes to appeal an arbitral award under the Optional Appellate Rules must pay a non-refundable $6,000 administrative fee upon the filing of a Notice of Appeal, and any party filing a cross-appeal must pay the same non-refundable fee. Where there is no cross-appeal, the appealing party is responsible for all fees and costs, including AAA administrative fees and the fees of the appellate tribunal members. If there is a cross-appeal, the appealing parties share the costs equally. Obviously, an additional appellate arbitration will add to litigation costs, especially if only one party appeals. Rule A-1, however, allows the tribunal to reallocate the parties’ shares of fees and costs in the award, and it seems likely a party could request such a reallocation based on the merits of the appeal. Nonetheless, take note that Rule A-11 grants the tribunal the discretion to award reasonable costs and attorneys’ fees (if a statute or the parties’ agreement authorizes an award of attorneys’ fees) to the non-appealing party if the appealing party does not prevail. Indeed, a frivolous appeal under the Optional Appellate Rules may prove quite costly to the appealing party.
Clearly, the AAA has taken notice of frustrated litigants’ attempts to seek judicial review of arbitral awards in the federal courts via the mechanisms allowed under the FAA. The new Optional Appellate Rules are a means by which parties ensnared in large and complex disputes, such as those in the construction industry, can preserve their ability to appeal an adverse award as if they were in court, while also enjoying the streamlined procedure, speed, confidentiality, and other benefits of arbitration. These rules are new and untested, and are certainly not without drawbacks. Yet, even the drawbacks may be a small price to pay to minimize the risk of an adverse, incorrect, and effectively final arbitral award.