Arbitration has long been used to resolve construction disputes, often because it is perceived as being faster, less expensive, and less formal than litigation. Additionally, many believe that judges and juries will not understand the nuances of the construction process as well as arbitrators, who often have substantial construction industry experience.
That said, sometimes the party having the higher-tier position (e.g., an owner contracting with a general contractor or a general contractor contracting with a subcontractor) would rather not arbitrate its disputes. A common reason for this is that the party in the higher-tier position is more likely to have procedural defenses to the claims of the lower-tier party.
Further reading:
Court rules against DOT’s disadvantaged business enterprise program
Expert witnesses are crucial in court; don’t lose one on a technicality
Expanding liability for design professionals: The hits just keep coming
These procedural defenses include arguments that the lower-tier party failed to meet contractual notice requirements or that its claims are subject to contractual disclaimers, such as the “no damages for delay” clause. While arbitrators are charged with following contracts, some higher-tier parties perceive that arbitrators will ignore procedural defenses if applying those defenses would reach unfair results.
Because of these concerns, some higher-tier parties require disputes to be litigated or will allow only small-dollar claims to be subject to arbitration. Others have tried to have it both ways by making the choice of arbitration subject to the sole decision of the higher-tier party. Is that acceptable? That was the question considered by the New Mexico Court of Appeals in Atlas Electrical Construction Inc. v. Flintco LLC, a case involving a general contractor and its subcontractor.
Interestingly, in this case it was the general contractor that found arbitration to be advantageous, whereas the subcontractor wanted to be in court. As evident by the title of this column, the court found that the general contractor could not be the one deciding where the dispute was to be heard.
The case
Flintco contracted with the city of Albuquerque, New Mexico, for renovations of the Albuquerque International Sunport, the state’s primary international airport. Flintco entered into a subcontract with Atlas, where Atlas was to perform electrical work on the project. The subcontract’s disputes clause stated in relevant part:
In the event (Flintco) and (Atlas) cannot resolve the dispute through direct discussions or mediation … then the dispute shall, at the sole discretion of (Flintco), be decided either by submission to (a) arbitration … or (b) litigation.
Under the subcontract, the term “dispute” included all claims between Atlas and Flintco arising out of the subcontract, including breach of contract.
Atlas filed a lawsuit against Flintco in federal district court. Flintco decided it wanted to arbitrate the dispute and filed a motion to compel arbitration. The lower court granted the motion, finding there was nothing procedurally or substantively unconscionable about the provision. Atlas appealed this ruling to the New Mexico Court of Appeals.
The holding
The appeals court’s decision was based upon its examination of the subcontract disputes clause to determine whether it was either procedurally or substantively unconscionable. It explained that the substantive analysis focuses on such issues as whether the contract terms were commercially reasonable and fair, the purpose and effect of the terms, the one-sidedness of the terms, and other similar public policy concerns. Procedural unconscionability, on the other hand, “goes beyond the mere facial analysis of the contract and examines the particular factual circumstances surrounding the formation of the contract, including the relative bargaining strength, sophistication of the parties, and the extent to which either party felt free to accept or decline terms demanded by the other.”
Atlas conceded that the arbitration clause was procedurally conscionable, acknowledging that both it and Flintco were sophisticated commercial entities and that Atlas had the ability to freely negotiate the subcontract. Consequently, the only issue before the appeals court was whether the clause was substantively unconscionable.
The decision noted that this was the first time the court was being asked to consider this issue, as much of New Mexico case law on arbitration was in the context of consumer contracts where, as the decision noted, “procedural unconscionability is often present due to the unequal bargaining power of the parties.”
Relying upon a 2020 New Mexico Supreme Court decision, the appeals court stated that when an arbitration agreement is facially one-sided, the drafting party needs to present evidence justifying that the agreement is fair and reasonable. Flintco conceded that the subcontract’s disputes clause was facially one-sided, in that Flintco had sole discretion to decide whether to arbitrate.
However, it argued that the agreement was fair and reasonable because Flintco – as the general contractor – was bound by the prime contract, which required all contractual disputes to be arbitrated, and was subject to personal injury claims, which were not subject to arbitration, arising from the project construction site.
The appeals court found that Flintco’s contractual obligations under the prime contract and its exposure to third-party tort liability were “not relevant to the commercial reasonableness of an arbitration clause that grants (Flintco) the sole discretion to decide disputes arising from the subcontract with (Atlas) by arbitration or litigation.”
It specifically found that Flintco’s assertions failed to justify why Flintco had the sole power to decide whether Atlas arbitrates or litigates its claims arising from the subcontract.
The court further found that Flintco failed “to identify any ‘legitimate, neutral reasons’ for it to exercise exclusive control over the manner in which any dispute arising from the subcontract is resolved.” As a result, the court concluded that the district court erred in determining that the provision was not substantively unconscionable. It sent the case back to the district court, with the result being that the Atlas-Flintco dispute would be heard in that court.
The takeaways
This was a simple but very important case. Many general contractors have one-way clauses like this in their subcontracts and typically justify the clauses’ enforceability by arguing that the subcontractors were sophisticated commercial entities that had the ability to negotiate the subcontracts. In fact, this is exactly what Flintco did in arguing that the clause was not substantively unconscionable.
However, the New Mexico appeals court said, in no uncertain terms, that these Flintco defenses were only relevant for assessing procedural unconscionability and had nothing to do with whether the clause was fair and reasonable.
