Businessman and businesswoman shaking handsArbitration continues to be the chosen dispute resolution process for many in the construction industry. Generally, arbitration is considered an efficient and cost-effective way to resolve most typical construction disputes.

Selecting arbitration as the dispute resolution process requires a written agreement. Most often, the arbitration agreement is included among many terms and conditions in the contract for a project. It is typically much easier to negotiate terms of arbitration agreement before a dispute arises as opposed to afterward, when parties often disagree about everything. Therefore, for those who want to make the most of the arbitration process, some advance planning is necessary to draft and negotiate a tailored arbitration agreement to take maximum advantage of the benefits.

Of course, it is recommended to consult experienced counsel to assist with this process. A poorly drafted arbitration agreement may still be enforced, which can inadvertently create procedural hurdles or delay the arbitration process. This, in turn, can result in additional costs to the parties. Like all provisions in construction contracts, the nuances of the language used in the arbitration agreement can be make a big difference in how the provision is interpreted and enforced.

Below are some of the key considerations for arbitrator selection. Future blog posts will address other arbitration agreement considerations.

Process for selection of arbitrators

The selection of arbitrators to decide a dispute is one of the most important decisions parties will make in the dispute resolution process. One of the advantages of arbitration is that the parties can design a process in which they have some control over who the arbitrators will be. Generally, there are three commonly used methods for selection of arbitrators:

  1. Selection from a list of pre-qualified arbitrators provided by an administrative agency such as the American Arbitration Association (AAA);
  2. The parties each select one arbitrator, and the two selected arbitrators chose a third arbitrator; and
  3. The parties mutually agree to an arbitrator without assistance from an administrative agency.

The first approach (list) is the default approach by the AAA under the Construction Industry Rules, unless a different method is specified in the arbitration agreement. Under the list approach, each party will strike a certain number of arbitrators from a list provided by the administrative agency and then rank the rest in order of preference. The administrative agency then identifies the potential arbitrator(s) for appointment by combining both lists and determining the highest-ranking, non-stricken arbitrators. The list approach is applicable for selecting one or three arbitrators.

The second approach (party-selected) is usually a process that starts with each party unilaterally choosing an arbitrator. This provides a party with more control over the selection of at least one arbitrator than the list method, under which a highly ranked arbitrator by one party may be stricken by the other party. Usually under this approach, the party-selected arbitrator is neutral (this is the “default” approach by the AAA under the Construction Industry Rules), but it is also possible for the parties to appoint non-neutral arbitrators. In all cases, the third arbitrator is neutral.

There are several potential methods for selection of the third arbitrator by the two party-selected arbitrators. The two party-selected arbitrators can be provided a list (similar to the first approach) by the administrative agency to rank arbitrators by order of preference, or if an administrative agency is not used, then the two party-selected arbitrators can attempt to mutually agree upon an arbitrator on their own. Whether chosen from a list or some other method, the parties could also have some input into the selection of the third arbitrator by specifying in the arbitration agreement certain qualifications for the third arbitrator. The party-selected approach is only applicable for selecting three arbitrators.

The third approach (ad hoc mutual selection) is most often used if the parties chose not to use an administrative agency. This approach requires the most cooperation and agreement between the parties to find a mutually acceptable, neutral arbitrator. As noted above, it is not unusual that once a dispute has arisen, parties cannot agree on much, including the important decision of selecting an arbitrator. Therefore, if this approach is chosen, it is recommended that the arbitration agreement include a default process for selection of an arbitrator in the event the two parties are unable to agree to an arbitrator within a specified period of time. There are cases in which parties have been required to resort to litigation to ultimately have an arbitrator appointed (undoubtedly resulting in unnecessary delay and costs), so this approach should be carefully considered. This process is usually applicable for the selection of one arbitrator.

For each of the three approaches, the potential for multi-party arbitrations should not be ignored. If it is contemplated that multiple parties may be joined (or multiple arbitrations consolidated into one), then designing a fair arbitrator selection process for multi-party arbitrations can be challenging (and beyond the scope of this blog post).

Interviews

Another general consideration for the selection process is whether to include a step for interviewing potential arbitrators. As noted above, the selection of an arbitrator is very important, and parties may feel better informed and prepared to select an arbitrator if they have an opportunity to first have a discussion with the arbitrator prior to selection. The parties may inquire about the arbitrator’s philosophy about discovery, motion practice, adherence to established schedules or a host of other issues regarding the arbitration process. Of course, both parties should jointly participate in the interviews. Certainly, this process will require careful tailoring to ensure it does not become overly difficult or time consuming to complete.

Number of arbitrators

The number of arbitrators is also an important consideration for the arbitrator selection process. Under the AAA’s Construction Industry Rules, the “default” is that one arbitrator will be appointed for arbitrations with claims and counterclaims totaling less than $1 million. However, some parties may want to vary the claim amount threshold up or down, or even specify a number of arbitrators for matters with claims of any amount. Obviously, the cost incurred by the parties for three arbitrators will be more than the cost for one arbitrator, and it generally takes longer to schedule conferences/hearings with three arbitrators due to the need to coordinate more schedules.

Rules and procedures

An essential consideration in the arbitrator selection process is the adoption of established arbitration rules and procedures. As noted above, the AAA has rules that provide certain “defaults” for certain circumstances if not otherwise specified in the arbitration agreement. Other administrative agencies have similar rules and procedures, but certainly not all rules and procedures are the same. It should also be recognized that established rules and procedures will likely also address other related issues for arbitrator disclosures, disqualification and vacancies, all of which can also be addressed in the arbitration agreement.

Qualifications of arbitrators

The ability to choose arbitrators who have the background and experience with construction issues is often considered particularly valuable. Generally, it is possible for parties to specify in their arbitration agreement that arbitrators have certain qualifications to be eligible for selection. Parties may want to include requirements that arbitrators have specific legal, technical or practical construction experience. Parties can specify that arbitrators have a certain amount of experience with the arbitration process itself, or require that the arbitrators be of a certain nationality or in a certain location. There are obviously many potential qualifications that could be specified for potential arbitrators, but it also should be recognized that the more prerequisite qualifications specified, the smaller the pool of potentially qualified arbitrators.

Cranes building moneyMissouri’s Public Prompt Payment Act was enacted in 1990, with its most recent modifications taking effect in 2014. The statute, R.S.Mo. § 34.057, has extensive requirements for owners, contractors, subcontractors and suppliers on public works projects in Missouri. For those in the construction industry, it is worth reviewing periodically to ensure that standard practices on public jobs are in compliance.

The requirements for public works projects differ in multiple respects from private projects. When performing work on a public job, it is important to make sure your contract forms and administration are consistent with the act. Here is a summary of the key requirements:

Payment timing

  • The owner must make payments at least monthly.
  • The owner must make payment within 30 days after whichever of these occurs latest:

– The materials or construction services purchased are delivered;

– The date the invoice is delivered to the person or place designated by the owner; or

– In instances where the contractor approves the public owner’s estimate, the date when that notice of approval is delivered to the person or place designated by the owner.

  • The contractor must pay subcontractors within 15 days of being paid by the owner or face potential penalty interest of 1.5 percent per month.
  • The owner must make final payment within 30 days of the earliest of the following events:

– Completion of the project and filing with the owner of all required documentation and certifications;

– The project is certified by the authorized architect or engineer as having been completed, including the filing of all documentation and certifications required; or

– The project is certified by the contracting authority as having been completed, including the filing of all documentation and certifications required.

Payment amount

If the contractor receives less than the full payment due under the public construction contract, the contractor shall be obligated to disburse on a pro rata basis those funds received. When, however, the public owner does not release the full payment due because there are specific areas of work or materials he is rejecting or has otherwise determined are not suitable for payment, then the specific subcontractors or suppliers involved shall not be paid for that portion of the work. The owner, however, must give a written explanation to the contractor, subcontractor or supplier involved as to why the work or supplies were rejected or deemed not suitable for payment, and all other subcontractors and suppliers shall be paid in full. 

Retainage/withholding funds

  • Retainage shall not exceed 5 percent of the value of the contract or subcontract. However, if the contractor is not required to obtain a bond because the cost of the contract is not estimated to exceed $50,000, the public owner may withhold retainage in an amount not to exceed 10 percent.
  • If the owner, engineer and contractor determine that a subcontractor’s performance has been completed and that the subcontractor can be released prior to overall substantial completion, the contractor shall request an adjustment in retainage. The owner may reduce or eliminate the retainage subject to holding 150 percent of the value of any remaining minor items.
  • If the owner does not agree with the contractor’s determination that the work is substantially complete, it must provide a written explanation to the contractor within 14 calendar days. The contractor must send that notice to any subcontractor or suppliers responsible for the work. If the owner fails to deliver its explanation, it must pay 98 percent of the retainage within 30 calendar days, less up to 150 percent of the value of any remaining minor items.
  •  If the contractor intends to withhold payment from a subcontractor due to progress, defects, disputed work, failure to comply with the contract, third-party claims, failure to pay sub-subs, evidence that subcontract cannot be completed for unpaid balance, etc., then contractor shall not include that amount in the application to the owner.
  • If the contractor receives payment from the owner and then determines that funds received should be withheld from a subcontractor, the amounts shall be identified in writing and deducted from the next pay application.

Penalties for improper withholding of payment

If a court determines that a payment withheld from a contractor or subcontractor/supplier was not withheld in “good faith for reasonable cause,” the court may impose interest at a rate of 1.5 percent per month and reasonable attorneys’ fees to the prevailing party.

construction plans and 3D buildingA statute went into effect Aug. 28, 2016, that adds Missouri to the list of states embracing design-build as an acceptable delivery method for public improvements.

Under the new statute, R.S. Mo. § 67.5060, design-build is an optional delivery method for:

  1. All civil works projects of any cost (such as roads, bridges, utilities and storm drainage)
  2. Any other public improvement over $7 million.

Public entities eligible to use the design-build method include any “political subdivision” of Missouri, which likely includes special districts and public school districts. In addition, this statute authorizes any political subdivision to use a design-build contractor for wastewater and water treatment projects. Metropolitan sewer districts established under the Missouri Constitution, however, are not eligible.

Under the new statute, design-builders can qualify for contracts in a three-phase selection process involving a point system similar to a best-value procurement system.

The phases and the point system

In phase I of the selection process, design-builders essentially have to qualify to submit proposals. Design-builders must submit a statement of qualification that includes references of owners, qualifications of personnel (for both the primary design consultants and primary trade contractors), and a resume of previous experience with similar projects. The political subdivision can select no more than five and no fewer than two design-builders to move on to phases II and III.

Phase II involves submission of a design for the project to the level of detail required by the request for proposal (RFP). The submitted designs are then evaluated and assigned points by the criteria in the RFP. Importantly, the phase II proposals cannot refer to cost.

Phase III involves submission of a firm, fixed cost for design and construction. The phase III proposal may be accompanied by bid security and other items, such as minority participation. The lowest cost proposal is awarded the maximum number of points available for phase III. Points for the remaining cost proposals are calculated by reducing the maximum available points by at least 1 percent for each percentage point by which the cost proposal exceeds the lowest bid.

Each design-builder must submit its phase III cost proposal along with the phase II design proposal. However, the cost proposals are opened only after the political subdivision has evaluated the design proposals and assigned points.

Phases II and III each account for at least 40 percent of the total point score (so phases II and III together constitute at least 80 percent). The remaining points (up to 20 percent) may be based on each design-builder’s qualifications and ability to design, contract and deliver the project on time.

Participation stipends and contract award

Obviously, submitting design proposals to the required level of detail and preparing cost estimates for both design and construction can require a significant investment from prospective candidates. For this reason, the political subdivision must pay each design-builder that submits phase II and III proposals a minimum stipend for its participation. The stipend amount must be at least one-half of 1 percent of the total project budget. For example, a $10 million project would offer a minimum $50,000 stipend to each design-builder submitting phase II and III proposals. In exchange, the political subdivision acquires a non-exclusive right to use the phase II design proposal.

Naturally, the design-builder with the highest point total is awarded a design-build contract, with the caveat that the political subdivision has the option to reject all proposals. In that event, the design-builder with the highest point total receives double the stipend amount.

Expiration

Under the new statute, the authority to use the design-build method expires on Sept. 1, 2026, giving eligible public entities exactly 10 years to experiment with this progressive delivery method. Presumably, the Missouri legislature will evaluate the success of the design-build method in Missouri as 2026 approaches and decide whether to modify or extend the authority granted under the statute.