Making Alternative Dispute Resolution Work For You

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A few months ago I got a call from John, a small remodeler with a 10-year track record and a respectable reputation.

December 01, 2002

 

A few months ago I got a call from John, a small remodeler with a 10-year track record and a respectable reputation. John's mom, a trial lawyer, was helping him battle for his business and reputation. They contacted me to serve as an expert witness in their upcoming trial. The trial was the result of a lawsuit filed by John and his partner, David, less than two weeks from finishing the job, for nonpayment of $18,000 in draws and unpaid change orders. The homeowners counterclaimed for about $60,000 more than John's original balance due, and the fur began to fly.

I came into the picture midway through what had already become a long ordeal. As I sat in a chair in his mother's office listening to his story, I could tell that John would've paid $1 million to turn back the clock and put an alternative dispute resolution (ADR) requirement in his estimate contract - anything to avoid this litigation pickle. I sat amid stacked boxes pertaining to John's dispute, amazed at the number of pages and files that had piled up during the two-year battle between John and the homeowners. I knew these symbolized the huge amounts of time stolen from John's family life and business. It was a humbling, visible reality check.

 

ADR clauses to include in contracts

In my opinion, every remodeling contract should contain a mediation-arbitration clause. If a client insists on deleting that clause, walk away as fast as you can. That is a huge red flag foreshadowing a possible lawsuit down the road. If you think you might want the option of litigation, you can call for dispute resolution by "mediation, arbitration or litigation," but if you do, be sure you add "at Contractor's sole option" so it is your decision.

Different states have special rules that control the language, effectiveness and enforceability of these clauses, so run any new med-arb clause past your lawyer before using it.

It's also wise to include a "divorce clause" that lays out formulas for your remedies if you end the project early.

Bases to cover in your remodeling contract

1. In the event irreconcilable conflicts arise, mediation is mandatory; if mediation fails, arbitration is mandatory. Mention you have binding ADR again in your warranty provisions.

2. Have a separate line for the homeowners to initial their approval of a med-arb clause. Make it bold and noticeable. This is a critically important section of your contract.

3. The rules of the American Arbitration Association’s Construction section will apply, even if you are not using its arbitration services. These are tried-and-true rules of the road for construction-related conflicts.

4. The case will be heard in your hometown or another location upon which the parties agree. I heard of a nightmare situation recently in which a Texas remodeler did not specify where the arbitration should take place. The homeowner moved to New York and succeeded in moving the case there, so the remodeler had to pay a whopping out-of-pocket travel bill on top of everything else to settle the case.

5. Add a clause in your general terms and conditions that obligates the homeowner to reimburse you for company time spent collecting past-due draws or change orders and for time and out-of-pocket expenses incurred to prepare for and attend any med-arb proceedings, billed at a stated company hourly rate, even if the original contract is terminated.

Sample med-arb clause for larger jobs

NOTICE: THIS AGREEMENT IS SUBJECT TO MEDIATION AND BINDING ARBITRATION.

In the event a dispute arises between the Contractor and the Owners, the parties agree to seek resolution exclusively through mediation, or if that shall fail, through binding arbitration as follows: 1) Either party may invoke alternative dispute resolution by giving written notice via regular mail or fax. 2) The notice should include a brief description of the disagreement. 3) The parties or their representatives will first meet promptly in an effort to resolve the dispute amicably. 4) Work on the Project shall cease during the pendency of mediation or arbitration.

Upon request of either party to this agreement, all unresolved disputes (not limited to breach of contract action) relating to this agreement and not barred by the applicable limitations period shall be submitted for mediation and/or binding arbitration, in accordance with the Construction Industry Arbitration and Mediation Rules of the American Arbitration Association (AAA) then in effect, and neither party shall have the right to bring suit in Court. The parties shall review the qualifications of several mediators and arbitrators with proven experience resolving residential construction matters via alternative dispute resolution methods. The parties agree to cooperate in agreeing upon a date, time and location for the hearing. The hearing will take place in [City], [State]. As an alternative the parties may agree to use the [City] Better Business Bureau system for alternative dispute resolution for a faster, cheaper remedy. In any case, the AAA Rules for Construction shall apply. Either party may specifically enforce 1) a decision rendered under this agreement to arbitrate or 2) any valid agreement to arbitrate with additional persons, under applicable arbitration laws. The award shall be final and binding, and any court with jurisdiction over the decision may enter a judgment upon the arbitrator's decision.

Click here for sample ADR contract clauses. For more information about med-arb, visit the American Arbitration Association's Web site at www.adr.org.

If you stay in the remodeling business long enough, you will get into a serious scrape with a homeowner no matter how good you are. John's case went to trial in District Court and lasted a week. I was prepared to testify for the better part of a day about quality standards, realistic expectations and the common challenges of finishing a remodeling project. The judge was rushed and gave me only 1 1/2 hours.

John's mother put on evidence that she had spent $50,000 worth of lawyer-legitimate hourly time preparing for the case and doing battle, sending numerous claims and counterclaims back and forth. Ultimately John prevailed in the case, and the judge awarded him most of the balance due, but his mother recovered only $20,000 of the $50,000 she had expended. John was lucky he had a family member who was willing to go to bat for him. If the same scenario happened to you absent free legal representation, it could shut your business's doors forever.

I have recently found myself in a similar clash and am testing my contract clauses in a nasty dispute with a client who's a trial lawyer. Fortunately, I have a binding arbitration and mediation clause in my contract, so I am not seeking relief in his world. The purpose of this article is to give you practical tips on how to stay out of a courtroom and resolve serious disputes using ADR methods such as mediation and arbitration.

What are mediation and arbitration?

Mediation refers to an informal, nonbinding procedure that tries to settle the dispute between you and the homeowner, much like a counseling session. There is no final judgment or adjudication. The mediator simply tries to find the strengths and weaknesses of each side's case and pushes to find a solution with which both parties can live. The parties meet initially in one room with the mediator, who explains the rules of the road. Both parties should be prepared to explain the core issues and desired results. This is not the place to put on witnesses and get into the details of each side's case. The mediator is interested only in looking at big-picture issues.

Next, the mediator asks each party to make a general opening statement. This is designed to give the mediator each side's view of the situation and establish the central issues. Remember, your head will be swimming with facts and figures, but the mediator knows nothing about your case.

Then the parties are led to separate rooms. The mediator shuttles back and forth between the two, exploring the strengths and weaknesses, costs and obligations, and also the temperaments of the parties involved. Mediators generally charge a set fee per day, so the parties are encouraged to find a solution within one day. A skilled mediator can cut through the emotion quickly to determine what each party really wants and to find a solution acceptable to both parties. If a settlement is reached, the mediator drafts a settlement document reflecting the terms of the agreement.

Mediation doesn't always settle the matter, however, and the parties then can proceed to arbitration.

Arbitration is more formal than mediation but less formal than a courtroom trial. It usually lasts one day, two days at the most. It is run more like a courtroom proceeding, but the rules of evidence are much more relaxed. The arbitrator has wide discretion to hear any witness or see any type of documentation or other evidence. The difficulty for you as the business owner is to boil down your argument to the big issues and your strongest points and leave emotions at the door.

The best way to avoid gushing secondary information is to work with an adviser. Usually this is an attorney with mediation and arbitration experience who can advocate for you while still allowing you to contribute your personal experience to the process. I do not recommend that you represent yourself in mediation or arbitration (especially arbitration), as you might be viewed as emotionally over-involved, even if you keep your cool fairly well. Hiring an adviser costs more, but your stress level will be lower, and the arbitrator won’t be worried about your getting out of control.

The arbitrator will make a final ruling that binds both parties. It can be filed at the courthouse and be enforced just like a court-ruled judgment. In fact, if you prevail and the other side does not honor that decree by paying up, you can pursue the same post-judgment collection procedures using the court system.

Pros, cons and costs of ADR

Advantages

  • Speed. This process is much faster than the traditional court system, taking a few weeks or months instead of two to four years.
  • Privacy. If you don't want a client to find your name in courthouse records, this is a consideration whether you win or lose.
  • Lower cost. In the past, arbitrating a dispute was guaranteed to cost significantly less than a trial. That is changing as preparing for arbitration becomes more complex and costly. You will pay the arbitrator as well as your lawyer.


Disadvantages

  • Lack of resolution. In mediation, you might go through the process and pay the mediator and your lawyer but never reach an agreement. Unlike in binding arbitration, no one has the power to make the final decision.
  • "Split-the-baby" syndrome. If you have an inexperienced arbitrator, or if there is fault on both sides, the arbitrator might split the case down the middle dollarwise. If you are convinced you are totally right but your client has built a large amount of bogus damages against you, this is not a cheery prospect.
  • No chance for appeal. That's why it's called binding arbitration. If you lose, you cannot decide you would rather take your case to a courtroom. Of course, appeals in litigation are very expensive; chances are you would not pursue an appeal unless more than $100,000 was at stake.


Costs Mediation and arbitration generally are charged for by the day, per party, with charges varying depending on the dollar amount in controversy. Mediation is usually more expensive than arbitration.

  • Costs for a good mediator in my area, Houston, run from $600 per day for non-attorneys to $1,300-$2,000 per day, per party for attorney-mediators. These are usually litigation veterans who like the faster resolution (and who enjoy getting to play judge without having to run for office).
  • Local Better Business Bureaus often do mediations for free for members or for a much-reduced cost. The downside is that you are more likely to get a mediator with little or no "construction experience" and lots of "homeowner experience," increasing the likelihood of an unfavorable result.
  • Mediators and arbitrators can rule on who pays which attorney's fees. You can specify in your contract that both parties will pay their own fees or that the prevailing party will pay all fees. The latter often discourages frivolous cases and game playing, forcing the parties to deal more forthrightly with each other.
  •  Small trials in justice-of-the-peace courts can run $5,000. Larger trials in higher courts can run $30,000 to $40,000 in attorney's fees alone.

 

Finding a good 'neutral'

Use "neutrals" (mediators and arbitrators) who have at least five years of experience, specifically including settling residential construction disputes if possible. The last thing you want is someone with little residential construction experience deciding your company's fate on a project. Some states license these folks. Invest in somebody qualified and experienced. After all, you encourage your clients to do the same in picking a remodeler.

You can find construction-savvy mediator/arbitrators from American Arbitration Association lists or by calling your local bar association. Ask your local builders association or NARI chapter if anyone has had good experiences with particular mediators. Get résumés and fee schedules by fax first. Then call and interview them to be sure they know about residential construction, have lots of experience in settling these types of cases and don't play golf with your opponent. They have a sworn duty to disclose any relationship with either party and are good about not taking the case if there's a conflict.

Use one neutral, not a panel of neutrals. Good neutrals charge $650 to $2,000 per party, per day, so two- to three-person panels get very expensive. Oil companies use panels.

If you select a mediator and things do not settle, you should not use the same person as an arbitrator. The reason is that the mediator, or "neutral," hears each side spill its guts about the weaknesses of its case "ex parte" in separate rooms and does not share many confidential facts with the other side. In arbitrations, both parties are in the same room the whole time, and only select evidence is disclosed. Someone who acted as a mediator cannot objectively hear the case as an arbitrator.

Often the party losing its shirt in an arbitration will request that the proceeding be switched back to mediation mode to better its prospects, but be warned: Once you switch to mediation, you can't go back to arbitration, for the reasons mentioned above.

I believe that all remodelers should have a binding mediation and arbitration ("med-arb") clause in their contracts. The wording and enforceability of these vary from state to state, so take your lawyer to lunch and confirm that these meet your local requirements before signing a contract containing them. ADR clauses in your contract can save you a lot of time, money and aggravation. They might even save your business. Dan Bawden, CAPS, CGR, GMB, J.D., is a practicing attorney and owner of Legal Eagle Contractors Co. in Houston.

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