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Will Federal Law Preempt Your Contract?

The Federal Arbitration Act of 1925 may preempt state arbitration law in construction contracts.

September 07, 2016 Photo

Construction contracts increasingly require arbitration of claims between the parties. Families of contract documents published by, for example, the American Institute of Architects and ConsensusDocs, widely used in projects today, require disputes between owners, architects, engineers and contractors to be submitted to some form of arbitration, either as a prelude to or in place of litigation.

In most cases, arbitration benefits all parties by providing an expeditious and relatively inexpensive alternative to litigation. However, few practitioners realize that substantive provisions of federal arbitration law preempt state law in some aspects of construction disputes.

Federal Preemption

The Federal Arbitration Act (FAA), enacted in 1925, established a national public policy favoring arbitration of commercial disputes. As the U.S. Supreme Court explained in Southland Corp. v Keating, the FAA not only “declared a national policy favoring arbitration” but actually “withdrew the power of the states to require a judicial forum for the resolution of claims which the contracting parties agreed to resolve by arbitration.”

The FAA applies to all written contracts (except certain employment contracts) (1) “evidencing a transaction” involving interstate commerce and (2) with provisions requiring arbitration of disputes arising out of the contracts or transactions. Most construction projects involve interstate commerce due to the involvement of out-of-state subcontractors and suppliers. And most construction contracts mandate arbitration. Thus, the FAA preempts state arbitration law in many construction disputes.

In disputes otherwise subject to the FAA, a general choice-of-law provision in the underlying contract is not sufficient to mandate the application of state law to the arbitration proceeding.

Rather, intent to arbitrate under state law must be “abundantly clear” from the language of the arbitration agreement. Take for example UHC Mgmt. Co. v. Computer Sciences Corp., which involved whether the more restrictive provisions of the FAA governed an application to modify an award or the more liberal provisions of the Minnesota Uniform Arbitration Act applied. Despite a contractual requirement that the arbitrators were bound by “controlling law,” the lack of specific reference to the Minnesota Uniform Arbitration Act was found to be a significant factor in enforcing the FAA.

Substantive provisions of the FAA apply in state court proceedings as well as federal court proceedings, but it is important to note that, while the FAA applies to transactions involving interstate commerce, the act does not provide a separate basis for federal jurisdiction. Thus, federal court jurisdiction in cases involving the FAA must still derive from other sources, such as diversity of citizenship or a question of federal law.

Who’s In Charge of What

Most arbitral construction disputes involve interplay between the Federal Arbitration Act and state statutes. The FAA governs substantive issues, such as whether a particular issue is subject to arbitration, and the grounds upon which awards can be modified or vacated. State arbitration statutes apply to procedural issues, and most are patterned after some form of the Uniform Arbitration Act (UAA) or, in some jurisdictions, the Revised Uniform Arbitration Act (RUAA).

Since the goal of most commercial arbitration agreements is to keep the dispute out of the courts (at least until an award is issued and the winner seeks the power of a court to enter and enforce a judgment or the loser seeks to avoid such a result), the parties are left to decide how their arbitration of disputes is to be administered. In construction contracts, the most common approach is to adopt—by reference—rules and procedures drafted specifically for construction arbitration. These are usually the rules for construction disputes promulgated by the American Arbitration Association (AAA) and JAMS (formerly known as the Judicial Arbitration and Mediation Service) or some other administrative service identified by the contracting parties.

A court must decide the threshold legal question of whether a valid arbitration agreement exists or if a particular issue is subject to arbitration unless the contract “clearly and unmistakably” evidences the parties’ intent to allow an arbitrator to decide those issues, under Section 4 of the FAA.

However, the arbitrator makes the initial determination on the remainder of the contract, even when issues are legal in nature. For example, the arbitrator decides whether procedural thresholds to arbitration (such as a limitations period, laches, waiver, or exhaustion or administrative remedies) have been satisfied. In Howsam v. Dean Witter Reynolds, for example, the parties’ agreement provided for arbitration under the rules of the National Association of Securities Dealers, which set a six-year limitation period from the date of occurrence. The question in Howsam of whether the arbitration proceedings were timely commenced was for the arbitrator to decide.

The FAA’s deference to the arbitrator on issues affecting the remainder of the contract was recently reinforced by the U.S. Supreme Court. In Nitro-Lift Technologies, LLC v. Howard, the court held that the arbitrator, rather than a judge, should have determined whether the underlying contract was void and unenforceable. When the parties commit to arbitrate contractual disputes, it is a mainstay of the act’s substantive law that “attacks on the validity of the contract, as distinct from attacks on the validity of the arbitration clause itself,” are to be resolved “by the arbitrator in the first instance, not by a federal or state court.”

Some Specific Differences

There are differences between federal and state arbitration law when it comes to discovery, punitive damages, modification of grounds for judicial review of awards, and correction of awards.

Discovery The FAA and the UAA empower arbitrators to subpoena witnesses and documents to the hearing. The discovery of documents in the possession of third parties and depositions of non-party witnesses are generally, however, restricted to proceedings attended by the arbitrator unless the parties agree otherwise. This limitation on third-party discovery was one of the main reasons for adopting the RUAA.

Section 17 of the RUAA authorizes the arbitrator to issue subpoenas to compel third parties to attend depositions and produce documents. This includes subpoenas for the hearing and subpoenas for discovery before the hearing. The arbitrator’s power to issue pre-hearing subpoenas may be modified by contract. However, under Section 4(b) of the RUAA, the arbitrator’s power to issue subpoenas for the hearing is not waivable by the parties.

Punitive Damages The FAA is silent on whether arbitrators have the power to award punitive damages, although case law under the FAA has established that arbitrators are so empowered if the contract authorizes punitive damages. Under the UAA, case law in the majority of jurisdictions authorizes an award of punitive damages. Under the RUAA, the arbitrator may award punitive damages if otherwise justified under the law of the particular jurisdiction and if the factual and legal bases for punitive damages are specified.

Modification of Grounds for Judicial Review of Awards Under the FAA, the parties cannot contractually modify the statutory grounds for judicial review of arbitration awards, as held by the U.S. Supreme Court in Hall Street Associates v. Mattel, Inc. Under the UAA, case law in each jurisdiction must be consulted to determine whether a contractual agreement to modify statutory grounds for vacating awards is enforceable. Under the RUAA, the drafters decided not to include a provision for expanded judicial review, leaving the issue for the courts.

Correction of Awards The FAA is silent on whether an arbitrator can correct errors in a final award once it is issued and delivered to the parties, but some cases have held that, once the award is issued and delivered, the arbitrator is divested of power to change it. Under the UAA and RUAA, correction of awards is permitted upon a required showing of statutory prerequisites which justify the correction.

Unless otherwise provided in the governing contracts, substantive provisions of the Federal Arbitration Act may supersede state arbitration law in many arbitral construction disputes. When preparing a case for arbitration, the provisions of the FAA as well as the governing contract, state law, and the rules of the arbitration forum must be considered on a variety of substantive and procedural issues that may arise.

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About The Authors
Multiple Contributors
Brit Weimer

Brit Weimer is a partner at Jones Satre & Weimer. Email him at bweimer@jonessatre.com

Rob Moschet

Rob Moschet is a partner at McCollum Crowley Moschet Miller and Laak Ltd. Email him at  RNM@mccollumlaw.com

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