View of downtown Newark from atop the Federal Building
View of downtown Newark from atop the Federal Building (Carmen Natale)

Want to build a house down the shore? Have an office in your commercial property renovated? Make sure you review your construction agreement first. Even form construction contracts in New Jersey may have pitfalls for both sophisticated and unsophisticated parties due to dynamics outside the state. New case law from the United States Supreme Court and New Jersey courts highlight the enforceability of arbitration provisions in construction agreements.

The U.S. Supreme Court recently upheld the preemption of the Federal Arbitration Act, 9 U.S.C. §§1-16 (FAA), over inconsistent state law regarding the validity of arbitration provisions in contracts. In May 2017, the U.S. Supreme Court reversed a Kentucky Supreme Court decision invalidating an arbitration agreement entered into by the personal representatives of certain decedents using powers of attorney. The Kentucky Supreme Court concluded that access to courts and juries were “fundamental constitutional rights” that were “sacred” and “inviolate” under Kentucky law. Given the sanctity of those rights, the Kentucky Supreme Court reasoned that the personal representatives did not have the right under the decedents’ powers of attorney to waive them. The U.S. Supreme Court vacated that decision on the basis that the FAA preempted the Kentucky Supreme Court’s reluctance to enforce arbitration agreements. While recognizing the continuing viability of state law contract defenses, like fraud or unconscionability, the U.S. Supreme Court would not allow a state to implement “legal rules that apply only to arbitration or that derive their meaning from the fact that agreement to arbitrate is at issue … for example [any state] law prohibiting outright the arbitration of a particular type of claim.” Kindred Nursing Ctrs. v. Clark, __ U.S. __, No 16-0032 (May 15, 2017) (internal quotations and citations omitted).

Notably, shortly before the U.S. Supreme Court decision in Kindred Nursing, the California Supreme Court had come to the exact opposite conclusion regarding the reach of state law protections concerning the arbitrability of disputes. In April 2017, the California Supreme Court invalidated an arbitration agreement on the grounds that the agreement waived a state law statutory right to a “public injunction” which prohibits activity to protect the public, not just an individual litigant. In McGill v. Citibank, No. S224086, Slip Op. at 1 (Cal. Apr. 6, 2017), the parties stipulated that the agreement at issue prohibited consumers from seeking public injunctive relief in any forum, not just in arbitration. The California Supreme Court cast the statutory right to a public injunction as an “unwaivable public right”—similar to the language used by the Kentucky Supreme Court—and was struck down by the U.S. Supreme Court a month later. Nevertheless, the California Supreme Court found precedent to support its position in an earlier U.S. Supreme Court case, AT&T Mobility v. Concepcion, 563 U.S. 333 (2011), upholding a waiver in an arbitration agreement of the right to pursue class action lawsuits. Thus, the California Supreme Court reasoned it could partially invalidate the arbitration waiver and allow Citibank’s consumers to pursue public injunction claims in court.

The tension between state law and the FAA is not quite as palpable in New Jersey as in Kentucky or California. Here, if a construction contract has an arbitration provision that does not specify whether federal (FAA) or state law (New Jersey Arbitration Act, N.J.S.A. 2A:23B-1 to -32) (NJAA) applies, a court would look at the nature of the transaction to make this determination. If the transaction had a sufficient nexus to interstate commerce, the FAA would apply. See Allied-Bruce Terminix Cos. v. Dobson, 513 U.S. 265, 273-75 (1995) (where the U.S. Supreme Court held that Section 2 of the FAA, which provides that an arbitration provision in “a contract evidencing a transaction involving commerce” is valid and enforceable, is broad and is the functional equivalent of the word “affecting” commerce.) Further, the nexus to interstate commerce need not be substantial. Id. See also Citizens Bank v. Alafabco, 539 U.S. 52, 56-58 (2003). Thus, it is a low burden for the FAA to apply and, after the Kindred Nursing case, it would likely be found to preempt any inconsistent New Jersey law.

Further, New Jersey recognizes that the FAA codifies the strong federal policy favoring arbitration. Tedeschi v. D.N. Desimone Constr., Civ. A. No. 15-8484 (D.N.J. May 8, 2017); Columbus Circle NJ v. Island Construction Co., Docket No. A-1907-15T1 (N.J. Super. App. Div. Mar. 13, 2017). The FAA provides: “A written provision in any … contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction, or the refusal to perform the whole or any part thereof … shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” 9 U.S.C. §2. The FAA mandates that courts “place arbitration agreements on an equal footing with other contracts and enforce them according to their terms.” Columbus Circle (quoting AT&T Mobility v. Concepcion, 563 U.S. 333, 339 (2011) (citation omitted)).

Moreover, the NJAA is almost identical to the FAA and follows the same principles favoring arbitration. The NJAA provides: “An agreement contained in a record to submit to arbitration any existing or subsequent controversy arising between the parties to the agreement is valid, enforceable, and irrevocable except upon a ground that exists at law or in equity for the revocation of a contract.” N.J.S.A. §2A:23B-6.

In New Jersey, an arbitration provision is interpreted according to state law contract principles and there must be mutual assent between the parties to the subject contract, i.e., there must be a meeting of the minds where the parties understand that they have agreed to arbitrate a dispute.See Tedeschi and Columbus Circle. Because an arbitration provision by definition means that the parties are giving up their right to have the dispute decided in court, and thus are giving up their rights to a civil jury trial, the language used in the provision must be clear and unequivocal. Id.

In the Tedeschi case, the plaintiff homeowners filed a complaint against the defendant construction builders with respect to the reconstruction of their home that was damaged during Superstorm Sandy. The plaintiffs alleged that they withheld payment to the defendants because of, inter alia, poor craftsmanship and false representations. In the complaint, plaintiffs sought to vacate an earlier arbitration award that required them to pay the defendants for the work completed, arguing that the applicable contract did not contain a valid arbitration provision. The governing agreement was the American Institute of Architects’ (AIA) Standard Form of Agreement Between Owner and Contractor, AI Form A101-2007 [this form has been replaced with an updated 2017 version, but the substance of the arbitration provisions are essentially the same]. This form was supplemented by the AIA’s General Conditions of the Contract for Construction, AIA Form A201-2007, which provides: “This document has important legal consequences. Consultation with an attorney is encouraged with respect to its completion or modification.” [This form has also been replaced with an updated 2017 version, but this language is identical]. Id.

In granting the defendant’s motion for summary judgment, dismissing the plaintiffs’ complaint and ordering the plaintiff to arbitrate the dispute, the court held that the arbitration provision in the parties’ contract was valid and enforceable. The plaintiffs had argued that they should not be compelled to arbitrate because they did not know they had waived their right to a jury trial because they did not discuss alternative dispute resolution options with the defendants before signing the agreement; the arbitration provision was hidden in the General Conditions Form which they allege was not provided to them; and the subject construction contract indicated that no other documents were included. The defendants correctly countered that the arbitration provision was not hidden in the General Conditions Form, but was clearly stated in the Standard Form. The defendants also argued that the plaintiffs admitted they did not read the entire contract, and thus their argument regarding what they were provided with was meaningless, and the plaintiff’s failure to read the contract was not a defense to enforcement thereof.

The court agreed with the defendants, and held that the Standard Form clearly provided that the method of dispute resolution was arbitration. In the Standard Form, under the “Binding Dispute Resolution” provision, Section 6.2, the parties had the option to check “arbitration, litigation or other,” and in this case, “arbitration” was checked. The court also specifically noted that this was not a case where one of the parties was an unsophisticated consumer who unknowingly agreed to binding arbitration, but rather was an agreement negotiated between sophisticated parties.

The Columbus Circle case, which the Tedeschi court cited with approval, involved a dispute between a property owner and a construction company, where the parties entered into a contract for the construction of a $1.96 million shore home.The subject contract utilized the same Standard Form and General Conditions Form discussed in Tedeschi, and “arbitration” was selected in the Binding Dispute Resolution section. After a dispute over the cost of the project arose, both parties terminated the agreement. The homeowner demanded mediation, and the construction company filed a demand for arbitration. Subsequently, the homeowner filed a complaint with the Superior Court of New Jersey, and the defendant filed a motion to dismiss for lack of subject matter jurisdiction and to compel the parties to arbitrate the dispute. The Appellate Division agreed with the construction company and affirmed the lower court’s grant of the motion to dismiss for lack of subject matter jurisdiction and to compel arbitration. The Columbus Circle court also discussed that the parties in that case were sophisticated, and distinguished cases where unsophisticated consumers possessing inferior bargaining power entered into a contract of adhesion with a more sophisticated party. In making this distinction, the court noted that the homeowner, which was actually a limited liability company, had its own representative as well as an attorney review and modify the contract, and thus the agreement was negotiated between sophisticated business entities.

Thus, Tedeschi, Columbus Circle and Kindred Nursing show that on both the federal and state levels, arbitration provisions in construction contracts in New Jersey are strongly favored and likely enforceable. Nevertheless, to ensure enforceability, the arbitration provision should be clearly worded, conspicuously placed and separately acknowledged by the parties (i.e., initialed). When using the AIA forms, be sure to call out the arbitration provision to the parties. Avoid confusion by clearly choosing arbitration over litigation (or other) in the Standard Form AIA contract.

In the case of other proprietary contract forms for construction—whether between owners and contractors or between general contractors/construction managers and subcontractors—the dispute resolution provisions should be consistent. If the owner–CM contract has AAA arbitration under the Construction Arbitration rules, the subcontracts should have similar provisions. Similarly, the architect, engineer and other consultant contracts should be consistent in requiring arbitration under the same paradigm. When a project goes south, there is nothing worse than having to fight on multiple fronts in different forums. To make the resolution process more efficient, all parties involved should expect to be involved with the same procedure. The best time to ensure that efficiency is at the time of contracting.•