Can project owners be the judge of disputes? Of course they can, especially if the contract clause allows for judicial review.
We’ve heard children ask parents to explain their decisions, only to get this response: “Because I’m the mom, that’s why!” Mom is the boss and her decision is final on the matter. Children walk away scratching their heads, learning an important lesson in life, sometimes called the “Golden Rule,” as in “He who has the gold makes the rules.” The more brazen child spouts back, “I’m gonna ask Dad!” in an effort to appeal to a higher authority.
Not far from this scenario is the growing trend for project owners, primarily public owners, to include clauses in their contracts which give them the authority to make final decisions under their own contract! The obvious question is whether a party with a financial interest in the contract can truly be a neutral party and make binding decisions on the other party’s claims. Generally, the courts will not enforce such clauses without a requirement of some level of judicial review or appeal.
For decades, we have seen alternative dispute resolution clauses that appoint a neutral person, such as the project architect or engineer, to decide disputes between the owner and contractor, or to be the “initial decision maker.” But what if the appointed decision-maker has a financial interest in the project, such as the project owner? Can such a person truly be considered “neutral?” As stated by one Texas court, “To allow a party to act as its own judge necessarily taints the process and is repugnant to a proper sense of justice.” The Court explained that, “Generally, parties may designate arbitrators of their choice … [but] an agreement in which a party is designated as an arbitrator is illusory and becomes not a contract to arbitrate, but an engagement to capitulate.”
The initial decision maker is generally deemed neutral even though he or she may be paid by the owner, such as an architect or engineer. However, an undisclosed financial interest in the project may be grounds to challenge that neutrality. For example, in a 1991 Kansas case, the contract required the architect to make decisions on the contractor’s performance, such as on payment and completion. The architect found the project to be substantially completed, but the owner disagreed and filed for arbitration. The owner claimed fraud when it learned that the architect was also the vice president and a 50 percent owner of the contractor and had wrongly certified the project because it was to his financial benefit to do so. The arbitration award against the owner was upheld, nonetheless. Several courts have upheld these owner-makes-the-final-decision clauses but only if there is a requirement for judicial review of the owner’s decision.
In a 1997 Colorado case involving a dispute over construction of the terminal building at Denver International Airport, the contract provided for a city official – the manager of public works – to determine the merits of the contractor’s claims. The court upheld that clause, stating, “this will not render a dispute resolution clause invalid so long as the ADR clause provides for judicial review of the official’s determination.” The court relied, in part, on an earlier 1994 Colorado case also involving DIA which held, “the fact that an official of the government is designated as the one charged with addressing the merits of the contractor’s claim does not, for that reason, invalidate the contract.”
There are many New York cases on this topic due to a clause used in New York City’s standard contract which allows the superintendent of the construction project to decide disputes, subject to judicial review.
The leading case is from 1993 involving the New York City Transit Authority, which held that the challenged provision did not violate New York public policy because it provided for “judicial review.” The contractor argued that the clause was unenforceable.
The court sympathized, explaining that “when powerful municipalities put their public works jobs out for bid and require competition, low cost and performance in accordance with published specifications, they enjoy a virtual monopolistic kind of power. But that does not make those contracts adhesion agreements. The courts should not, except for compelling reasons, wrest away from contracting parties a superior marketplace bargaining hand and try to equalize relatively arm’s length commercial dealings. The judicial review check provided for in this ADR provision should be sufficient to regulate and remedy intolerable abuses and one-sided economic oppression.”
More recent New York cases have continued to uphold the clause where the city official’s decisions were subject to limited judicial review on whether the decision was “arbitrary, capricious, or so grossly erroneous to evidence bad faith.” In a 2016 New York case, a contractor argued that submitting the dispute to an employee of the project owner “would be futile due to bias.” The court said such fear of bias was unpersuasive, citing back to the 1993 case which upheld these clauses “even in cases where the contract expressly designated a single arbitrator who was employed by one of the parties or intimately connected with him.”
In a 1999 Florida case, the construction contract provided that disputes would be submitted to the Board of County Commissioners “and those persons to whom it delegates authority to decide disputes,” and that such decisions would be “final and conclusive unless determined by a court of competent jurisdiction to be fraudulent, capricious, arbitrary, so grossly erroneous as to necessarily imply bad faith, or not supported by substantial evidence.” A contractor challenged the clause but the court upheld the provision, stating that the contractor signed the construction contract knowing it contained this dispute resolution procedure, and “it must comply with the terms thereof.”
So, be duly-warned when signing design or construction contracts that give the owner, or a public official, or other third party employed by them, the right to make final and binding decisions on claims. It may seem like the cards are stacked against you (and they may be), but if there is an appeals process for decisions that are “fraudulent, capricious, arbitrary, so grossly erroneous as to necessarily imply bad faith,” the clause is likely to be upheld as valid.
No running to dad for an appeal.
William Quatman is general counsel and senior vice president at Burns & McDonnell Engineering Co. He can be reached at firstname.lastname@example.org.