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October 08, 2018

When Less is More: The Dangers of Multiple Inconsistent Arbitration Agreements

Adam Stone and Kaytie Pickett

Construction lawyers know the value of arbitration.  No one wants to watch jurors yawn as the asphalt engineer explains how the mix didn’t meet the ASTM code.  Because of this, arbitration clauses are common in every type of contract even touching construction. 

But when a project is unpopular with the local jurors, or a contractor is prominent in the community, the home-field advantage can trump the risk of juror boredom.  In real estate, it's location, location, location; in litigation, it's venue, venue, venue.  When an arbitration clause gets thrown out by a court, the stakes of a case can change dramatically.  So an enforceable arbitration clause is essential to a strong defense against a tough venue.  

In the almost 100 years since the Federal Arbitration Act was passed, creative lawyers have tried dozens of theories to avoid arbitration.  Experienced litigators have weathered arguments over scope and unconscionability many times.  But a new argument against arbitration has won in the Tenth Circuit, and it's only a matter of time before someone makes the same argument in the construction context. 

Ragab v. Howard

When, in the course of one business transaction, the parties sign six arbitration clauses, one would think they'd definitively agreed to arbitration. The Tenth Circuit held otherwise in Ragab v. Howard.

In Ragab, an individual, Mr. Ragab, and a company called Ultegra Financial entered into six agreements (Consulting Agreement, Purchase Agreement, Operating Agreement, Assignment, Employment Agreement, Non-Circumvention Agreement, and Confidentiality Agreement) as part of their business relationship.  All six of these agreements contained arbitration clauses.  But the terms of the six arbitration clauses differed regarding which rules applied (Colorado Uniform Arbitration Act versus AAA Commercial Arbitration Rules), how the arbitrator should be selected, notice requirements, and who would be entitled to recover attorneys' fees.  After Ragab sued Ultegra, Ultegra moved to compel arbitration.

The trial court denied the motion to compel arbitration, finding that because the terms of the arbitration agreements differed, there was no meeting of the minds.  That is, the trial court held that, despite the fact the parties had agreed to arbitrate six separate times, there was no agreement to arbitrate.  Upset by the ruling, Ultegra appealed to the Tenth Circuit Court of Appeals.

The Tenth Circuit affirmed the decision of the trial court.  The court noted that the presumption in favor of arbitration does not apply to whether an agreement to arbitrate was formed.   The court further held that state law, not federal law, informs the inquiry of contract formation.  Under Colorado law, as in many states, contracts entered into by the same parties at the same time are construed as one contract.  Applying Colorado law, the court held that the differing terms were essential and, therefore, there was no meeting of the minds and no agreement to arbitrate. 

Then-Circuit Judge, now-United States Supreme Court Associate Justice Gorsuch wrote a forceful dissenting opinion in Ragab.  Justice Gorsuch noted that the applicable law, whether Colorado's arbitration statute or the Federal Arbitration Act, envisioned incomplete arbitration agreements.  For instance, the Federal Arbitration Act provides that if an arbitration agreement provides no method for selecting an arbitrator, the court appoints the arbitrator.

In his dissent, Justice Gorsuch suggested two solutions to better "effectuate the intent of the parties."  First he suggested that the plaintiff could be allowed to bring an arbitration under whichever clause he liked best.  Given that the parties agreed to all of the clauses, there would be no injustice.  Next Justice Gorsuch noted that arbitration agreements had been enforced when they said nothing more than "disputes 'shall be submitted to binding arbitration' without any discussion of procedural details."  Because statutes such as the Federal Arbitration Act provide answers when a contract is silent on terms, Judge Gorsuch argued that the conflicting terms should be knocked out and the gaps should be filled in by the statutes.  This knock-out procedure is in fact regularly used in contracts involving the sale of goods.

The majority in Ragab rejected these solutions, holding that the terms that conflicted were "essential" and that Colorado law would not allow the enforcement of a contract without agreement on essential terms.  The majority was particularly uncomfortable with picking one arbitration clause because to do so would violate the other five. 

Since the Tenth Circuit's ruling in 2016, Ragab has been cited in a handful of cases.  An interesting case relying on Ragab was Willis v. Tower Loan of Miss. Following the reasoning in Ragab, a bankruptcy court found that there was no meeting of the minds to arbitrate a consumer-lending case.  Specifically, the Court held there was no agreement to arbitrate because there were inconsistencies in the arbitration agreements contained in the Loan Agreement and several insurance policies.  The Court held this despite the fact that the lender was not a party to the insurance agreement and the insurance companies were not parties to the Loan Agreement.  Despite not being parties to both agreements, the lender had a right to arbitrate under the insurance policies and the insurance companies had a right to arbitrate under the Loan Agreement.  The lender has appealed this decision and the case is now pending before the Fifth Circuit.  It is likely, therefore, that the Fifth Circuit will soon weigh in on this issue.

The Risk of Ragab in Construction

While Ragab did not involve a construction contract, and has not yet been cited in a reported construction case, the legal principles at issue are equally applicable to the construction context.  The potential for multiple contracts with conflicting terms is particularly high on construction projects.  There are prime and sub construction contracts, contracts with design professionals, financing agreements, purchase orders, surety agreements, confidentiality agreements, insurance agreements, and employment agreements, just to name a few.  And contracts used on construction projects often incorporate other contracts by reference.

For instance, subcontractors are regularly bound by the terms of the general contract through flow-down clauses.  If the arbitration agreement in the general contract differs from the arbitration agreement in the subcontract, a court applying the reasoning of Ragab might easily hold there was no meeting of the minds and therefore no agreement to arbitrate. 

How to Protect the Right to Arbitrate

There are three practical steps a construction lawyer can take at the contract-drafting stage to protect against a Ragab-like result down the road. 

  • Read all the contracts.

It's absurdly obvious, but obtaining all the relevant contracts, particularly any incorporated by reference, is a necessity.  The fact is, however, subcontractors often sign contracts containing flow-down clauses without ever obtaining copies of the  general contract.  This is a dangerous practice that subcontractors should cease.  Parties to contracts should always obtain copies of and review all of the contracts that apply to them.  And all the relevant contracts' arbitration clauses should be compared, and any inconsistencies removed if possible.

  • Draft a tight precedence clause.

Parties to contracts should have provisions in their contracts providing which contract controls in the event of conflicting terms. This is a wise practice for many reasons, and because of Ragab, particularly important in regard to conflicting arbitration clauses. This is precisely the solution suggested by the majority in Ragab.  The majority in Ragab specifically noted that other "courts have granted motions to compel despite the existence of conflicting arbitration agreements when the contracts themselves provide the solution." <\/u>

  • Limit the scope. 

The temptation with an arbitration clause is to draft it as broadly as possible to avoid any argument that the dispute falls outside it.  But when two or more arbitration clauses are drafted broadly, the fact that they overlap supports construing the clauses together.  If the arbitration clauses are clearly delineated to separate types of disputes with separate parties, the argument is stronger that the clauses cannot be construed as one and that any conflicts do not render either clause unenforceable. 

Don't take for granted that everyone involved in the project will want to arbitrate.  In a high-stakes case, whether an arbitration clause will hold up in court may make the difference between a win or a loss.  Knowing on the front end the arguments against enforceability helps protect against an arbitration agreement falling apart -- no matter how many times the same parties agreed, in writing, to arbitrate.

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Adam Stone

Jones Walker LLP, Jackson, MS, Division 5 (General Contractors)

Kaytie Pickett

Jones Walker LLP, Jackson, MS, Division 5 (General Contractors)