Does Your Client’s Contract Help Control Dispute Resolution Costs?

Due Diligence: Business and Legal  

Owners, contractors, trade contractors, and suppliers likely perform business due diligence before undertaking development and construction of a project. Owners identify the financial parameters of the project business model. At what cost does the project no longer make economic sense? What are the factors and risks in completing the project so it does make economic sense? Contractors, trade contractors, and suppliers likewise undertake a business due diligence review before undertaking a project. What resources do I have to commit to the project, at what cost, and for what expected profit?

Having undertaken a business due diligence review, has your client also undertaken a legal due diligence review? Owners should include the appropriate clauses in design and construction contracts to control the risk of disputes and the consequent costs of litigation, arbitration, or other dispute remedy process. The following are examples of the questions owners should be asking:

• Have I provided for forum selection and governing law clauses in my contracts?


• Does a liquidated damages clause for delayed completion make more sense given the perceived difficulty of proving actual damages for delay?


• Do I want a mutual waiver of consequential damages clause or a waiver of subrogation rights or, where not disallowed by law, the contractor’s waiver of mechanic’s lien rights?

The same questions apply to contractors in reviewing the prime contract and to subcontractors and suppliers in reviewing the proposed subcontract and purchase order for the project.

Clients may also ask, who should perform the legal due diligence review? Not to sound like a shill for attorneys, you may have to advise them that the legal due diligence review should be performed by someone who knows design and construction contracts, understands the allocation of design and construction risks under the law applicable to the project contracts, and can point out alternative terms for the client to decide how the risks of the proposed terms fit the client’s business model for the project—in short, that a construction attorney should be reviewing the construction contract.

Applying legal due diligence can be a significant cost saver later on when that legal due diligence review has resulted in allocating the risks of the project to better suit your client’s project business model, whether the client is an owner, general contractor, or subcontractor. Allocation of risks is the first step in using the contract to control litigation costs. I have included below other specific ideas of clauses you might want to consider when performing your legal due diligence review.

Defining Prevailing Party Recovery

How often have you read a contract that includes terms for recovery of “reasonable attorney’s fees and costs” by the “prevailing party”? Such terms can be unintentionally limiting and not achieve the cost control (in this case, the recovery) anticipated.

First, why limit the prevailing party’s recovery to reasonable attorney fees and costs? A court could define “costs” to include only the costs specified in a statute such as 28 U.S.C. § 1920, e.g., clerk and marshal fees, fees for transcripts obtained for use in the case, and costs for copies obtained for use in the case. Such costs could be but a small fraction of your client’s litigation costs. Consider expanding the word “costs” to include expert and consultant fees and costs, deposition transcript costs and reporter fees, mediator or arbitrator fees, paralegal fees, investigative costs, document copying costs, filing fees, e-discovery costs, and other such costs typically incurred in litigation or arbitration.

Second, consider defining “prevailing party” in the contract or purchase order. In most jurisdictions, “prevailing party” is not only a subjective phrase but also one subject to the court’s or arbitrator’s determination of whether there even was a prevailing party. Remember, there are three possible outcomes when the court or an arbitrator deals with a “prevailing party” question: (1) your client prevailed, (2) your client’s opponent prevailed, or (3) no one prevailed.

You should consider defining “prevailing party” in the contract, perhaps tied to settlement offers as well. Below is one example:

Prevailing party means that party, plaintiff or defendant, who substantially prevails against the other party. If, however, a written offer of compromise made by either party is not accepted by the other party within 21 days after receipt, and the party not accepting fails to obtain a more favorable judgment, the non-accepting party shall not recover prevailing party’s fees and costs (even if it is the prevailing party) and shall pay the costs of suit, and reasonable attorney fees and costs incurred by the offering party.

The point is to think about defining “prevailing party” at the outset, rather than having a court or arbitrator define the phrase after the fees and costs are incurred.

Arbitration Costs

What if your client wants the contract to set arbitration as the dispute remedy procedure? Arbitration is by agreement. Consequently, contracting parties can include terms in their contracts that limit the arbitration hearing and thus the costs of the process. Such terms are typically enforceable, barring fraud or other similar conduct inducing agreement to the contract.

When drafting the contract, consider adding terms to the arbitration clause limiting the number of witnesses and hearing days. For example, for claims arising from contracts, subcontracts, or purchase orders where the contract sum (exclusive of change orders) is $500,000 or less, allow for no discovery except a mandatory exchange of documents, limit the witnesses to no more than two witnesses per party, and limit the number of hearing days to two consecutive days. For contracts, subcontracts and purchase orders where the contract sum is more than $500,000 and less than $1,500,000, allow for the mandatory exchange of documents and three witnesses per party, including experts and deposition of experts only, not to exceed eight hours per deposition. The hearing would be agreed not to exceed three days. For contracts, subcontracts, and purchase orders where the contract sum is in excess of $1,500,000, allow for the mandatory exchange of documents and four witnesses per party, including experts and depositions of experts only, not to exceed eight hours per deposition. The hearing would be limited to five days. These limits can be changed, of course, but the guiding principle should be to include terms to control the costs of the arbitration.

After the arbitration process has started, if you are under the American Arbitration Association’s Construction Industry Arbitration Rules, do not forget to invoke Rule 24. Under this rule, the arbitrator may direct the production of documents and otherwise manage the exchange of information between the parties.

If you want the contract also to include mediation as part of the remedy process, be sure the mediation process is defined in such a manner that it is an express condition precedent to the initiation of litigation or arbitration. You should also consider time limits on the mediation process, pre-appointment of mediators, and the locale of the mediation.

Electronic Documentation and Discovery Controls

Electronic discovery is one of the most disruptive and expensive aspects of dispute resolution. While discovery rules may or may not give one party an advantage over the other party after a dispute has arisen, both parties are likely motivated at the time of contracting to prospectively limit their electronic discovery liability, whether in litigation or arbitration. By limiting discovery up-front, the parties can tame what tends to be the largest category of dispute resolution expense.

Key discovery terms to include in contracts are the following:

• specifying when the duty to preserve documents attaches;

• limiting the number of employees whose email would be required to be reviewed and produced;

• defining the number of server-based systems that would be discoverable;

• limiting spoliation sanctions to only those situations involving actual knowledge and bad faith; and

• agreeing to cooperate to the extent practicable on issues of electronic discovery.

The case law on electronic discovery continues to evolve in the federal and state courts. For that reason, electronic discovery remains a very costly element in the dispute process and one you and your client should consider when looking to control litigation and arbitration costs.

Conclusion

The process of dispute resolution can be expensive. Clients are well advised to conduct business due diligence and legal due diligence reviews before contracting and to use contracts to control the expense of litigation and arbitration. Thus, it is advantageous to spend a little more time on the front end of a project ensuring that your client’s contract limits dispute resolution costs, as opposed to dealing with such issues after problems arise and being stuck with the language in the contract.

Keywords: litigation, construction, legal due diligence, contract, dispute resolution, costs 

Bob Cox is the chair of the Construction Practice Group at Williams Mullen P.C. in its Tysons, Virginia, office. 

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