Waiving the Right to Enforce an Otherwise Valid Arbitration Provision

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Arbitration is a very common method of alternate dispute resolution. Parties to a construction contract often agree to participate in binding arbitration for a variety of reasons, including to streamline resolution of the dispute, and have the matter heard by a person or person(s) with construction industry experience. But what happens if a party, who previously agreed to arbitration, instead files a lawsuit?

In Morgan v. Sundance, Inc., the U.S. Supreme Court considered whether a parties’ participation in litigation impacts their right to later enforce an otherwise valid arbitration provision.

Morgan, involved a dispute between an employee and its employer. After the employee filed suit in federal court, the employer sought to compel arbitration pursuant to the dispute resolution provision in the employment agreement. However, the employer did not move to compel arbitration until almost eight months after the lawsuit was filed, during which time the employer had filed various pre-trial motions, an answer, and engaged in scheduling discussions concerning the litigation. The employee argued that the employer could not enforce the arbitration provision, and that it had waived the right to arbitrate the dispute “by litigating for so long.”

Based on prior precedent, the lower courts considered whether the employee could show that it had been “prejudiced” by the employer’s conduct by engaging in the litigation process and waiting to compel arbitration for several months. Finding no prejudice, the court concluded that the parties were bound by the dispute resolution provision in the contract. On appeal, the employee argued that it should not be required to show prejudice, and that the employer’s conduct alone should be considered when determining whether the arbitration provision was waived. The Supreme Court agreed.

The Court reasoned that the policy favoring arbitration under the Federal Arbitration Act “does not authorize federal courts to invent special, arbitration-preferring procedural rules,” and concluded it was wrong to condition a waiver of the right to arbitrate on a showing of prejudice. The Court then remanded the case back to the Eighth Circuit to determine (1) whether the employer “knowingly relinquished the right to arbitration by acting inconsistently with that right,” without considering prejudice, or (2) whether a different procedural framework (such as forfeiture) would be appropriate.

Notably, the arbitration provision in Morgan was governed by the Federal Arbitration Act (FAA). The FAA is a federal statute that governs the enforceability of arbitration agreements “involving interstate or foreign commerce.” The Supreme Court has interpreted the statute broadly to give expansive scope to the FAA and foreclose state legislative attempts to undercut the enforceability of arbitration agreements. Accordingly, if a contract containing an arbitration provision involves an economic or commercial activity, the arbitration provision will most likely be governed by the FAA. It is therefore difficult to imagine a construction contract that would not fall within the scope of the FAA.

The Morgan decision is already impacting state courts. For example, the Nebraska Supreme Court has already clarified that the Morgan decision alters the law in Nebraska for determining whether a party to an otherwise valid arbitration agreement has waived the right to enforce the agreement; a showing of prejudice is no longer required. Given the breadth of the FAA, the Morgan decision will likely alter the rule in other states that currently condition waiver on a showing of prejudice, such as Iowa and Colorado.

A more nuanced issue is what impact, if any, Morgan will have on a claimant’s right to enforce a mechanic’s lien or Miller Act claim through the judicial process. Generally, to preserve a contractor’s lien rights, Miller Act rights, or other statutory Prompt Payment Act remedies which require suit in a specific court, a claimant will first initiate a lawsuit, and then stay the lawsuit in favor of arbitration. After the Morgan decision, it is unclear whether initiating a lien foreclosure action could be considered “acting inconsistently with the right” to arbitrate, even when there is no prejudice to the other party. Similar concerns arise in the context of a statutory bond claim. Accordingly, moving forward we recommend that contractors include specific carve out language in their contract documents to (1) clarify that nothing contained in the arbitration provision should be construed to limit any lien rights or statutory bond claim, unless otherwise expressly waived and (2) expressly allow the contractor to commence a civil action to preserve its statutory rights, before staying such action in favor of arbitration.

Key Takeaways

  1. Federal courts and Nebraska state courts no longer require a showing of prejudice to find a party waived its right to arbitration. The Morgan decision will likely impact the rule used in Iowa, Colorado, and other states for determining whether a party has waived its right to arbitrate.
  2. Moving forward, courts will look solely at the conduct of the party seeking to compel arbitration to determine whether it voluntarily and intentionally relinquished its right to arbitrate.
  3. In light of Morgan, parties should carefully draft arbitration provisions governed by the FAA to preserve their litigation rights without waiving their ability to compel arbitration.

If you have any questions, please contact one of Woods Aitken’s Construction Attorneys. We encourage you to subscribe to our Construction Law E-Briefs for the latest construction news, tips, and updates.