By: Thomas S. Tripodianos Published: May 2006

Arbitration not Mandatory

Question. Is a mandatory arbitration clause in an agreement between property owners and a contractor engaged by them to manage and direct renovation of their residence enforceable?

USUALLY. Although the Courts of New York favor alternative dispute resolution clauses, generally few things in the law are black and white. This is especially true in matters involving consumers.

In the case in question, the home owners entered into a Construction Management Agreement with construction manager, in which construction manager agreed to manage and direct the renovation of home owners' residence. The Construction Management Agreement provided that:

Any disagreement, dispute, controversy or claim arising out of or relating to this contract or the breach thereof shall be settled by binding arbitration in accordance with the Construction Industry Arbitration Rules of the American Arbitration Association. Judgment upon the award rendered by the Arbitrator(s) may be entered in any court having jurisdiction thereof.

The home owners terminated the construction manager. Prior to receiving notice of termination the construction manager had sent home owners several invoices, some of which remain unpaid. The construction manager, in accordance with his contract, served home owners with a Demand for Arbitration and Notice of Intention to Arbitrate. Home owners in turn, served and filed their Answering Statement to the construction manager's Demand for Arbitration.

Home owners now seek a permanent stay of the arbitration.

General Business Law Section 399-c(2)(a) provides, in relevant part, that: "no written contract for the sale or purchase of consumer goods, entered into on or after the effective date of this section [September 5, 1984], to which a consumer is a party, shall contain a mandatory arbitration clause." General Business Law Section 399-c(2)(b) further provides that: "the provisions of a mandatory arbitration clause shall be null and void."

At first glance, therefore, it would seem that General Business Law Section 399-c bars enforcement of a mandatory arbitration clause in a residential construction agreement with the property owners. It would follow therefore that the mandatory arbitration clause in the agreements between homeowners and construction manager herein would be similarly unenforceable.

However, it may be argued that, General Business Law Section 399-c is pre-empted by the Federal Arbitration Act.

Section 2 of the Federal Arbitration Act makes enforceable a written arbitration provision in "a contract evidencing a transaction involving commerce." In order for the Federal Arbitration Act to apply, the transaction at issue must "involve interstate commerce," which the US Supreme Court has defined to be the equivalent of "affect commerce."

InNew York, the Court of Appeals, (the highest appellate court in the state system) recently addressed the issue of the applicability of the Federal Arbitration Act to a construction contract performed in New York, which contained a mandatory arbitration provision. In that case, the Court of Appeals concluded that the project "affected interstate commerce, "triggering application of the Federal Arbitration Act. Among the factors cited by the Court were the following: the project manual and engineer's drawings were created in a joint effort with a structural engineering firm headquartered in Illinois; petitioner's largest supplier of materials for the project was a New Jersey company; project meetings and visits were often scheduled at the New Jersey supplier's offices; the largest supplier of equipment for the project was a Massachusetts company; and further additional materials, equipment and services for the project were obtained from Oklahoma, Maryland and Kansas.

The construction manager in our case may argue that its agreements to renovate the house "affect commerce" because certain materials used during the course of the home improvements came from out of state. The counterargument would be that, if the use of any out of state materials triggers the applicability of the Federal Arbitration Act, then General Business Law Section 399-c would be eviscerated and pre-empted in most cases.

While the Federal Arbitration Act may in some cases pre-empt a state statute such as Section 399-c, it may only do so in transactions "affecting commerce." The agreement herein, when measured against the standards set by applicable caselaw, may not be found to "affect commerce." Indeed, too liberal an application of the Federal Arbitration Act would render General Business Law Section 399-c a virtual nullity.

The mandatory arbitration clause contained in the Construction Management Agreements may be declared null and void, pursuant to General Business Law Section 399-c even if the home owners' application for a stay of arbitration is untimely. Pursuant to CPLR 7503(c), which provides, in relevant part, that "an application to stay arbitration must be made by the party served within twenty days after service upon him of the notice or demand, or he shall be so preclude." an untimely application to stay arbitration may, be granted if the agreement for which arbitration is sought is facially illegal or if upon facial examination of the agreement, a court may conclude that it would be against public policy to permit arbitration of the issue sought to be arbitrated.

Because the arbitration clauses contained in the Construction Management Agreement may be declared null and void pursuant to General Business Law Section 399-c the untimeliness of their application to stay the arbitrations should not be a bar due to the public policy issue involved.

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