Alternative dispute resolutions in public contracts

Real Estate Weekly, August 17, 1994 by Carol J. Patterson

As the economy has declined in the past few years, firms in the construction industry have been forced to accept an unpalatable combination: lower fees and more onerous contract terms. Many of the hardest bargains are driven by public entities which hire design professionals and contractors on a competitive basis. Often the opportunity to modify the terms of public contracts through negotiation is extremely limited. Furthermore, as the New York Court of Appeals' 1993 decision in Westinghouse Electric Corporation v. New York Transit Authority clearly demonstrates, anyone who signs on the dotted line and hopes that the courthouse may offer a reprieve from obligations which are especially one-sided is making a big mistake.

The central issue in Westinghouse was whether to enforce a contractual alternative dispute resolution (ADR) mechanism that gave an employee of tracting parties the power to make "conclusive, final and binding decisions on all questions arising under the contract" - even though that employee was personally involved in the dispute.

Westinghouse argued that this ADR provision was barred by New York public policy. The Court did not agree.

The employee was a Chief Electrical Officer of the New York City Transit Authority (NYCTA) and he functioned as the Superintendent designated by the parties' agreement. The ADR provision of the contract provided that in the event of a dispute between Westinghouse and NYCTA "concerning a determination by the Superintendent," the parties were obligated to proceed with the contract ADR requirements, which authorized the Superintendent "acting personally, to decide all questions of any nature... related to or on account of this contract..." and his decision shall be "conclusive, final and binding on the parties." Presenting the dispute to the Superintendent for resolution could not be avoided; the contract made it a prerequisite to any legal proceeding.

Westinghouse had bid on and won a contract with NYCTA and the Metropolitan Transportation Authority (MTA) for the sale, delivery and installation of power rectifier equipment for five substations for the New York City subway system. Over the course of the project, many disputes arose as Westinghouse claimed it was entitled to damages for delay and compensation for additional work. Westinghouse also complained that unresolved design problems and other restrictions on its work were an insurmountable obstacle to its timely completion of its contractual obligations. When it was unable to reach an agreement with the NYCTA Superintendent, Westinghouse wrote to advise him that it considered the problems to be a constructive stop work order. Three months later Westinghouse advised the Superintendent that it was suspending work because of NYCTA's failure to address the problems identified in Westinghouse's previous letter. The Superintendent, in turn, responded that Westinghouse's suspension of work was a breach of contract. As a result, in accordance with the Superintendent's recommendation, Westinghouse was declared to be in default. Pursuant to the ADR provision, Westinghouse asked that the default declaration be rescinded and that its claim for millions of dollars of additional compensation be accepted. Not surprisingly, the Superintendent rejected both claims.

Westinghouse filed suit federal court contending that NYCTA breached the parties' agreement. It argued that the ADR provision in the contract was invalid and violated New York public policy because it is a process which is predisposed to be biased. The argument emphasized that since the decision-maker is an employee of out of the parties to the dispute, it was unlikely that the contractor would receive a fair hearing.

The Court rejected Westinghouse's argument and ruled that the contract ADR mechanism was enforceable. This provision was simply one of the business risks Westinghouse assumed when it bid on the multi-million dollar contract with the NYCTA and MTA. Having accepted the benefits of the deal "with its business eyes open," Westinghouse could not seek to modify it after the fact. Accordingly, the Court agreed that Westinghouse was bound to follow the contractual procedure of presenting its claims to NYCTA's Superintendent for final resolution. Court review of that decision would, in accordance with the parties' agreement, be limited to the question of whether the Superintendent's determination is "arbitrary, capricious or grossly erroneous to evidence bad faith."

Westinghouse is consistent with other decisions which reflect courts' reluctance to modify the terms of a commercial bargain. The Court of Appeals has rejected similar appeals to fairness and upheld "no damage for delay" clauses. Although public authorities have tremendous leverage in negotiating these agreements, courts reason that contractors can choose to avoid these provisions by refusing to bid for the work. This is precisely what many prospective bidders may decide to do now that it is clear that the ADR provisions which give a public agency extensive license to resolve disputes in its favor will be strictly enforced.