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May 15, 2015

Texas Supreme Court Addresses Arbitration Issues Involving AIA Contracts in Construction Defect Case

By: Michelle Robberson

The Texas Supreme Court in G.T. Leach Builders, LLC v. Sapphire V.P., LP, No. 13-0497, 2015 WL 1288373 (Tex., Mar. 20, 2015), addressed multiple issues relating to arbitration among parties to a construction defect lawsuit. 

A. Procedural History

Sapphire was the developer of a condominium project on South Padre Island, which suffered extensive damage in Hurricane Dolly.  Id. at *1.  Sapphire initially sued its insurance brokers because, eight days before the hurricane, the brokers allowed the builder’s risk policy to lapse and be replaced by a permanent policy, even though construction was not complete.  Id.

Years into the litigation, the insurance brokers designated several responsible third parties, including (a) the general contractor, Leach, (b) subcontractors Power Design and Atlas Comfort Systems, and (c) the project engineer.  Id.  Sapphire then added these parties as defendants.  Id. 

The general contract between Sapphire and Leach was the 1997 version of the standard AIA general contract.  Id. at *2.  Leach moved to compel arbitration of the claims under this contract.  Id.  The insurance brokers, subcontractors, and engineer filed similar motions to compel arbitration, even though they had not signed the general contract.  Id.  The subcontractors also relied on their subcontracts, even though Sapphire had not signed those.  Id.  The trial court denied all the motions without giving any reasons.  Id.  The court of appeals affirmed, and the Texas Supreme Court granted review.

B. General Contractor’s Right to Arbitration

As to Leach, Sapphire argued Leach expressly and impliedly waived its right to arbitration by participating in the lawsuit, moving for continuance, and agreeing to a new trial date.  Id. at *3.  The supreme court analyzed the relevant factors for determining a waiver of arbitration and considered the totality of the circumstances.  Id. at *4-6.  The court concluded that Leach’s participation was defensive in nature and necessary to preserve its rights against the plaintiff, Sapphire; thus, its actions did not amount to a waiver of its right to arbitrate.  Id. at *6.  Likewise, the court concluded Sapphire suffered no prejudice by Leach’s participation in the lawsuit, given that Sapphire initiated the litigation.  Id. at *6-7.

Sapphire’s next defense was that Leach waived arbitration by failing to request it by the deadline in their contract (i.e., within a reasonable time after the claim arises and in no event later than the date on which institution of legal proceedings would be barred by the applicable statute of limitations).  Id. at *10.  The supreme court detailed the law of substantive arbitrability (issues regarding the existence, enforceability, and scope of an arbitration agreement that a court decides) versus procedural arbitrability (issues such as whether the party met contractual requirements regarding notice, time limits, etc. that the arbitrator decides).  Id. at *11.  Ultimately, the supreme court concluded that the issue of whether Leach complied with the contract deadline was a matter of procedural arbitrability to be decided by the arbitrator.  Id. at *12.  The court was careful to limit its holding to the facts of this case and stated it was not holding a dispute over a contractual deadline will always be a question of procedural arbitrability.  Id.

As to Leach, the court reversed the denial of its motion to compel arbitration.  The court then analyzed whether the other defendants were entitled to arbitrate.  Id. at *13-20. 

C. Other Defendants’ Right to Arbitration

The insurance brokers and engineer had contracts with Sapphire that did not have arbitration agreements, and the subcontractors had contracts with Leach that allegedly did include enforceable arbitration agreements.  Id. at *13.  The supreme court made the following holdings:

1. The other defendants could not compel arbitration with Sapphire based on the general contract between Sapphire and Leach, because they were not parties to that contract.  Id. at *14.

  • Despite the arbitration clause having a broad scope (“any claim arising out of related to the contract”), the joinder provision of the standard AIA arbitration agreement (which Sapphire and Leach modified to state that “any” arbitration “may” include other parties and added “subcontractors” to the list) was permissive, rather than mandatory.  It did not require Sapphire to arbitrate with the subcontractors.  Id. at *15.

  • Although the definition of “Contractor” included any contractor who executed a separate agreement with Sapphire, the contract expressly stated that the “Contract Documents shall not be construed to create a contractual relationship of any kind” between anyone other than Leach and Sapphire.  Id.  Thus, the general contract did not require Sapphire to arbitrate with any of the other defendants.  Id. at *16.

2. The other defendants also argued Sapphire was equitably estopped to deny it had agreed to arbitrate with them.  Id.  Typically, estoppel only applies if the party seeks to derive a direct benefit from the contract.  Id.  The supreme court concluded that Sapphire was not suing the other defendants based on any breach of the general contract; rather, Sapphire sued the insurance brokers, subcontractors, and engineer based on their contracts and their failures to perform as a reasonable professional would have performed.  Id. at *17.  Thus, Sapphire’s claims against the other defendants did not seek a “direct benefit” under the general contract, and Sapphire was not equitably estopped from denying it agreed to arbitrate.  Id.

3. Lastly, the supreme court examined whether the subcontracts contained an enforceable arbitration agreement.  Id. at *19.  The court did not state whether the subcontracts were standard AIA forms.  However, the subcontracts contained conflicting provisions regarding arbitration: 

Section 11.1 stated that all claims arising out of, or relating to, the subcontract or breach thereof shall be decided by arbitration. 

Section 11.3 stated that, if Leach enters into arbitration with Sapphire, the subcontractors agree to consolidation of arbitrations and the subcontractors shall be bound by the result of the arbitration to the same degree as Leach. 

Section 12.13 stated, however, that notwithstanding contrary provisions, the subcontract did not contain a provision requiring mandatory arbitration or incorporate such a provision from the general contract. Id.  The supreme court concluded that a direct conflict existed between section 11.1 and section 12.13 but that, because section 12.13 stated it applied “notwithstanding any provision to the contrary,” section 12.13 resolved the conflict.  Id. at *20.  That is, in the event of a conflict, section 12.13 prevailed.  Id.  Therefore, the subcontracts did not contain a valid, enforceable agreement to arbitrate between Sapphire and the subcontractors, and the lower courts did not err in denying arbitration.  Id.