Contractor Must Pay Punitive Damages in Arbitration Case

Contractor Must Pay Punitive Damages in Arbitration Case

by James R. Keller

This article appeared in St. Louis Construction News & Review, p. 21, November-December, 2001.

Missouri's appellate court just upheld an arbitrator's award of $50,000 in punitive damages against a contractor in a dispute with a homeowner. Since arbitration agreements are the industry standard in construction, this case may impact dramatically the nature and scope of future construction awards.

Until now, arbitrator's seldom assessed punitive damages. Many had questioned whether arbitrators even had the power to do it, especially in construction cases.

The case is Groceman v. Pulte Homes Corp., No. 59110 (Mo.App. W.D. 2001), decided August 21. Pulte Homes, the contractor, also must pay another $50,000 in actual damages to compensate for structural defects in the house, including a downward sloping roof, inadequate rafters and roof framing, and cracks in the ceiling.

Punitive damages are designed to punish the defendant for particularly bad conduct, and send a message to others of a like mind not to do the same. Punitive damages are in addition to the claimant's actual damages.

Several hurdles make punitive damages hard to recover and even harder to keep in a traditional lawsuit. The trial judge typically finds that there is not enough evidence of bad conduct to allow the jury to consider punitive damages. When allowed to consider punitive damages, juries seldom award them. Then, when awarded, either the trial judge or the court of appeals often reduces or eliminates them after trial.

Punitive damage awards are even rarer in arbitration, but with this decision, when they are awarded, they may be nearly impossible to overturn on appeal.

The road to Pulte's punitive damages started in circuit court in Kansas City in 1998 when the homeowners sued the contractor for fraud, negligent misrepresentation, breach of contract, professional negligence and breach of warranty of habitability. Pulte convinced the judge to move the case from court to arbitration because the parties' agreement required resolution of disputes under the Federal Arbitration Act.

Unlike a traditional lawsuit, arbitration allows the parties to pick their arbitrator and the proceedings are private rather than public. Like a regular trial, the evidence comes from the sworn testimony of witnesses and from documents, such as contracts and letters. In this case, the hearing took two days.

After an arbitrator's award, the next step is to file an application to confirm it in a trial court. Pulte challenged the filing, arguing that the damage award showed a manifest disregard of the law.

The appeals court looked at the Federal Arbitration Act to decide the grounds for overturning the arbitrator's award. This Act applied because the agreement called for it and because the contract in question involved interstate commerce, since Pulte built homes in both Missouri and Kansas and had materials for this home shipped to Kansas City from several states.

The Act spells out the only grounds for a court to vacate the arbitration award. All involve arbitrator misconduct such as fraud, corruption, misbehavior in refusing to postpone the hearing or hear evidence, or that the arbitrator exceeded his or her power. Various courts interpreting the Act over the years have included another ground not expressly set out in the Act; namely that the arbitrator's award shows a manifest disregard of the law.

All of these grounds are narrow and severely limit chances of success on appeal. Thus, in virtually all cases the arbitrator's decision is the first and the final word.

To succeed on appeal on the "manifest-disregard-of-the-law" standard, Pulte had to prove that its arbitrator correctly understood the law but then chose to ignore it. Establishing that the arbitrator mistakenly interpreted the law or wrongly decided the facts would not be enough. This is a very high standard, far exceeding what would be necessary to win on appeal in a traditional lawsuit.

Had the Federal Arbitration Act not applied, the court would have used Missouri's Uniform Arbitration Act, but the result most likely would have been the same with this court. Missouri courts do not recognize "manifest disregard of the law" as a basis for vacating an arbitration award falling under Missouri's Uniform Arbitration Act.

The court in Pulte upheld the arbitrator's award even though the arbitrator "did not clearly delineate the law applied or the analysis used in reaching his decision." The court reiterated what other courts have already decided: the arbitrator is not required to explain his decision or even to write an opinion justifying the award.

The arbitrator's award in Pulte contained some explanation but not enough for the appellate court to conclude that the arbitrator understood the law and ignored it. Apparently, there was little if any detail on what evidence prompted the punitive damages. Ironically, the law is such that an arbitrator's award that says nothing has the best chance to hold up on appeal.

Savvy parties to arbitration already know this, but when asked by the arbitrator if they want a decision detailing the law and the facts, the parties typically do not request it. The parties pay for the arbitrator's time. An award with reasons takes more time and this costs the parties more money.

James R. Keller is a partner at HERZOG, CREBS & MCGHEE, LLP, where he concentrates his practice on business and construction litigation. He also is an arbitrator with the American Arbitration Association.