Unless told otherwise, a contractor who works on a project expects that, if a dispute arises out of its compliance with the contract or payment thereunder, the dispute will be heard locally and will be governed by local law.

Laws exist to help reinforce this expectation. In Wisconsin, the Construction Lien Law – Wis. Stat. section 779.135(2) – renders void any provision in a contract for construction in the state calling for the application of another jurisdiction’s laws or for the venue of any dispute resolution proceeding – whether mediation, arbitration, or litigation – to be in another jurisdiction. Many other states have similar laws.

Construction contracts often contain an arbitration clause as an alternative to litigation. Indeed, arbitration used to be the default option in the American Institute of Architects’ (AIA) form contracts.

But while we learn in our Contracts I class that state law is the source of nearly all contract law (which includes the laws voiding a foreign venue), there are exceptions. Federal law is the “supreme law of the land” and, where the Constitution gives the federal government authority to legislate and federal law conflicts with state law, the latter gives way.

Yet, one might reasonably ask: why would federal law poke its nose into the venue and applicable law governing a local construction dispute that is traditionally in the purview of state law?

The answer lies in the Federal Arbitration Act (FAA).¹

The Federal Arbitration Act

The FAA was enacted pursuant to the Commerce Clause.² Since the Great Depression of the 1930s, the U.S. Supreme Court’s interpretations of the Commerce Clause have greatly expanded Congress’s power to include regulation of nearly all economic activity that affects interstate commerce.

Thus, while state contract law governs the elements of formation of the contract (i.e., mutual assent, consideration, etc.), once an agreement to arbitrate is found, the FAA kicks in to enforce that agreement.

Section 2 is the primary substantive provision of the Act, declaring that a written agreement to arbitrate “in any maritime transaction or a contract evidencing a transaction involving commerce ... shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.”³ Section 2 is a congressional declaration of a liberal federal policy favoring arbitration agreements, notwithstanding any state substantive or procedural policies to the contrary. The effect of the section is to create a body of federal substantive law of arbitrability, applicable to any arbitration agreement within the coverage of the Act.⁴

Thus, unless the parties have agreed to arbitrate and have expressly designated the application of a state’s arbitration law, the FAA governs the validity and enforcement of the arbitration agreement in both federal and state courts “notwithstanding any state substantive or procedural policies to the contrary.”⁵

Section 2 of the FAA provides that an arbitration agreement “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract,” ⁶ and, as a general rule, courts must “rigorously enforce” arbitration agreements according to their terms.⁷

NOIC Case: ‘Commercial Impracticability’

Thus, generally, agreements on the situs of an arbitration proceeding are enforceable as written, with rare exception:

the forum selection clause contained in an arbitration provision must be enforced, even if unreasonable. A forum selection clause establishing the situs of arbitration must be enforced unless it conflicts with an “explicit provision of the Federal Arbitration Act.” Under the Act, a party seeking to avoid arbitration must allege and prove that the arbitration clause itself was a product of fraud, coercion, or “such grounds as exist at law or in equity for the revocation of the contract.”⁸

In a consumer context, one might be successful in arguing that the choice of the situs of an arbitration proceeding is unconscionable.⁹

But for commercial parties, the party trying to escape an arbitration in another state usually is stuck with arguing commercial impracticability or impossibility, and that presents a very high bar – as noted by the Fifth Circuit in National Iranian Oil Co. (NIOC) v. Ashland Oil.¹⁰

In NIOC, the parties entered into an agreement in April 1979 for the purchase and sale of oil that contained an agreement to arbitrate in Tehran, Iran. On Nov. 12, 1979, following the Nov. 4 takeover of the American Embassy in Tehran and the seizure of American hostages, President Jimmy Carter banned the importation of all oil from Iran not already in transit.¹¹

Each party asserted that the other breached the contract. NIOC sought to arbitrate in Iran, but Ashland refused to participate (and presumably lacked assets in Iran that the new Iranian government could seize). NIOC then filed suit in U.S. District Court in Mississippi seeking, inter alia, to compel arbitration in Mississippi.

The case includes many interesting aspects, but critical for this discussion is the Fifth Circuit decision that the party seeking relief under the doctrine of commercial impracticability must prove two elements:

• affected parties must have no reason to know at the time the contract was made of the facts on which they rely; and

• a party may not rely on the doctrine of impossibility or impracticability “if the event is due to the fault of the … [party] himself [or herself].”

Finding both of these elements present, the court held that “[u]nder traditional principles of contract law, NIOC’s argument that the political atmosphere in Iran renders arbitration there impossible or impracticable certainly supplies an adequate predicate for finding the forum selection clause unenforceable and without effect.”

Conclusion: Confirm a Local Arbitration

It is fair to state that “commercial impracticability” is very much the exception to the rule and that, in general, an agreement among commercial parties to arbitrate in another U.S. state will be enforced.

Once an arbitrator or panel is selected, mistakes of law, or even whether the arbitrator(s) purport to apply the chosen law, are nearly unreviewable by courts absent an agreement for some kind of review. Such clauses are uncommon, because review defeats some of the major perceived advantages of arbitration in the first place – speed and cost savings.

Thus, if your client agrees to arbitrate – including via a “flow down clause” where a subcontractor agrees to abide by the terms of the general contract – it is important to confirm the situs of the arbitration is local. Otherwise, you can end up arbitrating in a far-away state playing by rules you aren’t used to, and there will be little that even a sympathetic local judge can do to help.

This article was originally published on the State Bar of Wisconsin’s Construction and Public Contract Law Section Blog. Visit the State Bar sections or the Construction and Public Contract Law Section web pages to learn more about the benefits of section membership.

Endnotes

¹9 U.S.C. § 1, et seq.

²Perry v. Thomas, 482 U.S. 483, 489 (1987) (citing U.S. Const., Art. I, Sec. 8, cl. 3).

³9 U.S.C. § 2 (emphasis added).

⁴Moses H. Cone Mem’l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24 (1983) (emphasis added).

⁵Perry, 482 U.S. at 489. “Congress intended to foreclose state legislative attempts to undercut the enforceability of arbitration agreements.” Southland Corp. v. Keating, 465 U.S. 1, 16 (1984). “This clear federal policy places § 2 of the Act in unmistakable conflict with [the state law] requirement that litigants be provided a judicial forum. ... Therefore, under the Supremacy Clause, the state statute must give way.” Perry, 482 U.S. at 491.

⁶9 U.S.C. § 2.

⁷American Express Co. v. Italian Colors Restaurant, 133 S. Ct. 2304, 2309, 186 L. Ed. 2d 417 (2013) (quoting Dean Witter Reynolds Inc. v. Byrd, 470 U.S. 213, 221 (1985)).

⁸National Iranian Oil Co. (NIOC) v. Ashland Oil, 817 F. 2d 326, 332 (5th Cir. 1987), reh’g denied en banc 823 F.2d 552 (5th Cir. 1987), cert. denied, 484 U.S. 943 (1987).

⁹E.g., Ortolani v. Freedom Mortg. Corp., 2017 U.S. Dist. LEXIS 232308, at 17 (C.D. Cal.).

¹⁰Supra n. 8.

¹¹Id. at 328.