Court of Appeals Finds Arbitration Provision Incorporated by Reference Unenforceable

Blocked Shot

Subcontractors have gotten accustomed to incorporation clauses in their contracts. While an incorporation clause can incorporate any document, most typically, it’s the prime contract between the general contractor and the project owner. Subcontractors will sometimes even accept these documents sight unseen which can be a recipe for disaster. But not in the next case.

In Remedial Construction Services, LP v. AECOM, Inc., Case No. B303797 (June 15, 2021), the 2nd District Court of Appeal examined whether a subcontractor was bound to an arbitration provision contained in a prime contract that was incorporated by reference into the subcontractor’s contract. In this case, it was the prime contractor who was in for a surprise.

The Remedial Construction Case

In 2015, Shell Oil Products US, LLC entered into a prime contract with AECOM Technical Services, Inc. for the demolition, remediation and restoration of the Gaviota oil terminal in Goleta, California. AECOM in turn entered into a subcontract with Remedial Construction Services, LP to perform portions of the work. When AECOM refused to pay Remedial for delay costs asserted by Remedial, Remedial filed suit.

In response, AECOM filed a motion to compel arbitration pursuant to its prime contract with Shell. The arbitration provision in the prime contract stated:

Any dispute or claim, arising out of or in connection with the CONTRACT or its subject matter or formation, whether in tort, contract, under statute, or otherwise . . . will be finally and exclusively resolved by arbitration under the International Center for Dispute Resolution (“ICDR”) International Dispute Resolution Procedures (the “Rules”).

The incorporation clause contained in Remedial’s subcontract with AECOM stated:

The contract between Contractor and [Owner] . . . is hereby incorporated into and made a part of this Agreement by reference. Subcontractor assumes toward Contractor all of the obligations and responsibilities contained in the Prime Agreement or client flow-down provisions . . . that Contractor assumes towards its Client as they relate to Subcontractor’s performance of the Work. In the event of a conflict between the provisions of this Agreement and Prime Contract the more restrictive provision shall govern.

The trial court denied AECOM’s motion finding that there was “no general obligation in [Remedial’s subcontract], that Remedial’s subcontract “does not directly incorporate the arbitration agreement from [AECOM’s prime contract], and that the arbitration provision in the prime contract only applied to claims against Shell not to claims between Remedial and AECOM.

AECOM appealed.

The Appeal

On appeal, the 2nd District Court of Appeal explained that “[a]lthough the law favors contracts for arbitration of disputes between parties, there is no policy compelling persons to accept arbitration of controversies which they have not agreed to arbitrate” and that “[a]bsent a clear agreement to submit disputes to arbitration, courts will not infer that the right to a jury trial has been waived.”

Further, explained the Court of Appeals:

[W]hile parties may incorporate by reference into their contract the terms of some other agreement . . . each case must turn on its facts. For the terms of another document to be incorporated into the document executed by the parties the reference must be clear and unequivocal, the reference must be called to the attention of the other party and he must consent thereto, and the terms pf the incorporated document must be known or easily available to the contracting parties.

Applying a de novo standard of review, the Court of Appeals held that the arbitration provision contained in AECOM’s prime contract with Shell was inapplicable to disputes between Remedial and AECOM for five reasons:

  1. The Incorporation Clause Applied to Remedial’s Performance of its Work Only: Under the incorporation clause, Remedial agreed to assume AECOM’s obligations under the prime contract, but only to the extent they related to Remedial’s performance of its work on the project, not AECOM and Shell’s agreement to arbitrate disputes between them.

  2. The Subcontract Included a Litigation Provision: Remedial’s subcontract included a litigation provision, not an arbitration provision, which stated that “[a]ny litigation instituted by and between the Parties arising out of or relating to this Subcontract shall be conducted in the federal or state court of jurisdiction in the State whose laws govern this Subcontract and Contractor and Subcontractor each consents to the jurisdiction of such court.” The arbitration provision in the prime contract, should it be applied, explained the Court of Appeal, would render the litigation provision “superfluous, void or inexplicable.” 

  3. The Order of Precedence Clause in the Subcontract Gave Precedence to the Subcontract: Remedial’s subcontract included an “Order of Precedence” clause that gave precedence documents in the following order: (a) amendments to the subcontract; (b) the subcontract; (c) the general conditions to the subcontract; (d) drawings accompanying the subcontract; and (e) specifications and “other Subcontract Documents including the Prime Agreement.” Thus, explained the Court of Appeals, “AECOM and [Remedial] expressly agreed the terms of the Subcontract would control over the Prime Agreement.”

  4. The Subcontract Expressly Incorporated Certain Provisions of the Prime Contract But Not the Prime Contract’s Arbitration Provision: Remedial’s subcontract expressly incorporated the “force majeure events” defined in the prime contract. As the drafter of Remedial’s subcontract, explained the Court of Appeals, AECOM could have similarly referenced the arbitration provision of the prime contract. Thus, explained the Court, “to the extent an ambiguity exists regarding whether AECOM and [Remedial] intended to arbitrate their disputes, it should be construed against AECOM as ‘the party who caused the uncertainty to exist.'”

  5. The Subcontract’s “Joinder” Provision Would Only Apply if AECOM Was in Arbitration, Mediation, or Litigation with the Shell: Finally, the Court of Appeal pointed to the “joinder” provision of Remedial’s subcontract, in which Remedial agreed to consent to joinder in any arbitration, mediation, or litigation between AECOM and Shell. That provision, explained the Court of Appeal, “further confirms that if there was an intent to arbitrate claims between [Remedial] and AECOM, the Subcontract would have so sated. The only agreement to arbitrate involving [Remedial] is one in which it is joined as a party to an action between AECOM and the Owner.”

Conclusion

This is the first decision I’ve seen analyzing in detail the enforceability of a document incorporated by reference. As such, there’s a lot to unpack. On one hand, one can take a broad view of this decision and argue that it applies to any document, and any provision contained in such document, that is incorporated by reference. As such, you name it, and this decision might apply to it, whether it involves an arbitration provision, payment hold-back provisions, etc. On the other hand, it could also be narrowly construed to only apply to arbitration provisions that are incorporated by reference.

The decision also opens up a potential can of worms. Not that I’m saying that the five points raised by the Court of Appeals weren’t appropriate. Rather, because the Court did not state that this was an exhaustive list of reasons why a provision contained in another document should not be incorporated, or that one of the five reasons it relied upon weighed more heavily than others in its decision, it raises the possibility that there will be more challenges to the enforceability of provisions incorporated by reference. Between us ducks I thought that the fact that Remedial’s subcontract contained a litigation provision, when the prime contract contained an arbitration provision, was the most compelling reason. However, because the Court of Appeals did not assign a weight to any of its reasons, again, not that I think they needed to, it does raise the possibility that there will not only be more challenges to the enforceability of provisions incorporated by reference, but it raises the possibility that there will challenges based on a variety of reasons.

For general contractors, I think there are a few take-aways from the decision. First, make sure that your subcontract does not contain a dispute resolution clause that is inconsistent (i.e., litigation vs. arbitration) with a dispute resolution clause your prime contract. Second, I’ve seen many incorporation clauses, like that in Remedial’s subcontract, in which the subcontractor agrees to be bound to the general contractor in the same manner that the general contractor is bound to the owner with respect to the subcontractor’s “work on the project.” I’ve always had a problem with that language, as it suggests that only work-related, not administration-related provisions, are incorporated by reference. That may be what you want. But if you don’t, as AECOM didn’t, you might want to include a more clearly expressed provision. Third, give thought to your “order of precedence” provisions. Not just in general, as in what document takes precedence over another, but whether you want the entirety of a document to take precedence over another or only certain provisions within that document. Yes, many construction contracts are already long, but clarity isn’t always bedfellows of succinctness. 

#AECOM #Arbitration #Remedial

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