State Statute Trumped by Federal Arbitration Act

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To protect contractors and subcontractors working on North Carolina construction projects, state law prohibits the enforcement of any agreement subjecting the parties exclusively to the laws of another state or making the forum of dispute resolution exclusively in another jurisdiction. Specifically, N.C.G.S. 22B-2 states, in part, that a provision in any contract or subcontract for improvements to real property in North Carolina is “void and against public policy if it makes the [contract/subcontract] subject to the laws of another state, or provides that the exclusive forum for any litigation, arbitration, or other dispute resolution process is located in another state."

The purpose of this statute is to make the laws of North Carolina apply to in-state projects and to prevent in-state contractors and subcontractors from having to expend unnecessary time and expense resolving disputes in locations unrelated to, and in many times a substantial distance from, the location of the project. However, a federal court has recently held that North Carolina’s statute is preempted by the Federal Arbitration Act (FAA). In U.S. ex rel. Red Hawk Construction, Inc. v. MSK Construction (MDNC May 8, 2018), the court concluded that under the Act, parties to a contract can be forced to arbitrate in another jurisdiction and be bound to the laws of a state other than North Carolina, even on a project exclusively within the state.

MSK Construction, Inc. was the general contractor on a Veterans Affairs construction project in Durham. MSK entered into a subcontract with Red Hawk Contracting, Inc., for demolition, earthwork and other services. Red Hawk contended MSK wrongfully withheld $80,000 from payments due and filed an action in United States District Court. MSK moved the court to stay the proceedings. MSK argued the subcontract agreement had a mandatory arbitration clause requiring all disputes to “be fully and finally decided by arbitration …. [which] shall be conducted in Charleston, South Carolina.” Further, the agreement specified South Carolina law would be exclusively applied in the arbitration proceeding. Red Hawk responded that N.C.G.S. 22B-2 voided subcontract provisions relating to arbitration and choice of law.

The court concluded the Federal Arbitration Act applied. The parties had an interstate commerce relationship. Further, the court stated the FAA’s jurisdiction could only be challenged if defenses of duress, fraud or unconscionability were raised. These were not present in this case. As a result, Red Hawk was required to arbitrate its dispute with MSK in Charleston, South Carolina, and pursuant to South Carolina law. As a result of this case, contracts or subcontracts with arbitration provisions (where the parties are in interstate commerce) can now contain exclusive non-North Carolina choice of law provisions and dispute resolution venues, all despite North Carolina statutory law to the contrary.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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