Ambac Assur. Corp v. Knox Hills LLC, 2018 Ky. App. Lexis 188 (June 15, 2018)

This case involves a February 1, 2007 design/build agreement governing the rights of the several parties involved with a military housing construction and renovation project at Fort Knox, Kentucky. Knox Hills, LLC (the owner) filed a breach of contract action against Ambac Assurance Corporation (the senior lender of the project) relating to what it characterized as Ambac’s wrongful withholding of consent to a change order that would have substantially reduced the scope of the project. Knox Hills then sought an order staying the proceedings and compelling Ambac to arbitrate. The circuit court granted the motion and, following an arbitration, entered an order confirming the arbitrator’s award in favor of Knox Hills. Ambac then appealed the court’s order.

On appeal, the Kentucky Court of Appeals focused on two questions: (1) whether the court or the arbitrator should have determined whether arbitration was required between Knox Hills and Ambac, and (2) whether arbitration was actually required.

The Court of Appeals noted that under the FAA, arbitration agreements are deemed valid, irrevocable and enforceable, except for the traditional grounds for revocation under contract law. As arbitration is a matter of contract, the consent of the parties to submit to arbitration must be clear. In the case of silence or ambiguity, courts are reluctant to infer that the parties intended to submit such issues to arbitration. Therefore, courts are required to make a threshold determination of whether parties have submitted a particular issue to arbitration. The court called these threshold issues “substantive questions of arbitrability.” The court further defined substantive questions of arbitrability to include such issues as whether parties have a valid arbitration agreement at all, and whether an arbitration clause applies to a particular type of dispute. These substantive questions of arbitrability, the court reasoned, are proper for judicial interpretation unless the parties’ intention to have these issues arbitrated is clear.

By contrast, the court defined “procedural questions” of arbitrability as questions that arise once it is established that the obligation to arbitrate exists. Procedural questions may include issues such as notice requirements, latches or the statute of limitations. The court reasoned that these types of issues are appropriate for an arbitrator to decide because they are the types of questions the parties would expect an arbitrator to decide and, perhaps more importantly, because they do not question the underlying authority of the arbitrator.

In the instant action, Ambac refused to arbitrate Knox Hills’ breach of contract claim on two grounds, which Ambac contended were conditions precedent to arbitration in the contract. First, prior to commencing the arbitration, Knox Hills failed to submit its dispute to an “Advisor” as described in the contract. Second, Knox Hills failed to designate the Advisor within forty-five days after the agreement was executed, as required by the contract. It was on the classification of these issues as procedural or substantive questions of arbitrability that the Court of Appeals differed with the court below.

The court below found these issues amounted to issues of procedural arbitrability on the grounds that having an Advisor was merely a condition precedent to any party invoking its right to arbitrate. The Court of Appeals reached the opposite conclusion, finding that these issues spoke to the authority of the arbitrator to determine this dispute and amounted to substantive arbitrability, and therefore should have been decided by the court. The Court of Appeals held that the timely appointment of the Advisor was a precondition to the validity of the arbitration clause itself.

Accordingly, the Kentucky Court of Appeals reversed the lower court, vacated the arbitration award, and remanded for further proceedings.