Arbitration in Construction Defect Litigation
The Call to Arbitration in Construction Defect Litigation
Stacy LaScala
October 24, 2012
In a possible nod to the economic realities and financial challenges facing the California judicial system, on Aug. 16, 2012, the state Supreme Court decided that homeowners associations may be bound by arbitration clauses contained in declarations of covenants, conditions and restrictions (CC&Rs) for common interest developments. Pinnacle Museum Tower Association v. Pinnacle Market Development, LLC, et al.,(2012) 55 Cal.4th 223. The most immediate and interesting question the Pinnacle decision raises is its impact on the resolution of construction defect disputes arising out of common interest developments. By approving arbitration provisions in CC&Rs and correspondingly, the Arbitration process in the construction defect arena, the Court has impliedly recognized the value a trained and experienced neutral can have as the ultimate fact finder.
Background:
The Pinnacle Museum Tower is a residential high-rise tower, 36 stories tall with 182 condominium units, located in San Diego, CA. Prior to selling any of the units, Pinnacle Market Development recorded CC&Rs which contained a provision that required binding arbitration pursuant to the federal and California arbitration acts for all construction disputes in which Pinnacle was named a party. The condo purchaser waived any right to a jury trial in such circumstances and the arbitration provision could not be amended without the written consent of Pinnacle.
The Decision:
In a 6-1 decision, the California Supreme Court confirmed that arbitration is “an expeditious and judicially favored method to resolve a construction dispute.” “That a developer and condominium owners may bind an association to an arbitration covenant via a recorded declaration is not unreasonable.” “[B]inding arbitration benefits both the developer and the entire common interest community by providing a speedy and relatively inexpensive means to address allegations of defect damage to the common areas and other property interests.”
The HOA argued that because the CC&Rs were recorded before it even became an entity, there was never an opportunity to consent to waive it’s right to a jury trial. The Supreme Court rejected this argument, stating the “Legislature has crafted a statutory scheme providing for the capacity of a developer to create a condominium development subject to covenants and restrictions governing its operation and use. There appears no question that, under the Davis-Stirling Act, each owner of a condominium unit either has expressly consented or is deemed by law to have agreed to the terms in a recorded declaration.”
Noting that there was nothing in Davis-Stirling Act that prohibited the developer from including an arbitration provision in the CC&Rs, the Court concluded that even though the Association did not participate in the drafting of the CC&Rs, the terms of the CC&Rs, including the arbitration provisions, reflected written agreements that were enforceable against the Association. Further, the application of the Federal Arbitration Act (FAA), which was referenced in the CC&Rs, trumps or preempts the application of California Code of Civil Procedure section 1298.7, which would otherwise allow a “construction and design defect action against a developer in court, even when the parties have signed a real property purchase and sale agreement containing an arbitration clause.” Arbitration under the FAA “is a matter of consent, not coercion.” Similarly, under California law, the issue is one of contract. The Court held that the provisions contained in the CC&Rs were sufficient in creating an enforceable obligation for binding arbitration.
California courts had previously struck down arbitration provisions in CC&Rs by utilizing the doctrine of unconscionability. “Unconscionability consists of both procedural and substantive elements. The procedural element addresses the circumstances of contract negotiation and formation, focusing on oppression or surprise due to unequal bargaining power. Substantive unconscionability pertains to the fairness of an agreement’s actual terms and to assessments of whether they are overly harsh or one-sided.” In this case, the trial court had found procedural unconscionability, basing its decision in large part on the fact that the CC&Rs were drafted and recorded against the project before the homeowners association was even formed. Disagreeing with this analysis, the California Supreme Court looked to the Davis-Stirling Act, noting that the CC&Rs were drafted and recorded as "dictated by the legislative policy choices embodied in the …Act." The Court went on to say that "a developer's procedural compliance with the Davis-Stirling Act provides a sufficient basis for rejecting an association's claim of procedural unconscionability.” As for substantive unconscionability, the Court analyzed the specific arbitration terms at issue relating to legal remedies, cost sharing, etc., and held that the arbitration provisions in the CC&Rs were not substantively unconscionable.
Thinking Points:
1. If Arbitration proceeds between the Association and Developer, will the arbitration also include subcontractors or design professionals? Are these entities tied to the arbitration process through the prime contractor or will a subsequent indemnity suit be required?
2. Was the California Supreme Court’s decision, effectively redirecting an entire set of litigated matters to private alternative dispute resolution firms, an acknowledgment of the severe fiscal constraints facing the California judicial system?
3. Will arbitration provisions within purchase contracts between individual owners and the developer be utilized to compel arbitration of both the individual owners and the association in the same arbitration?
4. In order to take advantage of Pinnacle, the developer must make a motion in court to compel arbitration. Under traditional general liability policies, the insurer, not the insured, has the ability to control the defense, arguably including the decision to compel arbitration. Will insurance carriers accept the Court’s invitation and pick up the arbitration gauntlet?
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