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Arbitration Provisions

The Court of Appeal Makes a Bad Call

06/15/10
Kurt F. Vote

A California appellate court wrongly holds that developers cannot implement arbitration provisions by including them in CC&R’s.

As the entire sporting world knows from recent events, when a baseball umpire makes a bad call, it can affect the history of the entire sport. Even a perfect game – one of the most rarely-accomplished feats in all of baseball – can be taken away by an errant judgment. The Fourth District Court of Appeal recently made a “bad call” in an important construction defect case, which could have far-ranging impact on the building industry and the administration of justice in California.

California law clearly provides that builders of residential housing are liable to any purchasers (whether they are the original purchasers or not) for latent defect claims asserted up to 10 years after the original completion of the home. A builder who wishes to include arbitration as part of an alternative dispute resolution program can insert an arbitration clause into the purchase agreement which is executed by the original buyer of the home. As long as the arbitration provision is not unconscionable and is properly executed by the original buyer, the arbitration provision will generally be enforced by the courts if a construction defect action later arises. The builder can then take solace in the fact that although the builder will be potentially liable for 10 years for any latent defects in the home, any claims which arise between the builder and the original purchaser will be resolved fairly, quickly, and efficiently through the arbitration process to which the parties have agreed. However, especially in today’s challenging economic times, properties are changing hands frequently. A home may be sold and re-sold several times within the first 10 years after construction. What if a subsequent purchaser wants to assert a construction defect claim?

Generally speaking, the attorneys for the subsequent purchaser will (correctly) note that the subsequent purchaser never signed an arbitration agreement with the builder and likely never even knew of such an agreement. These arguments are routinely accepted by the courts. Concerned builders responded to this argument by including the same arbitration provision that was in the purchase agreement in the covenants, conditions and restrictions (CC&Rs) which are recorded at the time the project is developed. Since all subsequent buyers have to review and approve the CC&Rs before they can take title, and since it is (or was) settled law that CC&Rs run with and bind the property and future owners, the builders who employed this strategy felt confident that they had effectively implemented an alternative dispute resolution program which would permit arbitration of all claims raised within the 10-year statute, regardless of whether they were raised by the initial owner or any subsequent owner. Unfortunately, in a recent case, the Fourth District Court of Appeal has voided this strategy.

In Villa Vicenza Homeowners Ass’n v. Nobel Court Dev., LLC (2010) 2010 DJDAR 7961 (June 1, 2010), the Fourth District held that CC&Rs are not an effective means of obtaining an agreement to arbitrate construction defect claims. The appellate court moved away from one of its earlier decisions, in which it held that CC&R’s were an adequate means of creating an agreement to arbitrate construction defect claims against a developer as long as the arbitration agreement was not unconscionable. Now, 10 years later, the court has decided to deem agreements to arbitrate construction defect claims contained in CC&R’s categorically unenforceable – regardless of the terms of the arbitration provision at issue. This decision, unless overturned by the California Supreme Court or corrected by the Legislature, contradicts California’s stated public policy in favor of arbitration and effectively precludes developers from being able to ensure that they can arbitrate construction defect claims brought by homeowners who are not original purchasers of their homes.

Public policy clearly favors arbitration. The California Supreme Court has noted that “[a]rbitration, like reference hearings, conserves judicial resources far more than the selection of a court trial over a jury trial. It therefore is rational for the legislature to promote the use of arbitration and reference hearings by permitting predispute agreements, while not according the same advantage to jury trial waivers.” (Grafton Partners v. Superior Court (2005) 36 Cal. 4th 944, 964.) In that same case, the Supreme Court noted that it was up to the Legislature to determine whether and under what circumstances waivers of jury trials should be enforced in this state. (Id. at 967.) Since 1961 the Legislature, through the California Arbitration Act, has determined that arbitration agreements, where they are not unconscionable, are valid pre-dispute waivers of jury trials. Now the Fourth District has turned a blind eye toward California’s public policy by holding that arbitration agreements in CC&Rs are per se unenforceable regardless of their terms.

From a public policy perspective, this decision makes little sense. Not only does it eviscerate the use of arbitration agreements in construction defect cases, but it violates long-standing principles of freedom of contract. A purchaser who acquires property subject to CC&Rs must review and approve the CC&Rs before escrow can close. Buyers who do not agree with the provisions of the CC&Rs applicable to the property they intend to purchase may either try to negotiate a change in the CC&Rs or elect to purchase a different property. Thanks to the Villa Vincenza decision, a buyer can approve CC&Rs which contain arbitration provisions and then decline to submit to an arbitration. Such action is allowed despite the settled law which holds that CC&Rs bind the property against which they are recorded. Apparently, the Fourth District believes that CC&Rs should be used to govern issues such as whether homeowners can park cars in their driveways, paint their homes purple, or leave portable basketball hoops in the streets – but that CC&Rs cannot be used to further the fundamental public policy of the State of California in favor of arbitration. If CC&Rs themselves are to be binding, all of the provisions in the CC&Rs ought to be equally binding.

A change in the law, such as that represented by the Villa Vincenza decision, ought to come from the Legislature, not a 3-judge panel on the Court of Appeal. Arbitration is favored by the public policy of the State of California as an effective, efficient, and fair dispute resolution process. The Villa Vincenza decision effectively denies the building industry the ability to use arbitration clauses as part of alternative dispute resolution programs. The Fourth District should re-hear this matter. Failing that, the Supreme Court or the Legislature should intervene to restore order on this important question.

http://www.mccormickbarstow.com/showarticle.aspx?Show=257

 

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