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.
UPDATE: The Court of Appeal granted the developer's Petition for Rehearing on June 25, 2010. The original Villa Vincenza opinion is no longer citeable law. Let's hope that, on rehearing the case, the appellate court makes the right call!
FURTHER UPDATE: On January 11, 2011, the Fourth District Court of Appeal issued an amended opinion after re-hearing the case. Unfortunately, the amended opinion maintains the earlier, erroneous conclusion that including a binding arbitration provision in recorded CC&Rs is not a viable way to obtain an enforceable arbitration agreement, even when subsequent purchasers take title expressly subject to the CC&Rs. The Court of Appeal did note in its amended opinion that there was a split of authority on the issue and that the California Supreme Court had recently accepted review of a different case, Pinnacle Museum Tower Assn. v. Pinnacle Market Development (US), LLC, review granted November 10, 2010, No. S186149 on the same issue. Hopefully, the Supreme Court will restore order and predictability to alternative dispute resolution by issuing an opinion confirming the enforceability of arbitration provisions in duly recorded CC&Rs.
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