STOP! Don’t Sign that Arbitration Clause! (Until you’ve considered the consequences!)

UPDATE:  Earlier this week, the United States Supreme Court granted Certiorari to consider whether or not an arbitrator acts within his powers under the Federal Arbitration Act or in excess of those powers by determining that the parties had affirmatively agreed to authorize class arbitration simply on the basis of broad contractual language that required arbitration of any dispute arising under the contract as a precondition to litigation.  Oxford Health Plans LLC v. John Ivan Sutter M.D.  This development is further evidence of the need to carefully consider the consequences when signing arbitration clauses without considering the range of consequences!

Most contracts nowadays contain an “Arbitration Clause,” which the parties often unwittingly sign without considering the consequences. After all, if a dispute arises under the contract, would it not be better to resolve the dispute in an efficient manner that is faster and more cost-effective than going to court?  It could take years for a case to get to trial, and then there’s post-trial motions, appeals, and on and on. With arbitration, the matter could be submitted, argued, and decided by a experienced judge or lawyer with specialized knowledge of the subject area and selected by the parties themselves! What could go wrong?

Ever since Calvin Coolidge signed the Federal Arbitration Act (FAA) in 1925, parties to a dispute could utilize arbitration as a method of “alternative dispute resolution” or “ADR” as these types of proceedings are often called. Designed to allow the parties to resolve their disputes without the usual delays – and costs – of a lengthy trial, the arbitration process steadily grew more popular over the years. According to a recent article in the California Real Property Journal (Vol 30, No 3 2012), authors Paal, Block and Roland note that by the late 20th Century, all 50 states had adopted arbitration statutes.  They note that concerns over court congestion and runaway jury verdicts raised interest in arbitration.

However, Paal, Block and Roland note that arbitration procedures have become more formal and “judicialized,” but lacking the court’s procedural and evidentiary rules, the arbitration process has become as “uncertain, costly, and time consuming as ever.” (Citing Thomas J. Stipanowich, “Arbitration: The ‘New Litigation.’” 2010 U. Ill. L. Rev.1). The Journal article goes on to note that at the 2009 National Summit of Business-to-Business, “seven out of ten participants believed that arbitration [fell]short of expectations in terms of efficiency and economy at least 50% of the time.”

There are several practical reasons that individuals considering contracts in real estate transactions should not agree to mandatory arbitration. For example, the judicial relief afforded by a Lis Pendens - a Notice of Pending Action – is not available under an arbitration clause. Neither is injunctive relief.  Or an action in Unlawful Detainer – which affords a landlord a relatively prompt, judicial process to evict a defaulting tenant.  In some instances, arbitration actually could take longer and end up costing much more than if the matter had simply proceeded through the litigation process.  It should be noted that almost all State and Federal Courts require that parties to litigation attempt one or more of several alternative dispute methods as part of the litigation process, ranging from Early Neutral Evaluations to Mediation and both binding and non-binding Arbitration – all under the  jurisdiction and time limitations imposed by the Court.

For better and worse, the Courts have upheld the enforceability of the contractual provisions of an arbitration clause, even if the applicable statutory law would yield a different result if tried in Court. In a recent decision by the United States Supreme Court, the noncompetition provison in a contract with an arbitration clause had been ruled invalid by a State Court, but the high Court ruled that subject to the terms of the contract, only the arbitrator could make the determination,  not the State court. (Nitro-Lift Technologies LLC v. Howard).  The Court noted that the Federal Arbitration Act “declare[s] a national policy favoring arbitration,” and provides that a “written provision in … a contract [providing for arbitration] shall be valid, irrevocable, and enforceable.”  In other words, if the contract declares that an issue in that contract is subject to arbitration, the parties must resolve the issue through arbitration.

Is there an alternative to this “alternative dispute resolution” process?  Paal, Block and Roland suggest that Mediation is fast becoming more popular, and “has, for all intents and purposes, replaced arbitration as the preferred method of dispute resolution.” [Citation] Certainly, there are many advantages, not the least of which is that the proceedings are subject to confidentiality.  In Mediation, the parties are encouraged to work out their own, final resolution of the dispute, with the assistance of the Mediator. The process is conducted informally, and the process is subject to strict confidentiality. In Mediation, the parties can restructure the deal and fashion remedies that are not available through the judicial process.

Some newer contracts contain “Mediation Clauses” that provide that the parties first attempt to mediate a dispute prior to initiating litigation. Some contracts also require arbitration if the parties are unable to resolve the dispute through mediation. In some instances, especially in real estate matters, it would be prudent to carefully consider the consequences of agreeing to mandatory arbitration before signing the contract. As always, consult with an attorney before you make the commitment.

Pride Goeth Before a Fall

A recent legal decision involving a real estate dispute received some attention because the Court denied the prevailing party attorneys’ fees. The Third District Court of Appeal was attempting to send a message when it overturned the Trial Court’s decision awarding the fees. But there was more than one message in the ruling worth noting.

The case, Cullen v. Corwin, was certified for only partial publication, which severely limits the extent to which it may be cited. The key facts were that Corwin, who had purchased a residential property from Cullen, later discovered a serious defect in the garage structure that caused the roof to leak and resulted in several thousand dollars of damage. In the published portion of the decision, the Court notes that although the Sellers (Cullen) successfully argued that the Buyers (Corwin) failed to bring their case before the applicable statutes of limitation had expired, and were therefore the prevailing party, the Sellers failed to comply with the requirement that a party must mediate before they litigate.

While this requirement is most often used by Defendants against Plaintiffs who rush into litigation before going through the procedures required under most standard Purchase and Sale Agreements (including standard CAR forms), the Court noted that the actual language of the provision allowing recovery of legal fees contains a condition precedent that requires any party to first attempt to resolve the dispute through mediation, and not refuse to mediate in light of a request to do so, in order to recover legal fees. The Court noted that the Plaintiff’s attorney had twice requested the Defendant to mediate, and Defendants refused. The Court took note of the fact that the Defendant’s attorney had declared that they wanted the results of discovery first, so that any mediation would be more “meaningful.” The Court saw that tactic for what it was, ruled that the response constituted a refusal to mediate in response to a request, and therefore overturned the award of attorneys’ fees.

The Court went on to note that the mediation requirement is designed to encourage mediation as a preferable alternative to litigation, which can be costly and time-consuming. But in the unpublished section of the case, the Court found plenty of fault with the Plaintiff, who had clearly failed to take reasonable steps to protect their rights in a timely manner when they first discovered the defects in the roof. Moreover, the Court found several errors in Plaintiff’s pleadings, but in the end, the Court found the Defendants’ excuses unconvincing.

The primary message in this case was that in order to recover legal costs and attorneys’ fees as a prevailing party, one must comply with the plain language of the requirement to make a good faith effort to participate in mediation. The secondary message appears to be “don’t overplay your hand.” The Defendants knew they had a very good chance of prevailing on the basis of the failure of the plaintiffs to meet the statute of limitations. Forcing the Plaintiffs to comply with discovery requests before agreeing to mediation would only drive up the Plaintiff’s costs, and not substantially change the outcome. But refusing to mediate was unacceptable, and on the basis of the Court’s interpretation of the contract provisions, sufficient grounds on which to deny recovery of their fees.

No matter how strong or righteous a case someone may think they have, public policy considerations and standard purchase agreement contracts require the parties to at least make a good faith effort to mediate. Arrogantly refusing to do so not only does not do your clients any good, but may end up costing you dearly!

What you need to know about Dispute Resolution

First of all, it is mandatory. Second, it is effective.Third, it can be relatively inexpensive. Today, most contracts including most real estate purchase agreements‚ contain a provision that requires the parties to submit disputes to arbitration before going to court. If you’ve ever been involved in litigation, you know that at some point in the process, Court rules require the parties to participate in some form of Alternative Dispute Resolution, or  ADR. This can take the form of arbitration or mediation. However, most people, including some attorneys, are confused by these terms.  What are they?  How are they different? Which one is better?

According to the Superior Court of California, County of Santa Clara, ADR is a process in which a neutral person helps people who cannot agree, so that they can resolve their case. The types of ADR available for civil litigation include mediation, neutral evaluation, private arbitration, judicial arbitration, and early settlement conferences. In addition, if the case does not settle, a mandatory settlement conference is usually scheduled the week before the matter is scheduled to go to trial.

Mediation is described as an informal, confidential, flexible and non-binding process‚ in which the mediator helps the parties to resolve the dispute. In mediation, the parties are free to come up with whatever solution is mutually satisfactory. The mediator facilitates the discussion, but does not make rulings. A good mediator can help the parties consider options they and their attorneys might not otherwise have considered. The Courts are somewhat limited in what they can order the parties to do — the parties themselves have a lot more flexibility to fashion a remedy more suitable to their situation. 

 Arbitration‚ is similar to but less formal than a trial. The parties submit their respective arguments to a neutral  either an experienced attorney or a specially appointed Judge who will make a ruling based on the evidence and arguments submitted.  There is no jury in arbitration. The parties can agree (in advance) that this decision will be either binding or non-binding. If the decision is non-binding, either party may reject the ruling and the matter will proceed to trial. However, in many cases the arbitrator’s ruling gives the parties an idea how the Court might view the case. The primary advantage of binding arbitration is that is can be less costly and produce faster results than a trial. In complex cases involving large sums of money, the parties often will pay for special private arbitration, usually conducted by retired judges. 

Dispute resolution is very effective, and can be relatively inexpensive.  Over 90% of all cases filed in Superior Court in Santa Clara County settle before going to trial, sometimes, quite literally, on the courthouse steps. Many of the forms of ADR are offered by the Court to parties in litigation for free or for nominal sums. However, for one reason or the other, parties ignore these opportunities and instead spend considerable time, money and effort to prepare for trial.  By the time they are directed to participate in mandatory settlement, they sometimes feel  erroneously  that they have nothing to lose. They fail to take advantage of the opportunity to take control of the outcome, and ignore the real costs of trial, post-trial procedures, and appeals‚  which can take years!

At any time, anyone may seek mediation to help them resolve a dispute and possibly avoid the cost, time and stress of litigation altogether. A key to saving money is to agree to mediation as soon as possible — before lawsuits are filed, if possible. The process is confidential, relatively inexpensive (especially when compared to the cost of lengthy litigation), and surprisingly effective. The ideal mediator should be knowledgeable about the subject area of the relevant law, experienced and trained, and skillful at getting the parties to explore all reasonable options.

ADR provides parties to a dispute the opportunity to control the outcome, reach an early resolution, and save thousands and thousands of dollars. Remember, the money you save may be yours!  If you need an experienced mediator who understands real estate, business, and common sense, please feel free to contact me.