Owners Can Use Binding Reference Provisions to Reduce Their Exposure in California Construction Defect Suits


July 28, 2003

Back to Industry Newsletters
 

Thelen Reid Brown Raysman & Steiner LLP

Four recent California Court of Appeal decisions have addressed the use of alternative dispute resolution procedures in real estate sales contracts. The most recent, handed down in April 2003, upheld the validity of provisions requiring construction defect disputes to be resolved in binding reference proceedings.

These decisions are important because the ability of developers to compel use of alternative dispute resolution provisions to eliminate the specter of massive damage awards by juries is a critical aspect of risk management in real estate development.

Villa Milano

The stage for this cutting edge area of law was set by Villa Milano Homeowners Association v. Il Davorge, 84 Cal.App. 4th 819 (2000). The court, in what it called a "case of first impression," held that a developer could not use a declaration of CC&Rs containing an arbitration clause to preclude condominium owners and the homeowners' association from pursuing a court action for construction defects. The Court of Appeal found that the CC&Rs were an adhesion contract in that the purchasers were faced with a "take or leave it" proposition to either purchase subject to the CC&Rs or not to purchase at all. Significantly, the CC&Rs also provided that the arbitration clause could not be amended without the consent of the developer. In finding the arbitration clause unconscionable, the court noted that the CC&Rs were 70 pages long, the arbitration clause was on Pages 67 and 68, and the clause failed to comply with Code of Civil Procedure §1298, which requires arbitration clauses in contracts conveying real property to be clearly entitled "Arbitration of Disputes" and to meet certain print size and capitalization requirements.

The court also relied on Code of Civil Procedure §1298.7, which it characterized as permitting a purchaser "to pursue a construction and design defect action against the developer in court, even if the purchaser signed an agreement to convey real property containing an arbitration clause." The court reasoned that if the developer could not compel arbitration based on the individual sale agreements, it could not compel arbitration by the association in its representative capacity based on the CC&Rs.

Basura

The next case involved an action for construction defects by 60 purchasers of single?family homes. Basura v. U.S. Home Corporation, 98 Cal.App. 4th 1205 (2002). Each of the purchasers had initialed the arbitration clause in the sales contracts, which apparently complied with Code of Civil Procedure §1298. The court held Code of Civil Procedure §1298.7 could not be applied to invalidate the arbitration provisions because it was pre-empted by the Federal Arbitration Act (FAA), citing the U.S. Supreme Court decision in Doctor's Associates, Inc. v. Casarotto, 517 U.S. 681, 683 (1996). In so holding, the Basura court recognized that "generally applicable contract defenses, such as fraud, duress, or unconscionability, may be applied to invalidate arbitration agreements without contravening" the FAA but concluded that "[c]ourts may not... invalidate arbitration agreements under state laws applicable only to arbitration provisions."

The opinion does not analyze whether the arbitration clause was unconscionable under the facts of the case. The Basura decision contravenes the portion of Villa Romano that relied on §1298.7 and leaves the enforceability of arbitration clauses subject only to an unconscionability analysis.

Pardee

The third case involved a class action by the purchasers of single-family homes. Pardee Construction Co. v. Superior Court, 100 Cal.App. 4th 1081 (2002). The sales contracts included a provision that all agreement-related claims, including those for construction defects, be determined by a general reference conducted by a single referee (a retired Superior Court judge) appointed under Code of Civil Procedure §638. The referee would try all issues relating to such claims, whether of fact or law; disputes about the validity and interpretation of the judicial reference provision would be decided by a court without a jury; and if the judicial reference provisions were found to be invalid, all claims would be tried by a court without a jury. Each purchaser initialed the paragraph including those provisions. The same paragraph provided that both parties waived their rights to punitive damages.

The Pardee court held that the contracts were unconscionable and were adhesion contracts and that the reference provisions were unenforceable. The court focused on the unequal bargaining power of the parties (plaintiffs were the "purchasers of entry level homes"), the misleading caption in the paragraph containing the reference provisions, the fact that the waiver of punitive damages benefited only the developer, the importance of the waiver of the right to a jury trial and the fact that the buyers received nothing in return for the waiver. The court found that invalidating the reference provision was consistent with public policy favoring a trial with full procedural and constitutional rights over alternative dispute resolution in the context of construction defect litigation, citing Code of Civil Procedure §1298.7.

Woodside Homes

The fourth case involved a construction defect action by purchasers of new single-family homes. The sales contracts required any lawsuit "relating to the condition, design or construction of any portion of the [purchased home]" be submitted to judicial reference pursuant to Code of Civil Procedure §638. The clause went on to provide that: the referee is to be a retired judge or attorney with substantial experience in real estate matters; the parties be entitled to discovery; the referee shall render a statement of decision with findings of fact and conclusions of law; the decision may be entered as a judgment but also is appealable; and the parties were to share the referee's costs and fees equally and to bear their own costs and attorney fees.

The contracts also provided that "Seller shall not be required to participate in the judicial reference proceeding unless it is satisfied that all necessary and appropriate parties will participate." The seller represented that all of its subcontractors were bound by agreements to participate in any reference of disputes.

The court held that the reference provisions were not unconscionable and were binding and enforceable. Woodside Homes of California, Inc. v. Superior Court, 132 Cal.Rptr. 2d 35 (2003). In so doing, it went to great lengths to distinguish Pardee, noting that there was no evidence that the subject homes were "entry level," the reference provisions in Pardee were "buried in the form contracts" and that the clause in Pardee contained a "surprise component" in that it made no mention of the referee fees. The court found that the buyers did get something in addition for their jury waiver - the seller's matching waiver.

In language that surely will disturb members of the plaintiffs' bar, the court stated in discussing the impact of the waiver of jury trial:

There is nothing "unconscionable" in requiring a party to a contract to give up the possibility of obtaining a windfall from a jury irresponsibly generous with someone else's money.

Overview

The Woodside Homes decision is important because it is the first California decision to hold that binding alternative dispute provisions in real estate sales documents are not unenforceable based on unconscionability. Further, the Woodside Homes court cited Villa Romano in its discussion of unconscionability, suggesting that the same analysis would apply to provisions in CC&Rs requiring that construction defect disputes be submitted to judicial reference.

In summary, the current state of the law in California is that provisions for binding arbitration and for reference in real estate sales contracts and CC&Rs can be enforceable. One court has held that Code of Civil Procedure §1298.7, which purports to invalidate arbitration provisions in construction defect actions, is pre-empted by the FAA and may not be relied upon to invalidate an arbitration clause. However, because there is no published California decision holding that arbitration provisions in real estate sales contracts and CC&Rs are enforceable, developers will find it prudent to utilize binding reference provisions.

Given the nature of construction defect litigation in California and the relatively minor effort required, sellers of all mass-produced real estate should consider including binding reference provisions in their sales documents. Ideally, the provisions would be in a separate document signed by the buyer that complies with the requirements of Code of Civil Procedure §1298, with appropriate modifications to the statutory notice provisions.

In the case of condominium projects, the provisions could be included in the sales contracts and the CC&Rs. The CC&Rs also might allow the reference provisions to be amended but only by a vote of 75 percent of the members eligible to vote (as contrasted with 75 percent of the votes cast). No waiver of punitive damages should be included, and the provision should require the referee fees to be split among the parties.

Below is the text of the judicial reference provision from the Woodside Homes case.

If you would like to receive legal reports and updates more quickly, by e-mail, click here and fill out the mailing list form.

For more information about the issues covered in this report, please contact Paul Berning in our San Francisco office at 415-369-7229 or at pwberning@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.





©2003 Thelen Reid Brown Raysman & Steiner LLP

Judicial Reference Language from Woodside Homes Case

10.    JUDICIAL REFERENCE OF DISPUTES. If either BUYER or SELLER commences a lawsuit for a dispute arising under this Agreement or relating to the condition, design or construction of any portion of the Property, all of the issues in such action, whether of fact or law, shall be submitted to general judicial reference pursuant to California Code of Civil Procedure Sections 638 (l) and 641 through 645.1 or any successor statutes thereto. BUYER and SELLER shall cooperate in good faith to ensure that all necessary and appropriate parties are included in the judicial reference proceeding. SELLER shall not be required to participate in the judicial reference proceeding unless it is satisfied that all necessary and appropriate parties will participate. The Parties shall share equally in the fees and costs of the referee, unless the referee orders otherwise. The Parties shall bear their own attorneys' fees.

The general referee shall have the authority to try all issues, whether of fact or law, and to report a statement of decision to the court. The Parties shall use the procedures adopted by Judicial Arbitration and Mediation Services/Endispute ("JAMS") for judicial reference (or any other entity offering judicial reference dispute resolution procedures as may be mutually acceptable to the parties), provided that the following rules and procedures shall apply in all cases unless the parties agree otherwise:

The statement of decision of the referee upon all of the issues considered by the referee is binding upon the Parties, and upon filing of the statement of decision with the clerk of the court, or with the judge where there is no clerk, judgment may be entered thereon. The decision of the referee shall be appealable as if rendered by the court. This provision shall in no way be construed to limit any valid cause of action which may be brought by any of the Parties.

BY INITIALING BELOW, THE PARTIES ACKNOWLEDGE THAT THEY HAVE READ AND UNDERSTAND THE FOREGOING AND ACCEPT THAT THEY ARE WAIVING THEIR RIGHT TO A JURY TRIAL.

BUYER'S INITIALS: ____        SELLER'S INITIALS: ____