Arbitration in real estate contracts: Will you sign away your right to your day in court?

Arbitration: the good and bad

When a dispute arises in a real estate transaction, instead of taking it to court, the people involved may grant an arbitrator the authority to hear and resolve their dispute.

Arbitration is less costly and quicker than allowing the dispute to go to court. It’s also the form of dispute resolution most consumers agree to abide by at some point or another — including in most real estate transactions. However, there are some major disadvantages:

1. Binding arbitration — the type of arbitration included in a provision of the purchase agreement published by the California Association of Realtors (CAR) — requires the buyer and seller to give up their rights to a trial by jury and prohibits them from appealing the arbitrator’s decision.
2. The arbitrator’s award is final, even if there was an egregious error or if they applied the law incorrectly. [Hall Superior Court (1993) 18 CA4th 427]
3. The arbitrator does not need to apply legal precedent, thus their final decision is unpredictable, or “arbitrary.”
4. The arbitration proceedings are not required to be published like court cases, thus it’s impossible for an outsider to know when disputes are decided fairly, or whether their assigned arbitrator is likely to be fair.
5. Arbitrators are not required to be unbiased or lack connections to an individual in the case, as many arbitrated disputes have assigned an arbitrator who is a long-time friend or acquaintance of one of the individuals in the dispute.
6. The arbitration provision is still enforceable as a separate agreement, even if the purchase agreement is unenforceable. [Prima Paint Corporation Flood & Conklin Mfg. Co. (1967) 388 US 395]

However, many homebuyers and sellers — and even some agents — assume they need to initial the arbitration provision in order to submit the purchase agreement. But this is not true.

Don’t initial that arbitration provision

As a matter of policy, Realty Publication, Inc. (RPI) forms do not contain boilerplate arbitration provisions. But when you are faced with an arbitration provision elsewhere — most commonly found in CAR’s forms, as well as credit card, auto and medical agreements — you are more than justified to steer clear.

The Consumer Financial Protection Bureau (CFPB), the watchdog standing between consumers and any potentially malicious financial systems, found most consumers have no idea what arbitration is, despite agreeing to arbitration agreement at one time or another.

The New York Times refers to arbitration agreements as “get out of jail free” cards for large corporations, since individuals can’t combine resources to bring a corporation to court for a fair hearing. This “opting out” of the legal system is rarely in the best interest of the consumer who has been wronged.

That’s because large arbitration companies are inherently biased, as they need to stay in business. To do this, they need to keep the businesses for which they arbitrate happy, since businesses are more likely than the individual to need to hire an arbitrator in the future. In other words, deciding in favor of big companies is always in the arbitrator’s best interest — never in the best interest of the consumer.

Next steps

If you’re convinced arbitration is the wrong approach to settle real estate disputes, consider informing clients about the risks of arbitration, before they agree to it. Download Client Q&A: What is arbitration? to distribute to clients prior to signing a purchase agreement that may include the provision.

Explaining the arbitration provision to clients does not constitute an unauthorized practice of law. In fact, it’s the agent’s duty to fully explain transaction details to their client. This includes informing them of the potential consequences of agreeing to arbitration.

Likewise, consider only using real estate forms which do not include the arbitration provision. RPI forms include a mediation provision for settling disputes. Unlike arbitration, clients who undergo mediation may later take the case to court if the dispute is not resolved to their liking. [See RPI Form 150]

first tuesday readers can download RPI forms, which are legal to use in California real estate transactions, for free here.

As a point of law, arbitration provisions are not included in trust deeds, consumer mortgage agreements or rental or lease agreements. [12 Code of Federal Regulations §1026.36(h)]

So why should your clients’ purchase agreements include such a provision?

For more reading on arbitration, see: Arbitration, explained.