This article presents the adverse impacts created by agreeing to a binding arbitration clause in a real estate purchase agreement.
Lost rights to a fair and final decision
The trend since 1978, encouraged by trade unions, has been to agree to solve real estate contract disputes through arbitration, rather than litigation. The wisdom of this trend in real estate-related contracts is now under increasing attack.
Many preprinted brokerage and purchase agreements include an arbitration clause. The arbitration clause is an agreement with an arbitrator, separate from the contract in which it is contained. [Prima Paint Corporation v. Flood & Conklin Mfg. Co. (1967) 388 US 395]
To become part of the agreement, the arbitration provision must be separately initialed in the purchase agreement on the sale of a one-to-four unit residential property. However, the arbitration provision is enforceable against any individual who initials the provision even if the individual is the only party to initial it, and the provision does not become part of the final agreement. [Grubb & Ellis Company v. Bello (1993) 19 CA4th 231]
Arbitration does not often live up to its reputation for being inexpensive or expedient.
Editor’s note – first tuesday’s purchase agreements and addenda do not contain either an arbitration clause or an attorney fees provision as a policy to reduce disputes by making them less economically feasible.
An arbitration clause in a contract:
- is the arbitration agreement between each party and the arbitrator; and
- defines the arbitrator’s powers and limitations. [Calif. Code of Civil Procedure §1297.71]
An arbitration clause encompasses arbitration statutes, and any arbitration guidelines and policies mentioned in the clause or adopted by the arbitrator chosen in the clause, such as the American Arbitration Association.
Unless the arbitration clause states an arbitration award is subject to judicial review, the award resulting from arbitration brought under the clause is final and binding. The award handed down by the arbitrator is then reduced to a judgment by the court so the award can be enforced. [Moncharsh v. Heily & Blase (1992) 3 C4th 1]
Arbitration proceedings are reputed to be swifter and less costly than trials. Also, arbitrating disputes rather than litigating them eases the burden on the court system and the taxpayer, and avoids a public airing of “dirty laundry.”
However, arbitration does not often live up to its reputation for being inexpensive or expedient. Filing fees for arbitration are excessively high compared to filing fees for litigation. The loser in an arbitration proceeding must pay the arbitrator’s charges, in addition to the winner’s attorney fees.
Just as in litigation, arbitration proceedings draw out for years when the dispute becomes complicated. Also, a legitimate disagreement with the arbitrator’s award frequently leads to litigation.
Consider a seller who contacts a brokerage office to list his property for sale. The broker delegates the sales activity to one of his agents, customarily called the listing agent.
The seller and the listing agent, on behalf of his broker, sign a listing agreement containing a binding arbitration clause.
A buyer is located and an offer is obtained by another agent employed by the broker, customarily called the selling agent. Both agents and the broker are actually aware the buyer is financially unstable and may encounter difficulties closing the transaction. Creditworthiness and net worth are not made a condition in a contingency provision.
A court of law cannot review the arbitrator’s decision for errors of fact or law.
|When the listing agent, acting alone, submits the buyer’s offer to the seller, the buyer’s financial status is not disclosed, orally or in writing. The supervising broker fails to catch or correct the oversight.The seller accepts the offer which provides for payment of a brokerage fee. The two agents will share in the brokerage fee to be received by their broker under the terms of their respective written employment agreements with the broker.|
The broker and the listing agent own few assets and have little net worth, while the selling agent has significant assets and net worth.
Later, the buyer fails to close the transaction because of his financial problems. The seller discovers the listing agent, the broker and the selling agent all knew of the buyer’s poor finances. The seller then makes a demand on the broker and both agents for his losses on the failed transaction.
As required by the arbitration clause in the listing agreement, the dispute is submitted to an arbitrator.
The arbitrator awards money damages to the seller, based on the professional misconduct of the listing agent and the employing broker in failing to disclose the buyer’s unstable financial status – the broker being vicariously liable for the listing agent’s failure to disclose.
However, the arbitrator further rules the selling agent is a “partner” of the listing agent since they shared the fee. Thus, the selling agent is liable as a partner of the listing agent for the seller’s money damages resulting from the misconduct of the listing agent.
The selling agent seeks to vacate the portion of the arbitration award holding him liable as a partner of the listing agent, claiming the arbitrator incorrectly applied partnership law to a real estate agency relationship – the listing agent works as an employee on behalf of the broker, not on behalf of other agents employed by the broker.
Can the award against the selling agent be set aside by a court since the arbitrator wrongfully applied partnership law?
No! The arbitrator’s decision is not subject to judicial review, since the arbitrator acted within his powers under the arbitration clause when he applied the wrong law and produced an incorrect result.
A court of law cannot review the arbitrator’s decision for errors of fact or law, even if the error is obvious and causes substantial injustice to the selling agent. [Hall v. Superior Court (1993) 18 CA4th 427]
Grounds for corrections
Any defect in an arbitrator’s award resulting from error of fact or law, no matter how flagrant, is neither reviewable nor correctable, unless:
- the arbitrator exceeded his authorized powers;
- the arbitrator acted with fraud or corruption;
- the award was procured by corruption, fraud or other misconduct; or
- the refusal of the arbitrator to postpone the hearing substantially prejudiced the rights of the party. [CCP §1286.2]
An arbitrator, unlike a judge in a court of law, is not bound by the law when arbitrating a dispute. And, unlike a court decision which can be corrected on appeal, an arbitrator’s decision is final and binding on all parties. No authority exists to correct an arbitrator’s decision.
The arbitrator’s award
A buyer and seller of real estate enter into a purchase agreement containing an arbitration clause.
Prior to closing, the seller discovers the property has significantly greater value than the price agreed to in the purchase agreement due to a sharply rising real estate market.
Motivated by his belief the property’s value will continue to increase, the seller refuses to close the sale.
The buyer sues the seller in arbitration for breach of the purchase agreement, seeking money losses amounting to the difference between the purchase price he agreed to pay for the property and the value of the property on the date of the seller’s breach, called damages.
The buyer no longer wants to acquire the property. Thus, he does not seek specific performance of the purchase agreement.
Prior to completion of the arbitration, the value of the property drops significantly due to a local economic downturn.
Years later, the arbitrator issues an award in favor of the buyer.
The arbitrator does not award money damages as requested by the buyer, noting the property’s current value is below the price agreed to in the purchase agreement and the present equity in the property is less than the buyer’s price-to-value loss at the time of the seller’s breach.
Instead, the arbitration award grants the buyer the right to purchase the property at its current fair market value.
The buyer seeks to vacate the arbitration award, claiming the arbitrator exceeded his powers by awarding a result not contemplated by the purchase agreement nor sought by the parties.
Did the arbitrator exceed his powers, act with corruption or prejudice the rights of the parties by awarding an equitable remedy that was in conflict with the purchase agreement and beyond the expectations of both the buyer and the seller?
No! The arbitrator was not corrupt and did not exceed his powers in awarding the buyer the right to purchase the property at its current market value, since the award was drawn from the arbitrator’s misinterpretation of the purchase agreement and the law – even though erroneous.
Basically, the remedy awarded by an arbitrator is not reviewable by a court of law, as long as the remedy has “some remotely conceivable relationship” to the contract. [Advanced Micro Devices, Inc. v. Intel Corp. (1994) 9 C4th 362]
Commercial certainty lost
When individuals enter into a purchase agreement, each person has expectations of performance which are defined by the terms of the agreement and set by law.
Yet by agreeing in the purchase agreement to arbitrate, not only is a person forced to accept the possibility of an arbitrator’s incorrect application of the law, he is forced to accept an award impossible to predict.
As the colorful dissent in Advanced Micro Devices, Inc. points out, a bizarre interpretation of the agreement underlying a dispute, coupled with a blatant error of law might result in an arbitration award “ordering the marriage of the disputing parties’ first-born children.”
An arbitrator may use his own discretion and need not follow regulations or case decisions.
An arbitrator has great latitude in making decisions. He may use his own discretion and he need not follow regulations or precedent. The arbitrator is not restricted by law but works “lawlessly,” legally called use of discretion.
Allowing arbitrators to disregard the law and terms of the contract by fashioning homespun remedies based on what the arbitrator arbitrarily deems fair and correct creates an aura of uncertainty surrounding contracts containing an arbitration clause.
The uncertainty surrounding these real estate contracts tends to destabilize the environment of real estate transactions, acting as a silent force to inhibit individuals from entering into agreements to sell or acquire interests in real estate.
Arbitrator’s authority to enforce
Consider two partners in a real estate development whose partnership agreement contains a boilerplate arbitration clause stating any dispute arising out of the agreement will be submitted to binding arbitration.
An arbitrator exceeds his powers when he attempts to enforce his award.
|As the partnership dissolves, a dispute arises. The dispute is arbitrated. On issuing the award, the arbitrator appoints a receiver to supervise the sale of the partnership’s property, rather than ordering the sale.One of the partners seeks to vacate the arbitration award, claiming the arbitrator exceeded his powers by appointing a receiver to sell the partnership’s property.|
Did the arbitrator exceed his powers by appointing a receiver?
Yes! The portion of the arbitration award appointing the receiver is invalid since the arbitrator cannot enforce his award by appointing a receiver.
The arbitration award must be reduced to a court ordered judgment. It is the judgment which is enforced, not the arbitrator’s award.
Although an arbitrator is not bound to follow the law when issuing an award, an arbitrator exceeds his powers when he attempts to also enforce his award – conduct that is reserved for a court of law after the award has been reduced to a judgment. [Marsch v. Williams (1994) 23 CA4th 238]
An arbitrator also exceeds his powers when he imposes fines on a party to an arbitration for failure to comply with the arbitration award. An arbitrator does not have the power to impose economic sanctions such as penalties and fines.
However, had the arbitration agreement authorized the arbitrator to appoint a receiver or impose fines, the arbitrator then has the power to do so, despite the general prohibition barring arbitrators from enforcing their award. [Mastrobuono v. Shearson Lehman Hutton, Inc. (1995) 514 US 52]
Attorney fees as a power
Now consider a buyer and seller who enter into a real estate purchase agreement containing an arbitration clause and another clause stating attorney fees are to be awarded to the prevailing party in any arbitrated dispute.
The buyer seeks to terminate the purchase agreement and submits the dispute to arbitration. The arbitrator decides in favor of the seller but denies the seller’s request for attorney fees.
The seller seeks a correction of the arbitration award in a court of law, claiming the arbitrator exceeded his powers by not awarding attorney fees as required by the purchase agreement.
Here, the arbitrator did exceed his powers by failing to award attorney fees since the prevailing party was entitled to an award of attorney fees under the purchase agreement. If the underlying agreement contains an attorney fees provision, the arbitrator must award attorney fees to the prevailing party. [DiMarco v. Chaney (1995) 31 CA4th 1809]
Editor’s note – It seems strange that errors of law, errors of fact and the arbitrator’s misinterpretation of the underlying contract do not warrant a vacation or correction of an arbitration award, but an award that fails to include attorney fees when an attorney fees clause is included in the underlying contract is correctable.
However, the underlying contract in an arbitrated dispute does not control the arbitrator’s powers.
Advanced Micro Devices, Inc. and other cases and California statutes hold the arbitration clause and arbitration statutes define an arbitrator’s powers and restrictions – none of which make any reference to the arbitrator’s power to award or not to award attorney fees. [CCP §1297.71]
The attorney fees dilemma has a flip side. Not only must the arbitrator award attorney fees to the winner if they are called for in the underlying contract, but the arbitrator must also determine the amount of the attorney fees to be awarded – an amount which is not subject to court review (i.e. one dollar, if you please). [DiMarco, supra]
A broker or agent who is a member of a local trade association agrees in the membership agreement to binding arbitration for disputes arising with other association members.
The arbitration panel that hears member disputes is composed of other members of the association who have little or no legal training.
These local arbitration panels frequently base their decisions on moral or social beliefs and local customs they have adopted rather than on legal principles. Preference and bias toward particular association members is more likely since the panel is acquainted with or knows about the members involved in the dispute. So much for “neutral” arbitrators!
The panels are also very much aware the decisions rendered are not appealable. Their word is final and binding.
The primary problem with arbitration proceedings heard by the local association’s arbitration panel is most brokers who are compelled to arbitrate feel they are railroaded through a process that disregards their rights, whether or not they are violated.
By becoming members of the local association, brokers are forced to relinquish their rights to discovery, a jury trial and an appeal to obtain a correct and final decision in any dispute with another member.
However, brokers who are only MLS members cannot be forced into binding arbitration proceedings heard by the local association’s arbitration panel, even if they own the MLS. Brokers who are only MLS members are sometimes referred to as “Palsson” members.
Agents employed by brokers who are association members can avoid the complications of membership and comply with their employer’s demand to join the MLS by paying “non-member dues” to become “paid non-members.” [Marin County Board of Realtors, Inc. v. Palsson (1976) 16 C3d 920]