This article is the second installment in first tuesday’s ongoing article series analyzing the use of arbitration in real estate transaction disputes. What follows is a rigorous critique of the arbitration provision included in the so-called “standard” purchase agreement form and a call to arms for real estate professionals to shield themselves and their clients from its inherent risks.
For an historical analysis of arbitration and a critique of arbitration’s chief defect — the lost right of judicial review — see the initial installment in this article series, Bargaining for Justice: arbitration and the loss of judicial review.
The rise of arbitration
What started over 30 years ago as several sentences requiring arbitration in real estate transaction disputes is now over 500 words of tortuous jargon. The detail and exhaustive length of the arbitration provision is purportedly designed to better protect all parties to a purchase agreement — unfortunately, the end result is further exposure to risk.
In 1988, the California state legislature mandated all arbitration provisions in real estate contracts must include a 165-word warning about the lost rights of judicial review. The legislature further required the arbitration provision to be initialed by each party in order to be enforceable in the hopes it would stand out as worthy of extra attention. This places a heavy burden on those who initial the provision to know what they are signing. Thus, an arbitration provision is enforceable against any person who initials the provision, even when that person is the only one to initial it. [Grubb & Ellis Company v. Bello (1993) 19 CA4th 231] ; Calif. Code of Civil Procedures §1298(c)]
The legislature mandated the inclusion of these provisos in 1988 due to a spike in the number of real estate claims filed to be settled through arbitration. In 1987, 510 real estate claims were filed with the American Arbitration Association (AAA). By 1989, case filings jumped 120% to 1,125. The legal community had done their job of popularizing arbitration. It became the legislature’s job to step in and protect the buyers and sellers initialing the provision — a project that lost steam after 1989 and is going nowhere today.
In spite of the myriad and obvious flaws in requiring arbitration, the legal community held to their now completely entrenched belief that arbitration is “preferable” to litigation. As this dogmatic belief became more accepted as standard public policy, rather than reforming this flawed approach to alternative dispute resolution, the proponents of arbitration continued to paint lipstick on the pig by adding ever-more language to the provision as problems arose — none of which were effective in eliminating the risks.
A well provisioned agreement
Prior to April 2010, the arbitration provision in the trade union purchase agreement contained language requiring the provision be “interpreted by California substantive law” according to the California Arbitration Act (CAA). However, it quickly became evident that the CAA did not support the dogmatic views of the real estate trade union regarding the enforcement of the arbitration provision.
In an effort to minimize inconsistent results in the event one party involved in a dispute is subject to arbitration (the principal) and one is not (the broker), the CAA allows a trial court to render an arbitration provision unenforceable. [CCP §1281.2]
This seemed a serious affront to the sanctity of arbitration, as California law essentially provides a loophole to arbitration. This precedent was set in a recent case decision in which the court held the arbitration provision was unenforceable since the buyer’s lawsuit included a third party (the buyer’s broker) who was not a party to the arbitration provision in the purchase agreement.
In a dispute arising out of the same transaction or series of related transactions, the buyer avoids arbitration’s consequences entirely since the court will deny arbitration and join all parties in a single action to be adjudicated in court in order to avoid inconsistent, but equally valid results. [Valencia v. Smyth (2010) 185 CA4th 153; CCP § 1281.2]
The trade union purchase agreement has since been modified to ensure anyone who initials a binding arbitration provision will not avoid arbitration by simply including third parties in the dispute. This was accomplished by including language in the current iteration of the “standard” purchase agreement requiring the arbitration provision be “enforced” by federal law under the Federal Arbitration Act (FAA) rather than California’s consistent result statutes. The FAA requires all binding arbitration provisions to be enforced regardless of the possibility of conflicting rulings by allowing for each disputant to settle their claims in separate venues. [9 Unites States Code §§3,4]
Thus, the arbitration provision in the trade union’s current purchase agreement jeopardizes the sanctity of legal precedent by which real estate professionals measure their behavior. A trial court’s decision based on sound interpretation of the law, monitored in result by judicial review, can no longer be used as a litmus test for proper conduct. Since an arbitrator has the authority to make a final and equally valid decision that may contradict a trial court hearing disputes out of the same transaction, this sets a legal precedent that comes dangerously close to advocating double jeopardy.
This is yet another example of the monstrosity created by perpetually tacking on provision after provision to undergird an initially damaged and now crumbling structure, where continual additions act only to precipitate the arbitration provision’s ultimate demise.
The long-term effect: without judicial review of disputes, real estate professionals lose their way. Legal precedent functions as a constantly evolving guide map for proper brokerage conduct. If every dispute in real estate transactions was settled within the confines of binding arbitration, legal precedent would cease to exist, thus eliminating the gold standard to which real estate transactions are held. Education would become unnecessary as rules would no longer control.
Binding arbitration is not binding
The binding provision located in the majority of the contracted forms published by real estate trade unions is designed to ensure each party will avoid litigation — which results in an action to recover — should a conflict arise between them. However, legal precedent has proven the provision inconsistent and unreliable. Under common circumstances, arbitration has been rendered unenforceable by individuals who initialed the agreement and enforceable by individuals who did not.
For example, a buyer’s broker seeks to compel arbitration of a dispute, but the buyer refuses since his broker did not sign the arbitration clause in the purchase agreement. The broker claims he has the right to enforce arbitration since he has an agency relationship with the buyer, and the buyer initialed (thereby agreeing to) the purchase agreement’s arbitration clause.
Can the broker compel arbitration with the buyer, even though he did not sign the purchase agreement’s arbitration clause?
Yes! Since the broker had a pre-existing agency relationship with the buyer under the disputed transaction, he has the right to compel enforcement of the arbitration clause signed by the buyer. [Nguyen v. Tran (2007) 157 CA4th 1032]
The notion that the arbitration provision constitutes a separate contract from the purchase agreement between those who initial it and the arbitrator is challenged when someone who did not sign the provision has the right to compel arbitration, such as in Nguyen.
The broker receives the benefit of the right to compel arbitration, but at no cost. The homeowner traded his right to a trial by jury for the guarantee that anyone who signed the provision would be compelled to arbitrate, and anyone who did not sign the provision would not be able to compel arbitration. The decision in Nguyen pokes holes in the contract’s “binding” characteristic by giving anyone who has an agency relationship with someone who signed the provision a free pass from litigation
For homebuyers, the advantages of binding arbitration are lackluster and vague. Rather than trading the right to litigate for the right to compel arbitration, homeowners are relinquishing the option of a lawsuit and their right to judicial review for the uncertain hope that the arbitration agreement they signed will remain enforceable if a dispute arises and that they will receive a fair and final judgment with a single action in one venue.
Mediation: a viable alternative
Rather than immediately resorting to the costly and adversarial process of arbitration or litigation, in recent years the trend in real estate sales transactions indicates disputants favor the use of mediation. [For more information regarding mediation, see the August 2008 first tuesday article, Mediation: best, faster dispute resolution.]
Litigation is, at its heart, a deeply adversarial process which ends with a spurned “loser” who can then move on to draw out the dispute in a time-consuming and costly appeals process. Arbitration is also an adversarial process that functions similarly, shunting the disputants into “winner” and “loser” roles with feet set in concrete.
Only with mediation’s familiar arena of offer and counteroffer between the feuding parties in a face-to-face environment, as nurtured by the mediator, do disputants have the ability to come to a mutually crafted and agreed-to solution — the main advantage mediation has over actions in litigation or arbitration where one party wins and one loses (or both lose).
The extremely low cost of mediation, in terms of time and money, has been deemed another major benefit of the process. Consider as part of the cost the time involved in mediation versus the time involved in litigation or arbitration. Litigation can be drawn out for years with various pre-trial, discovery and appeals processes, all while attorneys’ billable hours soar. Arbitration may also last years and, in addition to contracted-for payment of the winner’s attorney fees, the loser is responsible for paying the arbitrator’s costs and fees.
However, mediation is typically a quick process lasting a few hours over a period of a few weeks, depending on the number of disputants and the complexity of the dispute. There are no lengthy waits for court hearings and no need for discovery or witnesses since the resolution is in the hands of the disputants themselves, again as encouraged and moved along by the mediator.
In addition to these benefits, the use of mediation also provides a solution to a dispute without adding or falling subject to the backlog of cases burdening the legal system.
Mediation does have its limits. In real estate matters, mediation is limited to resolving disputes involving buyers and sellers. Landlord-tenant disputes and trust deed defaults are largely based on very specific statutory requirements for performance which are either satisfied or unsatisfied, leaving little room for discussion. Mediation is a tool best used by disputants in sales of property and agency disputes.
In pursuit of justice
If mediation is not possible, disputants seeking a fair and final decision need to prepare for their only real option: litigation. There is no rational reason to risk an arbitrator making an erroneous decision barred from judicial review when a sound judgment held accountable under the law can be obtained for about the same cost and in nearly the same amount of time.
The responsibility of educating buyers and sellers of real estate about the toxicity of arbitration rests on the shoulders of their agents and brokers, who must advise their client on the consequences of initialing the provision and triggering its enforceability. Brokers who require their agents to use the trade union’s purchase agreement must make a point of providing their client with the full extent of their knowledge regarding the risks of arbitration.
Aside from the multitude of arguments against arbitration, one simple fact prevails: rather than expeditiously resolving disputes, arbitration creates disputes. Consider this axiom of business conduct: if an aspect of real estate sales transactions is known to create disputes, especially when that aspect was designed to limit them, it must be avoided.
Future homebuyers can be shepherded past the snare of arbitration by the gatekeepers of real estate who fully understand the danger of initialing and thus agreeing to the binding provision. As the devastating wounds of the Great Recession begin to heal in this plateau recovery and the California real estate market arms itself to abide by broader consumer protection laws, homebuyers will soon resent any failure to disclose the risks involved in arbitration. [For more information regarding the new real estate paradigm, see the May 2010 first tuesday article, Looking through the window towards recovery: a real estate paradigm shift — Part I and Part II.]
Educating homebuyers about the pitfalls of arbitration when advising them on the use of a form is not, contrary to popular and erroneous opinion, the unauthorized practice of law. Thus, brokers and agents have an unavoidable duty to inform their clients of the many risks involved should they choose to initial the provision, and that they are not required to do so in order to purchase a home.