The real estate market has become flooded with agents and brokers inculcated to reassure their buyers and sellers that initialing the arbitration provision is “standard practice.” If any guidance is given by agents, it is that arbitration bears multiple benefits with no comment on the risks. This advice is wrong!

Most homebuyers and misguided real estate agents know little about arbitration beyond the pretext it is less costly and more efficient than litigation. The myth of arbitration’s benefits is so ingrained, it has become an unquestioned real estate mantra.

Buyers and sellers do not know enough to incite their inquiry. Most agents do not have the sufficient knowledge or awareness to develop an opinion on arbitration. Thus, arbitration’s virtues are passed down as custom, while deleterious widespread ignorance of its risks persists among agents and sweatshop brokers.

Arbitration was born out of a genuine desire to save on court costs, expedite the dispute resolution process and generally improve the efficiency of the real estate marketplace. In practice, however, arbitration has insufficient controls. Arbitration often results in absurd legal consequences, antithetical to the reasons and practical purposes for its inception. There is a very simple remedy — the soft medicine of mediation.

Mediation buttressed by judicial certainty

Mediation is an informal, confidential, non-binding legal process. When agreed to, the buyer and seller are compelled to use it in good faith. Designed to help the parties reach an accord, mediation puts disputes to rest without litigation, while still allowing for judicial intervention if resolution cannot be finessed.

Rather than requiring parties to a purchase agreement to initial away their rights to a fair and reviewable judicial determination, mediation allows for a mutually acceptable termination of a dispute.

In the process, a neutral third party — the mediator — acts as an avuncular facilitator. The mediator encourages the disputing parties to arrive at their own decision. They do this by fostering an environment of discussions while listening for a commonality of thoughts needed for settlement and resolution. Mediators are trained to help craft that conclusion and end a dispute.

Also, while a mediation agreement requires participation, either party can withdraw from the process.

Arbitration, like mediation, is a confidential process structured as an alternative to judicial litigation.  However, the neutral third party appointed to hear the case makes a final decision awarding judgment in favor of one of the parties. This decision is binding under arbitration provisions when included and initialed in purchase agreements. The arbitrator’s award, when erroneous, cannot be reviewed and corrected by a court of law.

This finality of an arbitrator’s decision naturally causes arbitrators to lack proper care in the decision-making. Appeals to review a faulty decision are prohibited. Thus, an arbitrator’s erroneous decision cannot be rectified regardless of how bizarre the outcome may be – frankly, they have no compelling reason to care since they are not subject to the consequences of oversight!

The reality of arbitration

The reality about arbitration provisions is that they do not belong in real estate purchase agreements. You will never find them in trust deeds, and you will never see them in rental or lease agreements. And they are omitted for good reason since rules of law, not an “arbitrary” arbitrator, must control results. Arbitration provisions lead to:

  • frequent misapplication and misinterpretation of the law;
  • erroneous awards;
  • a bar to discovery in preparation for hearings;
  • waiver of the right to judicial review; and
  • a lack of legal precedent for future conduct of buyers, sellers, brokers and agents.

Usually from an unfounded fear of engaging in the unauthorized practice of law or of killing the deal, many agents refuse to educate their client on known adverse ramifications of initialing the arbitration provision. This aspect of real estate must change. Pricing of property will become very stable with little room for error over the next couple of decades due to the financial crisis and zero-bound interest rates.

Explaining the consequences of a contract provision which you or your agents have requested your client to initial is not engaging in the unauthorized practice of law. It is your duty as a fiduciary to explain transaction documentation to the best of your knowledge. This counseling is sufficient to alert the client to the need for possible further inquiry.

Also, fear not that your disclosures will kill the deal — your client will thank you for your candor and reward you for looking out for their best interest. Transparency is the free flow in information affecting the client.  Most agents and brokers have relevant information on their mind from basic licensing education and mandatory updates on relicensing.

By including an arbitration provision, CAR’s purchase agreement exposes your clients to the risk of arbitration, but there are readily available alternatives:

  • use a purchase agreement form that does not include an arbitration provision; or
  • counsel your client that they are not required to initial the provision in order to enter into a binding agreement or to close the deal.

The first solution is a no-brainer. There are many real estate forms superior to those produced by the trade unions which do not include an arbitration provision. (first tuesday has been publishing California real estate purchase agreements free of the provision for over 35 years).

If you are among the ranks of those who stalwartly refuse to change their forms provider, or if you are an agent whose broker refuses to permit change, simply:

  • inform your client of the consequences involved in agreeing to binding arbitration;
  • advise them they are not required to initial the provision to form a binding contract – even if the other party initials the provisions and your client does not;
  • verify that a mediation provision is included in the purchase agreement; and
  • make sure an attorney fees provision is omitted, to discourage litigation.

If you haven’t done so lately, pull out a copy of your “standard” purchase agreement. If it includes both an arbitration provision and an attorney fee provision (they are linked as you might expect), seriously consider switching forms. To do otherwise is to act at your peril for discouraging resolution of a future dispute and failing to mitigate your risk of involvement in arbitration or litigation.

Related articles:

The fate of arbitration

Arbitration’s lack of legal precedent

Bargaining for justice: deconstructing the arbitration provision

Mediation: best, faster dispute resolution