1. What is arbitration?

Arbitration is a form of alternative dispute resolution (ADR). In arbitration, the parties to an agreement, such as a real estate purchase agreement, forego a court action and agree to be bound by an arbitrator’s decision. The arbitrator is a neutral third party appointed by a court or selected by the parties to the agreement to hear the dispute. The arbitrator makes the final decision, awarding judgment in favor of one of the parties to the agreement. [Calif. Code of Civil Procedure §1297.71]

The arbitration provision is enforceable by either the buyer or the seller:

  • when both parties initialed the provision agreeing to submit disputes to arbitration; and
  • as a separate agreement from the purchase agreement which contains the provision. [Prima Paint Corporation v. Flood & Conklin Mfg. Co. (1967) 388 US 395]

An arbitration provision may be included in multiple types of real estate agreements, including purchase agreements, listing agreements, escrow instructions and leasing agreements. However, consumer mortgage agreements may not include mandatory arbitration provisions. [12 Code of Federal Regulations §1026.36(h)]

Each person who agrees to be bound by the terms of arbitration is required to initial the arbitration provision. Only those who initial the provision are bound by its terms.

Arbitration’s popularity stems from claims it is a faster and less costly method of dispute resolution than taking part in a court action.

2. What are the drawbacks of using arbitration?

Persons who agree to arbitration risk misinterpretation of the law since an arbitrator’s award is a final decision and is not subject to judicial oversight for error.

Unless the arbitration provision states an arbitration award is “subject to judicial review,” the award resulting from arbitration brought under the clause is binding and final. Any erroneous or unfair application of the law prevails since the arbitrator acted within the powers granted to them by the arbitration provision.

A court confronted with an initialed arbitration provision without a clause for judicial review cannot review the arbitrator’s award for errors of facts set by the arbitrator or the law they apply. Disturbing for courts (and those asking for relief) is that even if the error is obvious to the court and causes substantial injustice, the court must enter judgment based on the arbitrator’s erroneous award, the judicial step needed for the award to be enforceable. [Hall v. Superior Court (1993) 18 CA4th 427]

Any defect in an arbitrator’s award resulting from an error of fact or law, no matter how flagrant or bizarre, is neither reviewable nor correctable, unless:

  • the arbitrator exceeded their authorized powers;
  • the arbitrator acted with fraud or corruption;
  • the arbitrator failed to disclose grounds for their disqualification;
  • the award was procured by corruption, fraud or other misconduct; or
  • the arbitrator’s refusal to postpone a hearing substantially prejudiced the rights of an affected party. [CCP §1286.2]

Thus, without judicial review of an award in an arbitration action, persons agreeing to mandatory arbitration have no assurance an award will be a fair or legally correct final decision.

Currently, the prevailing arbitration provision used in trade union purchase agreements has not yet evolved to include language allowing for judicial review to ensure fair results. firsttuesday purchase agreements do not and have never contained arbitration clauses (or attorney fee provisions).

Further, arbitration can be time-consuming, as disputants take part in an arbitration hearing to determine and enforce the arbitrator’s decision. Thus, parties remain subject to the arbitrator’s lengthy procedural requirements.

3. What rights are lost during arbitration?

Principally, parties subject to arbitration forfeit the right to appeal the arbitrator’s decision, a constitutionally protected right. An appeals process allows a person to dispute an award and seek correction of errors through a court’s astute analysis of the facts and the application of relevant law. However, without the right to appeal, parties to arbitration are bound by an arbitrator’s judgment, even if it is unfair and misinterprets the law. Thus, they relinquish the protections granted by law and are denied the opportunity to challenge an arbitrator’s erroneous decision through a court action – a major loss not adequately explained to homebuyers by their agents when asked to initial the provision.

Further, persons agreeing to an arbitration provision are not guaranteed the right to discovery, unless the provision specifically includes these rights. Discovery rights give persons in a dispute the opportunity to gather appropriate documents and evidence to present their cases. The procedure allows them to identify the issues in the dispute and review the other person’s arguments so they can prepare a defense.

Currently, the trade union purchase agreements do grant pre-hearing discovery rights in the arbitration provision. However, discovery procedures and the admissibility of presented evidence are subject to the arbitrator’s control. [CCP §1283.05]

Arbitration’s lack of judicial involvement also prevents resolutions from producing reports of important court case opinions on evolving legal issues. These reports are needed to resolve legal ambiguities for application and as guidance in future real estate disputes. A lack of legal precedence leaves those involved in real estate disagreements – buyers, sellers, brokers and attorneys – without judicial direction for properly applying real estate law.

Further, failure to constantly apply current law through a court’s thorough analysis of the facts in real estate transactions muddles an arbitrator’s understanding of real estate law. This void contributes to the proliferation of inequitable and legally unsound arbitration decisions.

4. What legal relief exists for parties involved in arbitration?

As a matter of public policy, arbitration provisions in California real estate contracts are mandated to include a 165-word warning about the lost constitutional rights to judicial review, should the provision be initialed and activated. This warning is intended to place a burden on those who initial and activate the provision to know the consequences they bring on themselves by initialing.

The requirement to initial the arbitration provision to activate it ensures more attention is given to the provision before its activation. An arbitration provision is thus enforceable against any person who initials the provision. Again, the provision is a separate contract with the arbitrator, not an agreement with the other party to the purchase agreement containing the provision. [Grubb & Ellis Company v. Bello (1993) 19 CA4th 231]; CCP §1298(c)]

Further, the likelihood of inconsistent results exists when a real estate dispute is simultaneously subject to both an arbitration action and a court action. The likelihood of distorted results arises when one person involved in a dispute has consented to arbitration (say a buyer, seller or both) and one has not (say the broker or escrow officer). Here, the California Arbitration Act (CAA) allows a trial court to declare an arbitration provision unenforceable to eliminate the possibility of conflicting awards in arbitration and a court action with a single, judicially reviewable court decision. [CCP §1281.2]

For example, a buyer files a court action against the buyer’s broker who did not agree to the arbitration provision in the purchase agreement. The buyer did initial the arbitration provision, as did the seller who was also named in the court action.

Here, by including the broker, the buyer entirely avoids the possible adverse consequences of arbitration. The court will deny arbitration and join all parties to the dispute in a single court action in order to avoid inconsistent, but fully enforceable awards with different results. [Valencia v. Smyth (2010) 185 CA4th 153; CCP § 1281.2]

However, the trade union’s most recent purchase agreement is now “enforced” under the Federal Arbitration Act (FAA), rather than California’s consistent result statutes. The FAA requires enforcement of all binding arbitration provisions regardless of the possibility of conflicting rulings in claims arising out of the same transaction but against persons who chose not to agree to arbitration.

This effectively cuts off a disputant’s ability to compel judicial action by including in a dispute any third party who has not agreed to arbitration. Thus, each person involved in a dispute may separately pursue their claims in different forums – increasing the risk of divergent results from the same dispute. [United States Code §§3, 4]

5. Why is arbitration included in real estate purchase agreements?

The California real estate trade union and its staunch member brokers perpetuate the use of arbitration provisions. Arbitration became their favored method of ADR in real estate transaction disputes some 35 years ago as a means of resolving disputes without the need for then more costly court action.

More importantly, the advent of arbitration allowed trade union leaders to maintain control over their constituents by requiring all disputes be settled internally without the influence and involvement of state or federal governments, and outside the influence of law and (view of) the public. [The People v. National Association of Realtors (1984) 155 CA4th 578]

Thus, members of the trade union, by agreeing to full membership, are required to settle disputes amongst each other via arbitration. Arbitration has since become a staple of real estate forms published by the trade union, requiring buyers and sellers of real estate (who initial the provision in spite of the 165-word warning) to adhere to the arbitration process. In this context, brokers and, thus, their agents, are trained to reassure their clients that initialing the arbitration provision is a standard practice, a custom that bears multiple benefits with no risks — if any guidance is given at all beyond “initial here, and here.”

However, though the 165-word required warning offers some aid, many agents are not property trained and thus not equipped with sufficient knowledge and awareness by their brokers to advise their clients on the pros and cons of initialing the provision. Homebuyers are mostly unfamiliar with arbitration, but all understand court actions and judicial responsibilities, oversight and public hearings to ensure fair results. Thus, the continued dependence on arbitration is passed down among union members as routine. In time, routine becomes established as a revered and unquestioned tradition. Meanwhile, the legal risks and loss of rights persist, unmentioned until a dispute arises.

Further, the arbitration provision in purchase agreements is encouraged by inclusion of an attorney fees provision. The attorney fees provision entitles the prevailing party in a dispute to recover costs and attorney fees if the dispute results in a court action or arbitration. Thus, the attorney fees provision encourages disputants to pursue an economically infeasible loss when attorney fees will total more than the amount of the loss.

The absence of an attorney fees provision in purchase agreements focuses the buyer and seller on the amount of monetary loss recoverable in a dispute. Without an attorney fees provision, the amount of any recovery is limited to actual money-based losses on a transaction, reduced by the amount of attorney fees incurred to pursue recovery of the loss.

Thus, when the purchase agreement does not contain an attorney fees provision, infeasible disputes rarely result in an arbitration or court action. Without an attorney fees provision, buyers and sellers are logically inhibited by their inability to recover attorney fees (if they prevail) in addition to their lost property value due to misrepresentation or other errors by the other party or an agent.

The trade union purchase agreements presently contain the attorney fees provision along with the arbitration provision. Thus, inclusion of the arbitration provision is supported by both the trade union’s dependence on arbitration — causing legal risk to the parties to the agreement — and incorporation of the attorney fees provision that promotes uneconomical disputes. These conditions are the antithesis of the risk mitigation brokers need to maintain when providing services.

6. What is an alternative to arbitration?

Mediation is another form of ADR, operating independently of an arbitrator or court. In mediation, a mediator works with the persons who are involved in a dispute to craft a mutually agreed-to solution using the familiar arena of offer, counteroffer, compromise, benefits and risks.

The cost of mediationis a major benefit of the process, as it is minimal. Further, in contrast to actions by arbitration or in court, mediation is typically a quick process lasting a few hours to a few months, depending on the number of disputants, their willingness to reach a resolution and the complexity of the facts and issues involved. There are no lengthy waits for court hearings or the need for witnesses since the resolution is in the hands of the participants themselves.

In addition to these benefits, the use of mediation also provides a solution to a dispute without falling subject to the backlog of cases in an understaffed legal system. Nationwide, the mediation success rate ranges between 60%-90%. [Final Report of Colorado Governor’s Task Force on Civil Justice Reform, Exhibit 7]

However, mediation does have its parameters for use. In real estate matters, mediation is limited to resolving disputes involving buyers and sellers. Landlord-tenant disputes and mortgage defaults are largely based on very specific statutory requirements for performance — which are either satisfied or unsatisfied — leaving little room to dispute the facts, the law and the procedures involved.

Mediation is a tool of first resort, with personally satisfactory conclusions, to be used to resolve disputes in real estate sales and broker and agent licensed activities — arbitration being the least effective tool for the satisfactory resolution of disputes.