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Question:

When is an arbitration provision in an agreement enforceable?

Answer:

An arbitration provision — when present in a real estate purchase agreement and initialed by both buyer and seller — grants a third-party arbitrator the authority to hear and resolve a dispute. On hearing a dispute, the arbitrator issues a binding award in favor of the buyer or seller as a remedy for the dispute.

In return for agreeing to arbitration of a dispute, the buyer and seller relinquish their rights to a judge or jury trial in a court and any appeal from the arbitrator’s decision, as well as discovery procedures to prepare for arbitration.

In real estate single family residential (SFR) transactions, the arbitration provision is voluntarily entered into when both the buyer and seller initial the provision in the purchase agreement, an activity controlled by state law. The 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.

The arbitration provision is a separate agreement

The arbitration provision in a purchase agreement is an agreement separate from the purchase agreement in which it is embedded, a condition called severability. [Prima Paint Corporation v. Flood & Conklin Mfg. Co. (1967) 388 US 395]

As a result, when a buyer or seller, or both, initial the provision, the underlying purchase agreement is not affected by what has been done regarding initialing the provision. Thus, any flaw or error in the purchase agreement does not alter the enforceability of the arbitration agreement created when both participants initialed the provision.

When a purchase agreement is determined to be unenforceable, the arbitration agreement remains enforceable as a separate agreement. The buyer and seller are legally bound to submit their dispute to arbitration, even when disputing the enforceability of the actual purchase agreement. It is only when the arbitration provision itself is flawed or against public policy that the arbitration agreement may be deemed void and unenforceable. [Prima Paint Corporation, supra]

As separate from the purchase agreement, an arbitration provision does not become enforceable or function as a counteroffer to the underlying purchase agreement when only one participant initials the provision. The act of initialing the arbitration provision is not considered a modification to the purchase agreement as the arbitration provision is separate from the terms and conditions of the purchase agreement itself.

Thus, the arbitration provision in a purchase agreement remains a separate offer by the buyer or seller who initials it, which may be accepted or ignored by the other participant and has no impact on the enforceability of the purchase agreement.

Mutual agreement required

A buyer or seller is only required to submit a dispute to arbitration which they have agreed to arbitrate.

However, an arbitration agreement between a buyer and seller is not enforceable — even against a consenting participant who initials the provision — when only one participant agrees to submit disputes to arbitration.

Both buyer and seller need to initial the arbitration provision to form an enforceable agreement between them to arbitrate. [Stirlen v. Supercuts Inc. (1997) 51 CA 1519]

An arbitration agreement initialed by only the buyer or only the seller is essentially an offer to arbitrate which the other person did not accept by entering their initials.

Thus, even though the buyer or seller has initialed and consented to submit all disputes to arbitration, they cannot be compelled to arbitrate unless the other person also initialed the provision at the time they entered into the purchase agreement — as required to form any binding agreement. [Marcus & Millichap Real Estate Inv. Brokerage Co. v. Hock Inv. Co. (1998) 68 CA 83]

Related article:

The problem with the arbitration provision