Bargaining for justice: deconstructing the arbitration provision

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.