By David Swedelson, Partner, SwedelsonGottlieb
So here is the question. Is a provision in the CC&Rs requiring that an association submit claims against the developer for construction defects to binding arbitration unconscionable and therefore unenforceable? This is what the Court of Appeal found in the Pinnacle case, holding that such provisions are procedurally unconscionable because neither the individual purchasers, nor the association, have any alternative but to accept the terms of the CC&Rs, and substantively unconscionable because they are unfair and one-sided.
This case is now before the California Supreme Court, and we are awaiting its decision.
Pinnacle Museum Tower is a condominium project in downtown San Diego located in a multi-use high-rise tower. Pinnacle’s CC&Rs contain a provision providing that the developer, the owners and the Association agree to resolve any construction disputes through binding arbitration in accordance with the Federal Arbitration Act (“FAA”), a federal law that applies to any written agreement to arbitrate a transaction involving interstate commerce. The FAA controls over state laws applicable to arbitration agreements, but defers to a state’s laws governing contract issues. The CC&Rs further provide that the Association cannot amend the arbitration provision without the developer’s consent. Each original purchase agreement contained a reference to the arbitration provision, and each purchaser was required to initial that reference.
Pinnacle brought a construction defect action against the developer, and the developer petitioned the Superior Court for an order compelling arbitration pursuant to the CC&Rs. The trial court denied the petition, and the developer appealed to the California Court of Appeal.
The Court of Appeal held that the FAA applied to the arbitration provision “because some of the materials used in the Project were manufactured in other states,” thus evidencing an affect on interstate commerce. However, since the right to arbitration depends on a contract, general California contract law applies to determine whether the CC&Rs constitute a contract.
The Court then concluded that the CC&Rs do not constitute a contract between the Association and the developer, noting that it was “aware of no California cases treating CC&Rs as a contract between anyone other than as between owners, or between owners and a homeowners association.” Further, when Pinnacle was formed, it had no alternative to accepting the CC&Rs. The Court also pointed out that at the time the CC&Rs were drafted, the developer was on both sides – it was the developer and it controlled the Association.
The Court then determined that even if the CC&Rs constitute a contract, the arbitration provision is unconscionable, and therefore unenforceable. The Court found that the contract was procedurally unconscionable because neither the Association nor the individual purchasers had any alternative but to accept its provisions, and substantively unconscionable because it was unfair and one-sided, notwithstanding the fact that it called for both the Association and the developer to arbitrate construction defect claims against the other. In reality, the Association would have to arbitrate its claims, but the developer “would have no conceivable reason to make a claim against condominium purchasers related to the use or condition of the Project, particularly after escrow closed.”
Pinnacle is just one of several cases now pending that deal with this binding arbitration issue. Follow this link for an in-depth article that addresses both the Pinnacle and the Villa Vicenza cases. The article, Will Construction Defect Cases Involving Homeowners Associations Be Subject To Binding Arbitration After All? California Supreme Court Grants Review Of Two Lower Court Of Appeal Decisions Which Barred Enforcement Of Binding Arbitration Clauses Contained In Covenants, CondItions and Restrictions Prepared By The Developer, by my friend Edward F. Morrison, Jr., Esq. (and Larry A. Schwartz, Esq. with the Morrison law firm), while setting out more of the background for the two cases, looks at the issue from the developer or builder’s perspective (because they represent builders). Their perspective and how they see these cases coming down are certainly different then the way we community association attorneys see the issues. I remain optimistic that the Supreme Court will find as the Court of Appeal did in Pinnacle, that the ADR provision in the CC&Rs is unconscionable and unenforceable. Let’s cross our fingers.
The California Supreme Court has taken this case and oral argument was recently heard, so we are expecting a decision on this important issue in the not too distant future. Until then, the law on this issue is unsettled.
David Swedelson is a condo attorney and HOA lawyer. David has successfully resolved dozens of construction defect claims for California community associations over the last 30 years. He can be contacted at email@example.com.