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Alert – California Supreme Court Upholds a CC&RS’ Construction Defect Arbitration Provision

Written By:  Roger J. Brothers, Esq.

Buchman Provine Brothers Smith LLP

Walnut Creek, California

The California Supreme Court recently decided in Pinnacle Museum Tower Association v. Pinnacle Market Development (US) LLC (“Pinnacle“) that an arbitration provision for construction defect disputes in the Conditions, Covenants and Restrictions (“CC&Rs”) was enforceable and binding on a homeowner’s association (“HOA”), even though the HOA did not exist when the CC&Rs were recorded (Supreme Court Case No. S186149). As a result of this decision, a construction defect dispute arising from a large-scale condominium project in San Diego was subject to arbitration instead of litigation.

The decision in Pinnacle will have a tremendous impact on the enforceability of arbitration provisions in CC&Rs. California courts have demonstrated an unwillingness to uphold arbitration provisions in contracts for a variety of reasons, including the unconscionability of the provision, the provision was part of an adhesion contract, the provision precluded the filing of class actions and the unilateral nature of particular arbitration provisions. The U.S Supreme Court’s opinion in AT&T Mobility LLC v. Concepcion highlighted the California courts’ propensity to declare certain arbitration provisions unconscionable (131 S. Ct. 1740, 1746 (2011), see also Discover Bank v. Super. Ct., 113 P.3d 1100 (Cal. 2005) abrogated by AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (U.S. 2011)).

The HOA in Pinnacle sued the developer—on its own behalf and on that of the individual unit owners—for damages allegedly caused to the condominium project during construction. The developer moved to compel arbitration under the Federal Arbitration Act (“FAA”), citing the clause in the CC&Rs. However, the Trial Court denied the motion on the grounds of unconscionability.

On appeal, the decision was affirmed. The Court of Appeal noted that the HOA and the original development company were not separate entities at the time that the CC&Rs were recorded, which thereby precluded the HOA from consenting to the arbitration clause. The arbitration clause provided for the application of the FAA to construction disputes arising under the CC&Rs because the construction project included materials and labor coming from outside of California. The Court of Appeal further noted that in the absence of consent, the parties could not be subject to the arbitration clause.

The Appellate Court explained that the FAA overrode a California statute (Code of Civil Procedure §1298.7). Section 1298.7 allows purchasers to file actions for construction defects in court notwithstanding the existence of an applicable arbitration agreement. The Court of Appeal determined that by purchasing a condominium unit the buyer agreed to be bound by the CC&Rs. However, the Appellate Court determined that the arbitration provision required special consent to be given before it became enforceable. The California Supreme Court disagreed with this distinction and rejected the notion that the arbitration provision in the CC&Rs required special consent in order to be enforceable.

The California Supreme Court’s decision in Pinnacle did not conflict with the existing case law defining unconscionable arbitration clause provisions. The arbitration clause at issue applied evenly to the parties. The California Supreme Court stated that arbitration clauses are not per se unconscionable. As written, the arbitration provision allowed both parties to seek the same remedies that would have been available through litigation. The Court rejected the application of procedural unconscionability to the facts in Pinnacle because CC&Rs are required to be recorded before individual units are sold and before the HOA has been properly formed.

While the California Supreme Court’s decision in Pinnacle does not amount to a sweeping ratification of the enforceability of arbitration clauses, the scope and impact of the decision are substantial. The most notable effects of the Pinnacle decision are as follows:

· Compelling arbitration is now much easier, especially in construction defects cases.

· It provides additional precedent by which to establish that CC&Rs bind future property owners.

· It affirms that cases dealing with interstate commerce are subject to federal arbitration law.

· CC&Rs are contracts, a notion that was subject to scrutiny in California.

· For cases that are governed by the FAA, it prevents valid contracts from being discriminated against on the basis that they contain arbitration provisions.

· It provides further guidance for parties attempting to determine the scope and interpretation of California’s rules governing unconscionability.

· The Court implied that unless an arbitration provision contained in the CC&Rs is deemed “unreasonable,” a developer is entitled to rely on the enforcement of the arbitration provision as stated in the contract.

For more information about Buchman Provine Brothers Smith LLP, please visit www.bpbsllp.com or the International Society of Primerus Law Firms.

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