Is It the Beginning of the End for Forced Arbitration Clauses? Let’s Hope

Deborah Trotter | Property Insurance Coverage Law Blog | September 28, 2019

In an historic win for American consumers and workers, on September 20, 2019, the U. S. House of Representatives passed H.R. 1423, the Forced Arbitration Injustice Repeal or FAIR Act,1 by a vote of 225 to 186. This groundbreaking bill could be the beginning of the demise of the remedy-stripping, rights-stomping, forced arbitration clauses in contracts of adhesion. Arbitration is often referred to an alternative dispute resolution—meaning an alternative to the litigation of a dispute.

Arbitration has a semblance of a legal forum with arbiters who make binding rulings, but there are no judges to rule on the applicable law or to seek appeal of an arbiter’s ruling; no jury; and no court oversight. The arbitration provision has morphed from a specialized industry, expertise-applying dispute resolution process among merchants to a liability-shielding clause for the drafter, or waiver of future substantive rights or remedies for the non-drafter—a Heads I Win; Tales you Lose deal.

An insurance policy is a contract of adhesion—a non-negotiated, unilaterally drafted contract by the insurer. We are seeing more and more forced arbitration clauses in contracts of insurance buried deep in the policy or endorsement pages. These forced arbitration clauses are sending policyholders to fight their claims in New York, the favored seat of arbitration; are applying New York law, regardless of where the insured property is located; and are imposing unrecoverable costs and expenses upon the policyholder.

One of the biggest problems we see, is the broad language of the forced arbitration clause. Many of these forced arbitration clauses require arbitration of disputes using phrases such as “any claims,” “arising out of,” “relating to,” and “in connection with.” The insurance carriers argue these “broad” arbitration clauses do not limit the claims to those that “arise under the contract,” but include all disputes between the parties, including extracontractual claims, e.g., breach of the duty of good faith and fair dealing; breach of state statutory laws or common laws, and any other “related” tort. The insurance carriers have been arguing the effect of this broad language coupled with the New York statutory limits placed upon the authority of an arbiter prohibiting an award of punitive damages effectively waives the policyholder’s remedies for extracontractual damages. We continue to fight these misguided assertions of the insurance carriers and welcome Congress to act in undoing insurance carriers’ misappropriated Federal Arbitration Act and Convention cloak they have come to openly abuse.

The Bill moved to the Senate on September 24, 2019. We encourage you to reach out to your Senators to restore your rights and remedies.

Arbitration Provision In Insurance Policy Applies Because Federal Arbitration Act Supersedes State Law Making Such Clauses Illegal

Chip Merlin | Property Insurance Coverage Law Blog | May 15, 2019

“Oh, Boy!” was my first thought after reading a case which holds that those arbitration agreements requiring policyholders to arbitrate in far-away places could not be stopped by state law. Congress should stop this, and state legislators should write laws to ban those insurance carriers who sell such policies.

Let’s all be honest and agree that these arbitration clauses are as anti-consumer as they come. The insurers and agents selling these products are no friends to policyholders. I warned about these clauses in, Surplus Lines Carriers Select Arbitration and Choice of Law in New York to Pay Less Coverage and Less on Claims.

The case1 involves a builders risk policy covering property in Louisiana that has an arbitration clause which states:

Any dispute, controversy or claim arising out of, relating to, or in connection with this Policy, shall be finally settled by arbitration. The arbitration shall be conducted in accordance with the International Arbitration Rules of the American Arbitration Association in effect at the time of the arbitration. The seat of the arbitration shall be New York, New York, in the United States of America.

The policyholder cited Louisiana law making such an arbitration clause illegal and unenforceable. The policyholder also pointed to the conformity to state law clause in the policy arguing that this clause meant that the policy should be interpreted to find that the Louisiana law making the arbitration clause illegal applied:

In the event any terms of this Policy are in conflict with the statutes of the jurisdiction where the Insured Property is located, such terms are amended to conform to such statutes.

The court disagreed and held:

[T]he policy contains an arbitration provision. It is the arbitration provision of the insurance policy that is said not to conform with [the Louisiana statute,] a statute prohibiting arbitration agreements. This state statute, however, as we held in Safety National, is preempted by the Convention….Because the state statute,….is preempted by the Convention, the statute does not and cannot apply to McDonnel’s policy. And because the statute does not apply to the policy, there is no conflict between the policy and the state statute. With that premise established, the conformity provision is not triggered; its inapplicability leads only to the conclusion that the arbitration provision survives, undiminished by state law.

Property insurance defense attorneys in New York, the most common place where the arbitration is to take place in these surplus lines policies, must be smiling because they will be getting a lot of legal business from far-away places. Surplus lines claims managers who are lowballing offers, delaying payments and denying claims are lighting cigars and fist pumping each other over this result. Surplus lines underwriters are getting flooded with messages to change the policy language and write policies with arbitration clauses in New York.

There is nothing good for policyholders in this decision. Surplus lines markets are growing, and this will give those carriers an ability to sell even cheaper insurance because most policyholders will generally find it too costly to fight for their benefits in an arbitration a long way from home.

Thought For The Day

Good intentions can often lead to unintended consequences. It is hard to imagine a law intended for the workforce known to Henry Ford can serve the needs of a workplace shaped by the innovations of Bill Gates.
—Tim Walberg
1 McDonnel Group, L.L.C. v. Great Lakes Insurance SE, UK Branch, No. 18-30817, — F.3d —, 2019 WL 2082905 (5th Cir. May 13, 2019).

Nevada Supreme Court Rules That Arbitration Clause in Common-Interest Community’s Covenants, Conditions, and Restrictions Binds Homeowners

Alex Corey | Pepper Hamilton LLP | June 14, 2018

United States Home Corp. v. Ballesteros Trust, 2018 Nev. LEXIS 28 (Nev. Apr. 12, 2018)

United States Home Corporation (“U.S.H.”) built homes in a Nevada common-interest community, subject to a Covenant, Conditions, and Restrictions agreement (“CC&R”), which provided that any dispute would be resolved by arbitration.

Between August 2013 and February 2015, twelve home purchasers filed pre-litigation notices against U.S.H. for alleged construction defects. Three of the purchasers had direct purchase and sales agreements with U.S.H. that contained arbitration clauses; the remaining homeowners did not sign such agreements, but took title subject to the CC&R. U.S.H. demanded arbitration, but the homeowners brought claims in a Nevada district court seeking damages for breach of contract and other claims. U.S.H. moved to compel arbitration. The court held that the transaction did not involve interstate commerce, so the Federal Arbitration Act (“FAA”) did not apply, and invalidated the arbitration agreements as unconscionable.

On appeal, the homeowners argued that arbitration cannot be compelled based on the CC&R, because CC&Rs are not contracts, but covenants that run with the land. U.S.H. argued that by purchasing homes in a common-interest community, the homeowners assented to the obligations in the CC&R, including the arbitration clause. Citing a comparable decision from California, the Nevada Supreme Court ruled that by purchasing a unit within the common-interest community, the homeowners accepted the CC&R, including its arbitration clause.

Relevant to the Court’s decision was the fact that each of the homeowners received the requisite informational notice that warned them that by purchasing a property encumbered by the CC&R, the purchasers agreed to limitations that could affect their lifestyle and freedom of choice, and that the CC&R bound the owners whether or not they read or had the CC&R explained to them. The Court emphasized that purchasing property in a common-interest community was a choice that “requires consideration of the CC&R,” which not only bind homeowners, but also the developer and homeowner association. In essence, “CC&Rs become part of the title of your property” as homeowner, the Court found.

The Court also noted that certain safeguards were in place to protect the homeowners from unwittingly becoming bound. First, the owners were given copies of the CC&R prior to their purchase as well as informational statements required under Nevada law. Second, the homeowners had five days to cancel the purchase at their election. Third, even though the CC&R arbitration agreement was effective, the homeowners could still raise individual defenses, such as unconscionability.

The Court next analyzed whether the FAA applied. U.S.H. argued that the FAA applied because the underlying home purchases affected interstate commerce. The homeowners argued that the sale of individual homes was a local issue. The Court noted that the FAA applies to contracts “evidencing a transaction involving interstate commerce”, with the word “involving” interpreted broadly. As such, even contracts evidencing intrastate economic activities are governed by the FAA if the activities viewed in the aggregate “substantially affect interstate commerce.”

While the Court was sympathetic to the homeowners’ argument that the CC&R addressed residential real estate, a traditionally local concern, the Court was persuaded by the “larger purpose” of the CC&R, which was to facilitate the creation and governance of a common-interest community consisting of common areas and multiple homes that protect the purchasers’ investments. The Court concluded that the transactions underlying the CC&R’s arbitration agreement, the construction and sale of multiple homes by out-of-state contractors using out-of-state suppliers, affected interstate commerce and fell under the purview of the FAA. The Court ruled that Nevada law disfavoring arbitration, therefore, was preempted and reversed the lower court’s holding that the CC&R arbitration agreement was unconscionable.

Undocumented Oral Agreement Came Within Scope of Written Arbitration Clause

Stan Martin | Commonsense Construction Law LLC | November 16, 2016

A hauling company submitted bids for removal of three different types of construction debris, and the parties agreed on and signed a contract covering two of those categories. Later, by oral agreement the third category initially bid on was added at a different price, but this agreement was never reflected in any written amendment or change order.

The original bid was for (1) concrete excavation and haul off, (2) brick haul-off, and (3) construction and demolition (“C&D”) haul-off. The parties signed a contract for the first two which included an arbitration clause. They later reached an oral agreement for C&D disposal at a lower price than originally quoted.

When a dispute arose, the prime contractor, Griffin, sought arbitration per the signed contract, including a dispute on the C&D disposal. The hauling company, Southwinds, objected to the arbitrator’s jurisdiction to hear the C&D dispute. The arbitrator ruled that she had such jurisdiction, finding that the C&D price was a modification to an existing contract containing an arbitration clause. She later ruled against Southwinds, who appealed. Distilled to its essence: was the C&D agreement a modification to an existing contract, or was it a new agreement?

The appellate court stated, first, that the issue of arbitrability was one for the courts, and not for the arbitrator. Looking then to the arbitration clause, the appellate court noted:

the Subcontractor Agreement’s broad arbitration provision covered “a claim by [Southwinds] against [Griffin]” and “a claim [filed by Griffin] against [Southwinds].” The parties did not limit the arbitration provision’s scope to claims arising out of the Subcontractor Agreement or to claims related to the Subcontractor Agreement. The parties placed no limitation on the nature of the claims between them that fell within the arbitration provision … The C&D haul-off claims involved the same construction project and the same essential type of work being performed; they differed only in the type of debris removed. Accordingly, we conclude the C&D haul-off claims had a significant relationship to, and were factually intertwined with, the Subcontractor Agreement.

Thus, those claims were subject to arbitration, and the arbitrator’s award was confirmed. The case is Southwinds Express Constr., LLC v. D.H. Griffin of Tex., Inc., 2016 Tex. App. LEXIS 12217 (14th Ct. of App., Nov. 15, 2016).

New Jersey Federal District Court Holds That Arbitration Clause In AIA A201-1997 Does Not Apply To Post Construction Disputes

Jane Fox Lehman | Pepper Hamilton LLP | September 15, 2016

Blackman & Co., Inc., v. GE Bus. Fin. Servs., Inc., 2016 U.S. Dist. LEXIS 87904 (D.N.J. July 7, 2016)

Grove Street Realty Urban Renewal, LLC (“Grove Street”) contracted with Blackman & Co., Inc. (“Blackman”) to manage a project (the “Project”) to construct a four-story apartment building in West Deptford, New Jersey between 2007 and 2009 (the “Contract”). The Contract incorporated AIA Document A201-1997General Conditions of the Contract for Construction.

GEBFS acquired the Project from Grove Street pursuant to foreclosure proceedings in 2012. Three years after it acquired the Project (and six years after construction was complete), GEBFS filed a $4,000,000 Demand for Arbitration with the American Arbitration Association (“AAA”) against Blackman for alleged post-construction defects, asserting claims for breach of contract and breach of implied warranty. Blackman filed an action in response to GEBFS’ Demand for Arbitration, seeking a judgment that the dispute was not governed by any agreements to arbitrate.

In the Third Circuit, a court will enforce an agreement to arbitrate “when it is apparent, based on ‘the face of a complaint , and documents relied upon in the complaint,’ that certain of a party’s claims ‘are subject to an enforceable arbitration clause.’” Guidotti v. Legal Helpers Debt Resolution, LLC, 716 F.3d 764 (3d Cir. 2013). Accordingly, the court looked to the language of the Contract to determine whether GEBFS’s claims were arbitrable.

GEBFS argued that the Contract’s arbitration provision, which was supplied in AIA Document A201, could be parsed to provide that “Any Claim . . . arising out of or related to the Contract . . . shall . . . be subject to arbitration.” The court, however, found that GEBFS’ parse omitted a key phrase: a Claim “shall after decision by the Architect or 30 days after submission of the Claim to the Architect, be subject to arbitration.” The court noted that AIA A201, like many construction contracts, designates the project architect as the arbiter of contract disputes. Such designation supports the conclusion that the arbitration provision only applies to claims that arise during construction because it would not make sense for the architect to be designated as the first-line arbiter in a sequential dispute resolution process that applied to post-construction claims.

The court found the Contract provision that made a decision by the architect a “condition precedent to mediation, arbitration or litigation of all Claims between the Contractor and Owner arising prior to the date final payment is due” to be dispositive. The phrase “arising prior to the date final payment is due” exemplified that “Claims” did not include post-construction claims. The fact that any decision by the architect would result in, if merited, a change in the contract sum or time also supported the conclusion that the arbitration provision only applied to claims that arose during construction because such remedies would be moot after construction is completed and paid for.

The court also noted that “Claim” included disputes arising out or relating to the Contract where the Contract was titled and defined as a “contract for construction,” and that a Claim had to be submitted to the architect for decision within 21 days of the occurrence or condition giving rise to the Claim. The requirement of timely notice of a dispute to the architect concerning a “contract for construction” further suggested that the entire Contract, including the dispute resolution process, related to the process of construction, and not occurrences or conditions that are discovered after construction is complete, because the entire purpose of the architect serving as the arbiter was to ensure that construction is completed in a proper and timely manner.

The court held that GEBFS’s claims were non-arbitrable.