Jon Paul Hoelscher and Amendeep S. Kahlon | Buildsmart
On December 8, 2020, in Taylor Morrison of Texas, Inc. v. Kohlmeyer, a Texas Court of Appeals rejected a contractor’s appeal of a trial court order denying the contractor’s motion to compel arbitration in a home construction defect dispute. The appellate court concluded that the theories of direct benefits estoppel and implied assumptions did not permit the contractor to bind a subsequent purchaser to mandatory arbitration required under the original purchase agreement.
In 2013, the contractor, Taylor Morrison, executed a purchase agreement with a homeowner for the construction of a new home in League City, Texas. The purchase agreement included a mandatory arbitration provision and provided that it may not be assigned without the prior written consent of Taylor Morrison. In March 2016, the homeowner sold the house, and, later that year, the property was sold again to the Kohlmeyers. In 2018, the Kohlmeyers sued Taylor Morrison “asserting that the house had a substantial amount of mold growth throughout resulting from numerous water and moisture sources caused by construction defects.” Taylor Morrison moved to compel arbitration under the doctrines of equitable or direct benefits estoppel and implied assumption, but the trial court denied the motion. Taylor Morrison then appealed.
The appellate court confirmed the trial court’s decision. The appellate court acknowledged that an arbitration agreement may bind a non-signatory such as the Kohlmeyers but only when one of the following six theories — none of which were applicable here — applies: “(1) incorporation by reference, (2) assumption, (3) agency, (4) alter ego, (5) equitable estoppel, and (6) third-party beneficiary.” Taylor Morrison only argued assumption and equitable estoppel applied in the instant action.
With respect to estoppel, Taylor Morrison contended that the Kohlmeyers’ claim sought a direct benefit of the original purchase agreement relating to the quality of workmanship and construction. According to the court, for Taylor Morrison’s direct benefits estoppel theory to apply, Taylor Morrison must show that the Kohlmeyers’ claims depended on and were unable to stand independently of the purchase agreement. Mere relation of the claims to the purchase agreement was insufficient to apply the estoppel theory to bind the Kohlmeyers to arbitration. The appellate court concluded that the Kohlmeyers’ claims did not arise solely from the purchase agreement because the Kohlmeyers did not allege breach of the purchase agreement, the economic loss doctrine could not be applied to bind the Kohlmeyers on a contract they never signed, and the Kohlmeyers’ claims for breach of implied warranties did not arise solely from the purchase agreement.
The appellate court also rejected Taylor Morrison’s argument for binding the Kohlmeyers to the arbitration clause under the theory of implied assumption because the purchase agreement had not been assigned to the Kohlmeyers. According to the court, an implied assumption of contract obligations arises when a contract is assigned to an assignee (here, the Kohlmeyers) and the benefit received by the assignee is so entwined with the burden imposed by the assignor’s contract that the assignee is estopped from denying assumption and the assignee would otherwise be unjustly enriched. Taylor Morrison argued the implied warranties in the purchase agreement had been automatically assigned to the Kohlmeyers when they bought the house and that the benefits of the implied warranties under the purchase agreement were entwined with the arbitration provision.
The court disagreed. Per the court, the alleged automatic assignment of the implied warranties was inapposite because there was no dispute that the purchase agreement (i.e., the contract) had not been assigned to the Kohlmeyers. Indeed, the appellate court noted that assignment of the purchase agreement was contingent on Taylor Morrison’s written consent, which the record showed had not been provided. Therefore, the court rejected the implied assumption theory and held that the Kohlmeyers could not be compelled to arbitrate.
Lessons from Taylor Morrison
Since arbitration is typically an animal of contract, it is important for contractors to understand how their arbitration clauses will be interpreted by a court. While attempts to compel arbitration of non-signatories to an agreement may invite some creative application of the applicable theories described above, a belt-and-suspenders approach in drafting a dispute resolution clause may provide more options to the party attempting to compel arbitration. Here, the appellate court appeared wary of applying a purchase agreement’s arbitration provision to a homeowner who was two-times removed from the original purchase agreement transaction. However, the court noted that three of the potential theories to enforce the arbitration clause were inapplicable based on how the agreement was structured.