Home Builders and Developers Beware: SC Supreme Court Beats Up Hybrid Arbitration Clauses Mercilessly

Ned Nicholson | Best Practices Construction Law

If you are a homebuilder, residential housing developer, construction industry insurer, or any one of the many participants in the industry providing affordable and decent housing for the citizens of South Carolina, you are already aware that South Carolina courts have for decades prioritized the promotion of consumer (i.e., home buyer) rights, usually at the expense of the providers of housing.  There is nothing inherently wrong with that; the goal is laudable.  But as in so many things, the implementation has been extremely costly for the residential construction industry as a savvy plaintiff’s bar has taken advantage of grey areas that are inevitably created in our judicial system.

For example, years ago a South Carolina Supreme Court Justice proudly stated that “South Carolina, through both its courts and legislature, has previously been in the vanguard of protecting consumers, particularly in the area of home construction.”  Reynolds v. Ryland Group, Inc., 531 S.E.2d 917, 921 (S.C. 2000).  It is also no secret to builders and insurers that South Carolina’s joint and several liability rules mean that if a builder is only 1% negligent in the cause of construction defects, the builder can still get stuck with 100% of the damages, with the courts leaving it up to the builder to try and collect from other negligent parties.

It is therefore no surprise that in South Carolina, and nationally for that matter, homebuilders have attempted to bring some economic fairness to the table by inserting arbitration clauses in their construction and sales contracts.  Arbitration is a private dispute resolution method where parties to a contract agree that instead of going to court in a public lawsuit, any dispute will be handled by a neutral third party, usually an attorney, in a more informal and less expensive manner than the court system.  Usually the homebuilders attempt to ensure that arbitrators knowledgeable in the construction world will decide such disputes, so that experts truly decide the disputes.

Not surprisingly, plaintiff’s lawyers do not generally like arbitration, as they tend to believe their client homeowners would be more fairly treated by a jury or judge who are not construction experts and perhaps would be more sympathetic to a consumer in a close case.  Because of that, there are constant attacks on arbitration clauses in the courts as owners try to find creative ways to bypass binding arbitration.

Beware!  The South Carolina Supreme Court on September 14, 2022 embraced one of those creative bypasses in Damico v. Lennar Carolinas, LLC, et al, Op. No. 28114.  In Damico, the homebuilder had masterfully integrated special warranty clauses, arbitration clauses, and other contract documents to provide a clear, reliable outline and process for both the home buyer and the homebuilder to follow for dispute resolution by arbitration.  Or so the homebuilder thought.

To the surprise of the builder, the Court held that the arbitration clauses were “unconscionable,” and thus not enforceable.  The only way the Court could reach that conclusion was that the arbitration clause in this case did not say that issues of enforceability of the arbitration clause were for the arbitrator, not the courts, to decide.  (If a clause says that, the court must stop and defer to the arbitrator on that issue.)  Unfortunately for the homebuilder in this case, the elaborate arbitration clause missed that one checkpoint, which opened the door for the Court to attack the clause itself.

And attack it did.  With the adroitness of a prize fighter, the Court bobbed and weaved through various legal barriers that ordinarily may have ended its decision making process and made its way to the unconscionability holding.  The Court seized on the arbitration clause’s joinder provision that provided that the homebuilder at its sole option could join any subcontractors or other potentially liable parties in the arbitration.  The Court held that this seemingly minor procedural issue made the clause unconscionable and unenforceable because normally the plaintiff (home buyer) decides who to sue and this provision took that right away.  The Court believed it also could lead to inconsistent results in other forums and force the homeowner to litigate the same issues in court.

Of course, in the real world, there is almost always a chance of there being many forums.  The homeowner can always sue at fault subcontractors in court under other theories; that happens all the time.  The reasoning of the Court if taken to its extreme could undermine almost any arbitration clause since the home buyer does not have contracts with subcontractors and thus no arbitration clauses.

So how does a homebuilder avoid the trap created by the Court in Damico Perhaps a work-around could be if homebuilder includes in every subcontract an arbitration provision that allows a home buyer to demand arbitration against a subcontractor as well as joinder in an arbitration with the homebuilder.   Another way may be the well-known legal maxim of KISS (Keep It Simple Stupid.)  Drafters of arbitration clauses may want to keep the clause very vanilla—for example, beyond the basic language needed to ensure arbitration is applicable to a dispute, let the rules of a national arbitration association govern and do not insert any procedural hurdles that a court could in any way interpret to be unfair in some way to the consumer.  And of course, make sure that the arbitrator, not a court, will determine if a clause if unconscionable or not.

There are other lessons to be learned from Damico, and the homebuilders will certainly face a new round of attacks on their contracts as lawyers and courts start applying the opinion in not just the homebuilder industry, but consumer transactions in general.


When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 888.684.8305, or email experts@adviseandconsult.net.

Can I be Required to Mediate, Arbitrate or Litigate a California Construction Dispute in Some Other State?

William L. Porter | Porter Law Group

It is not uncommon in the construction industry for an out-of-state general contractor to include a provision in a subcontract requiring a California subcontractor to resolve disputes outside the state of California, even though the work is to be performed within California. Fortunately, most California subcontractors are immune from this tactic. California law generally prohibits clauses requiring subcontractors to travel outside California to resolve construction disputes.

California Code of Civil Procedure Section 410.42, [CCP 410.42 Link] renders “void and unenforceable,” any provision in a contract that “purports to require any dispute to be litigated, arbitrated, or otherwise determined outside this state,” so long as the contract is “between the contractor and a subcontractor with principal offices in the state, for the construction of a public or private work of improvement in this state.” Similarly, this law voids any similar contractual term that might prevent the California subcontractor from commencing an action, obtaining a judgment, or resolving its dispute in the courts of California.

The Third Appellate District of the California Court of Appeal has provided the only published opinion that analyzes and applies Section 410.42. In the case of Dick Emard Electric, Inc. v. Templeton Development Corp., (2006) 144 Cal. App. 4th 1073, Emard sued Templeton and various other parties in California for breach of contract and foreclosure of a mechanics’ lien after Templeton failed to pay Emard for the labor, services, materials, and equipment supplied by Emard pursuant to the contract, which was performed in California. Templeton unsuccessfully moved to dismiss the lawsuit, arguing that Emard must mediate before filing suit and that any mediation or lawsuit must take place in Las Vegas, Nevada, pursuant to the contract. Prior to Templeton’s Motion, Emard offered to mediate in California, pursuant to Section 410.42. Templeton refused the offer.

The Appellate Court ruled that Section 410.42 dictates that the out-of-state mediation provision was unenforceable and that Emard fulfilled any mediation requirement by offering to mediate in California instead of Las Vegas. Templeton filed a petition for a writ of mandate with the Third Appellate District seeking to have the decision set aside, in part because Section 410.42 does not specifically mention “mediation.” The Appellate Court upheld the prior ruling, determining that the phrase “or otherwise determined,” includes mediation. The Court published its opinion, establishing a legal precedent for future California cases.

The out of state forum selection clause seems a daunting hurdle to a subcontractor contemplating whether to enter into a subcontract where it would appear that the subcontractor could only enforce its rights by traveling out of state. The prospect of bringing witnesses and legal counsel to another state sets an unequal bargaining position from the outset. Fortunately, CCP Section 410.42, and the Emard case avoid the prospect of dragging California subcontractors to another state to resolve their dispute.

As a final bit of advice, when subcontracts contain a provision that would force a California construction dispute between a contractor and subcontractor to be mediated, arbitrated or litigated in another state, be sure to consider the impact of the Federal Arbitration Act, 9 U.S.C., §1, et seq. (“FAA”). To avoid any confusion, and to keep the dispute resolution process within California, be sure that the agreement also unambiguously states that California procedural and substantive law will govern the agreement rather than the provisions of the Federal Arbitration Act.


When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 888.684.8305, or email experts@adviseandconsult.net.

AAA Amendments to the Commercial Arbitration Rules and Mediation Procedures

Justin Leonelli and Rich Paciaroni | K&L Gates

Effective 1 September 2022, the American Arbitration Association (AAA) has updated its Commercial Arbitration Rules and Mediation Procedures, representing their first revisions since 1 July 2013. These amendments provide key updates and improvements to the commercial arbitration process, including with respect to the following:

CONSOLIDATION AND JOINDER

In likely the most significant revision of the amendments, under revised Rule R-8, parties can now request to consolidate arbitrations or join additional parties. The decision to permit consolidation or joinder rests with the case arbitrator (if one has been appointed) or a special arbitrator appointed by the AAA for the sole purpose of deciding consolidation or joinder. In assessing a request to consolidate, the arbitrator will consider (a) the terms and compatibility of the agreements to arbitrate, (b) applicable law, (c) whether the arbitrations raise “common issues of law or fact,” and (d) whether consolidation of the arbitrations would serve the interests of “justice and efficiency.” While consolidation and joinder have been available under the AAA’s Construction Industry Arbitration Rules for years, this is the first time such a procedure will be available under the Commercial Rules.

DISPOSITIVE MOTIONS

The amendments to Rules R-34 and R-49 now give arbitrators the ability to limit dispositive motion practice and award fees and expenses in accordance with any dispositive motion decision. Therefore, parties should be weary of excessive motions practice and confer on issues outside of formal submissions when possible.

CONFIDENTIALITY

Under new Rule R-45, the AAA has made clear that all matters relating to the arbitration and final award are confidential. Thus, attorneys and clients should be cautious publishing or disclosing any information related to ongoing or completed arbitration proceedings before the AAA. In addition, arbitrators may now issue confidentiality orders related to any matters in connection with the proceeding.

PROCEDURES FOR LARGE, COMPLEX COMMERCIAL DISPUTES

Under revised Rule R-1, the amount-in-controversy to qualify for the “Procedures for Large, Complex Commercial Disputes” has increased from US$500,000 to US$1,000,000. The key features of these procedures include, among other items, a mandatory preliminary hearing with the arbitrator(s), broad authority of arbitrator(s) to control and limit the discovery process, and a mandatory requirement that hearings take place on consecutive days to maximize efficiency and minimize costs. Moreover, absent an agreement of the parties, in order for a large complex case to qualify for a panel of three arbitrators, the amount-in-controversy must now be at least US$3,000,000 (up from the previous US$1,000,000 threshold). Otherwise, one arbitrator will hear the case.

PROCEDURES FOR EXPEDITED ARBITRATIONS

In order to qualify for the Expedited Procedures, revised Rule E-2 provides that the amount-in-controversy must not exceed US$100,000 (up from the previous US$75,000). Furthermore, the new amendments further restrict discovery in cases governed by the Expedited Procedures. Except for exchanging exhibits that each parties intends to rely on at the hearing, no further discovery is permitted unless expressly allowed by the arbitrator upon a finding of good cause.

CONDUCT OF PARTIES

The AAA’s expectations for professionalism of all participants in the arbitration have been codified at revised Rule R-2. In fact, the AAA may now decline further administration of the case if the parties’ and their representatives fail to uphold the AAA’s Standards of Conduct.

REMOTE HEARINGS

Likely as a result of the manner in which hearings took place during the COVID-19 pandemic, amended Rule R-25 now expressly allows arbitrators to conduct hearings remotely by electronic means.

IMPACT ON ONGOING ARBITRATIONS

Unless otherwise stipulated to by the parties, the recent amendments to the AAA’s Commercial Arbitration Rules and Mediation Procedures will not apply to any arbitrations initiated prior to the amendments’ effective date of 1 September 2022.


When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 888.684.8305, or email experts@adviseandconsult.net.

U.S. Litigation Basics – What Are Your Options?

Jihee Ahn | Harris Bricken

When issues come up, most of our international clients believe filing a lawsuit is the only answer. Unfortunately, the United States litigation process is often complicated and expensive – there will be an exchange of information and documents, the taking of depositions, and probably some motion practice along the way – and most likely, it will be at least a year or two before you get your “day in court.” Sometimes litigation can be the only answer that makes sense, but we typically let our clients know there are other options out there that can be much more cost-efficient and effective in achieving mutual goals. Here’s a breakdown of the alternatives:

Demand Letters

A demand letter is essentially a formal notice that you will initiate some legal action unless the dispute is resolved informally beforehand. Demand letters come in all shapes and sizes, and they can be very effective because (1) it will lay out what gives rise to your legal claim or claims, (2) it will serve as a “final notice” that they better pay attention to, and (3) usually, the last thing people want to receive in the mail or in their inbox is a letter from an attorney. It’s very commonplace for people or companies to bury their head in the sand and hope the problem goes away when they’re dealing with a foreign person or company, so a demand letter from a U.S. attorney typically makes a big difference.

Mediation

Another available option is mediation, which is a non-binding form of dispute resolution that can be a good fit for many types of disputes. Mediation is a negotiation between the parties that is moderated by a mediator. Typically, the parties will select a mediator and provide that mediator with submissions that outline their claims and defenses, prior settlement negotiations (if any), and attach key documents, such as contracts or operating agreements. Mediation can be a powerful tool because: (1) it brings the parties together for the sole purpose of trying to resolve the dispute, (2) the mediator will help facilitate the discussion by encouraging meaningful and productive dialogue, and (3) the mediator, a neutral third-party with no decision-making authority, will also provide his or her honest opinion as to how strong the parties’ respective claims are, which is great perspective to consider given that mediators are typically retired or very experienced judges or attorneys.

Arbitration

I like to loosely define arbitration as a private court case – the parties will agree on one or more neutral third-parties, or arbitrators, to decide their dispute after receiving evidence and hearing arguments. Compared to traditional court cases, arbitration is much more relaxed and has more flexible rules, making it easier to streamline the entire process. For example, I’ve commonly seen agreements to limit the number of depositions per side or set an overall shorter or expedited timeline to complete discovery. Ultimately, this does lead to a faster and more cost-efficient process.

Receiverships

Sometimes, the best answer for some companies is a court-appointed receiver. These receivers are neutral third-parties that will take over a business’s operations while it’s involved in legal proceedings. A receiver’s sole purpose is to preserve and protect the business during this period – and, if you take care to ensure that your receiver understands your business, they can typically handle everything while the issues are worked through.

Final Note

In most cases, if you find yourself in a dispute, the above options likely can and should be considered as alternatives or additions to running to the court. And of course, the options often can and should be tailored to fit your specific circumstances.


When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 888.684.8305, or email experts@adviseandconsult.net.

In All Fairness: Illinois Appellate Court Finds That Arbitration Clause in a Residential Construction Contract Was Unconscionable and Unenforceable

Gus Sara | Subrogation Strategist

In Bain v. Airoom, LLC, No. 1-21-001, 2022 Ill. App. LEXIS 241, the Appellate Court of Illinois (Appellate Court) considered whether the lower court erred in enforcing an arbitration clause in a construction contract between the parties and, as a result, dismissing the plaintiff’s lawsuit. The Appellate Court found that even if the arbitration clause was enforceable, the appropriate action would have been for the court to stay the lawsuit, as opposed to dismissing the case entirely. The Appellate Court then considered the language of the arbitration clause and found that several provisions were substantively unconscionable, which rendered the entire arbitration clause unenforceable. The Appellate Court reversed the lower court’s decision compelling arbitration and reinstated the plaintiff’s complaint.

In 2018, the plaintiff, Ms. Bain, a disabled senior citizen, hired the defendant, Airoom, LLC (Airoom), to renovate her home. Airoom provided its “Cash Sales Contract,” which included a binding arbitration clause. The clause required that any dispute arising or relating to the contract be resolved by binding arbitration through the American Arbitration Association (AAA), using the Construction Industry Arbitration Rules and Mediation Procedures (Construction Industry Rules).

Ms. Bain eventually filed a lawsuit against Airoom, alleging that Airoom grossly overcharged her and failed to perform the renovation work properly and in a timely manner. Ms. Bain’s complaint alleged breach of contract, breach of the impliedly warranty of reasonable workmanship and materials, and violations of Illinois’ Consumer Fraud and Deceptive Business Practices Act. Ms. Bain alleged damages in excess of $180,000, and also sought punitive damages and attorney’s fees.

Airoom filed a motion to compel arbitration, arguing that the contract mandated binding arbitration through AAA. Ms. Bain opposed the motion on the grounds that the agreement was procedurally unconscionable because she had substantially less bargaining power than Airoom and was not given a reasonable opportunity to understand the agreement before signing it. She also claimed that Airloom’s representative bombarded her with several documents, including schedules and specifications, and required her to sign 48 pages, which overwhelmed her. Further, she claimed that the Airoom representative did not explain the arbitration agreement to her and did not mention that signing the contract would waive her right to a jury trial. In addition, Ms. Bain argued that the arbitration clause was substantively unconscionable because solely Airoom chose the forum and the arbitration provision precluded punitive damages, provided costs for the prevailing party, precluded an award for attorney’s fees, prohibited the arbitrator from reaching any finding contrary to the express terms of the contract, and contained a strict confidentiality clause. Ms. Bain also argued that the requirement to arbitrate with AAA using the Construction Industry Rules would be too costly for her to afford to seek arbitration. She estimated that it would cost her over $13,000 just for the opportunity to have her case heard.

Airoom argued that its arbitration agreement was a standard arbitration agreement found in contracts signed every day and that the clause complied with Illinois’ Home Repair and Remodeling Act. Airoom also argued that if the court found any portion of the agreement improper, that portion could be severed but the agreement itself would remain enforceable.

The lower court agreed with Ms. Bain that the provision waiving punitive damages was unenforceable under Illinois law. However, the court found the rest of the arbitration clause to be enforceable. The court found that under Illinois law, the plaintiff was required to show that the arbitration clause was both procedurally and substantively unconscionable and that Ms. Bain failed to do so. The lower court concluded that the arbitration clause was not procedurally unconscionable because the terms were clearly expressed, and Ms. Bain had the opportunity to object to the terms. The court was not persuaded by Ms. Bain’s claim that she lacked bargaining power or meaningful choice on whether to agree to the clause. The lower court granted the motion to compel arbitration. The court also dismissed the complaint entirely on grounds that all of Ms. Bain’s claims arose out of the contract. Ms. Bain filed an appeal with the Appellate Court.

The Appellate Court found that the lower court erred in requiring the plaintiff to show that the clause was both procedurally and substantively unconscionable. The Appellate Court explained that such approach was outdated and that the new standard was that the plaintiff need only show that the arbitration clause was either procedurally or substantively unconscionable, but not necessarily both. The court noted, however, that the procedural aspect of how a contract was entered can also be considered when determining if the contract is substantively unconscionable.

The Appellate Court focused primarily on the substantive provisions of the arbitration clause, finding several provisions to be unconscionable. In addition to the provision prohibiting punitive damages, the court found that the prohibition on attorney’s fees was improper because the Consumer Fraud Act allows for an award of attorney’s fees. Further, the court found the confidentiality provision to be unfair because while it applies to both parties, such a provision would put Airoom in an advantageous position since they would have knowledge and information from past proceedings that the individual homeowner would lack.

The Appellate Court also took issue with the provision requiring that the arbitration be conducted by the AAA under the Construction Industry Rules. The court found that those rules and procedures appeared to be designed for complex construction disputes and were quite costly to navigate. Also, the details of these rules were not disclosed in the contract, and the mere inclusion of AAA’s main website was insufficient. The court also noted that the fees and rates for AAA using the Construction Industry Rules are excessive for homeowners, particularly in light of the fact that the AAA has a different, cheaper set of rules, the Home Construction Arbitration Rules and Mediation Procedures (Home Construction Rules), designed to make the resolution of home remodeling disputes streamlined and affordable. The existence of the Home Construction Rules was not disclosed in Airoom’s contract.

The Appellate Court acknowledged that the contract included a severability clause, and that Illinois law allows a court to modify a contract so that it comports with the law, but ultimately found that there are too many unconscionable provisions in the arbitration clause to modify the clause. Thus, the Appellate Court found the entire clause to be unenforceable. The Appellate Court reversed the lower court’s decision and reinstated the insured’s lawsuit.

The Airoom case reminds us that Illinois provides protections against unconscionable arbitration provisions. If an arbitration agreement appears designed to make a claim expensive to bring, to bar full recovery and to prevent the public from learning of adverse findings against the drafter, then there is an argument that the arbitration clause is not enforceable. Subrogation professionals practicing in Illinois should consider this decision when reviewing arbitration clauses as there may be legitimate challenges to a seemingly unfair arbitration clause.


When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 888.684.8305, or email experts@adviseandconsult.net.