Contractor Loses Effort to Bind Remote Home Purchaser to Arbitration Clause

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.

Posture Away, You May Still Get Your Way

Carly Miller and Luke D. Martin | Buildsmart

The Sixth Circuit recently reversed a decision from an Ohio federal court related to whether a party waived its arbitration rights through posturing correspondence written prior to the filing of litigation or arbitration. In Borror Property Management, LLC v. Oro Karric North, LLC (No. 2:19-cv-04375), the Sixth Circuit upheld the defendant’s contractual right to arbitration by concluding that no waiver of such right had occurred.

Oro Karric North, LLC and its related entities (entered into contracts with Borror Property Management, LLC, for Borror to manage Oro’s residential apartments. Each management contract included an arbitration provision stating, in essence, that disputes between them would be determined by arbitration unless they first resolved the dispute among themselves.

When a dispute arose, Oro asserted in a letter that Borror was in breach of contract and stated that it planned “to proceed directly to litigation in either state or federal court” as the contracts “do not limit litigation exclusively to arbitration.” Borror then filed a lawsuit in court. Oro then moved to compel arbitration, but the district court denied that request. The question on appeal was whether Oro waived its otherwise enforceable right to arbitration by its pre-litigation conduct.

Federal law looks favorably upon arbitration, and any waiver of that right “is not to be lightly inferred.” A party waives its arbitration right only when (1) the party’s acts are “completely inconsistent” with its arbitration right, and (2) the party’s conduct is prejudicial to an opposing party (such as by significantly delaying one’s asserting the right to arbitrate).

The Sixth Circuit concluded that Oro did not waive its right to arbitration. It found that Oro’s “litigation-threatening” correspondence did not amount to conduct “completely inconsistent” with its arbitration right. Pre-litigation letters serve a variety of purposes — from identifying a party’s concerns to foreshadowing litigation to articulating a path to settlement. These letters, as the Sixth Circuit noted, are often more rhetorical art than legal science. And because a party’s true intentions in crafting such correspondence cannot be known, courts are reluctant to give those letters the same legal force as it might give a party’s representations in other settings.

Even if it were to find Oro’s letter entirely inconsistent with its arbitration rights, as the Sixth Circuit noted, Borror was not materially prejudiced by Oro’s actions. Typically, in this context, prejudice appears when one party spends substantial time or money in litigation before an arbitration right is invoked. Such was not the case here.

Having determined that Oro’s pre-lawsuit communications were neither inconsistent with its arbitration right nor prejudicial to Borror, the Sixth Circuit held that there was no waiver of Oro’s arbitration rights. Concluding otherwise, as the Sixth Circuit reasoned, would make it much more difficult for parties to work out their differences short of litigation, which would, in turn, unnecessarily increase the load on the judicial system.

This opinion supports the freedom to negotiate, posture, and act in one’s interest when faced with a dispute. While there is always some risk that pre-lawsuit or pre-arbitration conduct could result in a waiver, such is not the result preferred by the courts. By enabling parties to speak freely prior to filing suit, courts are facilitating out-of-court resolutions of their differences.

Arbitrator Snooze … You Lose? A Reminder To Raise Specific Objections To An Arbitrator First, Or Risk Forfeiting Them On Appeal

Gregory N. Heinen | Foley & Lardner

You represent a business owner who ends up arbitrating a dispute with a supplier.  After spending tons of time and money preparing for the 5-day evidentiary hearing, you look up to hear snoring from the arbitrator – he fell asleep for part of the proceedings!  Surely you’ll be able to get the result vacated by the circuit court on appeal, right?  Well, no – not if you slept on your objection by failing to first specifically raise it with the arbitrator, according to the Wisconsin Court of Appeals’ recent decision in Loren Imhoff Homebuilder, Inc. v. Lisa Taylor, et al., No. 2019AP2205, 2020 WL 6495102 (Wis. Ct. App. Nov. 5, 2020).   

The underlying facts of Loren Imhoff, a remodeling dispute between homeowners and a builder, are commonplace.  But the case took an unusual turn after the arbitration hearing, when the homeowners asked the arbitrator to recuse himself, alleging, among other reasons, that he had been sleeping (or at least drowsy) during parts of the hearing.1   Loren Imhoff, 2020 WL 6495102, *2.  The arbitrator rejected the request, and issued a decision in the builder’s favor, which the homeowners persuaded the circuit court to vacate on the ground (under Wis. Stat. § 788.10(1)(d)) that the arbitrator had “imperfectly executed” his powers.  Id. *2-3.  The Court of Appeals reversed, holding that the homeowners had forfeited their objection by failing to raise it during or after the arbitration hearing.  Id. *3.

The opinion includes a lengthy discussion of Wisconsin law involving arbitration, as well as forfeiture of objections.  The key point was that, just as a potential appellant generally forfeits arguments not first presented to the trial court, parties to an arbitration generally forfeit objections not first raised before the arbitrator.  Id. *5-9.  The Court found additional support for this holding in the fact that appellate standards of review are very deferential to arbitration decisions.  The fatal flaw for the homeowners was that they did not specifically present to the arbitrator the issues that his sleeping caused, but raised it for the first time in the circuit court.  They thus snoozed on (and forfeited) their objection. 

Careful readers may protest, noting that the homeowners had asked the arbitrator to recuse himself on this basis.  That was not enough.  Instead, the homeowners needed to point to what evidence the arbitrator slept through, and ask him to resolve any issues that his naps had caused in his final decision.  Id.  They didn’t do this, so their arguments about making “reasonable attempts to rouse the arbitrator” while “trying to be subtle about it” were unavailing.  Id. *10.  Perhaps an air horn next time?  In all seriousness, practitioners should note that in any litigation, particularly in arbitration, they need to raise objections soon as possible, and make them as detailed as possible, pointing to exactly what errors they allegedly caused.  Otherwise, your hopes of delivering your client a win may be nothing but a dream.

Footnote

1 One of the funnier aspects of the opinion is that its citations reveal this is not the first – or third, or fourth – time an appellate court has needed to confront issues arising from a dozing arbitrator.  See id. *9.  Parties to arbitration may want to consider spicing up their presentation of the evidence.or at least making sure salads are served at lunch?

The Right to Arbitrate and the Risk of Losing It

Katherine H. Blankenship and J. David Pugh | Buildsmart

The Alabama Supreme Court recently found that a party was in breach of an arbitration agreement for declining to pay the fee schedule set forth by the American Arbitration Association (AAA) and thus lost the right to compel arbitration. This case serves as a reminder to follow the orders of arbitral institutions or risk losing the opportunity to arbitrate your dispute. The Alabama Supreme Court’s decision further enforces the sage advice to draft arbitration agreements carefully and meticulously to protect and ensure your rights and preferences in the adjudication of a dispute.

In Fagan v. Warren Averett Companies, LLC, the parties disputed the applicability of the Employment Arbitration Rules in regards to a dispute arising from a personal service agreement (PSA). Upon review of the plaintiff employee’s arbitration demand, the AAA determined the arbitration would be administered in accordance with the Employment Fee Schedule that required the defendant employer to submit a substantially higher filing fee than the employee.

When the employer declined to pay the AAA filing fee, the AAA closed the case. The employee then filed suit against the employer in state court, and in response, the employer filed a motion to dismiss and compel arbitration. The employer argued that the AAA’s administrative ruling applying the Employment Fee Schedule violated the PSA. The employee responded that the employer was precluded from enforcing the arbitration provision in the PSA because it had declined to participate in the arbitration.

The Alabama Supreme Court agreed with the employee holding that the employer’s refusal to pay the filing fee constituted a default of the arbitration agreement in the PSA and that, based on its breach, the employer had lost the right to compel arbitration.

What can you learn from this decision? First, if you elect arbitration as your means of binding dispute resolution, then the rules, decisions, and procedures of the chosen arbitral institution should be followed or you run the risk of losing the right to arbitrate altogether. That risk is not to be taken lightly. Arbitration is intentionally selected as a means of resolution for any number of reasons, but all of them important to the party so choosing. Arbitration can provide an arbitral tribunal that is expert and well versed in the subject matter and industry providing parties with crucial expertise they may not have access to in state or federal courts. It may also offer a more expedient and efficient means of resolution. But, whatever the motivations for selecting arbitration, the parties most likely want to preserve and protect that right. To preserve the arbitration remedy and all its accompanying benefits, adherence to applicable rules and procedures is important.

The second key takeaway from this case is to carefully and precisely draft your contracts. In this case, if the parties had specified they would split all costs and fees 50/50 in the arbitration agreement, the court may have decided differently. Enlisting legal help for an assiduous contract review may not sound appealing, but it is a task that can save you much heartache and expense down the road. Ensuring that your priorities, intentions, and requirements are codified clearly and unambiguously in a binding document is money well spent.

Lawyer’s Advocacy in Arbitrations: No. 5 of the Top 10 Horrible, Terrible, No Good Mistakes Lawyers Make

David K. Taylor | Buildsmart

This post is a continuation of the Top 10 most horrible, terrible, no good, “bang your head against the door” mistakes that I have seen lawyers make before, during, and after arbitrations in which I served as the arbitrator. As stated in the previous posts, there are pros and cons to binding arbitration versus trial in a court that go beyond a series of blog posts. In many instances, representing a party in an arbitration requires more due diligence and work than a trial. Great “arbitration” lawyering is essential, but many times does not happen.

No. 5: Know When to Fold ‘Em (Bad Claims/Defenses)

As the late Kenny Rogers sang, when playing poker, “you’ve got to know when to hold ‘em, know when to fold ‘em.”  The same analysis equally applies to preparing for an arbitration hearing and determining what claims/defenses will actually be presented at the hearing. Without repeating the title of these series of blogs, one serious mistake I see, while both acting as an arbitrator or counsel, is lawyers (and clients) who feel that they not only need to present every single possible claim/defense to the arbitrator, but refuse to concede positions in the middle of a hearing when it’s clear the facts are not going their way. An arbitration is not a hearing before a jury or a judge who may not know anything about the subject matter of the dispute. Your arbitrator is an industry expert, most of the time an experienced lawyer in the field at issue. She knows what good and bad positions are and when one side is trying to pull the wool over her eyes. Especially in arbitrations where there are multiple claims (such as a construction dispute), a party’s credibility on ALL positions is vital. Presenting four great claims/defenses but also one to two highly questionable ones, or stubbornly sticking to positions that look like losers, is a serious mistake. Your adversary will use anything they can to oppose the four great claims/defenses and use the questionable claims/defenses to cast doubt on the valid claims/defenses. More importantly, the arbitrator will look askance (he may not say so) at those bad claims/defenses and wonder why you are still presenting a position that appears to be a sure loser. Conceding certain claims/defenses during a hearing, no matter how hard fought, can increase your credibility to the arbitrator. Such a narrowing down on positions and in-hearing concessions can also help reduce exposure, especially if there’s a prevailing party attorneys’ fees clause. This may take some persuasion for a client who may be worried about making ANY concessions, especially in a hard fought, emotional arbitration. But part of your job as a counselor is to give the best advice possible and lay out the pros and cons, and the client can then decide if he wants to go “all in” on all stated positions.

Finally, the other great line from this song is “you never count your money when you’re sittin’ at the table.” Knowing what claims and defenses to “hold” and present, and which ones to dump and fold, will give you and your client the best chance of walking away from the arbitration table with money in your client’s pocket (after legal fees are paid, of course…).

Read numbers 123, and 4 on the list.