Initial Those Arbitration Provisions

Whether or not the Federal Arbitration Act preempted Code of Civil Procedure section 1298.7 relating to construction defect litigation, and whether or not sufficient interstate commerce existed for such preemption were integral issues in Edward D. Basura, Jr., et al., vs. U.S. Home Corporation, (Case No. B151131, Second District Court of Appeal, filed May 31, 2002).

The court of appeal reviewed the order by the Los Angeles County Superior Court (Case No. BC240683) in the construction defect litigation filed by Edward Basura and more than 60 other Plaintiffs. The lower court had denied Defendant Home’s petition to compel arbitration.

The nature of the litigation was allegations of construction and design defects in the residential housing built by Home. Although each of the plaintiffs initialed the arbitration clause in paragraph 14 of their contracts, Home initialed only 48 of the arbitration provisions. When the superior court litigation was filed, Home filed a petition to compel arbitration of all of the 60-plus plaintiffs’ claims.

The plaintiffs opposed Home’s petition as follows: First, that the arbitration provisions was unenforceable against certain plaintiffs because Home had failed to initial them; second, CCP section 1298.7 specifically permits a buyer of real property to pursue a construction defect case in court regardless of the existence of an arbitration provision in a sales contract; and third, Federal Arbitration Act does not preempt CCP section 1298.7 because there was no “interstate commerce” involved in the subject real estate purchase contract. [See, Allied-Bruce Terminix Cos. v. Dobson (1995) 513 U.S. 265, 274: the FAA’s “reach” is coincident with that of the Commerce Clause, therefore the FAA applies to contracts “relating” to interstate commerce].

Home replied as follows: First, since all of the plaintiffs had consented to arbitration by initialing the arbitration provisions, the lower court had to order them into arbitration; second, CCP section 1298.7 does not unequivocally prohibit arbitration of construction defect litigation and third, the FAA preempts CCP section 1298.7 because the sales agreements “involve” interstate commerce.

The Second District Court of Appeal reinforced the requirements of CCP sections 1298 through 1298.8, noting that arbitration provisions must meet certain print size and capitalization of words requirements, contain a prominent notice provision and must be initialed if the parties agree to arbitration. [CCP section 1298, subd. (c)], and see, Villa Milano Homeowners Assn. V. Il Davorge (2000) 84 Cal.App.4th 819, at 829-830.

In Basura, the court cited Villa Milano, supra, reaffirming that a buyer may pursue a construction/design defect action in the court even if he signed an agreement conveying real property and containing an arbitration provision. “With respect to the impact of section 1298.7, Villa Milano explained: ‘[S]ection 1298.7…provides that even when an arbitration provision is included in an agreement to convey real property, ‘it shall not preclude or limit…any right of action to which…Section 337.1 or 337.15 is applicable.’ [Fn. Omitted.]…[S]ections 337.1 and 337.15 pertain to litigation to recover damages for construction and design defects. In other words, the net effect of section 1298.7 is to permit a purchaser to pursue a construction and design defect action against the developer in court, even if the purchaser signed an agreement to convey real property containing an arbitration clause. [Fn. Omitted] [Citation.]” Villa Milano, supra, at 830.

What follows next in the analysis is a question of federal preemption: does the Federal Arbitration Act preempt CCP section 1298.7?

Section 2 of the FAA, gives validity, enforceability and irrevocability to written arbitration clauses, (save for the contractual defenses for revocation at law or in equity, such as fraud, duress or unconscionability). But courts may not invalidate arbitration agreements under those state laws, which by definition apply only to arbitration provisions. The U.S. Supreme Court has ruled previously that CCP section 1298.7 directly conflicts with section 2 of the FAA, “…[b] ecause the California statute is a state law applicable only to arbitration agreements, allowing a purchaser to pursue a construction and design defect action against a developer in court, despite having signed an agreement to convey real property containing an arbitration clause”. See, Doctor’s Associates, Inc. v. Casarotto (1996) 517 U.S. 681, 683

It is well settled that the FAA applies to a contract “involving” interstate commerce. Referencing the U.S. Supreme Court’s holding in Allied-Bruce Terminix Cos. V. Dobson, supra, at 269, the Second DCA reaffirmed that the term “involving” interstate commerce is broad and is the “functional equivalent” of “affecting” commerce. Here, the court decided that there existed sufficient evidence of interstate commerce so as to invoke the reach of the FAA. For example, two of Home’s executives submitted declarations stating that the construction of the Palmdale residential development involved the receipt and use of building materials and equipment such as GE Appliances, World Carpet, Armstrong Flooring, and other products manufactured and/or produced in various states outside of California.

Further evidence showed that Home contracted with out-of-state design professionals, trade contractors and subcontractors. It utilized a marketing and advertising plan, which initiated marketing activities throughout the United States. Home communicated by interstate mail and telephone with its out-of-state independent contractors and agents. All of these facts persuaded the appellate court that interstate commerce was, in fact, “involved” in the underlying sales contracts and therefore CCP section 1298.7 could not be used to avoid the agreements to arbitrate.

As to Home’s failure to initial the arbitration provisions contained in 28 of the sales agreements, the superior court had ruled that accordingly, those 28 plaintiffs could not be compelled to arbitrate. In essence, there was no “agreement” to arbitrate between the parties. Although the Federal Arbitration Act does in fact create a presumption in favor of arbitration, the presumption does not mean that a court is free to compel a party to arbitrate that which it has not agreed to do so.

Courts typically apply ordinary state law principals when determining whether or not a party agreed to arbitrate a particular matter, notwithstanding the issue of federal preemption. “When it is clear, both from a provision that the proposed written contract would become operative only when signed by the parties as well as from any other evidence presented by the parties that both parties contemplated that acceptance of the contract’s terms would be signified by signing it, the failure to sign the agreement means no binding contract was created. [Citations.] This is so even though the party later sought to be bound by the agreement indicated a willingness to sign the agreement [Citations.]

On the other hand, if the respective parties orally agreed upon all of the terms and conditions of a proposed written agreement with the mutual intention that the oral agreement should thereupon become binding, the mere fact that a formal written agreement to the same effect has not yet been signed does not alter the binding validity of the oral agreement. [Citations.]” See, Banner Entertainment, Inc. v. Superior Court (1998) 62 Cal.App.4th 348, 358.

Accordingly, the Second DCA concluded that the lack of a perfected written arbitration agreement does not automatically foreclose the possibility that the parties intended to arbitrate. Here, those 28 plaintiffs who had each initialed the arbitration provisions in their sales contracts clearly evidenced an intention to arbitrate. As to Home’s failure to initial 28 contracts, the court concluded a reasonable inference could be drawn that its failure was simply inadvertent and the result of clerical error, employee oversight or time constraints.

The Second DCA on remand directed the superior court to conduct an evidentiary hearing for the express purpose of assessing the likelihood of Home’s intention to be bound by arbitration. If the evidence showed such intention the lower court was directed to produce an order compelling those 28 plaintiffs to arbitrate their claims with Home.

The facts and the law in this case underscore the importance of several logical deductions: First, real estate developers (and their lawyers) should make every effort to ensure that each and every arbitration provision in the operative sales contracts are initialed by all parties. In the instant case one of the issues was related to the question of a party’s “intention to arbitrate” -- the corresponding litigation might have been avoided. Second, review the FAA and the relevant cases assessing its “reach”. Recall that when advising a client on the merits of binding arbitration any effects of the FAA should be reviewed, discussed and analyzed to avoid surprise. Third, reliance on the notion that CCP section1298.7 is sacrosanct is legal folly: if interstate commerce is involved in the subject contracts, it may well provide the nexus for federal preemption of the state statute.

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Are Contractual Waivers of Class Actions Valid in Arbitration Provisions?

How would you react if, six years after you entered into a credit card agreement, the credit card company took the position that, based upon its one-sided purported amendment, you (the consumer) not only had waived your right to a jury trial but also to your right to institute a class or representative action against them? Would you be surprised? Outraged? Would you even care?

This is precisely the factual situation that appellant John Szetela found himself in before he was awarded a staggering $29.00 award as damages in a binding arbitration in accordance with the ‘amendment’. These facts formed the underpinning for an April 2002 decision by California’s Fourth District Court of Appeal. Echoing much of the rationale espoused in Bolter v. Superior Court, 87 Cal.App.4th 900, (2001), the Court agreed with the appellant that an arbitration provision which is procedurally and substantively oppressive and unconscionable will be revoked.

Filed on April 22, 2002 and certified for publication, Szetela v. Discover Bank is an appeal from an order of the Superior Court in Orange County, California, [Superior Court Case Number OOCC12582]. A putative class action, it was born out of appellant John Szetela’s challenge of the Orange County Superior Court’s order granting Respondent Discover Bank’s motion to compel arbitration where the subject binding arbitration provision sought to prohibit class or representative treatment of small individual claims. The 4th District Court of Appeal agreed with the appellant that based upon the facts and circumstances in the case, the arbitration provision contained in the purported ‘amendment’ to the Cardmember Agreement was not only unenforceable but also unconscionable. The Court did not rule on the arbitration provision as a whole, but only that portion of it prohibiting class or representative actions.

The material facts in the case were undisputed. The appellant opened a Discover credit card account in 1993, the terms of which were embodied in the CardMember Agreement. Almost to the exact day six years later, he received written notice from the respondent Discover that sought to change the terms of the original Carmember Agreement to include a binding arbitration clause. The first portion of the clause contained broadly written wording providing for binding arbitration in the event of any claim, as well as the admonition that neither the cardholder (consumer) nor the company (Discover) would have the right to a jury trial on any claim, and pre-hearing discovery and post-hearing appeal rights would be limited. The next portion of the provision was set forth in caps and provided, in pertinent part, “NEITHER YOU NOR WE SHALL BE ENTITLED TO JOIN OR CONSOLIDATE CLAIMS IN ARBITRATION BY OR AGAINST OTHER CARDMEMBERS WITH RESPECT TO OTHER ACCOUNTS, OR ARBITRATE ANY CLAIMS AS A RESPRESENTATIVE OR MEMBER OF A CLASS OR IN A PRIVATE ATTORNEY GENERAL CAPACITY”.

If the consumer chose not to accept the terms of this proposed amendment, his only recourse was to notify Discover, which, under the very terms of the purported amendment, would then close his account. The consumer would be ‘allowed’ to continue paying his remaining balance, if any, to Discover under the terms of the original CardMember Agreement.

The causes of action alleged against Discover in the First Amended Complaint filed in the superior court included breach of contract, breach of the implied covenant of good faith and fair dealing, fraudulent or negligent misrepresentation and deceptive business practices. Specifically included in the allegations against Discover was one that improper “over limit” fees were charged to those cardholders who exceeded their credit limits (“available credit”). The over limit fee was $29.00. Ultimately, Discover’s motion to compel arbitration of Szetela’s claim on an individual basis was granted. Szetela prevailed at the arbitration and was awarded $29.00 in damages. Appeal followed.

After finding it had the requisite jurisdiction to hear the appeal, the Court exercised its discretion to treat the appeal as a petition for a writ of mandate, denying Discover’s motion to dismiss.

In addressing the differences between procedural and substantive unconscionability, the Court emphasized the unequal bargaining power between the parties. Procedural unconscionability is directed toward the manner in which assent to the disputed term was sought or obtained. Substantive unconscionability relates to the impact of the provision itself. Was the provision so harsh or oppressive that it should not be enforced? Referencing Armendariz, the Court indicated that these factors don’t have to be present in the same degree. “[T]he more substantively oppressive the contract term, the less evidence of procedural unconscionability is required to come to the conclusion that the term is unenforceable, and vice versa.” (Armendariz v. Foundation Health Psychcare Services, Inc. (2000) 24 Cal.4th 83, 114).

Respondent Discover argued that since the appellant could have contracted with another credit card company, which did not require such a provision, the subject provision was not procedurally unconscionable. The Court rejected that theory, specifying the appellant’s weaker bargaining position: “When the weaker party is presented the clause and told to ‘take it or leave it’ without the opportunity for meaningful negotiation, oppression, and therefore procedural unconscionability, are present.”

The Court also found the subject arbitration provision substantively unconscionable: “The manifest one-sidedness of the no class action provision at issue here is blinding obvious”. Essentially, the Court opined that the provision was designed to prevent Discover’s consumers from seeking legal redress for small amounts of money ($29.00). Instead, the respondent was attempting to insulate itself from potential class actions while suffering no such corresponding detriment itself. As such, the provision violated fundamental notions of fairness as well as public policy.

In essence, the provision bestowed a ‘get out of jail free’ card upon the respondent, with no such similar benefit given to the consumer. To the contrary, since such a provision seriously jeopardized the consumer’s rights, the provision also violated public policy. It did so in another important way as well: “One of the policy reasons for class actions is to promote judicial economy and streamline the litigation process in appropriate cases. To allow litigants to contract away the court’s ability to use a procedural mechanism that benefits the court system as a whole is no more appropriate than contracting away the right to bring motions in limine, seek directed verdicts, or use other procedural devices that allow the courts to operate in an efficient manner.”

The Court of Appeal issued a writ of mandate directing the superior court to vacate its order directing the appellant to arbitrate his claim, and to enter a new order striking the provision against representative or class actions from the arbitration provision.

The Court’s ruling is yet another sobering reminder to lawyers who draft and interpret arbitration provisions. The defenses that exist for contracts shall likewise be applied by courts to arbitration agreements, where applicable, because arbitration is inherently contractual by nature. Arbitrators receive their authority from the parties’ arbitration agreements, some of which are entered into years in advance of the actual arbitration. Although the liberal federal policy arising out of the Federal Arbitration Act does create a presumption in favor of arbitration, the presumption does not mean that a court is free to compel a party to arbitrate when it has not agreed to do so, nor may the court compel a party to accept an amendment to a card member agreement which was “oppressive in nature” and procedurally unconscionable.

Lawyers should insert a choice of law provision in the arbitration agreement so that later there is no, (or inconsequential), debate. In Szetela, the respondent argued that Delaware law governs the Discover CardMember Agreement. But the Court said that it applied the law of California because the respondent had not established that the law of another state should apply.

Although adhesive and unconscionable contractual qualities are not mutually exclusive, we are reminded that even if a contract is not adhesive per se, it may, nevertheless, be deemed unconscionable. Citing Villa Milano Homeowners Assn. V. Il Davorge, (2000) 84 Cal.App.4th, 819, 827, the Court noted that the availability of goods or services from an alternate source goes to the issue of whether or not a contract is adhesive in nature. Unconscionability has separate standards.

As it relates to consumer transactions, lawyers are reminded that a “take it or leave it” approach adopted by the stronger party against the weaker party might provide the foundation for a defense of procedural unconscionability. This may be particularly true where little or no opportunity for meaningful negotiation exists. Assessing one party’s relative bargaining strength against that of the other is important to the analysis. Determining, in advance, how a court might analyze what constitutes “meaningful” negotiation is critical.

We are reminded that contract terms that are so one-sided as to shock the conscience might have the corresponding defense of substantive unconscionability. And while adhesive arbitration provisions are not per se unconscionable, “there may be arbitration provisions which do give an advantage to one party…In those cases…it is not the requirement of arbitration alone which makes the provision unfair but rather the…manner in which the arbitration is to occur.” (Szetela, citing Strotz v. Dean Witter Reynolds, Inc., (1990) 223 Cal.App.3d 208, 216). “It is the manner of arbitration, specifically, prohibiting class or representative actions, we take exception to here. The clause is not only harsh and unfair to Discover customers who might be owed a relatively small sum of money, but it also serves as a disincentive for Discover to avoid the type of conduct that might lead to class action litigation in the first place.” (Szetela)

We are reminded to ‘think contract’. We must pay scrupulous attention when drafting arbitration agreements so that our clients are as insulated as possible from the assertion of certain defenses to the contract. We are also reminded to ‘think contract’ when, on our client’s behalf, we seek to successfully assert contract defenses.

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Avoiding Hobson’s choice in Mediation: Five Proven Strategies

The decision to mediate was an easy choice. It was faster, more expedient and less expensive then going to trial, and the upcoming mediation seemed to portend a positive result. Our hypothetical 5-year litigator has spent hours reviewing the case, both alone and with his client. He seems to have the “right” amount of client control. Although he hasn’t been before this mediator previously, his colleagues at his law firm assure him of the mediator’s competence. His client seems anxious to settle – within appropriate parameters, of course. The lawyer is prepared, anxious and ready, and he needs to be. A good result from this mediation will guarantee acknowledgement and acclaim for hard work from the “partners that matter” and secure future litigation work from the client.

As he glances at his watch while walking into the 26th floor conference room, he doesn’t realize that both he and his client are about to experience a “Hobson’s Choice” in this mediation. What is this ubiquitous Hobson’s choice? The term has its genesis in Cambridge, England in 1544 –1631, with one Thomas Hobson. To make his living he maintained a livery stable and required that every customer take either the horse nearest the stable door – or none at all. [Similarly, in 1914 Henry Ford offered his customers of the Model T a famous Hobson’s choice, making it available in any color “so long as it is black”]. Although similar to the “take it or leave it” ultimatum, it is more understated and less discernible to the uninitiated. Regrettably, it has become a familiar negotiation tactic by some attorneys in mediations. The purpose of this article is to both expose this ploy and discuss certain strategies and techniques that can be used to either prevent it altogether or minimize its consequences.

Seasoned lawyers as well as their naive clients have faced a Hobson’s choice in mediation when they have been given an apparent free choice by the opposite side, (as it relates to the ultimate resolution), when in reality it was no choice at all for them. [For example, in a situation where a widow in ill health sells an office building primarily so that she can fund her medical and retirement expenses, her opponent’s unwavering insistence on rescission of the property, as opposed to other breach of contract remedies, may very well constitute a Hobson’s choice for the retiree]. One side’s demand or counter offer of what really is a Hobson’s choice too often sounds the death knell for the mediation, replete with a panoply of comments such as “a complete waste of time”, “lack of good faith” and “hidden agenda.

There were five strategies our litigator could have used that would have mitigated the possibility of this occurring or would have avoided it altogether. Bear in mind that what transpires between opponents in mediation is usually a by-product of the quality of their relationship pre-mediation, especially in litigated actions. Said another way, encountering a Hobson’s choice tactic in mediation is less common when the lawyers initiate and litigate the case with the goal of reaching a settlement in mind.

First, remember that it’s the client’s case – not the lawyer’s. At first glance this might seem pedestrian, but the truth is that lawyers may forget that it is the client’s life and future at stake, his occupation, his property and money, his investment, his debt – not the lawyer’s. When a lawyer consistently focuses on the client and his needs and objectives, balanced against the merits or lack thereof of the case, sound litigation decisions are more readily orchestrated. Another way of saying this is that form follows function. If and how the litigation strategy should be employed should begin and end with a white-knuckled analysis of the client’s needs and goals, individually and collectively with the client. The onset of litigation is the time and the place for the ultimate reality-check and perhaps a “come to Mecca” approach. It bears repeating: it is the client’s case.

Second, maintain objectivity. After identifying and understanding a party’s needs and objectives, the lawyer must analyze the facts of the case and relevant case law, statutes, rules and regulations without emotion. He should be dispassionate in his examination of all of the pertinent information because emotion on his part or his client’s is what often produces a flawed assessment of the risks and benefits inherent in the action. It also manifests unreasonable, unrealistic and ludicrous demands for settlement in the mediation, which, in turn, produce equally unrealistic or hostile responses from the other side. Negative emotion on the part of the client or the lawyer, or both, contributes to an uncooperative mediation atmosphere …and leads to the disappointing Hobson’s choice. A lawyer should be passionate about a cause where appropriate, but be able to maintain an objective and unemotional stance where his client’s case is concerned.

Third, develop a “probabilities decision tree” with the client prior to the mediation. Identify the possibilities of disappointing “moves” by your opponents and how to best preempt them, or thwart them, especially if suspicion exists that such will be experienced in the mediation. Identify and explain to the client his BATNA, (best alternative to a negotiated agreement), as well as his WATNA, (worst alternative to a negotiated agreement). Jointly predict what is most likely to occur in the mediation, next likely, marginally likely, and least likely to occur. Achieve a consensus with the client that your part in the mediation’s negotiations will begin with the end in mind and will therefore be positive and constructive – regardless of the other side’s posturing and pretensions.

Fourth, adhere to the “Partner Principle”: remember that opposing counsel and his client will be your and your client’s “partners” in the latent settlement. Treating your opponents, as theoretical partners before and during the mediation will certainly assist in preventing any Hobson’s choices later. It will also help to both facilitate and ensure that the post-settlement obligations of both parties proceed smoothly.

While this does not mean abandoning enthusiastic advocacy of the client’s action, it does mean advocating common sense, courtesy and professionalism, the same qualities one would want a partner to have and extend. For example, exchange the mediation briefs prior to the mediation. Omit the truly confidential information beforehand but exchange them. Extend a reasonable opening demand that can later be substantiated by jury verdicts, reported cases, and other objective and historical criteria. If you make an opening statement in the mediation, do so mindful of the fact that this is not the trial in the case – this is the mediation. Fire and brimstone need not apply. Emphasize your client’s interest in pursuing settlement if at all possible. De-personalize your censure of the other party and his positions. Do not argue – illustrate. A plausible explanation is more effective and accepted than arguments and accusations.

Finally, abide by this simple rule: no hidden agendas. Do not participate in mediation for any other reason other than a good faith undertaking toward resolution. This means avoiding the obvious transgressions: no information gathering or informal discovery, cross-examination and harassment, or bare “compliance” to satisfy a contract or statute or to generate attorney’s fees or churn the case. Any of these motives will be readily apparent to the others, including the mediator. Most importantly, your client’s case will not be served by such misleading practices.

When confronted by a Hobson’s choice in the mediation, how should our hypothetical litigator respond? First, enlist the aid of the mediator privately in caucus. Ask for her thoughts, perspectives and assistance in getting past the blockage. Second, analyze the additional information and possibilities, if any, with your client and the mediator. Leave no stone unturned when it comes to brainstorming. Third, if the other side refuses to shift its position, don’t give up on the mediation and don’t let the client give up. Remain stalwart in your commitment to resolution. Fourth, ask for more time. Even if it means continuing the mediation for a few days or weeks, very often the additional time will provide a more leisurely opportunity for the parties and counsel to examine other options and possibilities for resolution. Remember that statistically, if parties and counsel maintain their efforts toward resolution, as many mediations successfully resolve within weeks or even months following mediation as settle at the mediation itself.

Finally, remember that choices abound at every phase in the life a case, whether litigated or not. Educating and assisting the client in making reasoned and intelligent choices early on and throughout the life of the case will help in avoiding the legacy of Mr. Hobson.

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Does Duality Precede Conflict Resolution?

When I think about what causes "conflict" to occur, I am reminded of the duality that is inherent in our world. For example, duality may be illustrated by day and night, male and female, black and white, positive and negative, front and back, high and low, up and down, sun and moon, summer and winter, and the like. In our "reality" duality is everywhere. Perhaps when we align ourselves too strongly with one of its subsets we are setting ourselves up for inevitable conflict. A key to Conflict Resolution, I think, may be to become educated and flexible.

To illustrate: there are, at long last, some wonderful books on the market that provide ground-breaking insight into the differences between the way that men and women are "wired". They illustrate (and prove) that men and women, with few exceptions, view the world differently because the totality of their physiology is systemically different. This, in turn, creates differing experiential "information intake" between the sexes and that in itself is "processed" by them differently. The microcosm of the macrocosm here, I think, is that on some very basic levels, men and women see, feel, hear and experience some things very differently. Unless one is armed with this information and has taken some time to internalize it, it's easy to see why women don't think men are sensitive enough,and why men think women are too "emotional". Both paradigms are likely platforms for conflict-filled situations . If, however, one understands and appreciates some of the inherent differences between the sexes then perhaps it becomes possible to forestall or minimize the difficult personal exchange. Maybe what's important is education (knowledge) and flexibility (willingness to adjust).

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