Jennifer Horn, Horn Williamson

Arbitration provisions are standard fare in a variety of contractual settings. In some cases, arbitration provisions make a lot of sense. Arbitration is a streamlined dispute resolution process, with limited discovery, that often leads to the swift and equitable resolution of disputes. Arbitration provisions can also act as a sword and a shield for the corporations that include these provisions in their employment agreements and other contracts. Similarly, in our day-to-day practice we see a pattern of builders employing arbitration provisions designed to prevent, or severely limit, a homeowner’s ability to recover against a builder who builds and sells a defectively constructed home.

Nonstandard Arbitration Forums

While arbitration clauses are common within real estate sale contracts and warranty documents, the forum chosen by builders can be surprising.  We have seen cases where the contractually mandated arbitrator does not live, nor holds a law license, in the state where the home and parties are located. Consequently, our attorneys have also had the experience of conducting arbitration proceedings over the phone.

These contractual traps are clearly designed to make recovery more difficult and costly for homeowners. For this reason, it is important to understand any arbitration provision in sale contracts and warranty documents. Certainly, if the arbitration provision specifies an unfamiliar forum, practitioners should be wary. In many cases, striking an arbitration provision can save your client headaches down the road.

The Unreasonable Cost of Entry for the Average Homeowner

Arbitration is not cost neutral and the costs can be prohibitive. For the average homeowner who spent $500,000 or less buying their home, paying $3,500-$5,000 to simply enter the dispute resolution forum can be daunting. While commercial litigants can easily afford the cost of arbitration, it is very likely that your homeowner client cannot. Whether you file in the Philadelphia Court of Common Pleas or arbitration, litigation costs money. Practitioners should counsel their clients about the costs and benefits of both venues to prepare their client for the day no one sees coming while closing on their dream home.

Hidden Arbitration Clauses

Here is where we get to tout the importance of our profession! The average homebuyer needs our help. Closing on a house without having a deep understanding of the buyers’ obligations and the builder’s limitations on liability is crucial. One of those obligations is agreeing to arbitrate in the event of a dispute. In our office, we’ve seen arbitration clauses tucked into contracts virtually everywhere: arbitration provisions in “limited” warranties, the home maintenance package, warranty work requests, and everything in between. We cannot stress strongly enough that it is your obligation as a real estate or construction practitioner to review and understand all the provisions within the Agreement of Sale and all related documents, including all warranties. Striking certain unfavorable contractual terms is an important part of negotiating an agreement of sale.

Arbitration’s Limitations

Construction defect matters are driven by facts and building science. For example, in matters that involve moisture intrusion, there is no way around conducting moisture tests, destructive testing, the subsequent documentation of this testing, and analysis of the applicable building code.  Without this evidence, the homeowner will have great difficulty proving their damages or any wrongdoing by the builder. This also means that experts gathering the evidence should also testify as to their findings. An arbitrator’s decision to severely limit discovery during the proceeding can materially hurt the homeowner. This may also create an appealable issue for the homeowner. However, if the whole point of arbitration is to cut down on costs, going through arbitration to only then immediately file an appeal in court seems to defeat the purpose of arbitration.

The lesson for practitioners here is that who your arbitrator is makes a huge difference. In the construction defect context, it isn’t necessary that the arbitrator have construction experience. Choose an arbitrator that has experience dealing with all types of factually dense and complex matters.

Builders’ Attempts to Force Subsequent Purchasers Into Arbitration

Once an arbitration provision has been established, we find most builders will do everything they can to enforce it against a homeowner with a defectively constructed home. Most recently, we saw a novel approach to enforcing arbitration provisions: A builder argued that subsequent purchasers were bound by the arbitration provisions within the first purchasers limited warranty documents. At first blush, any reasonable practitioner would think lack of contractual privity would prevent any builder from making such an argument. Nevertheless, 30 of our clients found themselves in the Philadelphia Court of Common Pleas dealing with this very issue.

In a motion to compel arbitration, the defendant builder argued that the limited warranty agreement with the original purchasers transferred to any subsequent purchasers, thus it had a valid contract with a valid arbitration clause. Alternatively, the builder argued that the plaintiff subsequent purchasers were third-party beneficiaries of the limited warranty and equitably estopped from asserting otherwise. Therefore, the defendant argued, the dispute between the builder and the plaintiff subsequent purchasers was within the scope of the arbitration agreement in the builder’s limited warranty.

However, the court found that the subsequent purchasers had not entered into a limited warranty agreement with the builder. The builder produced a blank sample “limited warranty” to the court which stated that the limited warranty may transfer to subsequent purchasers upon the execution and submittal of a ‘Subsequent Home Buyer Acknowledgement and Assignment.’ The builder could not produce any documents signed by the subsequent purchasers that would bind them to the terms of the limited warranty and therefore the builder could not prove there was an agreement to arbitrate the dispute.

Moreover, the court found that the subsequent purchasers were not “third-party beneficiaries” bound by the terms of the limited warranty because the plaintiff subsequent purchasers never claimed to be, nor benefited as, third-party beneficiaries of the limited warranty and the plaintiff subsequent purchasers were not named in the contracts between the original buyers and the defendant builder. The court found that the plaintiff subsequent purchasers were not making any claims under the defendant builder’s limited warranty, and were not third-party beneficiaries of the limited warranty, therefore the doctrine of equitable estoppel did not apply. Lastly, the court found that the defendants had not shown the second prong required to compel arbitration, “the gist of the Plaintiffs’ action lies in tort not contract, and therefore falls outside the scope of the arbitration agreement,” Phila. CCP Docket No. 161100904.

The lessons for practitioners to draw from this matter are clear. There is a time and place for novel legal arguments, this was not such a time. In the absence of clear evidence that parties agreed to arbitrate,courts will generally not find such an agreement.

Jennifer M. Horn is managing member of Horn Williamson. She has built her practice representing owners, construction managers, contractors, subcontractors, suppliers, sureties and homeowners in matters arising from public and private construction projects. Contact her at jhorn@hornwilliamson.com and at 215-987-3800.