California Supreme Court Affirms Strong Policy in Favor of Arbitration, Affirming Mandatory Arbitration Clause in CC&Rs for Construction Defect Litigation

August 20, 2012

The California Supreme Court in Pinnacle Museum Tower Association v. Pinnacle Market Development, 12 C.D.O.S. 9387 (August 16, 2012), upheld a clause in the recorded declaration of covenants, conditions and restrictions (CC&Rs) providing that the condominium homeowners’ association and the individual owners agree to resolve any construction dispute with the developer through binding arbitration.

The Pinnacle Museum Tower is a “premier” residential high-rise tower, 36 stories tall with 182 condominium units and a three-level garage, in “the most desirable location” in San Diego, CA. It is the city’s second-tallest building.

The developer, Pinnacle Market Development, began the project in 2003. Prior to the sale of any of the units, Pinnacle recorded a “Declaration of Restrictions” (the project CC&Rs that included easements, restrictions and covenants), which was intended as “enforceable equitable servitudes” and “binding on all parties having any right, title or interest in the property.”

The CC&Rs contained a provision that required binding arbitration pursuant to the federal and California arbitration acts for all construction disputes in which Pinnacle was named a party. The condo purchaser waived any right to a jury trial in such circumstances. The provision provided that it could not be amended without the written consent of Pinnacle.

The Court’s Ruling
An action was filed by the Pinnacle Museum Tower Association (HOA) alleging a myriad of construction defects. Pursuant to the CC&Rs, Pinnacle filed a motion to compel arbitration. The trial court held that there was an agreement to arbitrate, but invalidated the agreement on the grounds it was substantively and procedurally unconscionable. The Court of Appeal affirmed, but the Supreme Court reversed, upholding the mandatory arbitration clause.

The application of the Federal Arbitration Act (FAA) trumps or preempts the application of California Code of Civil Procedure section 1298.7, which would otherwise allow a “construction and design defect action against a developer in court, even when the parties have signed a real property purchase and sale agreement containing an arbitration clause.” Arbitration under the FAA “is a matter of consent, not coercion.” Similarly, under California law, the issue is one of contract. The Court held that the provisions contained in the CC&Rs were sufficient in creating an enforceable obligation for binding arbitration.

The HOA argued (and the Court of Appeal agreed) that it never was given an opportunity to consent to waive its right to a jury trial because the CC&Rs were recorded before it even became an entity. “Pinnacle was the only party to the ‘agreement,’ and there was no independent homeowners association when Pinnacle recorded the CC&Rs.” The Supreme Court rejected this argument, stating the “Legislature has crafted a statutory scheme providing for the capacity of a developer to create a condominium development subject to covenants and restrictions governing its operation and use. There appears no question that, under the Davis-Stirling Act, each owner of a condominium unit either has expressly consented or is deemed by law to have agreed to the terms in a recorded declaration.”

Such “equitable servitudes” or provisions that bind purchasers and subsequent purchasers, are enforceable “unless unreasonable,” or as the Court notes, “unless they are wholly arbitrary, violate a fundamental public policy, or impose a burden on the use of affected land that far outweighs any benefit.”

In strong language, the Court confirmed that arbitration is “an expeditious and judicially favored method to resolve a construction dispute.” “That a developer and condominium owners may bind an association to an arbitration covenant via a recorded declaration is not unreasonable.” “[B]inding arbitration benefits both the developer and the entire common interest community by providing a speedy and relatively inexpensive means to address allegations of defect damage to the common areas and other property interests.”

Unconscionability Defense
An otherwise enforceable contractual provision mandating arbitration may be avoided if it is deemed unconscionable. “Unconscionability consists of both procedural and substantive elements. The procedural element addresses the circumstances of contract negotiation and formation, focusing on oppression or surprise due to unequal bargaining power. Substantive unconscionability pertains to the fairness of an agreement’s actual terms and to assessments of whether they are overly harsh or one-sided.” Under either test, the Court upheld the provision for mandatory arbitration.

The Court reasoned that there was no oppression, and consequently no procedural unconscionability, due to a “lack of negotiation and meaningful choice.” The Court reiterated its logic, stating “while a condominium declaration may perhaps be viewed as adhesive, a developer’s procedural compliance with the Davis-Stirling Act provides a sufficient basis for rejecting an association’s claim of procedural unconscionability.”

Substantively, the Court could not agree that mandatory arbitration “is overly harsh or so one-sided that it shocks the conscience.”

The fact that the provision could not be amended without the written consent of the owner was insufficient to support substantive unconscionability. The statutory framework provides “that a recorded declaration may restrict or even eliminate the authority of an owners association and owners to amend its terms.” According to the Court, “Far from evidencing substantive unconscionability, the consent provision reflects a restrictive term that the Legislature, for policy reasons, has determined is reasonably and properly included in a recorded declaration.”

In sum, the Court’s opinion demonstrates a strong public policy in favor of the mandatory arbitration of disputes. “The expectation of all concerned is that construction disputes involving the developer must be resolved by the expeditious and judicially favored method of binding arbitration.” This case has clear implications regarding the enforceability of mandatory arbitration provisions in many other areas as well.

If you have questions about this case or other issues regarding civil litigation in California, please contact:

John R. Clifford
Partner – San Diego

Edward P. Garson
Partner – San Francisco

Ian A. Stewart
Partner – Los Angeles

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