California Supreme Court Enforces Arbitration Provision in Construction Defect Case

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In our December 2011 Under Construction newsletter, we reported on the tendency of certain California courts to decline to enforce arbitration provisions in construction defect cases. See Arbitration in California Construction Defect Cases After AT&T Mobility v. Concepcion. As we noted, California courts have continued after the U.S. Supreme Court’s decision in AT&T Mobility LLC v. Concepcion to evidence their long-standing hostility to arbitration provisions in consumer contracts, despite Concepcion’s clear message that invalidation of arbitration provisions could not be justified on grounds of unconscionability.

On August 16, 2012, the California Supreme Court threw its weight behind the enforceability of arbitration provisions by holding that a condominium owners’ association was bound by such a provision in the recorded declaration of covenants, conditions and restrictions (CC&Rs) when it brought a construction defect lawsuit against the condominium developer. Pinnacle Museum Tower Assoc. v. Pinnacle Market Development (US), LLC, et al., No. S186149 (Cal. Aug. 16, 2012). 

The case involved the familiar scenario where a developer (Pinnacle) developed a mixed use residential and commercial common interest property and recorded CC&Rs governing the use and operation of the property pursuant to California’s Davis-Stirling Act, which governs the creation and operation of common interest developments. See California Civil Code § 1350 et seq. The CC&Rs, among other things, created an owners’ association (Association) responsible for managing and maintaining the property and specified that by accepting a deed for any portion of the property that the Association and each condominium owner would be required to have any construction disputes against developers resolved exclusively through binding arbitration in accordance with the Federal Arbitration Act (FAA) and the California Arbitration Act. The purchase agreements signed by individual owners included references to the CC&Rs generally and the arbitration provision specifically.

The Association filed a construction defect action against Pinnacle on behalf of itself and its owner-members and Pinnacle moved to compel arbitration. The trial court invalidated the agreement, primarily on the grounds of procedural unconscionability, and the Court of Appeal affirmed, again on the ground of unconscionability.

The California Supreme Court’s opinion, reversing the Court of Appeal, rested on two primary grounds – the binding nature of the CC&Rs and the fact that they were not unconscionable as regards to the Association. 

The California Supreme Court found that the CC&Rs should be given binding effect, even if they do not fulfill common law requirements for equitable servitudes or the privity requirements of contracts, because recorded declarations act as contracts. Although the Association did not agree to the contract, the court found that it was bound by the fact that the owners of the condominium units (its exclusive members) had either “expressly consented or [are] deemed by law to have agreed to the terms in a recorded declaration.” The Association thus “should not be allowed to frustrate the expectations of the owners (and the developer) by shunning their choice of a speedy and relatively inexpensive means of dispute resolution.” The court also found that its conclusion was bolstered by the policies of the FAA, which would preempt “singling out an arbitration clause as the only term in a recorded declaration that may not be regarded as contractual in nature.”

The court also rejected the argument that the CC&Rs were unconscionable, finding that the fact that they were drafted and recorded before the sale of any units and without input from the Association was due to the “legislative policy choices embodied in the Davis-Stirling Act.” Although such declarations may be viewed as “adhesive,” the developer’s compliance with the act “provides a sufficient basis for rejecting an association’s claim of procedural unconscionability.” The court also found that the CC&Rs were not substantively unconscionable because the Association had not met its burden of finding that any aspect of the arbitration provision was “overly harsh or so one-sided that it shocks the conscience.” Indeed, the court found that the provision in question was consistent with the Davis-Sterling Act.

Although Pinnacle represents a definite “win” for condominium developers, it is worth reiterating that careful consideration of both the pros and the cons of arbitration is important when parties are involved in construction disputes. Knowledgeable counsel can be helpful when considering this issue.