Home Builders and Developers Beware: South Carolina Supreme Court Beats Up Hybrid Arbitration Clauses Mercilessly

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If you are a homebuilder, residential housing developer, construction industry insurer, or any one of the many participants in the industry providing affordable and decent housing for the citizens of South Carolina, you are already aware that South Carolina courts have for decades prioritized the promotion of consumer (i.e., home buyer) rights, usually at the expense of the providers of housing. There is nothing inherently wrong with that; the goal is laudable. But as in so many things, the implementation has been extremely costly for the residential construction industry as a savvy plaintiff’s bar has taken advantage of grey areas that are inevitably created in our judicial system.

For example, years ago a South Carolina Supreme Court Justice proudly stated that “South Carolina, through both its courts and legislature, has previously been in the vanguard of protecting consumers, particularly in the area of home construction.” Reynolds v. Ryland Group, Inc., 531 S.E.2d 917, 921 (S.C. 2000). It is also no secret to builders and insurers that South Carolina’s joint and several liability rules mean that if a builder is only 1% negligent in the cause of construction defects, the builder can still get stuck with 100% of the damages, with the courts leaving it up to the builder to try and collect from other negligent parties.

It is therefore no surprise that in South Carolina, and nationally for that matter, homebuilders have attempted to bring some economic fairness to the table by inserting arbitration clauses in their construction and sales contracts. Arbitration is a private dispute resolution method where parties to a contract agree that instead of going to court in a public lawsuit, any dispute will be handled by a neutral third party, usually an attorney, in a more informal and less expensive manner than the court system. Usually the homebuilders attempt to ensure that arbitrators knowledgeable in the construction world will decide such disputes, so that experts truly decide the disputes.

Not surprisingly, plaintiff’s lawyers do not generally like arbitration, as they tend to believe their client homeowners would be more fairly treated by a jury or judge who are not construction experts and perhaps would be more sympathetic to a consumer in a close case. Because of that, there are constant attacks on arbitration clauses in the courts as owners try to find creative ways to bypass binding arbitration.

The South Carolina Supreme Court on September 14, 2022 embraced one of those creative bypasses in Damico v. Lennar Carolinas, LLC, et al, Op. No. 28114. In Damico, the homebuilder had masterfully integrated special warranty clauses, arbitration clauses, and other contract documents to provide a clear, reliable outline and process for both the home buyer and the homebuilder to follow for dispute resolution by arbitration. Or so the homebuilder thought.

To the surprise of the builder, the Court held that the arbitration clauses were “unconscionable,” and thus not enforceable. The only way the Court could reach that conclusion was that the arbitration clause in this case did not say that issues of enforceability of the arbitration clause were for the arbitrator, not the courts, to decide. (If a clause says that, the court must stop and defer to the arbitrator on that issue.) Unfortunately for the homebuilder in this case, the elaborate arbitration clause missed that one checkpoint, which opened the door for the Court to attack the clause itself.

And attack it did. With the adroitness of a prize fighter, the Court bobbed and weaved through various legal barriers that ordinarily may have ended its decision making process and made its way to the unconscionability holding. The Court seized on the arbitration clause’s joinder provision that provided that the homebuilder at its sole option could join any subcontractors or other potentially liable parties in the arbitration. The Court held that this seemingly minor procedural issue made the clause unconscionable and unenforceable because normally the plaintiff (home buyer) decides who to sue and this provision took that right away. The Court believed it also could lead to inconsistent results in other forums and force the homeowner to litigate the same issues in court.

Of course, in the real world, there is almost always a chance of there being many forums. The homeowner can always sue at fault subcontractors in court under other theories; that happens all the time. The reasoning of the Court if taken to its extreme could undermine almost any arbitration clause since the home buyer does not have contracts with subcontractors and thus no arbitration clauses.

So how does a homebuilder avoid the trap created by the Court in Damico? Perhaps a work-around could be if homebuilder includes in every subcontract an arbitration provision that allows a home buyer to demand arbitration against a subcontractor as well as joinder in an arbitration with the homebuilder. Another way may be the well-known legal maxim of KISS (Keep It Simple Stupid.) Drafters of arbitration clauses may want to keep the clause very vanilla—for example, beyond the basic language needed to ensure arbitration is applicable to a dispute, let the rules of a national arbitration association govern and do not insert any procedural hurdles that a court could in any way interpret to be unfair in some way to the consumer. And of course, make sure that the arbitrator, not a court, will determine if a clause if unconscionable or not.

There are other lessons to be learned from Damico, and the homebuilders will certainly face a new round of attacks on their contracts as lawyers and courts start applying the opinion in not just the homebuilder industry, but consumer transactions in general.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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