Helping Lambs Slay Lions:

California Courts Refuse to Enforce Binding-Arbitration Clauses in Developer-Drafted CC&Rs.¹

by Gabriel P. Rothman, Esq.

“Do I believe in arbitration? I do. But not in arbitration between the lion and the lamb, in which the lamb is in the morning found inside the lion.” — 19th Century Labor Union Organizer and Activist, Samuel Gompers

Those who read our article in the January 2009 ECHO Journal entitled, “Homeowners Associations have a Right to a Jury Trial in Disputes with their Developers,”² are already familiar with the growing body of law in California where courts have refused to enforce provisions in developer-drafted CC&Rs that deny homeowners and homeowners associations the right to have their disputes with developers heard in court. These types of one-sided provisions, such as binding-arbitration clauses, judicial-reference provisions, and “jury-trial waivers,” have been discussed at length by our state appellate courts over the last ten years. To briefly summarize:

In Villa Milano Homeowners Assn. v. Il Davorge, 84 Cal. App. 4th 819 (2000) (“Villa Milano”), the Court of Appeal found that a developer's arbitration clause in a set of CC&Rs was not enforceable by the developer in a case brought by the homeowners association to recover damages for construction defects. The court ruled that the arbitration clause was “unconscionable,” and therefore invalid, given that it was not a negotiated term of the CC&Rs and because the developer essentially buried the provision at the end of the 70-page set of governing documents.

In Grafton Partners v. Superior Court, 36 Cal. 4th 944 (2005) (“Grafton”), the Court of Appeal ruled that the right to a jury trial is so fundamental - indeed it is enshrined in the state Constitution - that it cannot be “frittered away or committed to the uncontrolled caprice of every judge or magistrate in the state.”³ The court found that, even in disputes between developers and nonprofit organizations such as homeowners associations, the right to a jury trial is so important that is must be “'zealously guarded” in the face of a “claimed waiver.” The claimed waiver in that case was a provision in the CC&Rs that purported to waive the association's right to a jury trial.

And in Treo @ Kettner Homeowners Assn. v. Superior Court, 166 Cal. App. 4th 1055 (2008) (“Treo”), the Court of Appeal refused to enforce a “judicial-reference” provision contained in a homeowners association's set of CC&Rs. A judicial referee is an independent lawyer who is hired by the parties to hear their dispute and, in some instances, has the power to decide the lawsuit outside of court. The homeowners association in that case wanted to have its dispute heard by a jury in a court of law, not by judicial referee. The Treo court found that CC&Rs are not a permissible means of enforcing judicial-reference clauses because neither the association nor the homeowners have actual notice or meaningful reflection to accept or reject such a clause given that clause was drafted by the developer and imposed upon the association before the homeowners took control of the board. The court noted that this problem is particularly concerning with respect to later purchasers who are not original homeowners under the CC&Rs. As successor owners, these homeowners certainly have no opportunity to meaningfully reflect on such a provision and choose to accept or reject it.

The above three opinions have been joined by two recent decisions from the Fourth District Court of Appeal in San Diego that speak specifically to the enforceability of binding-arbitration clauses: Villa Vicenza Homeowners Ass'n v. Nobel Court Development, LLC, 185 Cal. App. 4th 23 (May 2010) (“Villa Vicenza”), and Pinnacle Museum Tower Association v. Pinnacle Market Development, LLC, 10 C.D.O.S. 9830 (August 2010) (“Pinnacle”).⁴ These two opinions go a step further than Villa Milano, Grafton, and Treo and essentially “take the gloves off” in the continuing fight against these types of one-sided developer-drafted CC&R provisions.

Can CC&Rs Require a Homeowners Association and its Members to Arbitrate their Claims against Developers Outside of Court and Without a Jury?

That is the key issue that the Court of Appeal addressed in Villa Vicenza. In that case, the developer, Nobel Court Development, LLC (“Nobel”), purchased a 418-unit apartment complex in 2004 and converted the apartments into condominiums in 2005. Nobel then drafted the CC&Rs and formed the Villa Vicenza homeowners association to operate and manage the development. After the association discovered construction defects in the common areas, and upon learning that Nobel did not provide sufficient reserve funds to repair the defects, a lawsuit was brought against Nobel for damages. After failing to resolve the dispute through mediation, Nobel filed a motion to compel the parties to arbitrate their dispute outside of court, relying on the arbitration provision in the CC&Rs. The trial court denied the motion, and Nobel appealed.

At the appellate level, the court relied on the reasoning in Treo to strike down Nobel's arbitration clause. In particular, the court emphasized the inequity that results from the fact that CC&Rs are drafted long before the homeowners purchase their units and, oftentimes, before the homeowners association is formed. As such, CC&Rs are almost universally never negotiated between the parties, and the provisions can be difficult or impossible to modify. Moreover, a set of CC&Rs can be extremely long and dense, making it difficult for the association and the homeowners to ferret out the existence of binding-arbitration provisions such as the one in Villa Vicenza.

In short, the Court of Appeal reasoned that developer-drafted CC&Rs do not provide homeowners or homeowners associations with adequate notice or opportunity to meaningfully reflect on how these types of one-sided provisions impact their constitutional rights. As a result, there can be no real agreement between a developer and a homeowners association to waive the association's right to jury trial through a binding-arbitration provision that is inserted by the developer in a set of CC&Rs. Should the Court of Appeal uphold Villa Vicenza following rehearing, the opinion will provide strong precedent for the point that binding-arbitration provisions in CC&Rs cannot be used by developers to circumvent the constitutional right of homeowners associations to have its dispute heard by a jury.

Pinnacle Museum Tower v. Pinnacle Market Development, LLC: Binding-Arbitration Provisions in CC&Rs are Not Enforceable by Developers

As with Villa Vicenza, the Pinnacle opinion arose out of a developer's attempt to force a homeowners association to submit its lawsuit against the developer to binding arbitration after the parties were unable to resolve their dispute through mediation. Not surprisingly, given the growing body of legal precedent rejecting such one-sided CC&R provisions, the Pinnacle court refused to enforce the developer's binding-arbitration provision against the association. In doing so, the justices respected the earlier Treo decision when it observed that, “[t]reating CC&Rs as a contract such that they are sufficient to waive the right to trial by jury does not comport with the importance of the right waived.”⁵ The court also commented on the developer's attempt to characterize the CC&Rs as a contract with the homeowners association such that the arbitration provision should be enforced:

[A]dherence to the principles articulated in Treo does not create any uncertainty regarding the circumstances when CC&Rs will be characterized as contracts and when they will not be characterized as contracts. As Treo clearly stated, “CC&Rs can reasonably be 'construed as a contract' and provide a means for analyzing a controversy arising under the CC&Rs when the issue involved is the operation or governance of the association or the relationships between owners and between owners and the association.⁶

In other words, the Court of Appeal clarified that CC&Rs are a contract intended to govern the relationships between a homeowners association and its members, and even between the members themselves. But CC&Rs are not intended to provide developers with a contractual right to enforce one-sided provisions, such as binding-arbitration clauses, that are unilaterally inserted into CC&Rs by the developers themselves.

The bottom line is that the Pinnacle decision is a significant victory for homeowners associations and their homeowner members in their effort to enforce their constitutional rights when developers attempt to enforce these types of one-sided provisions in CC&Rs.

The End of the Road for Arbitration, Judicial-Reference, and Jury-Waiver Provisions? A Final Word of Caution

Despite affirming the principle that arbitration provisions in CC&Rs cannot be enforced, the Pinnacle decision isn't all roses for homeowners associations and their members. Towards the end of its analysis, the Pinnacle court envisions two hypothetical scenarios whereby developers might be able to obtain the necessary agreement of a homeowners association such that a binding-arbitration provision in a set of CC&Rs would be enforceable:

There is no reason a developer cannot place a provision in the CC&Rs requiring a homeowners association and its members to decide via the amendment process to ratify a binding arbitration provision. Alternatively, the CC&Rs could provide that the failure of the homeowners association to amend the CC&Rs to eliminate a binding arbitration provision amounts to an acceptance of the provision.⁷

The first scenario is fairly innocuous. If that type of provision existed in a set of CC&Rs, the association's members would need to take affirmative steps to ratify the binding-arbitration provision by voting on an amendment to the CC&Rs. That is unlikely, of course, given the punitive nature of such provisions. Thus, in that scenario, even if the CC&Rs contained a binding-arbitration provision, the association would still have to act against its own interests to ratify the provision for it to have any effect. Otherwise, such a provision would be subject to the same standards of unenforceability discussed at length in this article.

It is the second hypothetical scenario that presents more of a concern. In Pinnacle, the fact that the binding-arbitration provision contained in that set of CC&Rs could never be amended without the written consent of the developer was a significant factor in the Court of Appeal's refusal to enforce it. But what happens if the CC&Rs specify that the arbitration provision becomes enforceable if the homeowners association fails to amend the governing documents in order to eliminate the provision? In one sentence, it appears that the Court of Appeal has opened the door to allow binding-arbitration provisions in CC&Rs to become enforceable as long as the terms require the homeowners association to formally amend the documents in order to remove such provisions.

The problem with this scenario, aside from the fact that the homeowners association may not recognize the legal impact of what might seem like a fairly harmless provision, is the fact that often times CC&Rs include provisions that make it extremely difficult to amend them. For example, the CC&Rs at issue in Villa Vicenza included the impossibly-high amendment requirement of a majority vote among 90% of the voting members and 90% of the mortgagees. Anyone that lives in a common-interest community can immediately recognize how difficult it is to get 90% approval for any association action, much less for amending the governing documents in such a manner. The Pinnacle court does not appear to recognize this real-world aspect of community-association living.

Another problematic aspect of this type of amendment provision relates to the timing of any such amendment. For example, how soon must the homeowners association amend its CC&Rs to eliminate these types of one-sided provisions? Immediately upon learning of the provision's existence? Before the association files a lawsuit against the developer for damages caused by construction defects? The appellate courts will eventually need to provide further insight into what will ultimately constitute a valid “mandatory amendment” provision as in the second hypothetical discussed in Pinnacle.

For the time being at least, homeowners associations can take solace in the fact that courts will be very reluctant to enforce any type of CC&R provision that takes away the association's right to have their developer-related disputes heard by a jury. That said, boards of directors for newer associations should review their governing documents to see if they contain a mandatory-amendment provision similar to the one discussed in Pinnacle. If so, the association may want to seek legal counsel for purposes of amending its governing documents to eliminate this type of provision. Above all, homeowners associations and their members should remain vigilant in making sure that they understand how all of the provisions contained in their CC&Rs affect their rights, no matter how benign such clauses may initially seem. Better to be the lion than the lamb.