Public Policy Encourages Mediation but Court Decision Says Developers Can Require It

Published on: December 6, 2012

Most community associations and their attorneys would probably agree that mediation can be a desirable alternative to litigation for resolving some disputes. But should associations be required to arbitrate disputes with condominium developers, even if neither the association’s board nor its owners explicitly agree to that requirement?

The California Supreme Court answered that question affirmatively in a recent decision, ruling (in Pinnacle Museum Tower Association v. Pinnacle Market Development) that mandatory arbitration provisions are enforceable in community associations as long as owners are aware of them when they purchase their units.

Until recently, courts in California and other jurisdictions have set the bar higher for enforcing mandatory arbitration requirements, holding that both parties m

ust affirmatively and voluntarily agree to them. But condominium developers have been pushing back, securing legislation in many states (Massachusetts not among them) giving developers a right to repair or requiring some form of alternative dispute resolution before community associations can initiate construction defect suits against them, and arguing with increasing success that mandatory arbitration is both an equitable solution and a desirable public policy.

In the California suit, the condominium’s developer (Pinnacle) had inserted a provision in the CC&Rs, requiring the association to resolve construction-related disputes through binding arbitration, and stating specifically that the owners agreed to waive their right to a jury trial in those matters.

When the association filed a construction defect suit, the developer filed a motion to compel arbitration. Both the trial court and an appeals court rejected the motion, finding the arbitration requirement to be “unconscionable,” void for public policy and thus unenforceable, because the condominium association, which did not exist when the developer drafted the CC&Rs, had not agreed to it.But the state Supreme Court took a different view. Owners ”should not [have been] surprised” by the arbitration provision, the court said, because it was in the condominium documents they had the opportunity to review and referenced in the purchase agreements they signed. Purchase of their units implied both awareness and acceptance by owners of the arbitration requirement, the court concluded, and the community association “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.” Nor should owners now be allowed to use the association “as a shell to avoid an arbitration covenant in a duly recorded declaration.”

An Enforceable Contract

The association argued (and both a dissenting and a concurring justice agreed) that signing the purchase agreement did not constitute voluntary consent to the arbitration provision, because owners had no reasonable opportunity to negotiate or reject it. But the court held that the state condominium statute (Davis-Sterling) treats a condominium declaration as the equivalent of a contract, making its terms equally enforceable.

Writing for the five-member majority, Justice Marvin Baxter explained: “Even when privity of contract is lacking, the Davis-Stirling Act ensures that the covenants, conditions and restrictions of a recorded declaration — which manifest the intent and expectations of the developer and those who take title to property in a community interest development — will be honored and enforced unless proven unreasonable….That a declaration operates to bind an association is both logical and sound,” Baxter wrote, “ for the success of a development would be gravely undermined if the association were allowed to disregard the intent, expectations and wishes of those whose collective interests the association represents.”

The arbitration provision met one of the key tests for upholding it (acceptance by the parties), the court concluded, and the association failed to demonstrate that the provision was either unreasonable or “so one-sided or unduly harsh it shocks the conscience.” Nor was there any basis for concluding that the provision was overreaching, the court concluded, because the developer had complied with the procedural requirements outlined in the condominium statute. Compliance with the law, the court said, “provides a sufficient basis for rejecting an association’s claim of procedural unconscionability.”
Construction industry executives in California and elsewhere view the decision as a major victory and a harbinger, they hope, of a legal trend that will lead more condominium developers to include arbitration requirements in the condominium documents they draft and lead more courts to uphold them. “Prudent insurers” may also begin insisting on these provisions as a condition for providing coverage for new condominium developments, an insurance industry executive commenting on the Pinnacle decision suggested.Equally important, the court concluded, the arbitration requirement was consistent with the state condominium law and the Federal Arbitration Statute, both of which encourage alternative dispute resolution.

Moves and Counter Moves

It is not clear how courts in other jurisdictions will resolve the questions raised in Pinnacle, but two recent Colorado decisions hint at the outlines of the legal chess match that is likely to unfold as developers and community associations vie to gain the upper hand.

In a 2004 decision (Eagle Ridge Condominium Assn. vs. Metropolitan Builders, Inc.), a Colorado appeals court ruled that an association could proceed with a construction defect suit because the association had properly and legally amended its bylaws to revoke the mandatory arbitration provision the developer had included in the condominium declaration. However, in another case (Glass House Residential Association v. Alta Riverfront LLC et al.) earlier this year, a Colorado District Court upheld a provision specifying that a community association could not revoke or amend a mandatory arbitration provision without the consent of the developer and the general contractor.

A commentator discussing this decision noted that while it clearly enabled developers to tie a community’s hands, there will be limits on how far developers will be able to press that advantage. “Any attempt…to go further and lock in substantive limitations on construction defect claims, like eliminating them or restricting recoverable damages, might not fare as well.”

Hints in Massachusetts

Massachusetts courts have not addressed the issues raised in Pinnacle and these two Colorado decisions. But two decisions hint at how the courts here might view the enforceability of arbitration requirements and the authority of community associations to revoke them.

In Scully v. Tillery, the Supreme Judicial Court ruled that the developer and owners in a phased condominium development could agree to changes altering the statutory formula for allocating percentage interest ownership and revising the governance of the community in ways that disadvantaged purchasers in the second phase, as long as those subsequent owners had notice of the changes before they bought. (The agreement resolved a long-running dispute that had stalled development of the second phase.)

The court concluded that deciding in favor of the plaintiffs (second phase owners) “could subvert a well-established public policy of respecting and enforcing litigation settlements.” It does not require too much of a stretch to anticipate that a future court might use this decision as a basis for upholding the “well-established public policy” supporting mandatory arbitration provisions, as well.

Another Massachusetts decision touches peripherally on the question of whether an association can amend its documents to erase a restriction the developer has included. The provision at issue in this 2009 case (Old Stone Bridge Acres Condominium Trust v. Richard E. Terrill), required 90 percent of the unit owners to approve litigation initiated by the association. A Massachusetts Superior Court rejected the developer’s motion to dismiss a construction defect suit, concluding that the board had acted legally in eliminating that requirement, and a Massachusetts Appeals Court agreed. In an unpublished decision, the court held that “a majority of the trustees could properly perform the ministerial act of implementing the unit owner’s right to amend the by-laws….”

Arbitrate or Litigate?

While these decisions are instructive, they are not definitive. We can’t predict how the courts are likely to rule on the enforceability of mandatory arbitration provisions and the authority of community associations to eliminate them. But we can predict with certainty that more condominium developers will be inserting arbitration requirements, which are not always in the best interests of community associations.

There is no question that arbitration can usually resolve disputes more quickly than litigation, although the process is not as cost-effective as many advocates assume. The parties must pay for their own attorneys and split the arbitrators’ fees, which, at $500 per hour, can make a three-day mediation pricey, indeed. Still, arbitration may be advisable when the dispute is relatively uncomplicated and the amounts involved are small. But that is not the case in construction defect disputes, where the damages sought usually total hundreds of thousands and sometimes millions of dollars.
In these cases, associations are usually much better advised to purse their claims in court, where the ability to file liens gives them significant leverage and where a judge or jury rather than an arbitrator or panel of arbitrators will make the decision. And unlike an arbitrator’s decision, a court judgment is subject to appeal. Arbitrators, for whatever reason, tend to “split the baby,” and however unreasonable or unfair associations find the decision, they are going to be stuck with it.

Every case is different. Associations have to base their decision to litigate or not on their own circumstances – the nature of their claim, the cost of litigating it, the likelihood they will prevail in court and the prospects for recovery if they do – all questions board should review with the association’s attorney.

But any board that is actively considering suing the community’s developer should have the association’s attorney review the condominium documents, and consider taking steps to eliminate mandatory arbitration provisions or any other restrictions on the board’s ability to sue. Even boards that are not currently contemplating litigation might want to consider amending their documents, if necessary, to preserve their rights to litigate complaints against their developer in the future, should they decide it is in the association’s interests to do so.