The Mandatory Arbitration Clause – More Important than You ThinkFebruary 28, 2014
In today’s frenzied real estate market characterized by bidding wars and tight offer deadlines, many buyers are signing on the dotted line without understanding all of the terms of a typical real estate contract. Some clauses are deemed to be so important that buyers are required to initial them separately. One such clause is Arbitration of Disputes, commonly referred to as Mandatory Arbitration.
The portion of this clause that is so critical is that the decision of the arbitrator is final. This is important because by signing this clause and agreeing that the arbitrator is the final say on the issue, both parties are giving up their day in court and their right to appeal. Neither party may file a lawsuit, with very limited exceptions, to further pursue a resolution in their favor, as they would have been able to if they had not initialed this clause. The main exceptions that allow parties to seek to have the arbitrator’s decision revoked are if the arbitrator does not follow the provisions of the Arbitrator Code or the arbitrator exceeds their power in granting an award. Due to the fact that the contract requires a sufficiently experienced arbitrator to resolve disputes relating to a real estate transaction, the risk of this is fairly low.
The clause requires that buyers and sellers, after attempting to mediate, must submit their unresolved disputes to binding arbitration. This means that rather than filing a lawsuit, the buyer and seller must present their cases to an arbitrator either agreed on by both parties or appointed by the Superior Court. Some argue that due to the fact that arbitrators are not required to be licensed in California, they are unqualified to make binding decisions. However, this should not be the primary concern for buyers and sellers because the PRDS clause expressly requires the arbitrator to be a retired judge or a licensed attorney with at least five years of real estate experience. Both buyers and sellers can rest assured that the arbitrator in disputes arising from real estate transactions will almost certainly be qualified to decide such matters.
Another facet of the Mandatory Arbitration clause is that the real estate agents handling the transaction, giving rise to the dispute between buyer and seller, are not required to arbitrate. This means that the agents are not held accountable for any wrongdoing in the transaction in the arbitration, so buyers and sellers would have to sue the agents after arbitration has been completed unless they voluntarily agree to participate in the arbitration. In reality, the effect of their exclusion is to lessen the chances they will be sued to address any wrongdoing in the transaction at issue. This is due to the fact that the parties are very likely to be “battle-weary” at the close of the arbitration and therefore will opt not to pursue a remedy against the agents, even if they have a good cause of action. Thus, there is an inherent conflict of interest when real estate agents encourage their clients to initial the Mandatory Arbitration clause, since it is effectively giving the agent a lower likelihood of being dragged into any legal action. To address this and align interests, the clause could be modified to require buyer, seller, and both agents to agree to the clause in order for it to take effect. While this could possibly reduce the likelihood of avoiding litigation, as the cash-strapped legal system would prefer, it would ensure buyers and sellers are more easily able to be made whole again by binding arbitration. However, as a practical matter, some listing agents may find this objectionable and the inclusion of such a clause could impact the strength of the offer in a multiple offer situation.
Therefore, buyers and sellers should be aware that it is almost certain that they are giving up their right to a day in court by initialing the Arbitration of Dispute clause. While sellers and their agents in this market often prefer the buyer to agree to the terms of this clause, it is still wise for buyers to take the time to fully understand what they are agreeing to in their attempts to get the house of their dreams under contract.