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VICTORY: WSH&B Wins a Landmark Construction Defect Case!

August 28, 2012

In a landmark decision for the building and construction industry, the California Supreme Court handed down this morning a closely watched decision which addresses the hot issue of enforcement of arbitration clauses.  We are pleased for our developer clients who brought this appeal and proud of the impact this decision has for the entire building and construction industry.  Wood Smith Henning & Berman has represented Pinnacle Market Development (US) LLC, Pinnacle International (US) LLC and Pinnacle Market Development (Canada), Ltd., in this litigation since its inception, initiating the underlying Motions to Compel Arbitration, drafted and argued the matter before the Court of Appeal, and assisted in the petition and substantive briefing as well as the oral argument before the California Supreme Court.

Background

The Pinnacle Homeowners’ Association (HOA) filed the underlying action seeking damages for alleged construction defects.  The Pinnacle Developer Entities filed a Motion to Compel Arbitration based upon the express covenant to arbitrate construction defect claims, which was set forth in the Conditions, Covenants & Restrictions (CC&Rs).  The HOA asserted the arbitration provision was unenforceable based upon both procedural and substantive unconscionability.  The trial court and Court of Appeal agreed with the HOA and held the provision was unenforceable.  The matter was taken up by the California Supreme Court, where it was asked to decide: (1) If an Association can be bound by an arbitration provision contained in the CC&Rs, which were executed and recorded prior to the time the Association came into existence? And (2) Did the Court of Appeal err by applying the state law doctrine of unconscionability only to the arbitration provision, and not to other provisions in the CC&Rs, in light of federal law prohibiting the application of state law to treat arbitration provisions differently from other provisions of the same agreement?

Holding

The California Supreme Court found the subject covenant to arbitrate is not unconscionable and is properly enforced against an Association.  The recorded CC&Rs manifest the intent and expectations of the developer as well as those who take title in a community interest development, and as such will be honored and enforced unless proven to be unreasonable.  As such, the language of Pinnacle Market Development’s CC&Rs requiring construction disputes involving the developer to be resolved via binding arbitration are enforceable.  The support for this holding was overwhelming, with 5 Justices supporting the majority decision, 2 concurring opinions (including one authored by a justice that was part of the majority) and only 1 dissenting opinion.

Significance

This case establishes that under the Federal Arbitration Act and the Davis-Stirling Act, which governs the creation and operation of common interest developments, it is possible for a developer to have construction defect claims resolved via arbitration even when the claims are brought by an Association.  In reaching this conclusion the California Supreme Court specifically acknowledged that placing a covenant to arbitrate in the CC&Rs, which are necessarily drafted and recorded before an Association is formed, does not support a finding of procedural unconscionability.  Accordingly, even though an Association may not bargain with a developer over the terms of the CC&Rs or participate in the drafting of the CC&Rs, under statutory and decisional law pertaining to common interest developments, the covenants and terms in the recorded declaration reflect the written promises and agreements that are subject to enforcement against the Association.  As such, a developer’s compliance with the Davis-Stirling Act provides a sufficient basis for rejecting an Association’s claim of procedural and substantive unconscionability. 

 

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