Arbitration Clause in Recorded CC&Rs is Not Binding in Common Area Construction Defect Litigation

In Villa Vicenza Homeowners Association v. Nobel Court Development, LLC, (— Cal.Rptr.3d —-, Cal.App. 4 Dist., May 27, 2010), a California Court of Appeal considered whether a homeowners association was bound to arbitrate its claim for construction defects against a developer where the developer had placed an arbitration clause in a recorded declaration of covenants, conditions and restrictions. The Court of Appeal held that, in light of the California Supreme Court’s 2005 ruling restricting pre-litigation jury trial waivers, a declaration of covenants, conditions and restrictions is “not an effective means of obtaining an agreement to arbitrate a homeowners association’s construction defect claims against a developer.”

Facts

Nobel Court Development, LLC (“Nobel”) purchased an apartment complex and converted the apartments into condominiums. Nobel recorded a declaration of covenants, conditions and restrictions (“CC&Rs”) which created the Villa Vicenza Homeowners Association (“Association”). The CC&Rs require Association and condominium owners to arbitrate any claims they may have against Nobel. Nobel transferred the ownership of the common areas and facilities to Association by deed, for no consideration.

The condominium owners brought a derivative action on behalf of Association against Nobel and alleged there were defects in the common areas and that Nobel failed to provide reserve funds in a sufficient amount to repair the defects. Association also filed a cross-complaint against Nobel for breach of express and implied warranties, strict liability, and negligence. Nobel filed a motion to compel arbitration but the trial court denied the motion for all claims except the breach of express warranty claims. Nobel appealed from the trial court’s decision.

Decision

The court found that while California law and federal law favor enforcement of agreements to arbitrate, “neither federal nor state law countenance imposition of arbitration where no agreement to waive judicial remedies exists.” The Court of Appeal found that no agreement to arbitrate existed in this case, where the arbitration requirement was imposed by the project developer in the CC&Rs without the actual approval of the homeowners or the Association. The court also found that the developer, as a non-owner, had no enforcement rights under the CC&Rs.

In the 2005 case of Grafton Partners v. Superior Court, the California Supreme Court limited the enforceability of pre-litigation waivers of jury trials due to the “inviolate,” “fundamental” and “sacred” right to jury trial under the California Constitution. Subsequent case law has restricted the ability of CC&Rs to submit disputes between developers and homeowners associations to judicial reference instead of a jury trial, finding that a jury trial waiver “requires actual notice and meaningful reflection” of the parties to be bound by the waiver. In this case the court found that CC&Rs which are created by the developer and are not signed by the homeowners do not satisfy that requirement.

The court agreed with Nobel’s argument that the Federal Arbitration Act (“FAA”) provides that when an agreement is covered by the FAA, the FAA preempts any conflicting state law. However, the court noted that state law governs “the question of whether an agreement to arbitrate has been made.”

In determining whether such an agreement had been made, the court concluded that “we do not believe the Legislature intended [that a declaration of covenants, conditions and restrictions] could be used as a means of creating any continuing contractual rights between a developer of [a] common-interest development and either a homeowners association or individual homeowners.” California law treats CC&Rs “as equitable servitudes which bind homeowners and homeowners associations with respect to claims they may have against each other.” The court noted that CC&Rs “are notoriously lengthy, are adhesive in nature, are written by developers perhaps years before many owners buy, and often . . . cannot be modified by the association.” The court found that CC&Rs unilaterally prepared and recorded by Nobel, and not signed by the homeowners, does not constitute a contract between the Association and Nobel.

Civil Code section 1354 provides that covenants in a declaration are enforceable “unless unreasonable” and the servitudes may be enforced by an owner of a separate interest or by the association or by both. The CC&Rs here contain a similar enforcement provision. The court found that neither section 1354 nor the CC&Rs at issue give Nobel the right to enforce the CC&Rs “other than as the owner of unsold units.” The court stated that non-owners are excluded from the benefits of the CC&Rs. The court found that the Legislature, when providing that CC&Rs would be treated as equitable servitudes, did not intend for them to be used “to provide continuing and irrevocable contractual benefits to non-owners such as Nobel.”

The court held the CC&Rs was not an effective means of obtaining an arbitration agreement that requires the homeowners association to arbitrate a claim for construction defects against Nobel. Accordingly, the Court of Appeal upheld the trial court’s denial of Nobel’s motion to compel arbitration.

Implications

This case calls into question the validity of arbitration and other alternative dispute resolution provisions contained in CC&Rs. It is likely that many homeowners and associations in construction defect litigation disputes will cite this case in order to have their disputes heard in court rather than in front of an arbitrator. Yet the decision does not necessarily prevent developers from including such arbitration and alternative dispute resolution provisions in their purchase agreements or other agreements with individual purchasers of homes or commercial property. Future cases will need to determine whether arbitration clauses in these individual contracts provide sufficient notice to and reflection by purchasers to be enforceable, or whether pre-dispute waivers of jury trials will generally be found invalid. Contractually requiring arbitration for disputes over common area construction defects, as in this case, may prove even more difficult.

Questions

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Jon Goetz | 805.786.4302