The Loose Noose of Binding Arbitration

When there is a binding arbitration agreement and the arbitrator has clearly made an erroneous decision, will the courts set it aside? Moore v. First Bank of San Luis Obispo (1998) examines this question.

The appellants (the persons who apply to a higher court for a reversal of the decision of a lower court) were shareholders in a privately held real estate development corporation. The corporation purchased real property in San Luis Obispo County on which it intended to develop condominium complexes. To this end, the real estate development corporation made a series of construction loans totaling $1,645,435.76 to the corporation secured by seven deeds of trust on the properties. 

After construction commenced, the shareholders discovered that the property was environmentally contaminated which increased development costs. In order to obtain further financing, the shareholders executed home equity lines of credit secured by deeds of trust to their personal residences in favor of the corporation. The purpose of this transaction was to create "equity" in the development project by shifting some of the corporate debt on the parcels to the individual residences of the shareholders. The shareholders alleged that, in return, the corporation promised to reconvey as many deeds of trust on the property as the new equity lines were able to pay for so that financing from a construction lender could be obtained. 

In early 1993, after payments were not made on the debt, the corporation initiated non-judicial foreclosure proceedings pursuant to the seventh deed of trust securing a construction loan in the amount of $160,000. In March of 1993, the corporation took title to the real property after making a full credit bid at the foreclosure sale. The corporation also filed notices of default against the shareholders' personal residences under the "equity line" deeds of trust and commenced non-judicial foreclosure proceedings on their homes. 

In response, the shareholders filed the instant action for damages, declaratory relief, and injunctive relief. The shareholders sought to prevent the foreclosures as violative of the anti-deficiency statutes, and to cancel their debt instruments and deeds of trust to their residences on grounds of mistake, fraud, and failure of consideration. What is the anti-deficiency statute? The anti-deficiency statute is legislation enacted by the United States Congress to prevent the incurring of obligations or the making of expenditures (outlays) in excess of amounts available in appropriations or funds. Their complaint also sought monetary damages for fraud and unfair business practices. Finally, they sought attorney's fees pursuant to a provision in the deeds of trust.

The corporation filed a cross-complaint, seeking judicial foreclosure of the subject deeds of trust, a deficiency judgment for the amount owed after deducting the proceeds of the sales of the homes, and attorney's fees.

The trial court subsequently ordered the action to binding arbitration before the American Arbitration Association pursuant to a provision in the equity line agreements. In July of 1997, the panel of arbitrators issued their award in favor of the appellants (the shareholders). The arbitrators ordered the corporation to (1) cancel all obligations under the home equity lines, the deeds of trust, and the blanket liens that were the subject of the action; (2) reconvey all deeds of trust; and (3) release all obligations under any promissory notes or other documents. The arbitrators found, however, that the corporation owed no monetary sum to the appellants, and they ruled that each party shall pay its own attorney fees. 

The corporation subsequently filed a motion in the trial court to confirm the arbitration award. The shareholders opposed the motion and moved to correct the arbitration award to provide that they were entitled to recover their attorney's fees and costs from the corporation. The shareholders argued that the arbitration award gave no effect to the mandatory provision for attorney's fees in the deeds of trust, that they had prevailed on their contract claims, and that the arbitrators exceeded their powers by failing to award appellants attorney's fees and costs. 

The corporation opposed the appellants' motion, contending that the arbitrators clearly determined that neither side was a prevailing party. The corporation contended that the arbitrators had the power to decline to find a prevailing party and fashion a relief they considered just and fair under the circumstances. The corporation argued the award was a 'mixed result' for the parties because both sides won and lost -- the corporation was denied foreclosure rights and the shareholders were denied monetary damages against it. 

The trial court denied the appellants' motion to correct the award, reasoning that the arbitrators were expressly asked to declare the appellants (the shareholders) the prevailing party and to award them attorney's fees, but it instead ordered the parties to bear their own fees and costs. Accordingly the court granted the corporation's motion to confirm the award and entered judgment consistent with the award. 

What was the legal error? When an arbitration panel issues an award which makes one side the prevailing party and then refuses to award attorney's fees under mandatory provisions of the parties' agreement, the award contains a legal error which is not subject to judicial review. Civil Code section 1717 provides that fees shall be awarded to the prevailing party on a contract where the contract provides for attorney's fees. The appellants were, as a matter of law, the prevailing parties in this action and were entitled to an award of fees and costs. The arbitration award shows a clear error of law on this point.

Any defect in an arbitrator's award resulting from an error of fact or law, no matter how flagrant, is neither reviewable nor correctable, unless:

• the arbitrator exceeded their authorized powers;
• the arbitrator acted with fraud or corruption;
• the arbitrator failed to disclose grounds for their disqualification of a dispute;
• the award was procured by corruption, fraud or other misconduct; or
• the refusal of the arbitrators to postpone the hearing substantially prejudiced the rights of the party

An arbitrator, unlike a judge in a court of law, is not bound by the rules of law controlling conduct when arbitrating a dispute. Even when the arbitrator agrees to follow applicable California law, their erroneous award, unlike an award of court, cannot be corrected by any judicial review. 

When I purchased my first house in 2018, I noticed in the pre-printed purchase agreement published by the California Association of Realtors (CAR), there was a boilerplate arbitration provision. Prior to taking Real Estate Practice, I didn't pay much attention to the arbitration provision. My real estate agent reassured me that initialing the arbitration provision is "standard practice." She did not mention any of the risks and did not educate me on the adverse ramifications of initialing the arbitration provision. Back then, I knew little about arbitration beyond the pretext that it is less costly and more efficient than litigation. In 2018, I didn't know enough to inquire about it. 

Arbitration was born out of a genuine desire to save on court costs, expedite the dispute resolution process and improve the efficiency of the real estate marketplace. In practice, however, arbitration often results in absurd legal consequences, in direct conflict with the reasons and practical purposes for its inception. 

Arbitration provisions can lead to:

• Frequent misapplication and misinterpretation of the law;
• Erroneous awards;
• A bar to discovery in preparation for hearings;
• Waiver of the right to judicial review; and 
• A lack of legal precedent for future application to conduct of buyers, sellers, brokers and agents

I argue that arbitration provisions do not belong in real estate purchase agreements. These provisions are not included in trust deeds, nor in most rental or lease agreements as all remedies in landlord-tenant law are judicial. They are omitted for good reason: it is rules of law, not an "arbitrary" arbitrator, which control for fair results. Do you think arbitration provisions should appear in real estate purchase agreements, trust deeds, rental and lease agreements?