Daily Development for Monday, February 27, 2007
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

The enforceability of arbitration clauses in form documents prepared by and for the benefit of one of the parties to a consumer transaction is an issue pitting two power interests against one another.  Courts and legislatures, and even the Congress, have shown a great fondness for alternative dispute resolution and an inclination to support contracts providing for it.  But the devices, of course, can be a tool to insulate unscrupulous cheaters from victimized consumers.  Here are three recent cases balancing these concerns.  The third may already have been a DD, but the editor couldnt find it in his personal archives, so it may have slipped through the cracks.

ALTERNATIVE DISPUTE RESOLUTION; ARBITRATION; UNCONSCIONABILITY: Developers preprinted real estate contract was not a contract of adhesion, but provisions of the arbitration clause requiring one party to pay all costs of arbitration and contained in the contract were substantively unconscionable and, therefore, unenforceable.

 State ex rel. Vincent v. Schneider, 194 S.W.3d 853 (Mo. 2006).

The plaintiffs were purchasers of single family homes from McBride & Son Homes, Inc.  Each plaintiff executed a preprinted written contract which contained a provision that gave McBride the unilateral right to require the plaintiffs to submit any claim arising out of the contract or the home to binding arbitration. The arbitration provision also provided that the arbitrator shall be selected by the President of the Homebuilders Association of Greater St. Louis andPurchaser shall be liable to Seller for all court, arbitration and attorneys fees and costs incurred by Seller in enforcing this provision. 

Each plaintiff initialed the arbitration provisions in their respective contracts to indicate that they had read, understood and agreed to the terms.  The plaintiffs later discovered problems with their newly-purchased homes and filed a lawsuit against McBride.  McBride sent a letter to plaintiffs stating that (i) McBride was requiring resolution of the claims by binding arbitration, (ii) plaintiffs were required to pay McBrides costs of enforcing the arbitration provision, and (iii) the president of the Homebuilders Association was also the president of McBride and was no longer willing to appoint an arbitrator. 

McBride then filed a motion to compel arbitration, which was granted by the trial court.  The plaintiffs sought a writ of mandamus from the Supreme Court to compel the trial court to deny McBrides motion to compel.  Plaintiffs argued that the real estate contracts they signed were contracts of adhesion and, therefore, unenforceable pursuant to Mo. Rev. Stat. 435.350. Plaintiffs, however,  failed to offer any proof that the contracts they signed were contracts of adhesion, and the Court noted that plaintiffs could not rely solely on the fact that the contracts in this case were pre-printed to prove they were contracts of adhesion. 

Plaintiffs also argued that the arbitration clause in the contract was unconscionable for three specific reasons: 1) it gave only McBride the right to select arbitration; 2) it gave the president of the Homebuilders Association the sole discretion to choose the arbitrator; and 3) it placed all costs of the arbitration on plaintiffs.  The Court rejected plaintiffs first argument, holding, as a matter of first impression, that since there was consideration as to the whole agreement, the lack of mutuality of obligation of the arbitration clause does not make it invalid. 

The Court did, however, agree with plaintiffs second and third arguments.  It determined that the arbitration clause was unconscionable because (i) the individual with sole discretion to select an arbitrator was in a position of bias and (ii) the cost-shifting provision of the clause essentially granted one party to the contract immunity from legitimate claims arising under the contract.  Thus, these two provisions of the arbitration clause were unenforceable.  The Court held that the rest of the arbitration provision is enforceable as long as the arbitrator is selected by the trial court and the costs of arbitration are allocated as provided in the arbitrators award. 

MORTGAGES; ALTERNATIVE DISPUTE RESOLUTION; ARBITRATION:  The New Jersey Supreme Court analyzes whether a subprime mortgages arbitration agreement, or any of it, is unconscionable, under New Jersey law. 

Delta Funding Corporation v. Harris, 2006 WL 2277984 (N.J. 2006)

A mortgage lender in the sub-prime lending market entered into a mortgage loan contract with a seventy-eight-year-old woman.  She had a sixth-grade education and little financial sophistication.  The loan was secured by a mortgage on her home.  The loan had an annual percentage rate of fourteen percent.  The consumer owned her home outright and had lived in it for more than thirty years.  The mortgage lender subsequently assigned the loan to a bank as a trustee.

The loan had an arbitration agreement that allowed either party to elect binding arbitration as the forum to resolve covered claims.  The agreement excluded from arbitrationany action to effect a judicial or non-judicial foreclosure or to establish a deficiency judgment.  It also excluded a number of similar actions.  Further, the agreement provided a cost allocation mechanism, including a provision that stated the costs for an appeal would be borne by the appealing party regardless of the outcome of the appeal. 

When the consumer, whose only source of income was social security payments, was unable to make the required loan payments, the assignee bank instituted a mortgage foreclosure action.  The consumer responded, alleging violations of the Truth in Lending Act (TILA), the Real Estate Settlement Procedures Act (RESPA), and the state Consumer Fraud Act (CFA).  The mortgage lender filed a petition in the United States District Court seeking to compel arbitration of the consumers claims against it. 

The consumer filed a motion contending that the arbitration agreement was unconscionable and unenforceable. 

The District Court granted the mortgage lenders motion to compel arbitration.  The state court presiding over the foreclosure action then dismissed the consumers third-party complaint against the mortgage lender, which had been held in abeyance.  The consumer appealed to the United States Court of Appeals.  That Court issued a petition order to the New Jersey Supreme Court in which the panel certified the question: Is the arbitration clause at issue in this case, or any provision thereof, unconscionable under New Jersey law and if so, should such provision or provisions be severed.  The Supreme Court granted certification, reformulating the question as follows:Is the arbitration agreement at issue, or any provision thereof, unconscionable under New Jersey law, and, if so, should such provision or provisions be severed?

First, the Supreme Court discussed the procedural posture of the matter.  It noted that because the Federal Court of Appeals asked the Court to answer a discrete question of state law, the Courts inquiry was limited.  It was ordinarily the role of an arbitrator and not the courts to interpret ambiguous provisions of an arbitration agreement.  The Court explained that for purposes of answering the question of state law posed by the Court of Appeals, it would address how the ambiguous provisions, if interpreted and applied in a manner detrimental to the consumer, could be unconscionable.

Turning to the principles of unconscionability, the Court explained that when a party to an arbitration agreement argues that the agreement is unconscionable and unenforceable, that claim is decided using the same state law principles that apply to contracts generally and contract defenses, such as duress, fraud, and unconscionability, to the extent those principles can justify judicial refusal to enforce an arbitration agreement.  The defense of unconscionability specifically calls for a fact-sensitive analysis in each case, even when a contract of adhesion is involved.  In determining whether to enforce the terms of a contract of adhesion, a New Jersey court looks not only to the take-it-or-leave-it nature or the standardized form of the document but also to: (1) the subject matter of the contract; (2) the parties relative bargaining positions; (3) the degree of economic compulsion motivating theadhering party; and (4) the public interests affected by the contract.

Several provisions of the agreement were alleged to raise unconscionability concerns because they had the effect of limiting the substantive statutory rights and remedies available to a consumer.  Related to that assertion was the claim that it is unconscionable for an arbitration agreement to include acost-shifting provision that allows an arbitrator unfettered discretion to allocate the entire cost of arbitration to a consumer.  The Supreme Court first addressed these provisions as they related to the consumers claims of unconscionability and unenforceability under state law.

The arbitration agreement stated thatat the conclusion of the arbitration, the arbitrator will decide who will ultimately be responsible for paying the filing, administrative and/or hearing fees in connection with the arbitration.  Thus, the consumer would be entitled to costs if she prevailed.  If, however, the consumer did not prevail in arbitration, then she could be forced to bear the entire cost of arbitration.  The Court stated that it is well understood that fee-shifting provisions can deter a litigant from pursuing a claim.  The Court reasoned that the prospect of having to shoulder all the costs of arbitration could chill this particular consumer and similarly situated consumers from pursuing their statutory claims through mandatory arbitration.  The Court found that although the public policy of the state would permit an arbitration agreement to shift costs and attorneys fees to a consumer who brings frivolous orbad faith claims, no such limitation was evident i

n the cost-shifting provision applicable to the consumer.  The Court also reasoned the agreement as written, and possibly as interpreted by an arbitrator, could force the consumer to bear the risk that she would be required to pay all arbitration costs.  The Court concluded that such a risk was unconscionable in that it was a deterrent to the vindication of her statutory rights.

The arbitration agreement also stated that unless inconsistent with applicable law, each party shall bear the expense of that partys attorneys, experts and witness fees, regardless of which party prevails in the arbitration.  The Court concluded that the mortgage lender could not limit a consumers ability to pursue the statutory remedy of attorneys fees and costs when it is available to prevailing parties.  The relevant statutory provisions provided mandatory attorneys fees and costs to prevailing parties.  The Court found that the arbitration agreement suggested that the arbitrator might not have the power to award attorneys fees when that statutory remedy was merely discretionary.  Thus, the Court concluded that to the extent this provision in the consumers contract would prevent the borrower from recovering discretionary attorneys fees and costs under the relevant statute, it was unconscionable.

With respect to appeals, the arbitration agreement stated that[t]he costs of such an appeal will be borne by the appealing party regardless of the outcome of the appeal.  Like the attorneys fees provision, the Court concluded that the appeals provision was unconscionable to the extent that it would bar the consumer from being awarded costs if she prevailed on her appeal.

The Court also held that following the interpretation of the arbitration provisions by an arbitrator, if the agreement was held to permit the shifting of arbitration costs to the consumer, then the unconscionable cost-shifting provision could be severed from the agreement.

Next, the Court turned to the arguments raised by the consumer in support of her claim of unconscionability.

In respect of the arbitration agreements class-arbitration waiver, the Court found that the consumers claim was not the type of low-value suit that would not be litigated absent the availability of a class proceeding.  The Court reasoned that the consumer had adequate incentive to bring her claim as an individual action.  Not only were her damages substantial, but the fact that her home was at stake in the foreclosure proceeding made it likely that she would contact an attorney.  Accordingly, the Court concluded that the class-arbitration waiver was enforceable in the context of this litigation.

In respect of the foreclosure action brought by the assignee bank, the arbitration agreement excluded any foreclosure actions that might be brought against the consumer.  Thus, foreclosure had to proceed in court pursuant to the arbitration agreement.  The Court stated that consumers defenses to the foreclosure action tracked her affirmative claims against mortgage lender; thus, she would be forced to litigate those substantively similar claims in two different forums.  The Court concluded that such a result was burdensome; however, it was not unconscionable.  Moreover, the Court noted that the consumers burden of having to litigate in two forums was alleviated by the fact that attorneys fees and costs were available under relevant statutes if she successfully asserted certain defenses in the foreclosure action.

Lastly, the Court addressed the consumers argument that other clauses of the arbitration agreement were unconscionable, specifically the discovery and confidentiality provisions.  She also argued that it was unconscionable for an arbitration agreement not to require a record of the proceedings or a reasoned and publicly available award.  The Court noted that neither the arbitration agreement, nor the rules of the potential arbitration administrators, prevented the consumer from obtaining a record of the proceeding or a reasoned award.  Additionally, there was nothing in either the arbitration clause or the rules of the arbitration administrators requiring that arbitration awards be kept confidential.  Accordingly, the Court concluded that it was not unconscionable to require that the proceedings before the arbitrator be kept confidential when the arbitrators written award was not required to be kept confidential.

Comment: The editor has left the discussion of the case entirely to Iras capable keyboard.  But he steps in with a common only to note that in a consumer adhesion contract, any provision that significantly disadvantages the consumer ought to be invalidated.  Clearly the court agrees that thetwo forum litigation is such a provision.  He doesnt understand why the lender should be able to dictate unilaterally additional legal burdens for the consumer. 

Alternative dispute resolution, of course, has been a favored child of the courts generally, as it tends to reduce their workload, and thus they tend not to regard commitments to arbitrate as inherently unfair.  But in consumer foreclosures, an argument exists that they might be just that.  It seems absurd to deprive the trial court of jurisdiction over important matters in an equity proceeding in which, normally, the court would have broad discretion to take into account all manner of issues in reaching a fair decision. 

Normally, the editor criticizes the New Jersey courts for their activism and bleeding heart efforts to help disadvantaged parties at the expense of predictability and efficiency in the system.  But here, the editor is surprised to find himself wanting even more liberalism from the court. 

The Reporter for this item was Ira Meislick of the New Jersey Bar.

ALTERNATIVE DISPUTE RESOLUTION; ARBITRATION; TITLE INSURANCE:  Title insurance policy's arbitration clause was not enforceable against insured because it was not included or referenced in preliminary title report. 

Kleveland v Chicago Title Ins. Co.,  141 CA4th 761, 46 CR3d 314 (2006)

Kleveland and AOK Land Company (collectively, Kleveland) purchased a title insurance policy from Chicago Title on the basis of a preliminary title report that described the property to be insured, the coverage to be afforded, and exceptions and exclusions. The preliminary title report did not indicate the policy would include an arbitration clause. The cover sheet of the preliminary report identified the form of title insurance as an American Land Title Association (ATLA) policy. The ATLA policy had an arbitration clause.

Chicago Title issued a California Land Title Association Standard Coverage Policy (CLTA) instead of the policy specified in the preliminary report. The CLTA policy contained an arbitration clause.

Kleveland sued Chicago Title after discovering an easement on the property not mentioned in the preliminary title report. Chicago Title moved to compel arbitration based on the clause in the CLTA policy. The trial court denied the motion.

The court of appeal affirmed. Chicago Title argued that Kleveland was bound by the arbitration clause in the CLTA policy because Kleveland received a copy of that policy and did not object.

Chicago Title relied on the rule that an insured has a duty to read the policy and cannot thereafter complain that the terms were unknown. The court noted, however, that that that rule does not apply to title insurance. Title insurance has a one-time premium and remains in effect as long as the insured owns the property; the insured may not cancel the policy and switch to another carrier without forfeiting the premium. Accordingly, the process of obtaining title insurance contemplates the receipt, before close of escrow, of a title report that sets forth the conditions on which the issuer is willing to issue its title policy. The insured's approval and acceptance of the conditions set forth in the preliminary report creates a binding contract based on the terms set forth in the report and any materials that are incorporated by reference. Therefore, whether the insured is bound by an arbitration clause depends on whether that term was set forth in the preliminary report or incorpor

ated therein by reference.

The preliminary title report did not contain an arbitration clause or explicitly state that such a clause would be contained within the policy to be issued.  It did refer to the type of policy to be issued, and the insurer argued that such reference was sufficient to establish the clause.  The court noted that incorporation by reference requires that:

"The reference to another document is clear and unequivocal;. . .  "[the reference is called to the attention of the other party and the other party consents to that term; and] . . .  "       the terms of the incorporated documents are known or easily available to the contracting parties.

Chicago Title argued that the preliminary report incorporated the ALTA policy and its arbitration clause by reference because it mentioned that policy by name. However, the ALTA policy never went into effect. The only arbitration clause that could conceivably be enforced was the one in the CLTA policy that was actually issued, but that policy was not clearly and unequivocally referred to in the contract.

Although Chicago Title contended it was unfair to deny arbitration when the clause in the CLTA policy was virtually identical to the arbitration clause in the ALTA policy, it was unreasonable to rely on an arbitration clause in a nonexistent policy to deny Kleveland the right to a jury trial. Chicago Title, the drafter of the preliminary report, was in the best position to avoid this problem by including the arbitration clause in the report itself.

Reporters Comment: : Is a party bound to arbitrate when the preliminary title report does not itself contain an arbitration clause, but says that an ALTA title policy will be issued-which policy does contain an arbitration clause-and then issues a CLTA policy instead, which also contains an arbitration clause, although one differently worded from the ALTA clause?

The clause in the originally promised ALTA policy would have said:

 a. If permitted in the state where the Land is located, You or We may demand arbitration.
b. The arbitration shall be binding on both You and Us. The arbitration shall decide any matter in dispute between You and Us.

c. The arbitration award may be entered as a judgment in the proper court.
d. The arbitration shall be under the Title Insurance Arbitration Rules of the American Arbitration Association. You may choose current Rules or Rules in existence on Policy Date.

e. The law used in the arbitration is the law of the place where the Land is located.
f. You can get a copy of the Rules from Us.

The clause in the CLTA policy actually issued instead said:

13. ARBITRATION. Unless prohibited by applicable law, either the Company or the Insured may demand arbitration pursuant to the Title Insurance Arbitration Rules of the American Arbitration Association. Arbitrable matters may include, but are not limited to, any controversy or claim between the Company and the insured arising out of or relating to this policy, any service of the Company in connection with its issuance or the breach of a policy provision or other obligation. All arbitrable matters when the Amount of Insurance is $1 million or less shall be arbitrated at the option of either the Company or the insured. All arbitrable matters when the Amount of Insurance is in excess of $1 million shall be arbitrated only when agreed to by both the Company and the insured. Arbitration pursuant to this policy and under the Rules in effect on the date the demand for arbitration is made or, at the option of the insured, the Rules in effect at Date of Policy shall be binding upon the part

ies. The award may include attorneys' fees only if the laws of the state in which the land is located permit a court to award attorneys' fees to a prevailing party. Judgment upon the award rendered by the Arbitrator(s) may be entered in any court having jurisdiction thereof. The law of the situs of the land shall apply to an arbitration under the Title Insurance Arbitration Rules. A copy of the Rules may be obtained from the Company upon request.

Notwithstanding linguistic and stylistic differences, both versions provided that:
Either party could demand arbitration; that such arbitration would be conducted under the insured's choice of current or earlier AAA rules, obtainable from the company; that the law of the land (situs) would apply; and that the award would be binding and could be entered as a judgment in court.

As to differences: The ALTA clause said arbitration could cover "any matter in dispute," while CLTA would cover "any controversy or claim arising out of or relating to the policy"; the difference is hard for me to discern. CLTA added that attorney fees would be awarded only if state law so provides, whereas ALTA was silent (and I know of no California law awarding fees). Finally, CLTA included a requirement that both parties agree to arbitrate disputes of over $1 million, which ALTA did not. (The briefs do not show the size of the claim, but the preliminary title report shows annual property taxes of under $600, which leads me to surmise that the claim did not fall into the over $1 million category.) Given the policies' similarities, I would say that the requirement that reference to another document be "clear and unequivocal" understates the real standard. These clauses were "virtually identical" in substance, yet incorporation was denied. Literal, not virtual, identity is the me


The opinion suggests that Chicago Title "could have simply included an arbitration clause in the report itself" (141 CA4th at 765), but I wonder: How effective would it have been if the clause in the preliminary report had differed from the clause in the policy? It would probably be safer for both clauses in a two-document transaction such as this to include savings provisos to the effect that if there is any discrepancy between their words, the insured has the option of selecting the version he or she likes best.

Editors Comment: To the editor, an agreement to arbitrate any matter in dispute between the parties is potentially much broader than an agreement to arbitrate only policy matters.  Further, if the any matters  arbitration agreement were to be given the broad reading that it suggests, the $1 million limit might become relevant as well. 

The Reporter for this item is Professor Roger Bernhardt of Golden Gate Law School in San Francisco, writing in the California CEB Real Property Reporter..  The editor has edited. 

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