Arbitration Clauses: Residential Contract Arbitration Clause Found Enforceable |[OH CT APP]|

In early 2013, a home owner entered a contract with a residential contractor for remodeling and construction work on his home. The contract was a form agreement entitled “Residential Purchase Agreement” provided by the contractor. Within the agreement, the parties agreed to the construction of a single-family home for $175,658. It also contained an arbitration clause entitled “Notice of Builder’s Right to Cure; Arbitration.” The clause contained the following pertinent parts:

All claims or disputes arising out of this Agreement or the breach thereof, including claims for construction defects that are not resolved by the right to cure process set forth in Ohio Revised Code 1312.01 et seq., shall be decided by a single arbitrator in an arbitration (emphasis added) in accordance with the construction industry arbitration rules of the American Arbitration Association. This Agreement to arbitrate shall be specifically enforceable in accordance with applicable law in any court having jurisdiction thereof. Notice of the demand for arbitration shall be filed in writing with the other party and with the American Arbitration Association and shall be made within a reasonable time after the dispute has arisen, except that ANY CLAIM NOT SUBMITTED TO ARBITRATION BY FILING A DEMAND FOR ARBITRATION WITHIN (1) YEAR AFTER THE CLAIM ACCRUES SHALL BE BARRED. The arbitrator’s decision shall be final and binding upon the Purchaser and Builder and a judgment for the enforcement thereof may be entered by a court of competent jurisdiction… Each party shall bear its own costs and expenses and an equal share of the arbitrator’s and administrative fees of arbitration, (and) the arbitrator may award attorneys fees to the prevailing party (emphasis added).

The clause was in the same font size and style as the preceding and subsequent clauses. On January 30, 2013, both parties initialed each page and signed the agreement.

Over the course of construction, problems and disputes came up. There were disputes about the timeliness of performance and deviations from the original plans. Problems with structural and workmanship defects also developed. The home owner withheld $9,750 from his final payment and hired an independent structural engineer to analyze the cost of resolving the alleged structural problems. In his report, the engineer estimated a cost of $75,000 to repair the structural issues.

On July 14, 2015, the home owner filed a lawsuit against the contractor in the Cuyahoga County Court of Common Pleas for breach of contract, negligence, and breach of implied warranty for workmanlike quality. The contractor moved to stay the trial for pending arbitration as required under the arbitration clause of the residential purchase agreement. Notwithstanding the arbitration clause, the owner claimed that the clause was unconscionable because it (1) did not define arbitration, (2) deprived him of his right to a jury trial, (3) reduced the statute of limitations, (4) lacked specific detail about the terms under the construction industry arbitration rules of the American Arbitration Association, and (5) applied loser-pay terms that violate Ohio law. The trial court agreed with the owner and found the clause unenforceable. The contractor appealed.

In CONTE v. BLOSSOM HOMES L.L.C., 2016 WL 6299148 (Ohio Ct. App. Cuyahoga County Oct. 27, 2016), the Eight District Court of Appeals reversed the trial court’s decision, finding that the arbitration clause in the residential home contract was enforceable, except for the loser-pay provision which it found unconscionable and removed from the contract. The court stated that the Ohio General Assembly, under R.C. 2711, not only encourages arbitration as a method of dispute resolution but also supports a presumption favoring arbitration when the claim in dispute falls within an arbitration clause. This presumption, however, must not be so unconscionable that “no man in his senses and not under delusion would make on the one hand, and as no honest and fair man would accept on the other.” Such unconscionability, the court explained, can be procedural or substantive.

Procedurally unconscionability occurs when the process is so unfair that one party to the agreement is devoid of any meaningful choice. The court explained that one can show procedural unconscionability by a lack of alternative sources for obtaining the goods or services. In response to the home owner’s claim that the clause did not define arbitration and he did not understand it, the court concluded that he had an opportunity to ask or seek advice elsewhere. It is not unconscionable because one did not take the time to apprise himself of the contract’s meaning.

On the other hand, an arbitration clause is unenforceable if the terms, or substance, is substantively unconscionable. According to the court, a provision is not substantively unconscionable if it is consistent with the applicable law. Although the arbitration clause did not specify the applicable state law, it said that the state law should apply where the contracted work was done. Ohio, like other states, has held that the “waiver of the right to a jury trial is a necessary consequence of agreeing to arbitration and [therefore] is not unconscionable.” Because arbitration is an obvious substitute for trial, the court held that parties are implicitly notified that they must waive their jury trial right in order to enter the contract.

The court further held that the reduced statute of limitation term was also enforceable. If the time limitation on claims was unambiguous, for a reasonable period, and not in violation of public policy, parties can reduce it by contract. The court, however, did not determine if contractual limit to one year is reasonable. Instead, it held that the reasonableness was in the arbitrator’s purview to determine. Regarding the lack of detail in the clause, the court held that the incorporation of rules under the American Arbitration Association does not alone invalidate a provision.

Unlike the other terms, the court did find the loser-pays term substantively unconscionable. The term, as listed above, placed the cost for attorneys and arbitrator fees on the losing party. This provision enables prevailing parties to place all costs of arbitration on the losing party, regardless of the claim. The Ohio Home Construction Service Supplies Act, R.C. 4722, limits the award of attorneys fees to “a defendant in the event of bad faith, groundless filings on the part of the homeowner.” In contrast to the statute’s limited applicability, this loser-pays term in the contract permits a prevailing party to shift costs for any claim. Consequently, the court found it unconscionable and excised it from the contract.

Best Practices:

1. Arbitration clauses are presumed to be enforceable – As the court held, Ohio encourages arbitration because of benefits such as encouraging party negotiations and alleviating the cases on courts’ dockets. Today’s form agreements, such as the one in the case, tend to include arbitration clauses. Contractors and owners should know how arbitration resolves disputes.

   

2. Things to include in arbitration clauses – Parties should include the applicable state law, forum, specific governing rules (i.e. American Arbitration Association rules governing construction), and a demand requirement for the other party to cure the defect before arbitration occurs.
3. Ohio requires homeowners to demand residential contractors to cure defect before arbitration – Under R.C. 1312.03, the contractor has a right “to offer to resolve any alleged construction defect before the owner may commence dwelling action or arbitration proceedings against the contractor.” Although the owner need not accept the contractor’s offer to cure, he or she must nevertheless provide the contractor with the chance to cure.
4. Arbitration clauses can be defeated – The court limited the presumption in favor of arbitration “where the disputed issue falls within the scope of the arbitration agreement, except upon grounds that exist at law or in equity for the revocation of any contract.” This provides opponents with ammo. First, ask whether the issue is governed by the contract in which the arbitration clause falls. If not, the arbitration clause has no effect. Second, consider legal or equitable reasons why the contract should not apply. Unconscionability is an adequate reason; however, courts are less likely to find unconscionable a contract in which two parties freely entered.
5. Evidence of procedural unconscionability – Although the court did not find procedural unconscionability, it did indicate what might constitute such conduct. Evidence of “(1) denying requests to make changes to the Contract, (2) refusing to address questions regarding the provisions, or (3) somehow den[ying] [a party] the opportunity to seek third-party advice” may demonstrate procedural unconscionability.
6. No defense for not having read the clause – Generally, courts give little validity to a party’s claim that he or she did not read the contract. “A person of ordinary mind cannot be heard to say that he was misled into signing a paper which was different from what he intended, when he could have known the truth by merely looking at what he signed.”
7. Time limitation on construction defect claims are reducible – As the court held, parties can reduce the time limit on claims from the relevant statute of limitation. It must, however, be (1) unambiguous in the contract, (2) for a reasonable period of time, and (3) not in violation of public policy or law. The reasonable period element implies that claims have an irreducible core and therefore cannot be contracted away.
8. Loser-pay provisions are unenforceable in residential construction contract arbitration clauses governed by Ohio law – The court held that Ohio law limits attorneys fees to certain claims in construction arbitration and therefore the broad loser-pay provision is unenforceable. However, other state law might not limit arbitration fees to certain claims.
9. Include severability clauses – This case is a classic example of the value a severability clause has. Severability clauses permit a court to sever an unenforceable clause without voiding the entire contract. Without a severability clause, the unenforceability of the loser-pay clause could have voided the entire arbitration clause.

– Christian H. Robertson II

All materials have been prepared for general information purposes only to permit you to learn more about construction law. The information presented is not legal advice, is not to be acted on as such, may not be current and is subject to change without notice.