Subdivisions: Supreme Court Upholds Arbitration Provisions in CC&Rs

August 16, 2012

This morning, the California Supreme Court issued its much-anticipated ruling in Pinnacle Museum Tower Assn. v. Pinnacle Mkt. Dev. (US), LLC, finding that a recorded declaration of covenants, conditions and restrictions for a common interest development (CC&Rs) can constitute an enforceable agreement to arbitrate construction defect claims with a homeowners association (HOA), and that such provisions are not per se unconscionable.

The Supreme Court focused on several provisions of the Davis-Stirling Act (the Act) to conclude that the CC&Rs are in fact a contract and that the recordation of the CC&Rs provides sufficient notice to HOAs and owners to permit the enforcement of, and to have owners and HOAs be deemed to have agreed to, the covenants and restrictions in the CC&Rs.  Most notably, the Supreme Court extended its analysis from its holding in Nahrstedt v. Lakeside Village Condominium Assn. (1994) 8 Cal.4th 361 (holding that land use restrictions contained in a recorded declaration are enforceable as equitable servitudes under the Act unless proven unreasonable) to apply to “all covenants in a declaration,” including binding arbitration provisions, unless the provisions are unreasonable.

Furthermore, the Supreme Court held that the placement of an arbitration provision in recorded CC&Rs does not violate any portion of the Act and that there is nothing in the Act itself which prohibits recorded CC&Rs from containing arbitration provisions.  The Supreme Court went on to note that the inclusion of arbitration provisions in recorded CC&Rs is consistent with California Department of Real Estate (which is charged with ensuring that the terms of the CC&Rs are fair and reasonable to the owners and HOAs in a common interest development) regulations and made it clear that the use of arbitration provisions in recorded CC&Rs supports public policy.  The ruling not only upholds the enforceability of arbitration provisions included in CC&Rs by developers of common interest development projects (as long as such provisions are reasonable), but reinforces arbitration as a preferred way to resolve disputes.

The Supreme Court rejected point by point the Court of Appeals’ basis for finding the arbitration provision unconscionable.  The Court of Appeals found a high degree of surprise and oppression (i.e. procedural unconscionability) in the fact that the CC&Rs are typically drafted and recorded before the developer forms the HOA; however, the Supreme Court held that a developer’s compliance with the Act in preparing and recording the CC&Rs provides evidence that it is not procedurally unconscionable.  The Supreme Court found the rationale by the Court of Appeals on substantive unconscionability to be either unpersuasive or off-target (the law requires a finding of both procedural and substantive unconscionability to invalidate the provision).  As an added bonus, the Supreme Court declared that the Court of Appeals erred in Villa Milano Homeowners Assn. v. Il Davorge (2000) 84 Cal.App.4th 819 when it relied on California Code of Civil Procedure Section 1298.7 (which precludes arbitration provisions that limit actions brought under California Code of Civil Procedure Sections 337.1 and 337.15 (these are statutes of frauds for actions relating to construction and design defects) to conclude that arbitration provisions in CC&Rs are categorically unenforceable on unconscionability and public policy grounds.  The Supreme Court also expressly disapproved Villa Milano to the extent any other portion of that case is inconsistent with today’s decision.

The Supreme Court was careful to point out that today’s decision only applies to arbitration provisions in CC&Rs, and not to other forms of alternative dispute resolution.  In distinguishing Treo @ Kettner Homeowners Assn. v. Superior Court (2008) 166 Cal.App.4th 1055, for example, the Court noted that judicial reference provisions in CC&Rs could be invalidated due to state law requirements that are not generally applicable to other contractual clauses (such as proof of actual notice, signature by all the parties, and meaningful reflection); whereas the Federal Arbitration Act precludes judicial invalidation of arbitration provisions on such grounds.  This should be carefully considered when drafting dispute resolution procedures for CC&Rs, and if judicial reference remains your preferred method of dispute resolution, we continue to recommend that an arbitration provision also be included in your CC&Rs as a fall back in case the judicial reference provision is determined to be unenforceable by a court.

If you have any questions regarding the holding in Pinnacle and its effect on alternative dispute resolution provisions in CC&Rs, please contact Scott Jackson, Sheri Marvin, John Leverett, Bill Turpit, Stephanie Nation, Abe Cook or Edward Galloway.

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