Morrison Law Journal
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The Morrison Law Journal
June 2010
Volume V, Edition 6

Yet Another Limitation on Arbitration Agreements? California. Court Of Appeal Rules That
Arbitration Of Disputes Under The California Association Of Realtors Form,-Revised In 2002 To
Specifically Refer To The Federal Arbitration Act, Are Still Subject California Law That Provides
The Court Discretion To Deny A Petition To Arbitrate Where The Dispute Involves Third Parties
Not Bound By The Arbitration Contract

By: Edward F. Morrison, Jr., Esq.
Brett C. Drouet, Esq.

In another important decision which may impact the arbitrability of disputes arising
from residential real estate purchase contracts in California, the California Court of Appeal,
Second Appellate District, has ruled that the California trial courts, in accordance with the
California Arbitration Act, may deny a Petition to Compel Arbitration where there are
parties to the same real estate transaction which are not bound by the arbitration contract.
The ruling occurred in spite of the fact that the California Association of Realtors form now
specifically refers to the Federal Arbitration -- which does not permit a trial court to stay or
deny arbitration in such circumstances.

As many are aware, the California Association of Realtors publishes and
periodically revises a standard form residential purchase agreement commonly used in
California. The agreement contains an arbitration provision which is widely relied upon.
In Gravillis v. Coldwell Banker Residential Brokerage Co. (2006) 143 Cal.App.4th 761, 782-
783 ("Gravillis Case "),a California Court of Appeal interpreted the October 2000version of
the agreement and ruled t~at, under the California Arbitration Act, see, Code of Civil
991280-1294.2, the trial court had the authority to stay or deny arbitration where
(1)some of the parties to the action were not parties to the agreement, and (2) proceedings
in different forums-arbitral and judicial-could result inconfli~ting rulings on a common
issue of fact or law. However, in October 2002 the California Association of Realtors
published a revised version of the standard form residential purchase agreement which
reads as follows (revised language in italics):

liThearbitrator shall be a retired judge or justice, or an attorney with
at least five (5) years of residential real estate Law experience, unless
the parties mutually agree to a different arbitrator, who shall render n
award in accordance with substantive California law. The parties shall
have the right to discovery in accordance with California
Code of Civil
S 1283.05. In all other respects, the arbitration shall be
conducted in accordance with Title 9 of Part III of the California Code
of Civil Procedure
Interpretation of this agreement to arbitrate shall be
governed by the Federal Arbitration Act."


Sincethe Federal Arbitration Act, see, 9 U.s.c. SS 1-16,does not permit a trial courtto stay
or deny arbitration in the circumstances set forth under the California Arbitration Act,
some legal observers questioned whether a California trial court still has the discretion to
stay an action based on the existence of a third party to the dispute (not bound to the
arbitration contract).

That question has now been answered in Valencia v. Smyth (2010) D.A.R. 8103
("Valencia Case"). The Valencia Case concerned the sale of real property in Palmdale,
California. Plaintiffs Jose Valencia and MaricelaMendoza (the "Valencias")retained Blanca
Rivera-Letrado of Keller Williams Realty to act as their licensed real estate agent. Richard
Velascoowned the subject property in Palmdale. Peter Smyth, a licensed real estate broker
doing business as California Investments, acted as Velasco'sbroker and the listing agent on
the property.

During the course of negotiations, Ms. Rivera-Letrado and Mr. Smyth convinced the
Valencias to offer $949,000for Mr. Velasco's property. Mr. Velasco accepted. At that time,
the Plaintiffs were unaware that Mr. Velasco was in default on his mortgage on the
Palmdale property in the amount of $660,000 and that the property was actually in
foreclosure. The Plaintiffs made a down payment of $175,000which was wired to a title
company. Without informing the Plaintiffs, Mr. Velasco transferred ownership of the
property to his broker, Mr. Smyth. Mr. Smyth's wife then executed an interspousal transfer
deed to assist in the transaction. An entity named Reliable Trust Deeds Services, Inc. then
became "a trustee of the deed of trust in favor of Smyth. II At the time of closing, the
Valencias believed thatMr. Velasco was still the owner of the property and that they were
buying the property from him. After escrow closed, the Valencias regularly deposited
funds into a designated bank account to cover the IImortgage II and other charges.
Thereafter, the Valencias learned that they had purchased the property from Mr. Smyth,
and not Mr. Velasco, and that they had been depositing funds into Mr. Smyth's personal
checking.account, and that the Smyths, together with others, had misappropriated the
Plaintiffs' funds and used the money to finance other real estate transactions of their own.

In late 2007, Mr. Smyth demanded that the Plaintiffs'make additional IImortgage II
payments, more than doubling the size of their monthly payment. The Valencias refused
and Mr. Smyth initiated foreclosure proceedings.

. The Valencias then filed suit naming Mr. Smyth, his wife, Ms. Rivera-Letrado, Keller
Williams Realty, the title company and Reliable Trust Deeds Services, Inc. After finally
serving the Smyths (the Valencias were required to do that by publication), the Smyths
answered and discovery ensued. After depositions which took place over a four (4) day
period, and with the Plaintiffs producing morethan 700pages of documents in discovery,
the Smyths filed a Petition to Compel Arbitration. The Valencias opposed the Petition to
Compel arguing that the Smyths had waived their right to arbitration by delay in seeking
arbitration and participating in discovery, and because the Smyths were not, under the


circumstances, parties to the real estate contract. The Valencias cited Code of Civil
S 1281.2,contained in the California Arbitration Act, which provides that the
Court does have discretion to deny a Petition to Compel Arbitration where there is a third
party to the litigation, whose disputes arise out of the same transaction or series of related
transactions, and there is a possibility of conflicting rulings on a common issue of law or

In reply to the Valencias' opposition to the Petition to Compel, the Smyths argued
that, given the specific reference to the Federal Arbitration Act in the standard form
residential purchase agreement, the trial court did not have the discretion to deny a
Petition to Compel based on the existence of third parties to the dispute. After multiple
hearings, the trial court denied the Petition to Compel on a number of bases including that
it had authority under Code of Civil Procedure S 1281.2(c)to deny a Petition to Compel
because there were third parties to a dispute involving the same transaction or series of
related ~ansactions and there was the possibility of inconsistent rulings.

The Smyths appealed. As before, the Smyths contended that the trial court had
erred in finding that they had waived their right to compel arbitration and further asserted
that the trial court lacked authority to deny the Petition to Compel under Code of Civil
S 1281.2(c)because the parties had adopted the procedural provisions of the
Federal Arbitration Act, among other reasons.

The Court of Appeal affirmed. In its holding, the Court of Appeal discussed a
number of decisions in which a tension between the California Arbitration Act and the
Federal Arbitration Act was discussed, such as Volt Information Sciences v. Board of
Trustees of Leland Stanford Junior University
(1989) 489 S.Ct. 468, Rosenthal v. Great
Western Financial Securities Corp.
(1996)14 CaL4th 394, Warren-Guthrie v. Health Net
(2000) 84 Cal.App.4th 804, Mt. Diablo Medical Center v. Health Net of California, Inc. (2002)
101Cal.App.4th 711, Cronus Investments, Inc-v. Concierge Services (2005)35 Ca1.4th376,
Rodriguez v. American Technologies, Inc. (2006) 136 Cal.App.4th 1110 and Cable
Connection, Inc. v. DIRECTV, Inc.
(2008)44 Ca1.4th 1334. In rendering its decision, the
Court of Appeal did note that there is a distinction in the Rosenthal, Cronus and DIRECTV
cases in that they directly involved interstate commerce, which, of course, a local real estate
matter, such as the Valencia case, would not. However, the Court of Appeal went on to
state that under the Rosenthal-Cronus-DIRECTV trilogy, the Federal Arbitration Act's
"procedural provisions do not apply in state court unless the parties expressly adopt them."
(italics supplied). Based on the case law on point, and the use of the "plain meaning rule"
as employed under the Federal Arbitration Act, the Court of Appeal held:


"...the Agreement's references to California law and the California
Code of Civil Procedure--which contains the CAA--do not expressly
adopt the FANs procedural provisions. Rather, the Agreement
expressly incorporates the CANs procedural provisions."

(italics supplied).

Stated succinctly, the Court of Appeal ruled that, in spite of the change in language
in the California Association of Realtors revised form, the discretion found in Code of Civil
S 1281.2(c) to deny a PetitIon to Compel remains within the province of the
California trial court. Based upon this holding, and applying the specific facts of the
Valencia Case, the Court of Appeal then ruled that the trial court had properly exercised its
discretion under Code of Civil Procedure S 1281.2(c)in its order denying arbitration, and
joining all the parties in a single action to be adjudicated in the trial court.

The Valencia Case is an important decision given that the vast majority of residential
transactions in California are performed pursuant to the California Association of Realtors
form, revised in October 2002, which was the subject of the Valencia Case. The authors
believe that the Court of Appeal's decision was somewhat fact driven, given the conduct of
the seller and its broker, but that the holding is generally in line with decisions which find
that the question of whether a matter is subject to arbitration will be governed by the
California Arbitration Act rules (which provide exceptions to the general rule of
arbitrability of disputes), unless expressly agreed otherwise.

About the Authors: Edward F. Morrison, Jr. is the founding partner and Brett C. Drouet is
a partner of The Morrison Law Group, a professional corporation. Their biographies can be
viewed .at the website
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