Morrison Law Journal


The Morrison Law Journal August 2012 Volume VII, Edition 8 When Arbitration Is The Only Forum: Court Of Appeal Rules That Homeowners Association Can Be Bound To Arbitration Clause Contained In Covenants, Conditions and Restrictions Prepared By Developer By: Edward F. Morriso n, Jr., Esq. Larry A. Schwartz, Esq.
An issue that the Courts have been grappling with deals with whether a developer, attempting to protect itself against prospective construction defect litigation, can impose a binding arbitration clause in the Covenants, Conditions and Restrictions that are prepared for a common interest development. As we previously reported in the August 2010 edition of The Morrison Law Journal, a California Court of Appeal had ruled that the inclusion of a binding arbitration clause in a common interest development's Covenants, Conditions and Restrictions, which could not be changed by the homeowners association without the written consent of the developer, did not constitute an agreement sufficient to waive the constitutional right to jury trial for construction defect claims brought by the homeowners association. The same Court further ruled that the mandatory arbitration provisions in the individual owners' sales contracts were unconscionable. Since we reported in August 2010, the developer, Pinnacle Market Development (US) LLC ("Pinnacle") petitioned the California Supreme Court. On November 10, 2010, review was granted by the California Supreme Court. The California Supreme Court has now decided this critical question. In its opinion issued on August 16, 2012 in Pinnacle Museum Tower Association v. Pinnacle Market Development (US), LLC (2012) DJDAR 11381 (“Pinnacle Case”), the Supreme Court reversed the Court of Appeal decision and ruled that, even though a homeowners association did not exist as an independent entity of the developer when the Declaration of Covenants, Conditions and Restrictions were drafted and recorded for a common interest development, the covenants and terms in a recorded Declaration reflect statutorily permitted written promises and agreements that are subject to later enforcement against the homeowners association – even where the constitutional right to a jury trial is implicated. 1 A brief review of the facts of the Pinnacle Case is in order. The Pinnacle Case involves a mixed use residential and commercial common interest community in San Diego known as the Pinnacle Museum Tower Condominium (the “Project”). The Project was developed by Pinnacle. Pinnacle as the owner and developer of the Project drafted and recorded a "Declaration of Restrictions" to govern its use in operation. The Declaration for the Project included Covenants, Conditions and Restrictions which contained a number of easements, restrictions and covenants. The project Covenants, Conditions and Restrictions also provided for the creation of a nonprofit mutual benefit corporation called the Pinnacle Museum Tower Association (“Association”) to serve as the homeowners association. In selling the project units, Pinnacle conveyed to each buyer an airspace condominium in fee and a proportionate undivided interest in the common area as a tenant in common. All other real property (including the property in the tower module, the parking structure, and other appurtenances) was deeded directly to the Association in fee. Pursuant to the Project's Covenants, Conditions and Restrictions, each condominium owner is a member of the Association with certain voting rights, and each agrees to pay assessments for all purposes described in the Declaration, including the Association's maintenance and improvement of the Association's property and common areas. As relevant to the Pinnacle Case, Article XVIII of the Covenants, Conditions and Restrictions recites that, by accepting a deed for any portion of the Project property, the Association and each condominium owner agree to waive their right to a jury trial and to have any construction defect dispute resolved exclusively through binding arbitration in accordance with the Federal Arbitration Act ("FAA") and the California Arbitration Act ("CAA"). It is noted that Article XVIII specifies that it applies only to a construction defect dispute in which Pinnacle has been named as a party, and provides that no amendment may be made to its terms without Pinnacle's written consent. Following completion of construction of the Project, individual owners bought condominium units in the Project pursuant to a Standard Purchase Agreement. The Standard Purchase Agreement anticipated creation of the Association and explicitly provided "by acceptance of the grant deed to the condominium, Buyer shall be deemed to have accepted and agreed to comply" with the Project's Covenants, Conditions and Restrictions. In addition, Section 8 of the Standard Purchase Agreement provides that, by agreeing to resolve all disputes as provided in Article XVIII, the buyers waive their respective rights to have such disputes tried before a jury. 2 The Association then later filed a construction defect action against Pinnacle and others alleging construction defects. As the sole Plaintiff, the Association sought recovery not only for damages to its own property, but also damage to the interest held by its individual members. Pinnacle thereafter filed a Motion to Compel Arbitration, contending that the FAA mandates enforcement of the Article XVIII arbitration provision. The Trial Court determined that the FAA applied and that Article XVIII embodied an agreement to arbitrate between Pinnacle and the Association. Nonetheless, the Trial Court invalidated the arbitration clause on the basis of slight substantive unconscionability and a high degree of procedural unconscionability. As stated above, the Court of Appeal affirmed the ruling of the Trial Court. Pinnacle then petitioned for review, which, as set forth above, was accepted by the California Supreme Court. In its opinion,1 the California Supreme Court first accepted the lower Courts’ determination that the terms of the FAA applied. The Court then went on to hold that notice to the prospective purchasers by virtue of a recorded Declaration and the stability of common interest associations were of paramount importance. Quoting the majority opinion: “One important feature contributing to the stability and success of condominium developments is that actual notice is not required for enforcement of a recorded declaration's terms against subsequent purchasers. [citations] Rather, the recording of a declaration with the county recorder ‘provides sufficient notice to permit the enforcement’ of the covenants and restrictions contained therein [citations] and condominium purchasers are ‘deemed to agree’ to them. [citations]” The Supreme Court then noted that the covenants and restrictions in the Declaration shall be enforceable equitable servitudes, unless they are unreasonable. In that regard, the Supreme Court held that placement of an arbitration clause in covenants in a recorded Declaration violates none of the Stirling–Davis Act's proscriptions (the Supreme Court also noted that a recorded Declaration may include an arbitration clause for disputes between a developer and an owners association and that disputes involving associations with 20 or 1 The Majority opinion was subject to separate concurring opinions from Justices Werdegar and Liu and a dissent Justice Kennard. 3 more units are subject to pre-litigation alternate dispute resolution for construction disputes, anyway). As for the question of unconscionability, the Supreme Court ruled that the fact that the Declaration was recorded prior to the establishment of the homeowners association is dictated by statute and that the Declaration was not substantively unconscionable. The Supreme Court also ruled that a provision that both sides would bear their own costs and fees is enforceable, although the Supreme Court noted that damages based on the Stearman decision would not be impacted by its holding. The Pinnacle Case decision is certainly significant and will likely bar, insofar as jury trials, many common interest association construction defect cases in the future. About the Authors: Edward F. Morrison, Jr. is the founding partner and Larry A. Schwartz is Of Counsel to The Morrison Law Group, a professional corporation. Their biographies can be viewed at www.morrisonlawgroup.com. Publication Note: The Morrison Law Group wishes to disseminate this publication to all clients and colleagues of the Firm who wish to receive it. Should any recipient desire to be removed from the distribution list, or wishes to have a colleague added, please contact Jim Van Dusen at The Morrison Law Group at 213 356-5504 or vandusen@morrisonlawgroup.com. Disclaimer Note: The legal article presented above is intended to provide general information which may be of interest or use to clients and colleagues of The Morrison Law Group and should not be construed as legal advice on any matter. 4

An issue that the Courts have been grappling with deals with whether a developer, attempting to protect itself against prospective construction defect litigation, can impose a binding arbitration clause in the Covenants, Conditions and Restrictions that are prepared for a common interest development.

As we previously reported in the August 2010 edition of The Morrison Law Journal, a California Court of Appeal had ruled that the inclusion of a binding arbitration clause in a common interest development's Covenants, Conditions and Restrictions, which could not be changed by the homeowners association without the written consent of the developer, did not constitute an agreement sufficient to waive the constitutional right to jury trial for construction defect claims brought by the homeowners association. The same Court further ruled that the mandatory arbitration provisions in the individual owners' sales contracts were unconscionable.

Since we reported in August 2010, the developer, Pinnacle Market Development (US) LLC ("Pinnacle") petitioned the California Supreme Court. On November 10, 2010, review was granted by the California Supreme Court.

The California Supreme Court has now decided this critical question. In its opinion issued on August 16, 2012 in Pinnacle Museum Tower Association v. Pinnacle Market Development (US), LLC (2012) DJDAR 11381 (“Pinnacle Case”), the Supreme Court reversed the Court of Appeal decision and ruled that, even though a homeowners association did not exist as an independent entity of the developer when the Declaration of Covenants, Conditions and Restrictions were drafted and recorded for a common interest development, the covenants and terms in a recorded Declaration reflect statutorily permitted written promises and agreements that are subject to later enforcement against the homeowners association – even where the constitutional right to a jury trial is implicated.

A brief review of the facts of the Pinnacle Case is in order.

The Pinnacle Case involves a mixed use residential and commercial common interest community in San Diego known as the Pinnacle Museum Tower Condominium (the “Project”). The Project was developed by Pinnacle. Pinnacle as the owner and developer of the Project drafted and recorded a "Declaration of Restrictions" to govern its use in operation. The Declaration for the Project included Covenants, Conditions and Restrictions which contained a number of easements, restrictions and covenants. The project Covenants, Conditions and Restrictions also provided for the creation of a nonprofit mutual benefit corporation called the Pinnacle Museum Tower Association (“Association”) to serve as the homeowners association.

In selling the project units, Pinnacle conveyed to each buyer an airspace condominium in fee and a proportionate undivided interest in the common area as a tenant in common. All other real property (including the property in the tower module, the parking structure, and other appurtenances) was deeded directly to the Association in fee. Pursuant to the Project's Covenants, Conditions and Restrictions, each condominium owner is a member of the Association with certain voting rights, and each agrees to pay assessments for all purposes described in the Declaration, including the Association's maintenance and improvement of the Association's property and common areas.

As relevant to the Pinnacle Case, Article XVIII of the Covenants, Conditions and Restrictions recites that, by accepting a deed for any portion of the Project property, the Association and each condominium owner agree to waive their right to a jury trial and to have any construction defect dispute resolved exclusively through binding arbitration in accordance with the Federal Arbitration Act ("FAA") and the California Arbitration Act ("CAA"). It is noted that Article XVIII specifies that it applies only to a construction defect dispute in which Pinnacle has been named as a party, and provides that no amendment may be made to its terms without Pinnacle's written consent.

Following completion of construction of the Project, individual owners bought condominium units in the Project pursuant to a Standard Purchase Agreement. The Standard Purchase Agreement anticipated creation of the Association and explicitly provided "by acceptance of the grant deed to the condominium, Buyer shall be deemed to have accepted and agreed to comply" with the Project's Covenants, Conditions and Restrictions. In addition, Section 8 of the Standard Purchase Agreement provides that, by agreeing to resolve all disputes as provided in Article XVIII, the buyers waive their respective rights to have such disputes tried before a jury.

The Association then later filed a construction defect action against Pinnacle and others alleging construction defects. As the sole Plaintiff, the Association sought recovery not only for damages to its own property, but also damage to the interest held by its individual members.

Pinnacle thereafter filed a Motion to Compel Arbitration, contending that the FAA mandates enforcement of the Article XVIII arbitration provision. The Trial Court determined that the FAA applied and that Article XVIII embodied an agreement to arbitrate between Pinnacle and the Association. Nonetheless, the Trial Court invalidated the arbitration clause on the basis of slight substantive unconscionability and a high degree of procedural unconscionability.

As stated above, the Court of Appeal affirmed the ruling of the Trial Court. Pinnacle then petitioned for review, which, as set forth above, was accepted by the California Supreme Court.

In its opinion,1 the California Supreme Court first accepted the lower Courts’ determination that the terms of the FAA applied. The Court then went on to hold that notice to the prospective purchasers by virtue of a recorded Declaration and the stability of common interest associations were of paramount importance. Quoting the majority opinion:

The Supreme Court then noted that the covenants and restrictions in the Declaration shall be enforceable equitable servitudes, unless they are unreasonable. In that regard, the Supreme Court held that placement of an arbitration clause in covenants in a recorded Declaration violates none of the Stirling–Davis Act's proscriptions (the Supreme Court also noted that a recorded Declaration may include an arbitration clause for disputes between a developer and an owners association and that disputes involving associations with 20 or

1 The Majority opinion was subject to separate concurring opinions from Justices Werdegar and Liu and a dissent Justice Kennard.

more units are subject to pre-litigation alternate dispute resolution for construction disputes, anyway).

As for the question of unconscionability, the Supreme Court ruled that the fact that the Declaration was recorded prior to the establishment of the homeowners association is dictated by statute and that the Declaration was not substantively unconscionable. The Supreme Court also ruled that a provision that both sides would bear their own costs and fees is enforceable, although the Supreme Court noted that damages based on the Stearman decision would not be impacted by its holding.

The Pinnacle Case decision is certainly significant and will likely bar, insofar as jury trials, many common interest association construction defect cases in the future.

About the Authors: Edward F. Morrison, Jr. is the founding partner and Larry A. Schwartz is Of Counsel to The Morrison Law Group, a professional corporation. Their biographies can be viewed at www.morrisonlawgroup.com.

Publication Note: The Morrison Law Group wishes to disseminate this publication to all clients and colleagues of the Firm who wish to receive it. Should any recipient desire to be removed from the distribution list, or wishes to have a colleague added, please contact Jim Van Dusen at The Morrison Law Group at 213 356-5504 or vandusen@morrisonlawgroup.com.

Disclaimer Note: The legal article presented above is intended to provide general information which may be of interest or use to clients and colleagues of The Morrison Law Group and should not be construed as legal advice on any matter.