Fall Real Estate 2006

Publication Date: Friday, October 13, 2006

Parachute or a brick?
Mediation and arbitration in real estate

by J. Robert Taylor, J.D.

Mediation and arbitration clauses are a part of all standard form real estate contracts that often are seen under the heading of "Alternative Dispute Resolution." These clauses are often taken for granted and misunderstood. Real estate brokers encourage buyers and sellers to agree to these clauses with very little knowledge of how these agreements may later impact a future dispute between the parties.

There is a strong tendency to sign anything that is on the form and in bold print because you will do anything just to "get the house." This is one area of the real estate negotiation that has become driven by the real estate forms, i.e., the real estate industry, and not by client requests for arbitration or mediation to be a part of their purchase contracts.

Arbitration clauses in real estate are regulated by the Civil Code and must be of a particular type size and/or in bold print. They also must be separately initialed by the buyer and seller to be effective. This is intended to be a warning sign to the parties, but instead it has become a standard spot where the agent/broker tells you to initial, just because it is there. Arbitration and mediation clauses are not required to form a binding and fully enforceable real estate contract. So why do they exist?

The basics

Both mediation and arbitration are a means to resolve a dispute between a buyer and seller without resorting to filing a lawsuit in Superior Court. Mediation is an informal non-binding negotiation between the parties with the assistance of a third-party neutral. The neutral should generally be an experienced real estate attorney or a retired judge with experience in real estate.

The mediator works with the parties to resolve the dispute and avoid civil litigation or a binding arbitration. All parties to the mediation share equally in the costs of hiring the mediator. Cost of mediators can be $200 to $600 per hour.

In addition both parties should be represented by an attorney; this is not required but it still is a process governed by laws and procedures that would overwhelm 99 percent of buyers and sellers. Many real estate contracts will include a clause that a buyer or seller who refuses mediation will lose his/her right to collect legal fees and costs even if they prevail in a later litigation and courts have upheld this type of agreement.

Mediation is completely confidential. Information and statements used in mediation cannot be used as evidence in a later trial or arbitration. No record of the mediation is kept and offers to settle the dispute cannot be used in any later proceeding for any purpose by the parties. Mediation can last for an afternoon, or over many days and weeks until a settlement is reached or any party sees the ongoing discussion as pointless. A successful mediation usually results in a new written contract containing the terms of the settlement between the parties to the dispute.

Arbitration is a somewhat more formal process, although not nearly as formal as a trial in Superior Court. Costs in arbitration are similar to mediation. The arbitrator should be a qualified real estate attorney or a retired judge with real estate experience. Arbitrations follow a similar format as trials do in that witnesses are under oath and the arbitrator can make rulings similar to a judge. Parties may conduct pre-arbitration discovery, but the discovery process is in some arbitration clauses somewhat more limited in comparison with the process in a court trial. Obviously, when you agree to arbitration you are waiving your right to have your case decided by a jury.

Arbitration can be non-binding or binding on the litigants. Non-binding means that the decision of the arbitrator will be confidential and shall have no outcome on a future trial. All real estate contracts have clauses that include binding arbitration. When binding arbitration is elected by the parties the decision of the arbitrator is binding and final. The judgment given by the arbitrator can be enforced in the same manner as any judgment received in Superior Court.

Binding arbitration is a confidential proceeding; no transcript is made and if the parties pay the judgment then no one will know about the litigation other than the parties, the witnesses and the attorneys. A judgment received in a binding arbitration cannot be appealed absent fraud, conflict of interest, or some other very extreme injustice. If the arbitrator merely applies the law incorrectly or uses some Solomonic formula to provide "justice" the losing party has no recourse to appeal the judgment.

What your agent doesn't want you to know

While the agent is telling you that everyone signs the arbitration clause and that not signing it will raise the suspicions of the seller, he/she does not tell you that he/she is not signing the clause and has no obligation to arbitrate or even mediate. When there is a dispute between a buyer and seller there is often an agent(s) that is partially to blame. Conveniently, the brokers have left themselves out of the alternative dispute resolution loop that they have encouraged their clients to participate in or in the case of mediation made it a default portion of the boilerplate.

The savvy buyer or seller might ask why brokers are not bound by the same terms. Given the choice, they have decided that it is better not to be bound to participate in disputes unless they are either compelled to by a filing in Superior Court or they elect to participate in the mediation or arbitration voluntarily. Obviously, being able to make the choice of whether or not to participate with a knowledge of what the dispute is about is a huge, I repeat, huge advantage. Since your real estate agent is a fiduciary, don't you think he/she should tell you about this huge advantage that they are building into the contract to protect themselves from liability?

A party that is necessary to the dispute, or in other words, has potential liability, cannot be compelled to participate in the arbitration or the mediation process. So the buyer and seller are forced by the contract to go through mediation without having all the parties that should be there participate, thus often making it difficult to settle, if not impossible. Still the costs continue regardless of the prospects for settlement.

Even though both the buyer and seller have agreed to arbitrate, the brokers and other parties that may have liability, such as the termite inspector or home inspector, can force the litigants to forego arbitration and file their action in Superior Court. One of the arguments for mediation and arbitration is that is a means of saving the costs of normal litigation. No savings exist if you cannot sue all of the necessary parties in arbitration and are forced to take your action to Superior Court.

I regularly speak to attorneys who are unhappy with the outcome of arbitration. Arbitrators can tend to fashion their own remedies in ways the juries and judges cannot. This is a major reason why the real estate industry has done everything they can to sidestep mediation and arbitration. It is a business decision to avoid a pitfall that they happily steer clients into without any serious discussion of the pros and cons.

There certainly are some pros to alternative dispute resolution. All litigation even if filed in Superior Court is going to be forced into some form of alternative dispute resolution in advance of trial. Judges are doing everything possible to avoid hearing real estate cases. There is very serious pressure applied on all parties to settle the dispute through mediation or arbitration due to the uncertainty of any trial and the costs involved.

It can also save money under certain circumstances; in other cases it may actually cost more -- mediators and arbitrators can be very expensive unless both sides are very efficient. This is not a characteristic of some attorneys I have dealt with. The good news is that the vast majority of cases do settle in advance of trial and this generally saves a lot in attorneys' fees and other costs. It also allows the courts to focus on criminal and other cases that are not amenable to arbitration.

Ironically, if you start asking your agent questions about arbitration or mediation they will quickly refer you to a simplified explanation or opine that they cannot respond because to do so would be giving legal advice. The irony is that the real estate industry can steer buyers and sellers into taking action to limit their legal rights without giving legal advice. In the meantime, not agreeing to waive your right to a trial is rarely a bad idea. After all the justice system is the core that we rely on to protect us.

J. Robert Taylor, J. D., a real estate attorney and broker for more than 20 years, has served as an expert witness and mediator and is on the judicial arbitration panel for Santa Clara County Superior Court. Send questions to Taylor c/o Palo Alto Weekly, P.O. Box 1610, Palo Alto, CA, or via e-mail at btaylor@taylorproperties.com.