Seller beware: Commonly used arbitration clause in home contracts ‘unconscionable’

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The South Carolina Court of Appeals has issued a warning to residential home builders.  In a 3-2 decision last month, the justices signaled that builders should be very careful in how they draft arbitration agreements.

The court found that the standard arbitration clause used in D.R. Horton Inc. contracts was unconscionable because it severely limited homeowners’ ability to recover damages for alleged construction defects in a house they bought from the company in 2005.

Because D.R. Horton’s arbitration agreement included a number of provisions that were “clearly one-sided and oppressive,” the Supreme Court said it was unenforceable.

The court’s decision in Smith v. D.R. Horton could have far reaching effects in South Carolina because the agreement in question is included in standard home purchase contracts used by D.R. Horton across the state. And many other builders include similar arbitration provisions in their home purchase contracts.

However, D.R. Horton already has asked the Supreme Court to reconsider the case, citing the divided nature of the July 6 decision. The court’s ruling included a sharp dissent written by Justice John Kittredge, which said the majority should have let an arbitrator decide whether the agreement was enforceable.

The justices have not said whether they will agree to reconsider the case. But until they do, Michael Timbes of Thurmond Kirchner & Timbes in Charleston, who represented the Smiths on appeal, said the case demonstrates that the Supreme Court intends to view broad arbitration agreements with some measure of skepticism.

“The decision is further evidence that the Supreme Court is moving away from the idea of ‘buyer beware’ to ‘seller beware’ when it comes to home sales” Timbes said. “This arbitration agreement severely limited or outright stripped the Smiths of their ability to recover damages stemming from the most important purchase they will make in their lives. We’re very pleased the court found that to be unconscionable.”

Construction concerns

Gregory and Stephanie Smith purchased a new home from D.R. Horton in 2005. But before long, they began to see evidence of water damage in a number of locations within the house.

Upon closer inspection, it appeared that the windows, flashing and the home’s water management system had not been installed correctly.

D.R. Horton attempted to repair the alleged construction defects many times over the next five years. But nothing the company did seemed to address the problem.

The Smiths filed a construction defect action against D.R. Horton and seven subcontractors in 2010. The company responded with a motion to compel arbitration, citing a section of the purchase agreement.

The trial court ultimately denied D.R. Horton’s motion after determining the arbitration agreement was unconscionable and thus unenforceable.

Judge Edgar Dickson noted that the agreement required the parties to arbitrate any claim arising out of D.R. Horton’s construction of the home. But the arbitration agreement went on to say that D.R. Horton expressly disclaims all warranties for the home, including the implied warranty of habitability, except for a 10-year structural warranty.

Additionally, the agreement said D.R. Horton “shall not be liable for monetary damages of any kind, including secondary, consequential, punitive, general, special or indirect damages.”

Dickson said the waiver of implied warranty of habitability and the prohibition on awarding money damages of any kind were “oppressive and one-sided.”

Higher ground

On appeal, D.R. Horton argued the unconscionability analysis was flawed because it did not discuss whether the Smiths lacked a meaningful choice in entering the arbitration agreement.

The company also argued that courts may only decide whether an arbitration agreement is fraudulently induced and thus invalid, not whether the contract as a whole is invalid. D.R. Horton said the arbitration agreement was contained exclusively in one subparagraph, so the allegedly one-sided terms in a different subparagraph should have no bearing on the arbitration agreement’s validity

The appeals court disagreed, affirming the trial court’s refusal to compel arbitration.

When the case reached the Supreme Court, the parties sought an answer to the question of whether the arbitration agreement was unconscionable.

Writing for the court, acting Justice Jean Toal said the agreement was indeed unconscionable because the “oppressive” requirements and the arbitration mandate were both included in the “Warranties and Dispute Resolution” section, which Toal said was so intertwined as to constitute a single provision.

“As the title indicates, all the subparagraphs of paragraph 14 must be read as a whole to understand the scope of the warranties and how different disputes are to be handled,” Toal wrote.

Toal went on to say that the agreement presented by D.R. Horton met the definition of an adhesion contract because it was offered on a “take-it or leave-it basis with terms that are not negotiable.”

“While adhesion contracts are not unconscionable per se, courts tend to look upon them with ‘considerable skepticism’ because they give rise to considerable doubt that any true agreement ever existed to submit disputes to arbitration,” Toal said.

House divided

Kittredge took a much different view of the case. Rather than focusing on whether or not the agreement was unconscionable, Kittredge focused instead on whether the case should have even reached the Supreme Court in the first place.

Kittredge said the majority failed to follow the Federal Arbitration Act when it affirmed the decision not to compel arbitration. The FAA generally applies to any arbitration agreement affecting interstate commerce.

Because many of the materials used in the construction of the Smiths’ home were obtained from suppliers outside of South Carolina and because D.R. Horton operates in 27 states, it should have been up to an arbitrator to determine whether the agreement was enforceable.

“In my judgment, state law does not provide a valid basis to avoid enforcing this particular agreement to arbitrate, and the court of appeals erred in upholding the circuit court’s refusal to compel arbitration,” Kittredge said.

Kittredge also rejected the majority’s finding that the arbitration provision constituted the entirety of paragraph 14, which includes more than 1,800 words and includes “numerous severable provisions.”

Kittredge was joined in dissent by Chief Judge Costa Pleicones.

D.R. Horton’s attorneys from Ogletree Deakins Nash Smoak & Stewart in Greenville declined to comment on the case.

However, Phillip Segui of Segui Law Firm in Mt. Pleasant, the Smiths’ trial attorney, said he thought it was notable that Kittredge did not reject the idea that the agreement was unconscionable.

“A number of other builders have similar contracts with arbitration agreements that seemingly limit and take away the rights homeowners have as a matter of law,” said John Chakeris of the Cahkeris Law Firm in Charleston, who also represented the Smiths.

“The case is applicable to D.R. Horton, but it’s also applicable to all other tract builders who attempt to limit homeowners’ rights. This will force tract builders to reconsider the manner in which they craft contracts, so as not to constrict or seemingly limit remedies to homeowners,” he added.

The 19 page opinion is Smith v. D.R. Horton, Inc. (Lawyers Weekly, No. 010-052-16). A digest opinion is available at sclawyersweekly.com.

Follow Jeff Jeffrey on Twitter @SCLWJeffrey.