Louisiana Court Invalidates Arbitration & Delegation Clauses in Residential Sale Contract

What Do You Need to Know?

• Arbitration clauses that reference the “AAA Construction Industry Arbitration Rules” are unenforceable if the contract does not define “AAA” or if the Construction Industry Arbitration Rules are not provided to lay homeowners.

• Incorporating a delegation clause by reference to external rules (such as the AAA Construction Industry Arbitration Rules) is insufficient to delegate threshold issues of arbitrability to an arbitrator, particularly when dealing with lay homeowners.

In Dixon, et al. v. D.R. Horton, et al., the 19th Judicial District Court issued a significant ruling addressing the enforceability of arbitration and delegation clauses in residential sale contracts. The court discussed three restrictions on arbitration and delegation clauses.

First, arbitration clauses that reference the “AAA Construction Industry Arbitration Rules,” but fail to define “AAA,” may be deemed unenforceable. Second, incorporating delegation clauses by reference to the AAA rules—without a clear explanation of the rules—does not delegate threshold issues of arbitrability to an arbitrator. Third, contracts cannot contain one-sided provisions that favor the builder without extending similar rights to the homeowner.

The decision is currently being appealed, we will provide a follow-up article on the appellate court’s ruling. For now, the trial court’s decision provides important guidance on contract formation, mutual assent, and the limits of arbitration and delegation clauses in residential sale contracts.

Background

The dispute arose from a class action filed by homeowners alleging defects in homes constructed and sold by the defendant builder. The builder sought to enforce the arbitration and delegation provisions contained in the sale contract. The homeowners challenged the validity of the arbitration and delegation provisions, as well as the enforceability of the underlying contracts.

The court ruled in favor of the homeowners, holding that neither the arbitration nor delegation clauses were enforceable. The court found three fatal flaws in the contract.

First, the arbitration clause referenced the “AAA Construction Industry Arbitration Rules” but did not define “AAA” and the arbitration rules were not provided to the homeowners, who were laypersons. Second, the delegation clause was not contained in the arbitration clause itself but instead was incorporated by reference to the AAA Construction Industry Arbitration Rules. Third, the contract contained numerous provisions favoring the builder, including unilateral rights to terminate, liquidated damages, and attorney’s fees, without extending those same rights to the homeowners. The key takeaways of this decision are summarized below.

Key Takeaways

The arbitration clause referred to the “AAA,” but did not write out the words “American Arbitration Association.” More specifically, the arbitration clause provided that “the buyer and seller agree to resolve such dispute . . . under the direction and procedures established by the AAA Construction Industry Arbitration Rules,” without defining what AAA stood for.

Furthermore, there was no evidence that the builder explained what “AAA” meant to the homeowners or provided them with a copy of the American Arbitration Association Construction Industry Arbitration Rules. The court explained that because the homeowners did not have the same industry knowledge as the builder, the contract should have defined “AAA”, and the builder should have provided the rules to the homeowners.

2. The delegation clause was not contained in the contract itself but instead was incorporated by reference to the AAA Construction Industry Arbitration Rules.

The builder argued that the validity and scope of the arbitration clause should be determined by an arbitrator, not the court, pursuant to a “delegation clause.” A delegation clause is a provision that delegates the issues of arbitrability, including the existence, scope, and validity of the arbitration clause, to an arbitrator rather than the court.

The builder asserted that reference to the AAA Construction Industry Arbitration Rules provided a “clear and unmistakable evidence of the parties’ intent” to delegate challenges regarding the existence, scope, and validity of the arbitration clause to the arbitrator. The court disagreed.

The court held that the reference to AAA rules did not constitute “clear and unmistakable” evidence of the parties’ intent to delegate issues of arbitrability to an arbitrator, particularly given the homeowners’ lack of industry knowledge and the absence of any explanation of the rules.

The court distinguished this case from others involving sophisticated parties, emphasizing that lay consumers must have clear notice and understanding of delegation provisions. The court also emphasized that incorporation by reference is insufficient to delegate threshold issues of arbitrability to an arbitrator, especially when the parties are not commercial entities and the rules are not explained or provided.

3. The contract contained numerous provisions favoring the builder, without reciprocal rights for the buyers.

The contract provided three rights to the builder that were not available to the homeowners.

First, the contract allowed the builder to terminate the contract simply based on “a bona fide dispute” between the builder and the homeowners, the contract gave no such remedy to the homeowners.

Second, the contract also gave the builder rights to liquidated damages and attorney’s fees that were not provided to the homeowners.

Third, the contract restricted the homeowners’ ability to record the contract in public records and allowed the builder to unilaterally terminate the contract if the homeowners attempted any such recordation. Therefore, the court held that provisions which favor one party and lack mutuality were unconscionable and inequitable.

Conclusion

This decision underscores the importance of clear, mutually agreed-upon contract terms and the risks associated with using standard form contracts, particularly in consumer transactions. The ruling also highlights the judicial scrutiny applied to arbitration and delegation clauses, especially where the parties have unequal bargaining power.

Builders and contractors should review their standard contracts to ensure compliance with these principles to minimize the risk of unenforceability in future disputes.

About Our Author

Evan Gaudet is a member of the Adams & Reese Litigation Practice Group. As an attorney in the firm’s Baton Rouge office, he represents clients in various areas of real estate, construction law, labor and employment, and commercial litigation. Evan is a former construction industry professional, he worked in the Environmental, Health, and Safety (EH&S) departments at Turner Construction Company and Excel Contractors.