The kindest word John Burchfield has for the statement that homeowners can't win in arbitration is "absurd.""To say consumers don't win in arbitration is so false, it's not even funny," says Burchfield, general counsel for private Texas builder David Weekley Homes. "Most of the time the homeowner does recover an award in arbitration, so to say they don't win is absurd."
Win or lose, arbitration has become one of the more controversial practices in home building today. The process, first adopted in the home building industry by U.S. Home (now part of Lennar Corp.) in its contracts in 1989, requires dissatisfied buyers to resolve disputes with their builder outside of court, in a private hearing before a third party. But arbitration has become much more widespread in recent years, as builders--often required by their insurance companies--embrace it as the answer to soaring litigation and insurance costs. States have even incorporated the practice in right-to-repair laws that give builders the chance to fix defects before a customer can sue.
As arbitration has spread, though, so has consumer opposition, spurred by the appearance of arbitration clauses in contracts for everyday basics such as cell phones and credit cards. Consumer advocates argue that arbitration, initially developed to resolve disputes between businesses, is unfair to consumers, who have often signed away their right to sue the moment they agree to purchase a home or pick a cell phone provider, long before they encounter any problem that might warrant arbitration or litigation. Then, if they do try to arbitrate, consumer groups say, buyers face a process that is biased against them and tilted in favor of the industry they are challenging. "[Arbitration in home building contracts has] always been sort of controversial, but the consumer movement has brought it to the forefront," says Robert E. Mead, vice president of New York-based American Arbitration Association.
So have some recent court cases involving builders. In Texas, an unhappy buyer is suing KB Home, asking the court to lift the mandatory binding arbitration clause in his contract given the long-running Federal Trade Commission consent decree that some believe does not allow KB to use arbitration. (See "New Rules".)
KB isn't the only one encountering arbitration opposition. So is David Weekley Homes, which has been fighting a case involving a family that says their new home made them sick. The buyers also say they had no idea they'd given up their right to sue by signing a contract containing an arbitration clause. The latest wrinkle? A Texas court decision requiring the parents (who signed the contract) to arbitrate with the builder, but allowing their young children to sue.
A better way
Builders who use arbitration all give the same reason for adopting the practice: They wanted a better, faster way for addressing customer disputes.
"Our purpose was to provide a reasonable method of dispute resolution," says Burchfield of David Weekley Homes, which began using arbitration in 1993. "At that time, a civil court case was taking four, five, six, seven years to get to trial. The relationship [with the customer] completely deteriorated."
In contrast, many arbitrations are completed within several months of filing, whether by settlement or voluntary withdrawal of the case. The arbitration hearings themselves are quicker too, lasting perhaps a day or two compared to one to two weeks for a trial. "I think most people are not aware of how much time it takes to be a plaintiff in a construction-defect case," says Jeffrey Masters, an attorney at Cox, Castle & Nicholson, a Los Angeles firm that represents builders in construction-defect suits.
Speed is one of the reasons the NAHB recommends arbitration to its members. "Arbitration cuts down on the amount of discovery, you get before an arbitrator more quickly, and you don't have the right of appeal," says David Jaffe, staff vice president, construction liability.
Other aspects of arbitration are also attractive to builders. While arbitrators can award punitive damages, just as the courts could, awards in home building arbitrations tend not to approach the jaw-dropping amounts sought or provided in jury trials, perhaps because the size of the claim affects the administrative fees participants must pay.
That said, the amount of those awards can be as unpredictable as the reasoning behind them is unfathomable. "That's the biggest complaint I've heard from attorneys who practice before arbitrators on a regular basis--that arbitrators pull the numbers out of air, and the attorneys can't figure out where those numbers came from," says Jackson Williams, legislative counsel for Public Citizen, a Washington-based consumer advocacy group that has expressed concerns about the use of arbitration in consumer contracts.
Arbitrations are private, so decisions aren't really part of the public record (and potentially precedent-setting) in the same way court cases are, although states are starting to press for more openness. A new California law, for example, requires arbitration providers to disclose data on consumer/business arbitrations. The American Arbitration Association releases these national numbers quarterly for the cases it handles, but getting actual new-home arbitration statistics is difficult. The database only provides limited details on the cases.
Arbitrations also aren't open to the media in the same way trials are, although builders say that doesn't affect their decision to arbitrate rather than litigate. "You'll hear about sensational arbitrations in the media [just as you would with a court trial] so that's not a factor for us," says Brian Woram, senior vice president and general counsel for Centex Homes, which first began using arbitration widely in 1996. "If there's bad news out there, it's going to make it into the media."
Arbitrators are also generally more familiar with real estate and construction issues than the average jury. While many arbitrators are retired judges, others are real estate lawyers, architects, engineers, and others with an industry background complemented by arbitration training.
But the very reasons builders like arbitration--knowledgeable arbitrators, reasonable decisions, a streamlined process--alarm consumer advocates. They worry about arbitrators' potential conflicts of interest, the limitations on consumers' ability to discover evidence or documents that could bolster their case, and the relatively short amount of time allotted to resolve complicated construction-defect and personal injury claims. While arbitration might be fine for resolving simple disputes, such as dishes broken during a move or a used car that proves to be a lemon, consumer groups say other situations are more justly decided in court.
"I'm not saying consumers can't get a fair result in arbitration with a business. I'm just saying it's highly unlikely," says Williams. "The two sides have unequal bargaining power. Anytime you have that, you have the opportunity for bias."
Last year, Public Citizen released "The Costs of Arbitration," a report challenging many of the common assertions about arbitration and the benefits to consumers. Among its targets: the cost savings of arbitration.
According to the report, the "forum costs" for an arbitration--the filing fees, arbitrator fees, and other related charges that are required to initiate an arbitration--far exceeded the equivalent charges for filing and handling a similar case in civil court. (For example, parties in a lawsuit don't have to pay to rent a courtroom or hire a judge to hear a case as they do in an arbitration.) Depending on the arbitration organization, these "forum costs" of arbitration for a consumer ran roughly 2,000 percent to 5,200 percent higher than suing in court for an $80,000 consumer claim such as a defective house.
(Public Citizen did not calculate the accompanying legal fees for either the consumer or business involved in such a dispute.)
In addition, many of these arbitration fees need to be paid up front, out of a consumer's pocket. Since these fees are generally more costly than court filing fees, that means it can be more expensive initially for consumers to demand an arbitration than it would be for them to sue. Consumer groups say those costs are an unfair burden on consumers, who may not be able to afford to file for arbitration to resolve their problems. "People just don't go through it," Williams says. "Attorneys say, 'Don't waste your money. You're just throwing good money after bad.'"
Those concerned about the overall process are equally wary of the arbitrators themselves. While the American Arbitration Association (which is commonly used by builders) provides both parties with a list of arbitrator candidates and then expects the two sides to agree on one, consumer and homeowner groups say the pool of arbitrators is inherently biased toward the industry. One recent Texas home building arbitration case decided in the builder's favor involved an arbitrator who turned out to have closer ties with the local home building community than the homeowners or their attorneys realized. The situation resulted in protests that the arbitrator had not fully disclosed his potential conflicts of interest.
Balancing the scales
While builders remain strong arbitration supporters, the consumer groups' charges that the process is unfair have not been ignored by the home building or arbitration industries. "Arbitrating with Centex Homes is not that situation," says Woram. "We have taken pains to create an arbitration process that is fair for consumers."
So does the American Arbitration Association, it says. "We spend an inordinate amount of time on [residential construction arbitration] because it is controversial," says Mead. "It's a small number of cases relative to the amount of attention paid to it."
In response to charges that arbitrators too often came from the construction industry, the organization three years ago began recruiting consumer lawyers to join the pool. It also added people willing to serve at no charge, in an effort to make arbitration less expensive for consumers. Finally, the group slightly revised the rules for residential construction disputes, which had been governed by rules (and fees) intended for the commercial construction industry.
Those changes include some limitations on the fees paid by the consumer. Under the new supplementary residential construction rules, consumers only need pay $125 in arbitrator fees for disputes with claims of $10,000 or less. If their claim is more than $10,000, then they still must follow the construction industry rules.
Builders say they've changed their policies, too. Lennar, for example, will pay the full cost of one day's mediation and, after a homeowner pays the first $750 of any filing fee, will cover the next $2,000. It also allows buyers with claims of $10,000 or less to choose small claims court over arbitration. If a Centex Homes buyer doesn't plan to have an attorney present at a fairly simple arbitration, the builder will offer to forgo legal representation at the hearing as well, sending a Centex employee familiar with the case instead. Centex says it will split the fees 50-50, from the filing fee to the arbitrator's charges.
Despite all the attention paid to arbitration and its consequences, though, builders say the actual occurrences are rare. (Most cases settle before an arbitration hearing is held.) Lennar, on track to deliver more than 30,000 homes this year, goes through perhaps 20 to 30 arbitrations annually, according to Steven Lane, associate counsel. At Centex Homes, which closed more than 26,000 homes in fiscal 2003, maybe a dozen construction-defect disputes have had to be resolved in arbitration or court during the past few years. Even at David Weekley Homes, which is currently appealing aspects of the controversial parent/child arbitration case to the Texas Supreme Court, arbitrations happen once or twice a year. (The builder is challenging a denial of its motion to compel arbitration in that case.)
"To us, arbitration is the last resort," Lane says, echoing his colleagues. "We don't want to go to arbitration to resolve a dispute. Our desire is to resolve any disputes informally or by going through mediation. We don't like to have third parties of any kind decide our fate."
That's because, contrary to popular perception, builders don't always prevail. "I can only think of one arbitration within the past 12 months where the homeowner did not receive any award," Lane says. "In every other case, the homeowner was awarded something--maybe not everything the homeowner wanted but something. Homeowners don't always receive everything they want from a jury either."
All the controversy surrounding arbitration means that builders who use it must be scrupulously careful in implementing it. Mead remembers a financial services company that spent thousands of dollars notifying its existing customers by mail that it would now be using arbitration. "No one attacked it," he says, because of the care and effort the company took in explaining the policy to its customers. "If you want to be really bulletproof, that's how you do it."
Builders don't necessarily need to send letters, but they do need to ensure that customers understand the implications of signing a contract containing an arbitration clause. That can be accomplished by highlighting the clause in the document and providing more information through a Web site or a brochure, as Centex does.
Builders should also take a careful look at the American Arbitration Association's residential construction rules, which are designed for new-home disputes. While incorporating those guidelines doesn't guarantee freedom from criticism (some groups say the rules don't do enough to protect buyers), they provide a more reliable legal framework than companies might devise independently. One common temptation for builders: eliminating the possibility of punitive damages, which courts can award if they want to punish a company for its actions.
But using arbitration to take away an accepted court remedy is unwise, home building lawyers say, and only supports the perception that arbitration is unfair to buyers. "The mistake some builders have made [regarding arbitration] is they try to draft provisions to exclude punitive damages. That's not what we do. All we do is change the forum for the dispute resolution," says Lane. "[Excluding punitive damages is a bad idea] because you're giving courts a reason to strike down the arbitration provision and refuse to enforce it. When you start to unlevel the playing field, you're taking a big chance."
So are those builders who find themselves actually facing an arbitration hearing. Despite the charges of bias in the system, home building lawyers hardly welcome the idea of going to arbitration. Instead, they strongly advise trying to settle one last time. "If you're going to arbitration, you need to recognize that there are two sides to every story, theirs and yours," Woram says. "You need to take a hard, fresh look at the disagreement from the customer's perspective and go the extra mile to resolve the disagreement outside of arbitration."
That's because at some level, everyone loses when a customer service problem reaches that level of antagonism and frustration. "Whether it's a court trial or an arbitration, it costs us," Burchfield says. "There's the cost of the defense and the loss of a good relationship with a customer. It's expensive either way you go. It should be avoided at all costs."