Contract drafters beware!

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SC Supreme Court invalidates builder arbitration clause … and refuses to enforce the severability provision

It’s rare that we read the Advance Sheets and pause to say “wow”, but this is one of those cases! Damico v. Lennar Carolinas, LLC* is a construction defect suit brought by a number of homeowners against their homebuilder and general contractor, Lennar Carolinas, LLC. The case involves new homes in The Abbey, a subdivision in the Spring Grove Plantation neighborhood located in Berkeley County, consisting of 69 single-family homes constructed between 2010 and 2015. The suit alleged, among other things, negligence, breach of contract, and breach of various warranties.

Lennar moved to compel arbitration. The Circuit Court denied the motion to compel, finding the contracts were grossly one-sided and unconscionable and thus the arbitration provisions were unenforceable. The Court of Appeals reversed, citing a United States Supreme Court case** that forbids consideration of unconscionable terms outside of an arbitration (the Prima Paint doctrine).

The South Carolina Supreme Court agreed with the Court of Appeals that the Circuit Court violated the Prima Paint doctrine but agreed with the homeowners that the arbitration provisions, standing alone, contain a number of oppressive and one-sided terms, thereby rendering the provisions unconscionable and unenforceable.  The Court further declined to sever the unconscionable terms from the remainder of the arbitration provisions.

The Court denied severability for two reasons. First, enforcing the severability provision would have required the Court to blue-pencil the agreement regarding a material term of the contract, a result strongly disfavored in contract disputes. Second, as a matter of policy, The Court found severing terms from an unconscionable contract of adhesion discourages fair, arms-length transactions.

The Court said that if it honored the severability clause in such contracts, it would encourage sophisticated parties to intentionally insert unconscionable terms—that often go unchallenged—throughout their contracts, believing the courts would step in and rescue them from their gross overreach. This is not to say, according to the Court, that severability clauses in general should not be honored, because the courts are constrained to enforce a contract in accordance with the parties’ intent.

Rather, the Court said it merely recognized that where a contract would remain one-sided and be fragmented after severance, the better policy is to decline the invitation for judicial severance.

I read this case to be a clear message to lawyers that it doesn’t pay to be too clever in drafting contracts.

The Court defined unconscionability to mean the absence of meaningful choice on the part of one party because of one-sided contract provisions, together with terms that are so oppressive that no reasonable person would make them and no fair and honest person would accept them. The touchstone of the analysis begins with the presence of absence of meaningful choice coupled with unreasonably oppressive terms.

What was so horrible about the contract in question?

One provision gave Lennar the sole discretion to include or exclude its contractors, subcontractors and suppliers, as well as any warranty company and insurer as parties in the arbitration. The Court said that it is a fundamental principle of law that the plaintiff is the master of the complaint and the sole decider of whom to sue for the injuries. Giving Lennar the “sole election” to include or exclude parties strips the homeowners of that right, according to the Court. Taken to its logical conclusion, this provision could require homeowners to litigate with some defendants and arbitrate with others.

Another provision said the homeowners “expressly negotiated and bargained for the waiver of the implied warranty of habitability (for) valuable consideration…in the amount of $0.”

Similarly, the contract specifically stated that the “(l)oss of the use of all or a portion of your Home” is not covered by its warranty to new homebuyers.

Another provision stated, “(T)his Agreement shall be construed as if both parties jointly prepared it”, a blatant falsehood, according to the Court, “and no presumption against one party or the other shall govern the interpretation or construction of any of the provisions of this Agreement.”

The Court found that these and other terms of the contracts to be absurd, factually incorrect, and grossly oppressive.

The Court pointed to the fact that Lennar is significantly more sophisticated than the consumer homeowners, creating a disparity in the parties’ bargaining power and that South Carolina has a deeply-rooted and long-standing policy of protecting new home buyers.

The Court said, “It is clear that Lennar furnished a grossly one-sided contract and arbitration provision, hoping a court would rescue the one-sided contract through a severability clause. We refuse to reward such misconduct, particularly in a home construction setting.”

WOW!

Lawyers who represent consumers should wave this case in the face of parties who claim contracts can never be negotiated. Every contract can be negotiated, and this case is clear evidence that this fact is true in South Carolina. Consumer lawyers, this is your case!

*South Carolina Supreme Court Opinion 28114 (September 14, 2022)

**Prima Paint Corp. v. Flood & Conklin Mfg. Co, 388 U.S. 395 (1967)

Court of Appeals Revises Opinion, but not Result, in Arbitration Case

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It seems the arbitration cases are all over the place in 2016. We’ve discussed three cases so far this year*, and the opinion in one of these cases has been withdrawn, substituted and refiled**, but the result did not change.

The South Carolina Court of Appeals decided to make a few changes in its opinion in One Belle Hall. The earlier opinion, filed June 1, held that an arbitration clause in a roofing supplier’s warranty provision was not unconscionable. The trial court had ruled that the supplier’s sale of shingles was based on a contract of adhesion and that the injured property owners lacked any meaningful choice in negotiating the warranty and arbitration terms, which were contained in the packaging for the shingles.

The Court of Appeals indicated that the underlying sale was a typical modern transaction for goods in which the buyer never has direct contact with the manufacturer to negotiate terms. The Court found it significant that the packaging contained the notation: “Important: Read Carefully before Opening” providing that if the purchaser is not satisfied with the terms of the warranty, then all unopened boxes should be returned. The Court pointed to the standard warranty in the marketplace that gives buyers the choice of keeping the goods or rejecting them by returning them for a refund, and blessed the arbitration provision.

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In the later opinion, filed September 28, the Court of Appeals addressed the South Carolina Supreme Court’s July 6, 2016 opinion in Smith v. D.R. Horton (cited in the footnote, below). In D.R. Horton, which this blog discussed on July, 14 the Supreme Court held that a national residential company’s contract contained a number of “oppressive and one-sided provisions”, including an attempted waiver of the implied warranty of habitability and a prohibition of awarding money damages of any kind. The Supreme Court held that the home purchasers lacked a meaningful ability to negotiate their contract, the only remedy through which appeared to be repair and replacement.

The difference in the two cases appears to be the location of the offending provisions. The United States Supreme Court has ruled that an arbitration agreement is separable from the contract in which it is embedded, and the issue of its validity is distinct from the substantive validity of the contract as a whole.*** The arbitration provision in D.R. Horton was construed in its entirety because various subparagraphs addressed warranty information and contained cross-references to each other. In addition, the contract did not contain a severability clause.

In the second opinion in One Belle Hall, the Court of Appeals admitted, as the supplier had conceded, that the agreement at issue was a contract of adhesion, but noted that our Supreme Court has stated that adhesion contracts are not per se unconscionable. The Court recognized that the roofing supplier’s contract continuously used language to the effect that any attempted disclaimer or limitation did not apply to purchasers in jurisdictions that disallowed them. The Court also found it significant that the agreement contained a severability clause.

In other words, since the objectionable provisions of the contract were outside the arbitration provision, and the arbitration provision is severable from the objectionable provisions, the arbitration clause is enforceable. The Court repeated its earlier point that the arbitration provision facilitates an unbiased decision by a neutral decision maker in the event of a dispute.

I believe we will see more of these cases, and I caution lawyers to be extremely careful in their drafting endeavors.

 

*  One Belle Hall Property Association v. Trammel Crow Residential Company, S.C. Ct. App. Opinion 5407 (June 1, 2016); Smith v. D.R. Horton, Inc., S.C. Supreme Court Opinion 27642 (July 6, 2016); and Parsons v. John Wieland Homes, S.C. Supreme Court Opinion 27655 (August 17, 2016).

**  One Belle Hall Property Association v. Trammel Crow Residential Company, S.C. Ct. App. Opinion 5407 (September 28, 2016)

***  Prima Paint Corporation v. Flood Conklin Mfg. Co., 388 U.S. 395 (1967)