Hidden Dangers to Arbitration in Real Estate Contracts

By Michael Repka, Esq.

When looking to buy or sell real estate, many clients ask their real estate agent whether they should initial the arbitration provision. If initialed by both sides, this provision binds the parties to arbitrate most disputes that arise under the contract. Realtors® typically respond in one of two ways: (1) they tell the clients that they do not have the requisite legal knowledge to competently answer that question, which leaves clients to select or reject arbitration with no guidance whatsoever; or (2) they simply tell the clients that arbitration is quicker and less expensive than litigation. Unfortunately, depending on the facts, the opposite may be true. This article will look at some of the pros and cons of arbitration and will point out one major challenge that often goes unconsidered.

What is Arbitration?

Arbitration is simply an alternative form of dispute resolution that generally reduces the involvement of the court system. Arbitration usually takes place after the parties have failed to reach a settlement through negotiation and/or voluntary mediation. Arbitrated disputes are heard by an independent arbitrator selected by the parties.

In real estate, the arbitrators are usually retired judges or highly qualified and respected real estate attorneys. The arbitration process is less formal than a courtroom hearing or trial, but more formal than mediation or negotiation. The parties may, and generally do, hire legal counsel to represent them throughout the arbitration process. The arbitrator considers the relevant facts and evidence of the case, listens to arguments, and renders a decision. The award in binding arbitration is final and binding on the parties. It may not be reviewed or overturned by a court except in very limited circumstances, such as when fraud, corruption, or misuse of power has been involved. Neither the trial court nor an appellate court provide recourse for a party that feels that the decision is wrong, even if the arbitrator made a mistake as to the facts or law.

Generally, this process is a less expensive and more efficient way to settle a dispute between two parties when compared to filing a lawsuit with the court. There is, however, a hidden pitfall that many are not aware of – namely third parties, such as real estate agents involved in the transaction, are not a party to the contract so they cannot be compelled to arbitrate.

What most Realtors® fail to realize, or disclose, to their clients is that the Realtors® are not required to participate in arbitration proceedings between clients. Therefore, disputes that involve the sellers, the buyers, and could involve one or more of the Realtors® (e.g., the listing agent or buyers’ agent) would need to go through both arbitration and litigation, unless the Realtors® agree to participate in the arbitration. Thus, the expense could be dramatically higher because of this doubling up of arbitration and litigation. This extra cost causes many clients to leave Realtors® out of disputes even if they have some level of culpability, and they may have carried a share of the financial resolution if they could have been forced to participate. On the other hand, had the parties opted not to initial the arbitration paragraph, the aggrieved party could name anyone responsible for the issue, including the Realtors®, in a lawsuit.

Naturally this problem could be solved if the Realtors® agree, in writing, that they will participate in any future arbitration in which their clients are named. When selecting a Realtor®, it may be beneficial to have this discussion with them upfront. Some managing brokers and individual real estate agents will agree to participate in any future arbitration despite the fact that they are not a party to the contract.

Another disadvantage to arbitration is that arbitration awards are not self-executing. In other words, the prevailing party may be forced to go to court to confirm the award, after which they could use all the ordinary means to collect on the judgment.

What is Litigation?

Litigation is what we all imagine when we think of going to court — lawyers, briefcases, marble, motions, objections, delays, and lots of money. In light of the overburdened court system, litigation can take well over a year to resolve a relatively straightforward matter. However, litigation is fairly predictable because of a concept known as stare decisis, which means that judges’ current decisions are based on established cases that have come before. Therefore, a review of old cases should give an indication of how the judge will decide a current case.

Another advantage to litigation is that parties named in the lawsuit have the opportunity to appeal an incorrect decision. While this adds an additional level of expense and considerable time, it also provides comfort for parties that are worried about an incorrect or unjust decision at the trial court level.

Making a Compelling Offer

Although buyers may want to ask their Realtors® to agree to participate in any future arbitration, they may want to be cautious about demanding the same from their listing agent because doing so could create a bias against their offer. Some brokerages may simply refuse to make this concession out of their own self-interest. Thus, the seller may select another offer that does not ask the listing agent for this concession.

There are certainly advantages and disadvantages to selecting arbitration; however, there is no one right answer that fits all circumstances. In making the decision as to what is right, the clients should consider whether they are the buyers or sellers, the likelihood of litigation, the likelihood of litigation that will also involve either the listing agent or the buyers’ agent, and the desire for a competitive offer. You should discuss these issues in depth with your Realtor® and/or a qualified real estate attorney well in advance of making an offer.