Hidden Dangers to Arbitration in Real Estate Contracts

When individuals are considering buying or selling real estate, they often turn to their agent for advice on whether to initial the arbitration provision.

If both parties initial this provision, it binds them to arbitrate most disputes arising under the contract. Realtors® typically respond in one of two ways: either they admit they lack the requisite legal knowledge to competently answer that question, leaving clients to select or reject arbitration without guidance; or they simply state that arbitration is quicker and cheaper than litigation. Unfortunately, depending on the circumstances, the opposite may be true. This article will examine some of the pros and cons of arbitration and shed light on a major challenge that is often unconsidered.

What is Arbitration?

Arbitration is simply an alternative form of dispute resolution that generally reduces the involvement of the court system and usually takes place after the parties have failed to reach a settlement through negotiation and/or voluntary mediation. Arbitrated disputes are adjudicated by an impartial arbitrator selected by the involved 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 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 resolving disputes between two parties compared to filing a lawsuit in court. Nonetheless, there exists 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 many Realtors® fail to realize, or omit to disclose to their clients, is that the Realtors® are not obligated to participate in arbitration proceedings between clients. Therefore, disputes involving sellers, buyers, and potentially one or more of the Realtors® (e.g., the listing agent or buyer’s agent) could need to go through both arbitration and litigation, unless the Realtors® agree to participate in the arbitration.

This dual process can significantly escalate expenses, as it entails both arbitration and litigation costs. This additional financial burden causes many clients to leave Realtors® out of disputes, even if they have some level of culpability, potentially relinquishing a portion of the financial resolution that they might have been compelled to contribute.

Conversely, if the parties had chosen not to initial the arbitration paragraph, the aggrieved party could include any responsible party, including the Realtors,® in a lawsuit. Another drawback of arbitration is that arbitration awards are not self-executing. This means that the prevailing party may have to resort to court proceedings 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 a good courthouse movie, L.A. Law or Perry Mason. Given the strain on the court system, it can take well over a year to resolve even a relatively straightforward matter. However, litigation offers predictability due to the principle of stare decisis, whereby judges based their current decisions on established precedents from previous cases. Therefore, a review of past cases can offer insight into how a judge might rule on a current case.

Another advantage to litigation is that parties named in the lawsuit have the opportunity to appeal an erroneous decision. While this adds extra expense and considerable time, it also provides reassurance for parties concerned about potential errors or an unjust decision at the trial court level.

Making a Compelling Offer

Although there may be many reasons why both buyers and sellers might prefer to opt for litigation over arbitration, this election could be viewed as a sign that the party requesting litigation is litigious or difficult, which could weaken their offer. Additionally, despite the potential benefits to both the buyer and the seller, the agents involved may not explain the request in its best possible light out of self-interest or unfamiliarity with this nuanced choice.

Choosing arbitration entails both advantages and disadvantages, but there is no one-size-fits-all solution. When deciding what is best, clients should take into account whether they are buyers or sellers, the likelihood of litigation, the potential involvement of the listing agent or the buyer’s agent in litigation, and the desire for a competitive offer. It’s essential to have in-depth discussions about these matters with your Realtor® and/or a qualified real estate attorney well before making an offer.

By Michael Repka, Esq.


Michael Repka | michael@deleonrealty.com Tel: 650.405.4631