Arbitration Clause in Residential Lease Agreements Now Void in California

Arbitration is an alternative for dispute resolution, but that’s about to change in California. Arbitration is a procedure that allows two parties to resolve disputes without going to court. Instead, concerned parties will involve a neutral third party called an arbitrator.  It is the arbitrator who will then make a recommendation or ruling based on the documents and evidence presented. 

What is the goal of arbitration?

The goal is to achieve a fair settlement and outcome favorable to both parties without needing a trial.

When parties enter an agreement, terms are laid out in a contract, signed and agreed upon by both parties. Failure to honor the terms of a contract or understanding gives both parties the right to seek legal action. But adding an arbitration clause in a contract offers a less costly and stressful alternative to litigation. 

In the case of landlord-tenant relationships, the landlord can add an arbitration clause to the residential lease agreement so that their case will be resolved through arbitration when disputes arise.

How arbitration works

The principal characteristics of arbitration are as follows:

• Consensual 
• Neutral 
• Confidential
• The parties choose the arbitrator
• The decision in arbitration is final and binding 

The pros and cons of an arbitration clause

There are clear advantages to adding an arbitration clause to your rental agreement and contracts. First, should a dispute arise, the clause allows you to take it out of the court system and force the other party to arbitrate. This procedure saves landlords time and money as legal fees can pile up when a dispute shows up in court. 

While parties don’t necessarily anticipate litigation when entering an agreement, disagreements can happen. But with an arbitration clause in the contract, landlords can avoid a trial by submitting the dispute to a neutral third party. 

The benefits of arbitration

Resolving a claim through arbitration has these benefits:

• The process is efficient and solved quickly. 
• The process is less complicated as both parties only need to produce documents for the attorneys to build arguments on
• Both parties will enjoy privacy as evidence, arguments, and resolutions can be made private.
• Arbitration can also be less biased as both parties get to decide on the “judge” or arbitrator.
• It’s also easier to achieve closure as binding arbitrations tend to have limited opportunities for further appeals.
• Depending on the severity of the case, the arbitration process can be less costly as it requires less preparation on the part of attorneys, which translates to lower billable hours.

The disadvantages of arbitration

Arbitration clauses can also be disadvantageous, which is why the California Court ruled that these clauses go against public policy under 1953. While arbitration, when done right, can benefit both parties, it comes with disadvantages, including:

• Questionable fairness is the primary concern as the resolution comes without a jury and judge. However, there’s also the possibility that the arbitrator could be biased or favor the side with more resources. 
• Lack of transparency may also be a concern as documents, evidence, and arguments are made private. This privacy means that the courts may not be able to review your case, making it vulnerable to bias. 
• Arbitration is binding. Finality may benefit some, but if the resolution isn’t favorable to you, you may not be able to file an appeal. 
• There are cases when arbitration may be costlier than litigation, as top-rated arbitrators tend to charge higher fees. 
• Lastly, arbitrations can be unpredictable as the rules of procedure and evidence tend to be more flexible. 

A new ruling in California

In California, landlords can include an arbitration clause in their residential lease agreements. If the tenant agrees to the clause and signs the contract, they voluntarily waive their right to a trial before a judge or jury. 

A recent ruling by the California Court of Appeals, Second District in Williams v. 3620 W. 102nd Street, Inc. has made this arbitration clause in residential lease agreements void and unenforceable as it is contrary to public policy. In making the decision, the California court cited two previous rulings from 2003 and 2020, which held that residential tenants should maintain their right to a jury trial in a lease agreement. 

The court held that arbitration clauses go against public policy given that they allow a lessee and lessor to agree that disputes “shall be submitted to arbitration instead of litigated in court.” Moreover, this protects tenants from unreasonable arbitration provisions that lack mutuality.

Arbitration clauses are contrary to public policy because there’s a risk of bias. For instance, a corporate landlord that owns thousands of properties could easily pool his resources to get an arbitrator to rule in their favor. Although the same landlord may have tens of thousands of tenants, the landlord has the collective purchase power that the arbitrator will see as a constant source of future business. 

That said, arbitration clauses in rental agreements tend to create unbalanced power. In contrast, this dynamic isn’t as problematic in arbitration agreements between individuals and employers or between consumers and businesses. For this reason, arbitration clauses are still allowed in other types of contracts. 

What does this mean for real estate investors?

The long and short of it is that the ruling limits the types of provisions real estate investors and landlords can include in their lease agreements. For one, they cannot require potential tenants to waive their procedural rights to assert a cause of action against the landlord.

However, it’s worth noting that there are still many provisions that protect landlords from losses. For instance, under the Civil Code, lessors have the right to evict a lessee who fails to pay rent. On the other hand, a lessee has the right to obtain damages if a tenant fails to maintain the property in livable condition. 

Final thoughts

For years, landlords have put arbitration clauses in their lease agreements to limit or reduce future legal fees. The recent decision from the California Court has changed that. Residential tenants can no longer waive their right to a jury trial. 

While arbitration has helped resolve disputes between lessees and lessors, it’s not a better alternative to litigation, as some conflicts require the established rules and procedures of the courts. However, when issues arrive at a resolution at the arbitration level, you get to save your time, money, and effort on pursuing a stressful legal case.