Litigation and Arbitration Update

Arbitration has become a “hot–button topic” for the Texas Supreme Court, which last week decided Perry Homes, et al. v. Cull, the third arbitration related opinion for this term, with as many as four more arbitration cases to be decided.  In this case, a divided court held that plaintiffs had waived their clear contractual right to arbitration by invoking the litigation process, rather than arbitration, to the prejudice of the defendants.

In the underlying case, the plaintiffs bought a home and a homeowner’s warranty.  The warranty included a broad arbitration clause making all disputes subject to the Federal Arbitration Act.  After the home suffered serious structural and drainage problems, the homeowners sued the home builder and warranty company.  One defendant immediately requested arbitration, the homeowners vigorously objected to it, but no one ever asked the trial court for a ruling.  Over the next 14 months, the plaintiffs sought extensive discovery from the defendants.  On the eve of trial, the plaintiffs changed their minds about litigating and asked the trial court to compel arbitration under the same contract clause to which they had originally objected.  The trial court ordered arbitration, and almost a year later the arbitrator awarded the plaintiffs approximately three times the purchase price of their home in actual damages, punitive damages, and attorney’s fees.  The defendants moved to vacate the award, arguing that the plaintiffs had waived their right to arbitration after so much litigation activity in court.  The trial court confirmed the award and the Fort Worth Court of Appeals affirmed the trial court.

The Texas Supreme Court reversed the court of appeals, vacated the arbitration award, and remanded the case to the trial court for a prompt trial, finding that the plaintiffs had waived their right to arbitration.  All nine of the justices agreed that longstanding Texas law provides that a party can waive an arbitration clause by substantially invoking the judicial process to the other party’s detriment or prejudice.  The court noted, however, that the presumption against waiver of arbitration is so strong that to date the Texas Supreme Court had never found such a waiver, and had held in a series of at least eight previous cases that parties did not waive arbitration by merely engaging in such litigation activities as filing suit, filing motions, seeking removal to Federal Court, conducting discovery, including interrogatories, request for production and depositions, and opposing discovery.

The court stated these key points regarding waiver:

  1. Waiver of arbitration involves substantial invocation of the litigation process.
  2. However, “substantial invocation” is not susceptible to a black and white test.  It requires a case-by-case analysis and depends on context and the “totality of the circumstances”:  four depositions may be all that are needed in one case but purely preliminary in another.
  3. Waiver cannot occur unless the opposing party suffers prejudice as a result.
  4. The opposing party has the burden to prove the prejudice.

By a slim majority of five justices, the court held that the plaintiffs substantially invoked the litigation process to the prejudice of the defendants.  The court found most significant:

  1. When the defendants initially requested the court to order the case to arbitration, the plaintiffs filed a 79 page response in opposition.
  2. While in litigation, the plaintiffs conducted extensive discovery on every aspect of the merits of the case, including numerous depositions, requests for production, and five motions asking the court to compel discovery from the defendants.
  3. The plaintiffs moved for arbitration very late in the trial process, 14 months after filing suit and on the eve of trial, justifying their change of heart on the basis that they wanted to avoid the delays of an appeal.

The majority had little problem finding that the plaintiffs’ conduct prejudiced the defendants.  They focused on the “inherent unfairness” of a party attempting “to have it both ways by switching between litigation and arbitration to its own advantage.”  The majority specifically pointed out that the plaintiffs obtained significant discovery under one set of rules and then sought to arbitrate the case under other rules:

They got the court to order discovery for them and then limited their opponents’ rights to appellate review.  Such manipulation of litigation for one party’s advantage and another’s detriment is precisely the kind of inherent unfairness that constitutes prejudice under federal and state law.

Four justices filed two dissenting opinions.  While agreeing that the plaintiffs had substantially involved the litigation process, one of the dissents argued that the defendants had not met their burden to prove that they were prejudiced or that the plaintiffs had obtained an unfair advantage.  The other dissent argued that the standard of review was abuse of discretion and the record was not sufficient to conclude that the trial court acted arbitrarily or abused its discretion in ordering the case to arbitration.

Bottom Line

While arbitration clauses will continue to be favored by courts, such favor is not absolute.  For the first time the Texas Supreme Court has determined that the conduct of a party was sufficient to create a waiver of the right to arbitration.  While in this case the conduct was extreme, future decisions may lower the bar.  If arbitration is important to your resolution of a dispute, do not allow litigation to linger without taking quick action to move your case to arbitration.  Conversely, if avoidance of arbitration is your strategy, work the litigation process as much and as long as you can.