A recent Texas opinion revealed an interesting, and rather harsh, provision in an arbitration agreement. D.R. Horton-Texas, Ltd. v. Drogseth, No. 02–12–00435–CV (Tex.App.-Fort Worth July 3, 2013). Click here for a copy of the opinion. The case involved a dispute between a homebuyer and homebuilder for negligent construction. The trial court, without providing any reasons, refused to enforce an arbitration clause in the sales contract for the home. The appellate court reversed, finding that the plaintiff’s unconscionability arguments on appeal failed, and the appellate court held that the arbitration clause was enforceable.
There is nothing unusual about the judge’s opinion; it was a routine order compelling arbitration. But what caught my attention is the following clause in the arbitration agreement: “If Buyer does not seek arbitration prior to initiating any legal action, Buyer agrees that Seller shall be entitled to liquidated damages in the amount of Ten Thousand Dollars ($10,000.00).”
I have noticed similar liquidated damages provisions in a few other arbitration cases, but I do not believe such provisions are common. Especially in the wake of Concepcion, I would expect companies to include more consumer-friendly arbitration clauses so that companies can take advantage of class action waivers.
The Texas appellate court in this case explained that the defendant homebuilder had agreed in the lower court to waive enforcement of the liquidated damages provision. Thus, the legality or unconscionability of this provision was moot. (However, I have seen judges look unfavorably to a company’s after-the-fact attempt to waive a harsh arbitration term, particularly in the context of arbitration fees.) The Texas appellate court noted in dicta that had the waiver not taken place, and further assuming that the liquidated damages provision was unconscionable, the provision could be severed from the rest of the arbitration agreement.
The Texas appellate court did not rule on whether the liquidated damages provision was unconscionable or enforceable. I suspect that the homebuilder here included the liquidated damages clause to scare off parties from challenging the arbitration clause in court. Under the right circumstances, with a negotiated arbitration agreement voluntarily entered into between two parties of relatively co-equal bargaining power – which is not the case here – I suspect a court may be willing to enforce such a liquidated damages provision.
This liquidated damages provision in this case reminded me of the pre-1920 status of arbitration agreements. Before the rise of modern arbitration laws during the 1920s, courts would generally refuse to compel specific performance of an arbitration agreement. There are court opinions from the 1800s and early 1900s recognizing that only nominal damages would be available for a breach of an arbitration agreement. To encourage compliance with arbitration agreements, parties would sometimes resort to creative measures because specific performance was not a remedy. For example, in the context of trade associations, trade associations would try to punish members who refused to honor arbitration agreements by kicking them out of the organization and/or shaming them by notifying the other members about the refusal. Also, because of the refusal of courts to order specific performance of an arbitration agreement, I have seen some pre-1920 treatises recommended the use of liquidated damages provisions for the failure to honor an arbitration agreement, just like the provision in the recent Texas D.R. Horton case. Nihil novum sub sole!