Arbitration and Home Improvement Contracts
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Arbitration and Home Improvement Contracts

February 2020 | By: Randy J. Heller, Esq.| GDB 2020 Winter Newsletter
Arbitration, as a dispute resolution mechanism, has a number of advantages going for it.  It is often more streamlined than litigation, with limited discovery and motion practice.  The arbitrator is usually an expert in the field.  Technical evidentiary rules are usually not invoked and greater flexibility is permitted in the scheduling and management of the hearings. 
 
In light of these advantages, it is not a surprise that arbitration clauses are often included in contracts, designating arbitration as the mandatory forum for resolving any disputes.  Courts favor arbitration as well, often granting motions to suspend litigation and sending the matter to arbitration whenever there is an arbitration clause in the parties’ agreement.
 
Given this widespread preference for arbitration, folks are sometimes surprised to learn that a New York statute prohibits the use of mandatory arbitration clauses in certain home improvement contracts.  A section of New York’s General Business Law (“GBL”) renders “null and void” any mandatory arbitration clause in an agreement for the sale or purchase of “consumer goods.”  While likely intended to protect consumers purchasing defective products from having to pursue a claim for personal injury in a forum without a jury of its peers, the statute has been construed to apply to the purchase of services as well—including home improvement contracts and architectural services.
 
The upshot of this law is that a home improvement contractor or architect designing a personal residence may not enforce a mandatory arbitration clause in its contract.  While the homeowner is free to consent to arbitration, and voluntarily appear, the contractor or architect cannot force the homeowner to give up its right to litigate in court.
 
This situation recently arose in a case concerning the renovation of a home in Sag Harbor.  When the homeowner discovered that the contractor had been submitting improperly inflated invoices from subcontractors in a scheme to receive kickbacks, the homeowner sued the contractor in court.  The contractor sought to suspend the litigation on the grounds that the contract contained a mandatory arbitration clause.  The court held that such a clause violated the General Business Law and was null and void.
 
But that raised another issue which works hand in hand with the NY law.  The Federal Arbitration Act (“FAA”) also addresses arbitration throughout the United States and strongly encourages the use of that forum.  Prior case law indicated that the FAA preempts contrary state laws (such as the GBL, here) where there is evidence that the contract affects “interstate commerce.”  If the contractor could demonstrate that the Sag Harbor renovation affected interstate commerce, the FAA would preempt the state law prohibiting mandatory arbitration, and the litigation would be suspended.
 
The court reviewed the circumstances and found that the contractor and its subcontractors were all local entities with no multi-state or national presence; the scale and scope of the work to be performed was not of such magnitude as would affect interstate commerce; and while some of the materials used in the renovation were sourced and secured from out-of-state suppliers, that factor alone, especially in the context of a single-family home renovation, was insufficient to establish an effect on interstate commerce.
 
Thus, under the circumstances, the FAA did not preempt the NY law, and the mandatory arbitration clause was unenforceable.
 
There is one interesting wrinkle to this prohibition against mandatory arbitration clauses which, while not germane to the case discussed here, might be applicable from time to time.  The Consumer Arbitration Rules of the American Arbitration Association themselves provide that a case fully within the jurisdiction of the Small Claims Court (now under $10,000) may be brought directly in Small Claims Court without having to go to arbitration if (1) the contract terms were non-negotiable (say where a “form” contract is imposed on the homeowner) and (2) the services were a “standardized consumer service” (which may be more applicable in the setting of a home inspection than the construction itself).  In such a scenario, even where arbitration itself is permitted, it may yet be pursued in Small Claims Court.
 
If consumers are intent on providing for arbitration in their contracts, they need to plan in advance an effective strategy for doing so, keeping an eye on ways in which their construction might affect interstate commerce.