Appraisals and Arbitrations: A Warning Note

Your client is leasing her building and giving the tenant an option to buy it.  The purchase price upon exercise of the option is the then-fair market value of the property.

Your client is leasing his building and the tenant is given the right to extend the term of the lease at the then-fair market rent for the space.

The option agreement or lease provides that, if the parties, upon the tenant’s exercise of the right to buy or extend, cannot agree on the fair market value or rent, then the fair market value or rent will be determined by an appraisal.

The time comes and the tenant gives notice of the exercise of the option.  Your client and the tenant cannot, however, agree on the purchase price or rent, so the parties engage an appraiser and the appraiser renders an opinion of the fair market value.  The tenant, however, doesn’t like the appraiser’s opinion, and insists that the fair market value or rent is lower, so litigation ensues.

Surprise!  Under California law, the appraisal process for resolving the parties’ dispute over the fair market value of the property is an arbitration.  The California Arbitration Act, in Code of Civil Procedure §1280(a), defines an “Agreement” to include “agreements providing for valuations, appraisals and similar proceedings…”  In Klubnikin v. California Fair Plan Assn. (1978) 84 Cal.App.3d 393, 395, the Court determined that, “”appraisers” empowered by the terms of a policy of fire insurance to determine the “cash value” and “loss” utilized to ascertain the amount payable on the policy are arbitrators within the meaning of Code of Civil Procedure section 1280…”

In Lambert v. Carneghi (2008) 158 Cal.App.4^th 1120, 1130-1131, the appellants argued that the fact that the California Arbitration Act defines “Agreement” to include appraisals and valuations does not mean that agreements to resolve disputes through such appraisals and arbitrations are necessarily “agreements to submit to arbitration”.  The court of Appeal rejected that argument, stating:

“What this argument fails to acknowledge is that the term “‘arbitration’” is not itself defined in the arbitration act.  In determining whether an internal employee review committee procedure was an agreement to arbitrate, our colleagues in Division Two concluded that “although arbitration can take many procedural forms, a dispute resolution procedure is not an arbitration unless there is a third party decision maker, a final and binding decision, and a mechanism to assure a minimum level of impartiality with respect to the rendering of that decision.” In reaching its conclusion, the court pointed to section 2071 and acknowledged that “California case law recognizes that this appraisal provision is an arbitration agreement.” **

“Appellants argue that an insurance appraisal is “vastly different” from an arbitration. They point to the fact that the appraisal clause mandated by section 2071 does not specify how an umpire and two appointed appraisers will decide issues where the appraisers fail to reach an agreement, and does not provide for the discovery, testimony, briefing, “or any of the other accouterments that we associate with litigation or with arbitration.” Although it is true that “arbitration can take many procedural forms” it does not follow that “a fire insurance appraisal is not an arbitration” simply because it does not have the “accouterments” that appellants claim are required in order for a procedure to be considered an arbitration. This is especially true in light of the fact that California law does not automatically guarantee the right to discovery in arbitration proceedings, except in certain types of cases or unless the parties agree.”

This fact, that a determination of valuation or price by submission of the issue to an appraiser is an arbitration, means there are traps for both parties:

The first trap is that Code of Civil Procedure §1298 requires that arbitration provisions in contracts for the sale of real property be clearly labeled as such, include large-type warnings of loss of jury trial rights, and be initialed by the parties.  Unless the drafter of the option agreement was aware that the appraisal procedure was an arbitration, the drafter might not have complied with §1298.  There is authority that §1298 is preempted by the Federal Arbitration Act and is, therefore, unenforceable (Westra v. Marcus & Millichap (2005) 129 Cal.App.4^th 759, 764), but it’s certainly wiser to comply with the statute than rely on its unenforceability.

The second trap is that contests of arbitration results are severely circumscribed.  Code of Civil Procedure §1288 provides that a Petition to Vacate or Correct an arbitration award must be brought within 100 days after the date of service of the signed award.  This 100-day time limit is applied strictly, so that even arguments against the validity of the award made in defense against a Petition to Confirm that arbitration award are barred unless the Petition to confirm was filed within that 100-day period.  (Code of Civil Procedure §1288.2.)

Klubnikin, supra at 398, held that the failure of a party to seek to vacate or correct an arbitration award within the 100-day period made the Award final and res judicata on the issues determined in the arbitration.  Eternity Investments, inc. v. Brown (2007) 151 Cal.App.4^th 739, 745, held that the failure to seek to vacate or correct an Award within the 100-day period bars seeking such vacation or correction even in response to a petition to confirm.

The “winner” in the valuation arbitration proceeding, therefore, can prevail in the face of meritorious objections to the arbitration award if the “loser” fails to seek to vacate or correct the award within 100 days after it’s issued, and then brings a Petition to Confirm it, to which all defenses have been waived by the loser’s failure to contest it within 100 days.

Even if the loser were to seek to vacate or correct the award within 100 days after it was issued, there are very few reasons for which an arbitration award can be vacated or corrected, and that the award is incorrect is not one of those reasons.  (Code of Civil Procedure §1286.2 & §1286.6.)  It appears, then, that the warnings about arbitration required by §1298 are highly relevant to the parties to an agreement that calls for valuation by appraisal.

The practice tips here are three: (1) Comply with the requirements of Code of Civil Procedure §1298 when drafting a lease or option agreement that calls for an appraisal to establish the fair market rent or purchase price; (2) If your client doesn’t like the result of the valuation, file a Petition to Vacate or Correct the Award within 100 days of its issuance; and (3) If you client does like the result of the valuation, wait until after 100 days have passed from its issuance to file a Petition to Confirm the award.

Joshua Genser was born and raised in West Contra Costa County, California, and is the second generation of his family to provide legal services to West County businesses. Mr. Genser is also the Chief Executive Officer of the Richmond Development Company, LLC, developing office, warehouse, industrial and commercial properties in and around Richmond.  He has a Master’s Degree in Economics from Stanford University and his law degree from the University of California at Berkeley.  Mr. Genser has practiced law since 1983, handling litigation and transactions in business and real estate matters.  In addition, Mr. Genser serves the community as a Director and past Chair of the Richmond Chamber of Commerce, Director of the Pinole and Hercules Chambers of Commerce, Director of the Richmond Community Foundation, and Director, Treasurer and Past President of Temple Beth Hillel.  In 2007, Genser & Watkins was given the Chief Justice Ronald M. George Pro Bono Law Firm of the Year Award by the Contra Costa County Bar Association, and Joshua Genser was named Pro Bono Attorney of the Year by The Law Center.  Joshua Genser has also been honored as a Northern California Super Lawyer.