September 2010
In This Issue:
No-Leasing Restriction May Violate Georgia Fair Housing Act
Enforcement of Monetary Judgment Stayed Pending Outcome of Appeal
Rental Restrictions Valid and Reasonable
Association Has Authority to Access Unit
Homeowners Not Required to Use Private Water System
Order Vacated Because ARC Not Party to Lawsuit
Mandatory Arbitration Clause Unenforceable, Unconscionable
Community Association Manager's License Revoked for Regulatory Violations
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No-Leasing Restriction May Violate Georgia Fair Housing Act

Bailey v. Stonecrest Condominium Association, Inc., No. A10A0579, Ga. App. Ct., June 18, 2010

State and Local Legislation and Regulations/Association Operations: A Georgia appeals court vacated an order of summary judgment in favor of a condominium association, finding that questions existed about whether a no-leasing restriction was adopted for nondiscriminatory reasons.

Barbara Bailey owned two condominium units in Stonecrest Condominium, located in Fulton County, Ga. The development is governed by Stonecrest Condominium Association.

Pursuant to Stonecrest's declaration, the association can amend its declaration and bylaws by a two-thirds vote of the association members. Due to a growing concern among the members that an increase in the number of units being leased might adversely affect property values, the board of directors discussed the possibility of amending the bylaws to include a no-leasing restriction.

In 2004, Bailey bought a condominium unit for her primary residence, and later that year she purchased another as rental unit. At the time, neither Bailey nor her real estate agent were informed by the association that leasing restrictions were being considered. In December 2004, she leased her rental unit to an African-American tenant. Shortly before the tenant moved in, Bailey informed a board member that her tenant was a young African-American woman. The board member stated it might cause a problem because she was unsure how the tenant would be received by other residents.

After her tenant moved in, Bailey received a call from another resident, in which the resident used racial epithets to complain about the new tenant and stated that other unit owners did not want "that kind of person" living in Stonecrest. Bailey called the board member to express her concern, and the board member reminded Bailey of their earlier conversation on the subject. The board member told Bailey that because of her tenant, the association was considering amending the bylaws to include a no-leasing restriction.

In February 2005, the board sent a letter to association members notifying them of the upcoming annual meeting and informing them that amendments to the bylaws that would restrict leasing were being proposed at the meeting. The letter stated that the purpose of the restriction was "to preserve the character of the condominiums as predominantly owner-occupied and comply with eligibility requirements for financing in the secondary mortgage market." Between 80 and 90 association members attended the meeting, and more than the required two-thirds majority voted to adopt the amendments, including the lease restriction with a grandfather clause and hardship exceptions.

Earlier in the month, Bailey's tenant broke her lease, stating she had gotten a job that required her to move to another city. When the amendments became effective, Bailey's unit was not rented, and, thus, she could not take advantage of the grandfather clause. She did not apply for a hardship exception, which, if approved, would have allowed her to lease her unit under the new amendments.

She sued the association, claiming that the bylaws amendments that restricted leasing constituted racial discrimination in violation of the Georgia Fair Housing Act ("Act"). She also contended that the board breached its fiduciary duty in proposing the amendments. The association moved for summary judgment on all of Bailey's claims, which the trial court granted. Bailey appealed.

The Act allows aggrieved persons to seek actual and punitive damages for violations. Under the Act, it is unlawful to "refuse to sell or rent after the making of a bona fide offer, or to refuse to negotiate for the sale or rental of, or otherwise make unavailable or deny, a dwelling to any person because of race, color, religion, sex, disability, familial status or national origin." Under subsection (2) of the Act, it is unlawful "to discriminate against any person in the terms, conditions, or privileges of sale or rental of a dwelling, or in the provision of services or facilities in connection therewith, because of race, color, religion, sex, disability, familial status, or national origin."

In order to prevail on a claim under the Act, a person must demonstrate unequal treatment on the basis of race that affects the availability of housing. To do this, a person can either show "discriminatory intent" or "disparate impact."

Bailey did not assert a disparate impact claim, so the appeals court considered whether the amendments demonstrated discriminatory intent. Although Bailey argued that she had provided direct evidence of discriminatory intent, she did not specify what evidence in the record demonstrated discrimination, other than the mention of her conversations with the board member regarding her tenant.

The court explained that its function was not to "cull the record on behalf of a party in search of instances of error. The burden is upon the party alleging error to show it affirmatively in the record." Nevertheless, having reviewed the record, the court assumed that the direct evidence referred to by Bailey consisted of the comments allegedly made by the association board member. The court determined that the remarks did not amount to direct evidence that the amendments were passed with discriminatory intent, because the remarks did not directly relate to the motives of the association's decision-makers: namely, the members who comprised the two-thirds majority who adopted the amendments.

Having found that Bailey failed to show direct evidence of discriminatory intent, the court focused on her assertion that she had presented circumstantial evidence of discriminatory intent. Specifically, she contended that the comments made by the board member and the resident who called her, in addition to the fact that the amendments to prohibit leasing were only proposed after she leased her unit to an African-American, constituted circumstantial evidence of discriminatory intent.

The court agreed that the resident's comments, combined with the timing of the adoption of the amendments, established a prima facie case, and the burden then shifted to the association to show legitimate non-discriminatory reasons for adopting the no-leasing restriction.

The association stated that the amendments were adopted in order to maintain Stonecrest's status as a predominantly owner-occupied community. They asserted that property values would be adversely affected because there was a perception that rental units are typically not maintained as well as owner-occupied units, and an increase in rental units could result in higher interest rates for potential buyers, thereby reducing the marketability of all units. The association cited evidence that the board first began discussions about the amendments a year before Bailey bought her units. Finally, the lack of any racial animus was demonstrated by the fact that unit owners could request permission to lease under the hardship exceptions.

The appeals concluded that the association did have legitimate non-discriminatory reasons for adopting the no-leasing amendments, but Bailey argued that these reasons were mere pretext. She pointed out that the amendments were not proposed until after she rented her unit to an African-American tenant and demonstrated that minutes from the 2003 and 2004 board meetings did not contain any mention of the leasing issue. She contended that the trial court erred in concluding, as a matter of law, that the no-leasing restriction did not interfere with her rights under the Act, and in granting summary judgment to the association on her claims for breach of fiduciary duty.

A claim for breach of fiduciary duty requires proof that: (1) a fiduciary duty existed; (2) that the duty was breached; and (3) damage was proximately caused by the breach. In this case, the only judicial issues were whether the exercise of the board's authority was procedurally fair and reasonable, and whether the decision was made in good faith, and was reasonable, not arbitrary or capricious. Although Bailey argued that the board failed to follow proper procedures by not timely notifying unit owners about the annual meeting at which the leasing issue was discussed, she failed to provide any evidence in the record to support her claim for breach of fiduciary duty.

Nevertheless, the appeals court concluded that factual questions remained as to whether the association's substantive decision to adopt the no-leasing restriction was made in good faith. Accordingly, it held that the trial court's grant of summary judgment was inappropriate. It further concluded that the trial court erred in granting summary judgment on Bailey's claims for punitive damages and attorney's fees.

Therefore, the court vacated the trial court's order and remanded the case for further proceedings.

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Enforcement of Monetary Judgment Stayed Pending Outcome of Appeal

Chapala Management Corporation v. Stanton, No. D055532, Cal. App. Ct., July 29, 2010

State and Local Legislation and Regulations/Covenants Enforcement/Architectural Control: A California appeals court determined that an award to a homeowners association for costs and attorney's fees was stayed, pending the outcome of the homeowners' appeal of the trial court's ruling.

Thomas and Donna Stanton own a unit in Chapala, a condominium development located in San Diego County, Calif., that is governed by Chapala Management Corporation ("association"). In December 2006, they replaced two windows in their unit with "sandtone" colored windows after the association denied their application because the windows were not an approved color. The association offered to resolve the dispute through mediation, but the Stantons declined. Thereafter, the association sued them, seeking declaratory and injunctive relief based on their violation of the condominium's governing documents.

The association's architectural guidelines include approved colors for exterior surfaces of the condominium building. The association has consistently required that windows on units that face the street be brown. The color installed by the Stantons was a lighter, gray-based earth tone that looked substantially different from the otherwise uniform look of the other windows. Although lighter colored windows had been allowed by the association for windows located in the rear or side units, no such window colors have been approved in areas facing the street.

The declaration required that the Stantons obtain the architectural review committee's ("ARC") approval before making any architectural modifications to their unit. The trial court found that they breached the declaration by installing the sandtone windows after they received express written disapproval of their application from the ARC. The court determined that the ARC acted within the scope and power granted to it under the declaration in denying the Stantons' application. Further, the ARC had completed a reasonable investigation by meeting with the Stantons to discuss the color of the windows and comparing the sandtone windows to the association's paint standards for similarly situated units.

The trial court ruled in favor of the association and ordered the Stantons to modify their windows by painting them a color approved by the ARC or, alternatively, to remove them and replace them with windows of an approved color, after submitting plans and specifications to the ARC and obtaining its approval. The court granted the association the right to enter the property to modify the windows if the Stantons failed to comply with specified time deadlines in completing the work. The court also awarded reasonable attorneys fees, with interest and costs, to the association. The Stantons appealed.

They challenged the trial court's order requiring them to post a bond or undertaking to stay execution of the costs awarded in the action, including the award of attorney's fees. They argued that costs in injunctive relief actions are stayed on appeal pursuant to the Sec. 915 of the California Code of Civil Procedure. The association argued that the matter was governed by Sec. 917.1, which specifically requires an undertaking to stay a monetary award pending appeal.

The purpose of the automatic stay rule contained in Sec. 916 is to protect the appeals court's jurisdiction by preserving the status quo until the appeal is decided. Sec. 917.1 provides an exception, referred to as the "money judgment exception," where an appeal will not stay the enforcement of a judgment, and, thus, an undertaking is required if the judgment is for "[m]oney or the payment of money, whether consisting of a special fund or not, and whether payable by the appellant or other party to the action." Sec. 917.1 provides another exception, specifying that no undertaking is required for a judgment consisting of only an award of costs.

The appeals court relied upon a California Supreme Court finding that "costs of suit are awarded to the prevailing party in nearly every civil action or proceeding." In other words, if a judgment for costs awarded were a money judgment within the meaning of Sec. 917.1, virtually every judgment would be within the scope of that section, and an undertaking would be required to stay every judgment pending appeal, and the exception to the automatic stay provision in Sec. 916 would cease to be an exception and become the general rule, obviously not the legislature's intent.

The court framed the question at hand to be whether, looking to applicable statutes and legislative intent, the trial court's judgment for attorney's fees and costs was a judgment "for money or the payment of money" or "solely for costs."

In an action to enforce an association's governing documents, the prevailing party shall be awarded reasonable attorney's fees and costs. The statutory award of attorney's fees is expressly awarded to the prevailing party, and such fees are awarded as a matter of right. No discretion is afforded the trial court in granting or denying such fees, other than their amount and reasonableness. Thus, the appeals court found that the Stanton's appeal from the costs and fee order stayed its enforcement under Section 916. Because it was limited to the order awarding costs and attorney's fees, it fell within the exclusion of Section 917.1(d), which eliminates the requirement of an undertaking when the appeal is solely from an award of costs. In sum, the court found that the trial court should have granted a stay of execution of the judgment in its entirety. The court affirmed the judgment and post-judgment orders but vacated the temporary stay and granted the Stanton's petition staying enforcement of the judgment for attorney's fees and costs.

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Rental Restrictions Valid and Reasonable

Harrison v. Sierra Dawn Estates Homeowners' Association, Inc., No. E045862, Cal. App. Ct., June 23, 2010

Sale and Lease Restrictions/Covenants Enforcement: In an unpublished opinion, a California appeals court found that the trial court properly ruled that rental restrictions established by a homeowners association were reasonable and valid measures to accomplish the goals of a majority of its members.

Sierra Dawn Estates is a senior citizen mobile home park in Hemet, Calif. It is a common interest development, and common areas are owned by Sierra Dawn Estates Homeowners' Association. Ownership is subject to a set of recorded covenants, conditions and restrictions. The association is responsible for enforcing the covenants.

In 2005, the association members, by majority vote, adopted a set of amendments to the covenants restricting the rights of owners to rent their units, including: (1) the new owner of a unit cannot rent it out for at least one year after acquiring; (2) the maximum term of a lease is one year; (3) leased units cannot exceed 20 percent of the total units; and (4) no owner can lease more than three units.

Isabelle Harrison and her adult children own approximately 25 units in Sierra Dawn. Harrison lives in one unit and the other 24 are rented out. When Harrison purchased her units, the covenants expressly allowed owners to lease their units with no restrictions other than those that would apply equally to owner-occupied units.

In early 2004, a number of owners complained to the association about the increasing number of rentals, and the association appointed an ad hoc rental committee to evaluate the effects of the rentals on the community. The committee reported that rental units were not as well maintained as owner-occupied units. From the police, the committee learned that felons, parolees, and registered sex offenders were looking for rentals in Hemet, including in senior housing developments.

Based on the committee's findings, the association proposed adding rental restrictions to its governing documents. In early 2005, the association held two "town hall" meetings to present and discuss the amendments. Harrison attended both meetings and vocally opposed the rental restrictions. Ballots to vote on the amendments were mailed to the membership, and when counted, the amendments passed by 53 percent of all total votes and 84 percent of all actual votes. On March 4, 2005, the amendments were recorded and became effective.

Thereafter, when Harrison asked the association to approve new leases, the association refused because Harrison already had three leased units. She sued the association, alleging that the rental restrictions were an unreasonable restraint on alienation and that the association had made misrepresentations to owners who voted for the restrictions. The trial court ruled in favor of the association, finding that the restrictions were not an unreasonable restraint on alienation. Further, it found that the electoral process was not misleading, improper or unlawful. Harrison appealed.

In the appeal, Harrison argued that the rental restrictions violated a fundamental public policy in favor of low-to-moderate income and/or senior housing. Although the court recognized that the provision of housing for low and moderate income persons was in keeping with public policy, it noted that while rental restrictions reduced low-income renal opportunities, they could actually increase ownership opportunities. Moreover, the record showed that the shortage in owner-occupied units in the low-to-moderate price range was larger than the shortage of rental opportunities. In any event, the homes in Sierra Dawn Estates did not qualify as "affordable housing."

Harrison argued that the rental restrictions bore no relationship to the community's stated goals, but the association offered three reasons for adopting the restrictions: (1) rentals were correlated with crime; (2) rentals were correlated with increased rule violations; and (3) rentals were correlated with reduced volunteerism.

Harrison challenged particular restrictions as arbitrary, arguing that limiting the lease terms to one year would increase renter turnover and decrease volunteerism. The association responded that the one-year limit did not require that every renter be evicted every year but simply contemplated that every lease would be renewed annually, giving the association the right to disapprove renewal of leases for good cause.

Harrison further argued that prohibiting new owners from leasing for at least one year would increase turnover and decrease volunteerism. The association's reasoning, however, was that new owners would most likely be buying their units for their own occupancy and not for rental purposes, and new owners were more likely than renters to volunteer. The appeals court found that there was no evidence that this requirement would not actually further the association's goals.

The court frankly acknowledged that the burden of the rental restrictions fell disproportionately upon those who, like Harrison, owned more than three units in Sierra Dawn. It observed that the restrictions seemed draconian, and the three-unit restriction seemed particularly harsh as it applied to Harrison. However, the association provided overwhelming evidence that renters create genuine problems in senior communities—Sierra Dawn Estates in particular—and the restrictions were a measured response to those problems.

The California Association of Realtors, as amicus curiae on Harrison's behalf, argued that the rental restrictions were unreasonable as a matter of law, because they applied to owners who purchased their property before the amendments went into effect. The realtors claimed that the basic right to rent must be grandfathered. Their argument was premised on the fact that the owner of more than three units was effectively forced to sell, and Harrison would lose the rental income from all but three of the units she rented out.

The court determined that, although the argument might be valid in some cases, in this case, no evidence was presented to the court showing that Harrison's having to sell her units would cause her financial loss or other harm, and the association pointed out that selling the units pursuant to an installment land sales contract would provide her with some of the same benefits of renting, including cash flow. In the absence of any evidence of damage, the court could not just presume that the effect of the restrictions would be deleterious.

Harrison also contended that the manner in which the amendments were adopted violated procedural due process. However, she failed to cite any authority to support her position, and the court found that it lacked merit.

In light of the record, the court found that the trial court properly ruled that the rental restrictions were reasonable and valid. The ruling was affirmed.

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Association Has Authority to Access Unit

Hollywood Towers Condominium Association, Inc. v. Hampton, No. 4D09-383, Fla. App. Ct., June 23, 2010

Powers of the Association/Covenants Enforcement/Architectural Control: A Florida appeals court ruled that a condominium association was entitled to enter a unit to repair a concrete balcony that was a common element depicted in the declaration.

Sharon Hampton owns a unit in the Hollywood Towers Condominium Association, located in Broward County, Fla. The association became concerned with the structural integrity of the units' concrete balconies and hired a consultant to inspect each balcony. When inspected, Hampton's balcony was found to have moderate corrosion, requiring repair. The engineering report stated that demolition should continue from inside Hampton's unit to remove the concrete four inches beyond the point at which the corrosion stopped.

Hampton hired another consultant, who performed several procedures to determine whether it was necessary to perform the additional repair work inside her unit. He concluded that her balcony did not require interior demolition. It was his opinion that the restoration work done on her exterior balcony was sufficient to make it structurally sound.

The association asserted that Hampton was not the only unit owner whose balcony needed to be repaired from the inside, and refuted Hampton's claim that the association allowed other unit owners to opt out of the repair work.

The declaration for Hollywood Towers provides that each owner shall allow the association and/or its agents to enter units to maintain, inspect, repair or replace improvements within the units, common elements, or limited common elements in cases of emergency, circumstances that threaten other units, or to determine compliance with the declaration. If an owner fails to maintain his unit and limited common elements or makes alterations or additions without the consent of the association, the association has the right, pursuant to the declaration, to sue for an injunction to seek compliance.

The concrete floor under each balcony is depicted in the declaration as a common element to be maintained by the association. However, the trial court held that the association failed to meet its burden of showing irreparable harm. The court found there to be a question not only as to whether the repair work was necessary, but whether failure to perform the work would cause immediate harm. Therefore, it denied the association's request for injunctive relief and issued a partial final judgment in Hampton's favor. The association appealed.

The dispute in the appeal was over the standard by which a trial court should review the decision of a condominium association. The association contended that, under the business judgment rule, a trial court is required to defer to the association unless there is a showing of fraud, self-dealing, dishonesty or incompetence. Hampton argued that the business judgment rule only applied in suits against directors for personal liability, and the trial court was required to determine whether the repair work on the interior of her unit was necessary. The appeals court noted that the business judgment rule has traditionally been applied to protect corporate directors from personal liability; however, courts had applied the business judgment rule to association decisions in an apparent effort to avoid second-guessing association decisions. In applying the rule to condominium association decisions, courts have generally limited their review to two issues: (1) whether the association has contractual or statutory authority to perform the relevant act; and (2) if the authority exists, whether the board's actions are reasonable.

In this case, there was no dispute that the association had the authority to repair Hampton's balcony, which was a common element described in the declaration. Thus, the court determined that the trial court's focus was misplaced when it denied the injunction.

However, in order to access Hampton's unit to perform the repairs, the association was obligated to show that such access was necessary. Under the Florida Condominium Act, "The association has the irrevocable right of access to each unit during reasonable hours, when necessary for the maintenance, repair, or replacement of any common elements or of any portion of a unit to be maintained by the association pursuant to the declaration or as necessary to prevent damage to the common elements or to a unit or units."

The appeals court instructed the trial court to use the two-prong test set forth in Lamden v. La Jolla Shores Clubdominium Homeowners Association, 980 P.2d 940, 942 (Cal. 1999) (CALR November 1999), which held that courts must give deference to a condominium association's decision if that decision is within the association's scope of authority and is reasonable.

In addressing the question of whether the association established that it would suffer irreparable harm if the court did not enter the injunction, the appeals court observed that the Florida Condominium Act provides that in an action for injunctive relief against an association, an alleged violation of the Act is itself a harm for which the statute authorizes injunctive relief. The Act "permits a unit owner to seek injunctive relief for failure of a condominium association to comply with its rules or the Condominium Act." It would follow that the same rule applied when an association brought an action for injunctive relief against a unit owner.

The court reversed the trial court's decision and remanded the case for further proceedings.

©2010 Community Associations Institute. All rights reserved. Reproduction and redistribution by CAI members or nonmembers are strictly prohibited.

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Homeowners Not Required to Use Private Water System

Jones v. Forest Lake Village Homeowners Association, Inc., No. A10A0810, Ga. App. Ct., June 18, 2010

State and Local Legislation and Regulations/Contracts: A Georgia jury found that a subdivision's restrictive covenants did not require the homeowners to remain connected to a private water system after a public water system became available to the subdivision.

This is a class action lawsuit in which homeowners in Forest Park Village subdivision, located in Fulton County, Ga., sued Andrew Jones, the owner of a private water system that served the subdivision since its inception in 1973. A jury found in favor of the homeowners, and based on the verdict, the court entered an order declaring that the restrictive covenants did not require homeowners to remain connected to Jones' private water system; and permanently enjoining Jones from billing the class members and/or attempting to collect a monthly connection fee. The court awarded attorney's fees to Forest Park Village Homeowners' Association, and denied Jones' motion for a new trial or, alternatively, a judgment notwithstanding the verdict. He appealed.

Among Jones' arguments on appeal was his assertion that the trial court erred by allowing class members to testify about the quality of water and the service Jones provided. The court held that the trial court did not abuse its discretion in allowing class members to testify about the poor service and the poor quality of water provided by Jones. It determined that the question of whether Jones was delivering sufficient, potable water was relevant to the issue of whether he had provided consideration for the contracts he was attempting to enforce, and, thus, whether any of the contracts were valid. The evidence established that water outages and water-quality issues were frequent, and that they affected the entire subdivision.

Jones claimed that the trial court erred in failing to charge the jury on the effect of a partial failure of consideration for a contract, but the appeals court found there was no likelihood that any miscarriage of justice resulted from that failure.

The class maintained that no provision in the restrictive covenants prohibited homeowners from connecting to the county's public water system when it became available.

The court vacated the trial court's order of final judgment and remanded the case for entry of an order that included a description of the class members, as identified in the trial court's order naming the class, but affirmed the trial court's order denying Jones' motion for a new trial or judgment notwithstanding the verdict.

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Order Vacated Because ARC Not Party to Lawsuit

McCraw v. Aux, No. COA09-1238, N.C.. App. Ct., July 20, 2010

State and Local Legislation and Regulations: A North Carolina appeals court vacated a trial court ruling in favor of a homeowner to enforce restrictive covenants, finding that he failed to join the architectural review committee as a necessary party to the lawsuit.

Katherine McCraw and George Aux, Jr. own homes in Crenshaw Manor Subdivision, located in Wake County, N.C. McCraw sued Aux to enforce restrictive covenants that required Aux to apply to the architectural review committee for approval to replace his existing cedar roof with one made of metal. Aux did apply for approval, but his application was denied by the committee. He, nonetheless, installed the metal roof on his house.

McCraw filed a motion for summary judgment that the trial court granted, ordering Aux to apply to the committee for approval to modify his roof within 30 days. The court further ordered that if the application were denied, Aux had 60 days from the decision to "restore the previous split western red cedar shake roof." Aux appealed.

The appeals court first noted that the remedy sought by McCraw depended on determinations to be made by the committee, which was not a party to the suit. The court observed that North Carolina statutes provide that "when a complete determination of a claim cannot be made without the presence of other parties, the court shall order such other parties summoned to appear in the action." N.C. Gen. Stat. Sec. 1A-I Rule 19(b).

Crenshaw Manor's restrictive covenants provide that:

4. There shall be an architectural review committee that shall have full responsibility for regulating any requirement of these restrictive covenants … no … structure shall be erected, altered, placed or allowed to remain on any premises in the subdivision unless approval in writing has been given by the architectural review committee …

5. The roof of each dwelling and its garage must be either cedar shake, cedar shingle, or stand-in-seam metal roofing of copper, tin or other metal material of similar quality, approved by the architectural review committee …

Finding that the committee had "full responsibility for regulating any requirement of the restrictive covenants," and that, as a practical matter, Aux could not remove the roof without first getting approval from the committee for a new roof, the court concluded that McCraw could not receive its requested remedy without the committee’s involvement.

Since the committee was not joined as a party, the appeals court held that the trial court should not have addressed the merits of the case. The appeals court did not address the substantive issues raised by McCraw, but, for purposes of guidance to the trial court on remand, noted that Aux's brief made the argument that the committee’s rights and obligations were transferred to Crenshaw Manor Homeowners Association. If this were true, the appeals court advised that the association might also be a necessary party to the action, and, thus, the appellate opinion should not be construed as a bar to its joinder.

The appeals court vacated the trial court's ruling and remanded the case for further proceedings.

Editor's Note: Thanks to Brian S. Edlin with the firm of Jordan Price Wall Gray Jones & Carlton in Raleigh, N.C., for bringing this case to the attention of Law Reporter.

©2010 Community Associations Institute. All rights reserved. Reproduction and redistribution by CAI members or nonmembers are strictly prohibited.

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Mandatory Arbitration Clause Unenforceable, Unconscionable

Pinnacle Museum Tower Association v. Pinnacle Market Development (US), LLC, No. D055422, Cal. App. Ct., July 30, 2010

Developmental Rights/Developer Liability/Contracts/State and Federal Law and Legislation: A California appeals court upheld a finding that a condominium association was not bound by a mandatory arbitration clause that required purchasers to waive their rights to a jury trial in construction defects disputes.

Pinnacle Market Development constructed and sold units in the Pinnacle Museum Tower Condominium project in downtown San Diego, Calif.. Pinnacle recorded the condominium declaration, forming Pinnacle Museum Tower Association to manage and maintain the condominium common areas. Pinnacle pledged to convey certain property, including easements, drainage facilities, and utility installations, to the association before the first unit was sold. It retained the right to convey property to the association at any time.

The Pinnacle declaration of covenants, conditions and restrictions contains a mandatory arbitration clause for resolution of construction defect claims that includes a waiver of the right to a jury trial. The clause recites, in capital letters, that Pinnacle, the unit owners, and the association agree to resolve any construction defect dispute through binding arbitration. Specifically, the clause states that, by accepting a deed for any association property, the association and each owner agree to give up their rights to a jury trial and have any construction defect dispute decided by arbitration.

The clause further states that its interpretation is governed by the Federal Arbitration Act ("FAA") because some of the construction materials used in constructing the condominium were manufactured in other states. The provision only applies to those disputes in which Pinnacle is a named party and further states that no amendment to the provision may be made without Pinnacle's written consent.

In marketing the condominium units, Pinnacle used a standard printed purchase and sale agreement that states, on the first page, that, by accepting a deed to the property, the buyer agrees to comply with the declaration. The purchase agreements contain dispute resolution procedures that require the initials of the buyer and seller.

After unsuccessfully mediating a dispute for damages to common areas, property owned by the association, and property owned by individual association members, the association sued Pinnacle for construction defects, which included a subterranean parking garage, drainage, exterior walls, windows, decks, interior walls and doors, roof and electrical systems, plumbing and mechanical components and systems. Pinnacle petitioned the court to compel arbitration under the provision contained in the declaration. The trial court denied its petition, finding that the arbitration clause was unconscionable. Pinnacle appealed.

The FAA applies to any written agreement to arbitrate a transaction involving interstate commerce; however, it defers to state contract law principles to determine the enforceability of arbitration clauses. California law prohibits enforcement of a binding arbitration provision in a purchase agreement that precludes a buyer from litigating a construction defect action in court. California case law supports the premise that a developer should not be permitted to accomplish through the declaration what it could not accomplish through a purchase agreement.

The appeals court observed that the right to arbitration depends on contract. A petition to compel arbitration is simply a suit seeking specific performance of a contract. Pinnacle developed the project as a common-interest community that was subject to numerous statutory requirements, including recording of the declaration, intended to be enforceable servitudes, unless unreasonable.

As a nonprofit mutual benefit corporation, the association has all the powers of a natural person, including the right to enter into contracts, but it can only act through its board of directors. As the developer, Pinnacle signed the declaration; however, the association did not. Based on fundamental contract principles, the association could not have agreed to waive its constitutional right to a jury trial because Pinnacle was the only party to the agreement contained in the declaration. Further, no homeowners association existed when Pinnacle recorded the declaration.

Although the arbitration clause states that the association agrees to give up its right to a jury trial, by accepting a deed for any portion of the association property, the association had no choice but to accept the property that Pinnacle conveyed.

The court rejected Pinnacle's arguments, which relied on cases that recognized arbitration clauses contained in employee handbooks as binding unilateral contracts, that agreement to the arbitration provisions contained in the declaration and purchase contracts may be shown by express agreement or implied by the parties' conduct. The court found there was not express acceptance by the association of the arbitration provision at issue here, or conduct by the association from which the necessary agreement could be implied. In any event, the language of the provision itself conveyed a mutuality of promises. Accordingly, the court found that the declaration's arbitration provision was not a proposed unilateral contract; but rather, purported to be a bilateral contract in which the parties made mutual promises concerning arbitration.

The court also rejected Pinnacle's claim that the association was bound by the provision as a third-party beneficiary, finding that a person who is not a party to a contract may enforce it if the contract is made expressly for his or her benefit;  however, here the association was not seeking to enforce the arbitration provision.

Pinnacle argued that it was required by law to record the declaration before any units were sold. It contended that if a developer is not allowed to include an arbitration provision in the declaration, it can never do so. The court would not address the threshold issue of whether a developer can include an arbitration provision in a declaration, asserting that, clearly, it can. Rather, it addressed the enforceability of a binding arbitration clause that waives an association's right to a jury trial and can never be changed by the association without the developer's written consent. Further, the court noted that the condominium's governing documents could be amended to include an arbitration provision if the association and its members decided to ratify the provision.

Finally, the court rejected Pinnacle's argument that because the association sued as a representative of its members who suffered damage to their individual units, the association should be bound by the jury waiver provision contained in the purchase agreements. However, the court held that the association was not a party to those contracts and had no standing to enforce them.

The purchase agreements incorporated the declaration's arbitration provision. The association did not dispute that the jury waiver provision in the purchase agreements constituted agreement between Pinnacle and the original unit owners to arbitrate construction defect disputes. Assuming that the association was bound by the jury waiver provisions, the court, nevertheless, found that the provision in the purchase agreements was unenforceable because it was unconscionable.

Unconscionability may be applied to invalidate arbitration agreements without contravening the FAA. The doctrine of unconscionability includes both procedural and substantive elements. Procedural unconscionability focuses on oppression or surprise.

Oppression arises when there is inequality in bargaining power that results in no negotiation and an absence of choice; while surprise involves the extent to which the terms of the provision are hidden in a form document drafted by the party seeking to enforce it.

The court observed that the declaration is 50 pages long. Without specific evidence before the court to show when Pinnacle made the declaration available for examination by purchasers, the court could not conclude that the declaration was easily obtainable as to be properly incorporated by reference into the purchase agreements. The court was skeptical that buyers eager to complete their purchase of a unit would stop the process to travel to the county recorder's office to obtain a copy of the declaration. Thus, it found there was a high degree of surprise because purchasers had no means of ascertaining, when they signed the purchase agreements, the kind of disputes for which they were waiving their rights to a jury, or that they would be required to arbitrate those disputes.

The court also found that oppression existed because the jury waiver clause in the purchase agreements and the arbitration clause in the declaration were part of pre-printed materials presented to purchasers on a take-it-or-leave-it basis. Accordingly, the court concluded that the existence of surprise and oppression revealed a high degree of procedural unconscionability.

The court further concluded that the arbitration clause was unfairly one-sided because it required that virtually every claim purchaser would rise up against Pinnacle to be arbitrated, while Pinnacle would have no reason to make a claim against purchasers. Numerous courts have held that arbitration agreements are substantively unconscionable if they provide for arbitration of claims most likely to be brought by a weaker party, but exempt claims brought by the stronger party.

The appeals court also concluded that the provision requiring the parties to bear their own costs, including expert costs, added to the substantive unconscionability of the arbitration provision.

Thus, even assuming that the association was bound by the jury waiver provision in the purchase agreements, the court concluded that those provisions were not enforceable.

The court affirmed the trial court's decision and awarded the association costs on appeal.

In a dissenting opinion, Judge O'Rourke, relying on Villa Milano Homeowners Association v. Il Davorge, 84 Cal. App. 4th 819, 24-25, asserted that condominium owners are "deemed to intend and agree to be bound by" the written and recorded CC&Rs inasmuch as they have constructive notice when they purchase their units. Finding that the association represented the collective interests of the individual homeowners, the owners could not be permitted to use the association as a shell to avoid application of the arbitration clause. Finding the arbitration agreement to be valid, Judge O'Rourke concluded that the declaration was not unconscionable. He agreed with the portion of the trial court's procedural unconscionability analysis, in that it found no evidence of "surprise." But, contrary to the trial court, he could find no substantive unconscionability in the requirement that any amendment to the provision be approved by Pinnacle in writing. Judge O'Rourke found that the provision requiring Pinnacle's written consent for modification was nothing more than application to the general principle of California contract law.

©2010 Community Associations Institute. All rights reserved. Reproduction and redistribution by CAI members or nonmembers are strictly prohibited.

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Community Association Manager's License Revoked for Regulatory Violations

Virginia Common Interest Community Board v. Sarraga t/a Lakeside Community Management, File No. 2010-00562, June 24, 2010

Association Operations: The Common Interest Community Board for The Commonwealth of Virginia revoked a community association management company's license for regulatory violations.

The Department of Professional and Occupational Regulation ("DPOR") administers and enforces laws regulating commercial occupations and professions in the Commonwealth of Virginia. The Common Interest Community Board ("board"), established by the General Assembly in 2008, licenses businesses that provide management services to property owners associations, condominium associations and cooperative associations. In a final opinion and order issued June 24, 2010, the board found that Shirley Sarraga t/a Lakeside Community Management violated Virginia Code Regulations that govern licensure of common-interest community management companies. It levied monetary penalties totaling $2,000 and revoked the company's license.

Sarraga and her daughter started a community-management company in 2003, incorporating the business as Lakeside, Inc., a Virginia stock corporation. The company experienced rapid growth, and, as a result of heavy workloads, kept poor records and failed to supervise its employees.

The charges in this three-count complaint arise from management contracts Lakeside entered into with four community associations: Dale City Homeowners Association, Highpointe Homeowners Association, Cabin Creekwood Homeowners Association and Belmont of Carmel Church Community Association, which have since been terminated.

The licensing regulations require that prior to commencement of the term of a management contract or acceptance of payments, the contract must be signed by the management company and the authorized agent of the homeowners association. The management agreement with Dale City was signed by Dale City, but not by Lakeside; therefore Lakeside was operating without a fully executed management agreement.

Lakeside's corporate status was terminated in February 2008, and Sarraga applied for her management license as a sole proprietorship in January 2009. The board noted that, upon termination of the company's corporate status, Sarraga should have amended its existing contracts to clarify its status as a sole proprietorship; but she failed to do so in the agreements with Highpointe, Dale City and Cabin Creekwood. The only agreement clearly in effect in 2009 was the Belmont agreement, because it had a self-executing rollover clause. Although Lakeside, the sole proprietorship, was licensed, Lakeside, Inc. was, in effect, practicing without a license.

It was clear to the board that Highpointe, Cabin Creekwood, as well as Lakeside, all assumed and operated as if the management contracts had rolled over and were in effect. Nevertheless, the licensing regulations require that a proper written contract be in place between the association and the management company.

In addition to contract issues, Lakeside failed properly to account for the funds and records belonging to three of the associations: Dale City, Cabin Creekwood and Belmont. Between January and March 2009, Lakeside incurred approximately 19 excessive withdrawal fees and 12 overdraft protection transfer fees on two of Dale City's bank accounts. Lakeside explained that it moved its offices in October 2008 and, during its computer transition, the company lost data from Dale City's general ledger and had to recreate its database. From October 2008 to March 2009, Lakeside wrote checks on the association's account without having sufficient funds on hand to cover the checks, resulting in unnecessary banking fees charged to the association. The board found that Lakeside's decision to allow a re-keying project to linger for four months, instead of hiring a temporary employee to assist in the project, constituted careless business practices and poor judgment.

In November 2008, Cabin Creekwood notified Lakeside that it was terminating its management agreement effective Jan. 1, 2009. Despite having two months notice of the termination, Lakeside continued to write checks from the association's operating account after Jan. 1, 2009, the last being written Feb. 17, 2009. Lakeside defended its actions, stating that the checks were for legitimate services on the association's behalf. Nevertheless, the issue was that Lakeside did not have the authority to issue checks after its termination and was no longer in a position to determine what expenses to pay or deem reimbursable.

The board expressed its appreciation of Lakeside's honesty in answering questions regarding these payments and noted that, although Lakeside had access to the association's funds, it did not access funds for any purpose other than to pay legitimate expenses. The board found no evidence of fraud or criminal activity.

Belmont terminated its management agreement with Lakeside in May 2009. Lakeside closed out all the association's records and electronically forwarded them to Belmont's new management company but failed to close the association's bank account. Lakeside explained that because it stopped receiving the association's bank statements, it assumed the account had been closed. The board found no evidence that Lakeside had acted negligently regarding closing of the account because the licensing regulations provide that, "The association shall notify vendors, services and banks of the change in management …" Further, the regulations provide that, "All bank accounts will be transferred from the managing agent to a designee named by the association." The record also indicated that upon learning that the account was still open, Lakeside immediately called the bank and took action to close the account.

As to count 1, the board concluded that Lakeside violated the regulations in two ways: First it was negligent in maintaining and updating its contracts; and second, it failed to properly account for association funds and/or records. The board imposed a penalty of $250 per violation for each association, a total of $1000.

Fiduciary responsibility is one of the core responsibilities of a community association manager. When this action was commenced, Sarraga's manager's license was expired, and her daughter's management certification was expired. It was clear to the board that Lakeside was not handling even simple matters pertaining to its own business, so there was no assurance that it could or would follow the regulations when managing associations' affairs.

Count 2 of the complaint asserted that it was Lakeside's responsibility to maintain registrations of each association it managed with the State Corporation Commission and the DPOR. Lakeside failed to maintain these registrations for Dale City and Highpointe. It allowed both associations to continue to operate with expired registrations, leaving individuals running the associations without the liability protections of corporate status and open to personal exposure. The fact that Lakeside could not properly discharge this contractual and regulatory responsibility was a factor when the board considered its ability to fulfill regulatory duties in the future. The board imposed monetary penalties of $250 per violation, a total of $500.

In considering count 3 of the complaint, the board observed that the regulations state that a management company provide complete records of a homeowners association within 30 days of any request by the association or within 30 days of termination of the management contract. Yet Lakeside failed to provide complete records to Cabin Creekwood and Highpointe, when its contracts were terminated. The board imposed a monetary penalty of $250 per violation, a total of $500.

In addition to the monetary penalties, the board imposed the following sanctions: Revocation of license for violation of count 1. For the two violations of count 3, Lakeside's license was suspended and placed on probation until Sarraga successfully completed the Community Association Institute's course M-310 and her daughter, as the Certified Manager of Community Associations ("CMCA") associated with the company, completed courses M-204 and M-206, financial management or other equivalent courses approved by the board.

Editor's Note: Special thanks to Douglas M. Kleine, CAE, PCAM, in Alexandria, Va., for contributing this case.

©2010 Community Associations Institute. All rights reserved. Reproduction and redistribution by CAI members or nonmembers are strictly prohibited.

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