Divided Court Strikes Arbitration Clause based on Unconscionable Remedies

Concluding that a dispute clause left homeowners with no effective remedy, a divided South Carolina Supreme Court has stricken an arbitration clause in a home construction contract. The dissent, citing recent US Supreme Court decisions, argued that the clause was subject to the Federal Arbitration Act and should have been upheld based on US Supreme Court precedent. The case is Smith v. D.R. Horton, 2016 S.C. LEXIS 155 (July 6, 2016).

Paragraph 14 of the contract, entitled “Warranties and Dispute Resolution” includes an arbitration clause in subparagraph 14(g). Other subparagraphs include a disclaimer of all warranties (other than a 10-year structural warranty), state that D.R. Horton will not be liable for any monetary damages, and provide the homeowners with the sole remedy of repair or replacement to be decided by D.R. Horton in its sole discretion.

The essential issue was whether the unconscionable provisions were severable from the arbitration clause, and whether the homeowners had to prove that the arbitration clause, standing alone, was unconscionable. The court majority held that the provisions of paragraph 14 were so intertwined that the unconscionable remedy provisions could not be severed from the arbitration clause. It noted that “all the subparagraphs of paragraph 14 must be read as a whole to understand the scope of the warranties and how different disputes are to be handled. The subparagraphs within paragraph 14 contain numerous cross-references to one another, intertwining the subparagraphs so as to constitute a single provision.”

Per the court, SC law defines unconscionability as “the absence of meaningful choice ... due to one-sided contract provisions, together with terms that are so oppressive that no reasonable person would make them and no fair and honest person would accept them.” The remedies provided in the D.R. Horton contract, per the court, fell within this definition.

The dissent would have found in effect that the unconscionable aspects of the contract could be severed without affecting the arbitration clause. Thus, if the arbitration clause, standing alone, was not unconscionable, the parties should proceed to arbitration and it would be up to the arbitrator to determine the validity, or unconscionability, of the contract remedies. It argued that the majority “adopts the findings of the trial court, which circumvent the application of these legal principles by expanding the relevant scope of the contractual language at issue to include matters beyond the arbitration provision.” The dissent even referred to the essential majority argument, noted above, as “the fiction that the arbitration provision is the entirety of Paragraph 14.” In support of its argument, the dissent reprints Paragraph 14 within the decision.

As a matter of contract interpretation, the dissent has the better argument. Where the specific arbitration subparagraph has not been challenged, it should be up to the arbitrator to rule on the viability of the remaining clauses, and whether those clauses are unconscionable. The majority appears to bundle the entire paragraph 14 together and make more of a public policy pronouncement, wanting to weigh in on the one-sided remedy clauses and not leave it to an arbitrator.

About Stan Martin

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Stan Martin holds a law degree and an undergraduate degree in architecture. He has been involved with the construction industry for more than 45 years, working in construction prior to law school and beginning his construction law practice. Over the course of his career, he has served on boards and committees for organizations including the Associated General Contractors of Massachusetts, the Boston Society of Architects, and the Massachusetts Building Congress.

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