Use Courts to Resolve Leasing Disputes, Arbitration for CAM
There is a common misconception among commercial property owners that arbitration is preferable to litigation, and they often allow their standard lease forms to provide that mandatory binding arbitration, rather than a court, will be used to resolve disputes. Arbitration may work well in certain types of disputes, but it isn't effective for the majority of commercial leasing issues. And contrary to many owners' opinions, arbitration is not necessarily faster, less expensive, or more favorable for them. Even if you draft and execute a lease with arbitration provisions that are slanted in your favor, it still isn't a wise choice—and it may get you into trouble.
Most states have a summary proceeding in a court, which is a faster way to resolve monetary disputes like rent defaults with a tenant. Do not place an arbitration clause in the lease when renting to a new tenant. And when possible, in a lease renegotiation replace the arbitration clause with provisions mandating the use of litigation to settle all future lease disputes.
Courts Expedite Rent Dispute Cases
The most hotly contested leasing disputes concern rent—namely, nonpayment of rent or common area maintenance (CAM) costs. In most states, the obligation for a tenant to pay rent is unconditional and is an independent covenant, says Arthur Mazirow, a California attorney who acts as a real estate arbitrator, mediator, expert witness, and consultant to law firms concerning real estate disputes. Most states have a very efficient way of getting a tenant to pay rent, he notes. For example, in California, it is called an “unlawful detainer action,” which is entitled to a priority on the court's calendar so that the dispute gets to trial very quickly, usually within 30 to 45 days.
In many states, the tenant cannot raise as a defense that the owner did not perform a covenant in the lease, because the obligation to pay rent is an independent covenant. In other words, the tenant is still required to pay rent, regardless of that fact that the owner is in default of its obligations under the lease. So although it may seem more intuitive to stay out of the court system by using arbitration, the fastest way to get relief from a defaulting tenant is through an unlawful detainer in California, or the equivalent action in your state.
CAM Disputes Are Exception to Court Advantage
There is one circumstance in which an owner should insist on having an arbitration clause in the lease, points out Mazirow. Disputes about the attribution or allocation of CAM costs, whether in office buildings or retail properties, are best resolved for owners using arbitration—but it has to be done carefully. Using litigation to resolve a CAM cost dispute with one tenant can affect everyone in the building or center, have an awful effect on the owner's ability to manage the property, and affect the value of the property, says Mazirow.
Mazirow says that sometimes owners will insist on arbitration for the lease provisions governing CAM costs in order to keep disputes about them confidential. But keep in mind that, while arbitrations are confidential as far as the arbitrator is concerned, unless there is a specific provision to the contrary, the parties and their lawyers may talk and write about it.
Therefore, if you negotiate for an arbitration clause as to CAM costs, make it clearly confidential by insisting on confidentiality agreements from the tenant, its counsel, its experts, and any other involved parties. The objective of a CAM arbitration clause is to contain the dispute so as not to affect the balance of the property.
Choose Arbitrators Wisely
Owners are rarely obligated by law to have an arbitration clause in their leases; rather, mandatory contractual binding arbitration is a voluntary act provided for in the lease if the owner and tenant agree. Despite that, you may have to include an arbitration clause to attract or retain a desirable tenant. Do not agree to an arbitration clause unless and until you understand it and how it will work if there is a dispute.
There are several methods for choosing arbitrators. One popular method allows each party to designate one person to be an arbitrator, and the two arbitrators then agree upon a third arbitrator. The third arbitrator must be a neutral person with no apparent bias in favor of or against any party or their counsel or witnesses. However, a party-appointed arbitrator may be biased in favor of the party that appointed him. Mazirow states that in his opinion, this method is not a desirable way to choose an arbitrator or arbitration panel. He believes that arbitrators should be neutral.
There are several organizations that act as the administrator of arbitrations, with each having its own set of rules and regulations in addition to the rules contained in state laws and in the Federal Arbitration Act. The largest administrator of arbitration is the not-for-profit American Arbitration Association (AAA). For an example of language requiring that a dispute be settled by an arbitration organization, see our Model Lease Clause: Specify Arbitration Organization in Lease.
Arbitrator selection is key to the outcome of arbitration. To get a “just award,” you must carefully consider how the arbitrators will be selected, how many are needed, and their specific qualifications. Use multiple arbitrators, none of whom are party appointed, advises Mazirow. And pick an arbitrator who has process skills and/or subject matter expertise.
An arbitrator with process skills understands, has experience, and knows the rules about how to conduct arbitration. Subject matter expertise means that the arbitrator is an expert in the area that is the subject of the dispute, which makes it easier for everybody because he knows when someone is not being candid. Know the statutory rules of arbitration and the rules of the administering organization that is running the arbitration; they are not all the same.
Impartiality of the arbitrator is also critical. There must be full disclosure of the arbitrator's experience and his relationship (and that of the arbitrator's immediate family) to the parties to the arbitration, their counsel, and the witnesses who will be produced. California has the most comprehensive disclosure rules, and many other states are strict. Check what the disclosure rules are in your state before picking an arbitrator.
“A great number of the attacks on an arbitrator's award by an unhappy party to the arbitration are on the basis that the arbitrator did not fully disclose his interest in or relationship to the parties,” Mazirow emphasizes.
Arbitration and Its Ramifications Here to Stay
Arbitration has become increasingly popular and will not go away, partly because it is less costly for the state legislatures to shift the costs of dispute resolution over to the litigants, cutting costs for the judicial system. Because of this, owners will continue to deal with the topic of arbitration, and should know everything about it, specifically what to avoid.
For example, beware of arbitration clauses that are so one-sided in your favor that they will be declared void as against public policy. Many owners' counsel draft leases that are biased in favor of the owner to such an extent that they are unconscionable and, therefore, unenforceable or against public policy—including the arbitration clause itself. An example of an unconscionable lease is one providing for mandatory binding arbitration, but setting the location of the arbitration in New York when the subject of the property in dispute is located in California.
Remember that a lawsuit is always a better alternative to arbitration when a lot of money is involved. “The disadvantage to arbitration is that there is no right of appeal, so for a really important case, you are better off having the right to appeal to an appellate court, rather than the right to arbitration,” notes Mazirow. A very important issue could be left in the hands of an arbitrator and wouldn't be reviewed by a higher court—even if the ruling seems inconsistent with the law.
It is critical for owners to know that arbitration usually does not move as fast as the court does on leasing issues, especially those arising from monetary disputes. The bottom line, says Mazirow, who has acted as a trial referee under the Reference Procedure of the California Code of Civil Procedure, is that arbitration clauses normally are not recommended to owners for their leases. The one exception to consider: making arbitration mandatory for CAM disputes.
Arthur Mazirow, Esq.: Real Estate Arbitrator, Mediator, Expert Witness, and Consultant; 1880 Century Park E., Ste. 615, Los Angeles, CA 90067; firstname.lastname@example.org.
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