Cracking The Armor Of An Arbitration Award

As California Courts continue to be impacted by the pandemic, and litigants are experiencing long delays on the path to trial, many contracting parties are agreeing to arbitrate disputes. With the popular shift towards arbitration, litigants should be aware of some of the pitfalls.

Under California law, arbitration decisions are generally not reviewable for errors of fact or law. There is, though, an exception to this general rule. Courts can vacate arbitration awards if the arbitrator exceeds its powers and the award cannot be corrected without affecting the merits of the decision. When this is found to have occurred, the arbitration decision is fully reviewed by the civil court. A recent case, Nicholas and Sharon Honchariw v. FJM Private Mortgage Fund, LLC, has expanded a litigant’s ability to challenge an arbitration award. This case applies to situations where the arbitrators issue an award that violates unwaiveable statutory rights or an explicit legislative expression of clear public policy.

In Honchariw, borrowers took out a $5.6 million bridge loan secured by a deed of trust on real property. The loan agreement included a term stating that if the borrowers missed a payment, they would be assessed a late fee based in part on the total unpaid principal balance of the loan. When the borrowers missed a payment nine months into the loan term, the lender demanded they pay the late fee. The borrowers immediately demanded arbitration.

In arbitration, the arbitrator ruled in favor of the lender. It held that the late fee did not violate California Civil Code section 1671, which governs the enforceability of contract provisions liquidating damages for breach of contract. Undeterred, the Honchariws petitioned the superior court to vacate the arbitrator’s award. The superior court affirmed the arbitrator’s decision, holding that the Honchariws failed to show that the late fee provision was an invalid penalty under 1671 and also failed to show that the arbitrator exceeded its powers by denying the claims.

Still undeterred, the Honchariws appealed. The appellate court reversed both the superior court and arbitrator’s decision. It held that the late fee imposed by the lender was an unlawful penalty and against public policy. The court heavily relied on the California Supreme Court case Garrett v. Coast and Southern Fed. Sav. & Loan Assn. In Garrett, the court held that liquidated damages assessed against a borrower’s entire unpaid principal balance are per se unlawful. Because a late fee based on the entire unpaid principle balance is meant to ensure payment rather than compensate the injured party, it violates 1671. The Court of Appeal ruled that Garrett was controlling law and evidences the clear public policy that all liquidated damages must bear a reasonable relationship to the actual damages that parties could anticipate would flow from the breach. If the damages fail to conform, they are an unenforceable penalty. The court reviewed the arbitration award and ruled that the arbitrator’s decision violated express public policy and was thus invalid.

While arbitrators’ decisions are generally not reviewable, parties to an arbitration should be aware of any arbitration award that may be challenged or claimed to have violated public policy.

If you have any questions about challenging or enforcing a challenged arbitrator’s decision, please contact the author or any of our experienced attorneys at Boutin Jones