On July 6, 2016, the South Carolina Supreme Court filed its Opinion No. 27645, captioned Smith v. D.R. Horton, Inc., in which it affirmed the Court of Appeals' refusal to compel arbitration between new home purchasers and the developer of the subject home, holding that the arbitration provision at issue was unconscionable. Of note, the opinion was a 3-2 decision with a strongly-worded dissent focused on the broad construction of the arbitration provision to include the other warranty provisions.
The D.R. Horton case involved the enforceability of the arbitration provision in a home purchase agreement after presentation of a claim for alleged construction defects by the homeowners. The provision stated that the parties agree to arbitrate any claim arising out of the construction of the home, as well as any disputes related to the warranties contained in the agreement. The subject arbitration provision was contained in a sub-section within a larger “Warranties and Dispute Resolution” section, which was critical to the Court’s analysis.
In South Carolina, the enforceability of an arbitration provision is determined by an unconscionability test. Unconscionability is defined as (1) “the absence of meaningful choice on the part of one party due to one-sided contract provisions,” (2) “together with terms that are so oppressive that no reasonable person would make them and no fair and honest person would accept them.”1 Interestingly, in determining the scope of the provision upon which to apply the unconscionability test, the Court construed the entirety of the “Warranties and Dispute Resolution” section as the arbitration agreement, as opposed to simply the subparagraph dealing specifically with arbitration. The Court’s logic was that all the subparagraphs must be read as a whole to understand the scope of the warranties and how different disputes are to be handled and that the subparagraphs contained cross-references to one another, “intertwining the subparagraphs so as to constitute a single provision.”
In applying the first prong of the test, the Court found the buyers had no meaningful choice after considering the “relative disparity in the parties’ bargaining power, the parties’ relative sophistication, whether the parties were represented by independent counsel, and whether [the home buyers] were a substantial business concern.”2 Under the second prong, the Court pointed to the seller’s “attempts to disclaim implied warranty claims and prohibit any monetary damages” as “clearly one-sided and oppressive.” Notably, these “attempts” the Court utilized in reaching its unconscionable conclusion are not a part of the arbitration provision, but part of the larger warranties provision.
The D.R. Horton opinion presents three primary takeaways3 to consider when drafting arbitration provisions, particularly in home purchase agreements:
- Clearly segregate the arbitration provision from other contract provisions, including warranty provisions, particularly if a court may be critical of the limitations of liability.
- Include a severability clause. The Court found that the lack of a severability clause in the subject agreement indicated an intention that the Court should not strike unconscionable provisions from the arbitration agreement.
- Allow for independent counsel review, particularly when bargaining power is arguably unequal.
The full opinion is available here.