On August 4, 2005, the California Supreme Court declared that predispute waivers of the right to a jury trial are unenforceable in contracts governed by California law.
This ruling by California's highest court has yet to have the legal equivalent effect of the "Big One" that seismologists predict will one day hit California, and that has commercial real estate underwriters on the look-out. But for commercial lenders across the country, the retroactive nullification of jury waivers in thousands of loan documents was barely a small trembler, going unnoticed during August vacations.
It would be best to pause and momentarily consider what the California Supreme Court actually declared and perhaps, more important, where do we go from here?
In Grafton Partners v. Superior Court, ___4th ____ (August 4, 2005) the California Supreme Court unanimously declared that a predispute waiver of the right to a jury trial embedded in any contractual agreement is unconstitutional. The Court's decision stemmed from a case in which the facts were not terribly complicated. Two business entities had simply agreed to waive their rights to a jury trial in the event of a dispute. This same waiver of rights appears in most commercial loan documentation.
In finding that an individual has an inviolate right to trial by jury except when explicitly provided by statute, the Supreme Court strictly construed Article I, Section 16, of the California Constitution.
"(T)rial by jury is an inviolate right and shall be secured to all …In a civil case a jury may be waived by the consent of the parties expressed as prescribed by statute."
One California statute prescribes the limited circumstances when there may be a jury waiver. The applicable statute is California Code of Civil Procedures, Section 631, which was implementing legislation of the California legislature. It clearly provides that a jury trial may be waived only in the event of the following:
- Failure to appear at trial
- Failure to demand a jury trial within a specified period after the case is set for trial
- Failure to pay required jury fees
- Granting or consenting to waive a jury trial in open court
- Written consent to waiving a jury trial (after commencement of a proceeding) and filing the same with the clerk or court
In Grafton Partners, the California Supreme Court makes clear that each of the legislated permitted waivers of a jury trial as set forth in CCP Section 691 arises after a legal action between parties commenced, as opposed to a contract that includes a predispute waiver of the right to a jury trial guaranteed by the California constitution.
In strictly construing California's constitutional language protecting the right to a trial by jury and the already existing implementing legislation, the Court invalidated all predispute jury trial waivers embedded in contracts governed by California law, including contracts or loan documents preceding the date of the decision.
Where do we go from here?
While some major law firms across the country have sent out client alerts, there is remarkable silence as to how the lending industry might or should react. Yet, the following is clear:
- It is not likely that the California legislature will debate or legislate the sanctity of contract issues.
- Some commercial lenders will rely on vanilla arbitration provisions that may already exist in their documentation, or which may be cut-and-pasted from other documents.
The recommended approach would be a form of arbitration agreement that falls within the ambit of California Code of Civil Procedures Section 1281 as the Court in Grafton Partners specifically stated that predispute jury-trial waiver should not be viewed as being the same as predispute arbitration agreement.
CCP Section 1281 provides that:
"(a) written agreement to submit to arbitration an existing controversy or a controversy thereafter arising, is valid, enforceable, and irrevocable, safe upon such grounds that exist for the revocation of any contract to it."
Clearly, a predispute arbitration agreement is statutorily authorized and therefore enforceable. Thus, the focus of commercial lenders grappling with the consequences of Grafton Partners should be on crafting a predispute arbitration provision that provides maximum lender protection, and not simply open the door to an American Arbitration Association proceeding.
While seldom found in California loan documents, a few lenders already provide that any claim arising in contract or tort, or by statute, relating to any of the loan documents, may only be determined by a referee (or in some cases by a panel of referees) selected under the auspices of JAMS. JAMS is a well-recognized national organization of active attorneys and retired judges with highly trained mediation skills. Such provisions further provide that any decision or award resulting from a decision of the referee(s), will be entered as a judgment in the court that appointed the referee, in accordance with the provisions of California Code of Civil Procedures Sections 644 and 645.
One of the benefits of a well-drafted "trial by reference" (sometimes referred to as "trial by referee) provision is that such a provision may also provide that the parties shall utilize their best efforts to maintain the confidentiality of any decision. Another benefit may be that the trial by reference results in a non-appealable court order.
Those in the lending industry focusing on the reconstructing loan documents for California transactions, will need to be careful to carve-out some exceptions to "trial by reference" provisions, including whether it is to be only for borrower claims against the lender, or utilized for both actions against lender and the borrower. If there is to be a "trial by reference" in the event of lender claims against the borrower or the lender, the loan documents must clearly preserve the lender's right to initiate judicial or on-judicial foreclosures against real or personal property collateral, or exercising a judicial or power of the sale right, or seeking interim remedies (such as, but not limited to, injunctive relief, reits of possession or appointment of a receiver). The trial by reference provisions will need to be well-crafted by California lawyers understanding not only that which is prescribed by statute, but the practical realities experienced by California lawyers to date resolving disputes with a "trial by referee".
There will be other issues still to be flushed out with respect to the Grafton Partners decision. As an example, consideration must be given to the effect of Grafton Partners on a contract or loan document that does not include a non-severability clause which provides that one clause being invalidated should not invalidate the contract or the document as a whole.
Whether of not Grafton Partners is viewed as the "Big One" or simply another shaker in California law, how lenders in California and national lenders making loans in California, respond (or choose not to respond) at this time, may well determine the magnitude of its after-shocks.
