Robert S. Gillison
March 2006

Business Law News

On August 4, 2005, the California Supreme Court, in Grafton Partners V. Superior Court ("Grafton"), ruled that pre-dispute contractual jury trial waivers are unenforceable under California law. Even though the Supreme Court acknowledged, particularly in the concurring opinion of Justice Chin, that its decision is out-of-step with the authority of other states and federal jurisdictions, it based its decision on a strict interpretation of Article I, section 16 of the California Constitution and section 631 of the Code of Civil Procedure-the legal authority and implementing statute for civil jury trial waivers in California. In doing so, the Supreme Court concluded that the Constitution premits jury trial waivers only when they are "prescribed by statute" and that the only statute on point, section 631, does not expressly authorize such waivers before the parties have submitted their controversy to a court of law.

The Supreme Court's ruling in Grafton is significant since pre-dispute jury trial waivers have become commonplace in many types of contracts as a suitable means of dispute resolution. In fact, such waivers were generally considered enforceable pursuant to a prior decision of the California Court of Appeal. The determination that these waivers are now unenforceable significantly impacts how disputes are to be resolved with respect to contracts that contain a jury trial waiver clause. To make matters worse, the SUpreme Court's holding is applicable to all existing contracts subject to California law, on a retroactive basis. As a result, many disputes will now be determined by a jury trial, with all of the inherent expense, delay, and added uncertainty.

With that said, however, it is unlikely that the decision in Grafton would be applied in a federal court located in California since the Unisted States Supreme Court has held that the right to a jury trial in federal court is determined as a matter of federal law in diversity as well as other actions. ALthough a factual determination must sometimes be made to determine whether a pre-dispute contractual jury trial waiver has been knowingly, voluntarily, and intelligently made, such waivers have been upheld in federal court. It is also unlikely that Grafton would apply in an action pending in another state, when that other state's substantive law applied to be proceeding. Whether Grafton would be applied in an action pending in another state in which California substantive law applied would depend on the laws of that particular state.

Assuming that parties doing business in California want their disputes to be resolved without a jury, and pending any new legislation authorizing pre-dispute contractual jury trial waivers, then other types of enforceable dispute resolution procedures should be considered when amending existing contracts (i.e. contracts executed prior to Grafton) or when entering a new agreement. Although there is no "one size fits all" approach to alternative dispute resolution, judicial reference and arbitration clauses have become increasingly popular and, unlike pre-dispute jury trial waivers, are expressly authorized by law. In fact, the Supreme Court in Grafton made a point of mentioning that, although judicial reference and arbitration proceedings involve a jury trial waiver, a pre-dispute agreement between the parties to resolve their differences in a judicial reference and arbitration proceeding is generally enforceable since they are each prescribed by statute.

Section 638 of the Code of Civil Procedure, the implementing statute with respect to judicial reference, provides that, among other circumstances, judicial reference is authorized, "upon the motion of a party to a written contract or lease that provides that any controversy arising therefrom shall be heard by a referee." Section 1281 of the Code of Civil procedure, the statute that authorizes arbitratin agreements, provides that, "a written agreement to submit to arbitration an existing controversy or a controversy thereafter arising is valid, enforceable and irrecovable." Thus, given the Supreme Court's discussion in Grafton and the statutory authority cited above, parties contracting under California law should strongly consider including judicial reference or arbitration provisions in their agreements as a means to avoid jury trial.

In either case, the judicial reference or arbitration provision should be added to a contract in addition to any jury trial waiver already set forth therein, since (a) the California Legislature may amend section 631 or anact a new implementing statute to expressly authorize pre-dispute contractual jurty trial waivers; or (b) litigation may be brought in a jurisdiction other than California, or in federal court, where pre-dispute contractual jurty trial waivers are enforceable. Thus, when amendments are made to an existing contract, or before a new contract is executed, the parties should modify the jury trial waiver by inserting the phrase "to the extent permitted by law" in connection therewith. This would permit the parties to retain the jury trial waiver if the dispute is heard by a federal or non-California state court of if the legislature passes legislation authorizing pre=dispute contractual jury trial waivers in the future.

It should not noted, however, that there may be a potential risk of retaining such a waiver, even a qualified one, in the wake of Grafton. In the consumer context, it may be argued that the inclusion of an unenforceable provision in a consumer contract violates section 1770, subdivision (14) of the Civil Code (i.e. the Consumer Legal Remedies Act). There may also be a risk in the commercial context if it is argued that the inclusion of such a provision in a comercial contract violates the covenant of good faith and fair dealing pursuant to section 1203 of the Commercial Code. Although it is not known how a court would react to these arguments, it is doubtful that a properly qualified jury trial waiver would violate the Consumer Legal Remedies Act of the Commercial Code since the waiver may indeed be enforceable under the circumstances set forth in the preceding paragraph.

Generally speaking, judicial reference and arbitration proceedings each provide a forum in which the parties can be heard before a neutral party (a referee or arbitrator depending on which option is selected). Each procedure is generally less expensive and time conosuming than a jury trial and the parties are afforded more freedom in scheduling their proceedings than is typical in a usual trial court hearing. In both cases there is also an opportunity to define, by agreement, the specific background and qualifications of the referee or arbitrator, which is a major improvement from pre-dispute jury trial waivers-where the parties were often subject to the "luck of the draw" as to the assigned judge. A disadvantage that is shared by both of these dispute resolution methods is that the parties must pay the fees charged by the referee or arbitrator, which may be an issue in disputes involving relatively small amounts. Despite these similarities, however, there are some significant differences between judicial reference and arbitration. In light of Grafton, the parties should consider the pros and cons of each method of dispute resolution before adopting either one.

A judicial reference proceeding is, in substance, a court proceeding that will result in a binding judicial decision. The parties' chosen referee has the powers of a court judge and the Codes of Civil procedure and Evidence will apply, so the parties have a reasonable expectation of what to expect and how to proceed. Because of the nature of arbitration, arbitrators sometimes feel less constrained to follow the rules of evidence and legal authorities, which can lead to decisions that are not legally correct. The judgment entered by the judge as a result of the referee's decision is fully subject to appellate review like any other judicial decision. In contrast, arbitration awards are not judicial decisions and the ability of either party to appeal is severly limited, if available at all.

Also, since the judicial reference procedure is a court proceeding, any party as to which the court has jurisdiction can be made to a party to the lawsuit. Although the referee's decision may only be binding on the parties who agreed to the judicial reference proceeding, the juge who is overseeing such proceeding may use the referee's decision to enter a court decision applicable against other parties based upon the referee's report as to the facts and law. With arbitration it is not possible to bring in all the involved parties to the underlying dispute since only those parties who have agreed to arbitration can be made a party. However, one benefit of arbitration is its status as a federally recognized procedure which is available regardless of the choice of law or forum applicable to the underlying transaction, unlike judicial reference which is a creature of California statute.

It should be noted that if the underlying trasaction involves real estate collateral, then the udicial reference or arbitration provision should provide that non-judicial foreclosure is outside the proceeding to avoid the effects of the "one action" and "security first" rules. As mentioned above, a judicial reference procedure is a court proceeding and, therefore, is an "action" capable of invoking the sanctions imposed by section 726 of the Code of Civil Procedure. Correspondingly, since a judicial reference procedure is an action, the court is authorized to handle all aspects of the trasaction, including judicial foreclosure on real property if so desired. With arbitration, it is not possible for the arbitrator to handle a judicial foreclosure.

Although an arbitration hearing does not involve an action in a court of justice, going to arbitration without first foreclosing on the real estate may be a violation of the "security first" portion of section 726 of the Code of Civil Procedure. Also, it should be noted that a number of courts outside of California have held that an arbitration proceeding is an action, and while there is at present no California case law that has held the same, the parties should be mindful that an arbitration hearing has the potential to violate the one action rule.

Similarly, the appointment of an receiver or the exercise of other provisional remedies such as writs of attachment or unjunctive relief should also be carved out of the judicial reference or arbitration provision and be determined by applicable law. However, although such provisional remedies may be carved out of a judicial reference provision, no new action is needed to obtain a writ of ataachment or any other provisional remedy since the judicial reference proceeding is a court action. This would not be the case in an arbitration proceeding.

Given the Supreme Court's strong language in Grafton, and even though California courts follow generally accepted choice of law principles, it is likely that, when a California court is asked to enforce a jury trial waiver contained in a contract that is governed by non-California law, it will look for significant contacts or a nexus with the state whose law has been chosen. Law and forum shopping in light of the strong public policy against pre-dispute contractual jury trial waivers makes any attempt to sidestep Grafton, by simply choosing non-California law, problematic.

This is not to say that with proper facts non-California choice of law and forum would not be upheld in connection with a pre-dispute jury trial waiver. However, since the right to a jurty in California in an inviolate right protected by the California Constitution, the burden of establishing the necessary contacts or nexus (such as where the parties are located, where the contract is signed, where the underlying transaction is being implemented, etc.) will be higher and more difficult to overcome. In all cases where non-California law is chosen, it should be coupled with a provision providing for the exclusive jurisdiction of courts outside of California in order to increase the likelihood that the choice of law provision will be upheld. This alternative, however, may not be available in many consumer contracts in which the consumer resides in California since a number of statutes require that actions arising out of such contracts be decided under California law and be litigated in the state of the consumer's residence.