Should Your California Agreements Contain a "Judicial Reference" Clause?

If you do business with California consumers and rely on alternative dispute resolution ("ADR") to resolve disputes, you may have to rethink your options. Recent decisions by the California Supreme Court cast doubt on two of the most commonly-used ADR options in consumer agreements today: Arbitration and "jury trial waivers." Given that, it may be time to consider "judicial reference" in California.

In California, parties are allowed to agree ahead of time to have any disputes between them decided by "judicial reference." (See Cal. Civ. Proc. Code §§ 638-645.1.) There are two kinds of judicial reference, general and special. In a general reference, the referee decides the whole case, whereas in a special reference the judge will essentially "subcontract" certain discrete issues for determination by a referee or "special master." Discovery disputes, settlements, and complicated damage calculations are prime examples of special references. This memorandum, however, concerns only general reference.

Under general reference, a private judge may "hear and determine any or all of the issues in an action or proceeding" and exercises all the powers of a sitting judge. (§ 638(a).) The judge’s decision, once confirmed by the court, results in a court judgment, i.e., a binding adjudication. (§ 644(a).)

You might think of judicial reference as a hybrid of judicial resolution and arbitration. On the one hand, like judicial resolution, the "referred" case remains in the court system, employs the same rules of procedure and discovery, and enjoys the same right to appeal as any court case. On the other hand, like arbitration, the dispute is decided by a judge of the parties’ choosing. But whereas arbitration happens outside the judicial system, in a judicial reference, the case stays within the judicial system, with the referee making a "recommendation" which the judge (after a comment period by the parties) then adopts or rejects within ten days, after which the order is like any other court order or judgment. (§ 643.)

Arbitration and jury trial waivers as ADR devices were dealt a blow by the California Supreme Court in two separate decisions handed down this summer. Let’s review the bidding.

In June, the California Supreme Court decided Discover Bank v. Superior Court (Boehr), ___ Cal. 4th ___, 2005 WL 1500866 (June 27, 2005). That decision held that class action waiver clauses—which prohibit classwide arbitration and/or prohibit a consumer from serving as class representative—are unconscionable in almost all circumstances. Until Boehr, these clauses had been upheld everywhere except West Virginia.

That holding may mark the end of arbitration as a way for companies to resolve consumer disputes, at least in California, because a company that uses consumer arbitration in California now runs the risk that it may be forced to undertake classwide arbitration, a prospect few companies savor. A more detailed discussion of Boehr can be found in our "Consumer Arbitration Update"

Six weeks after Boehr, the California Supreme Court struck again, this time addressing jury trial waivers. Until now, these clauses were enforceable everywhere except Georgia. We can now add California to that list.

In Grafton Partners L.P. v. Superior Court, ___ Cal. 4th ___ (Aug. 4, 2005), the California Supreme Court held that a party to litigation may waive its right to jury trial in only one of the six ways enumerated in Code of Civil Procedure section 631. Not on that list is a predispute contractual agreement. So, these clauses are flat-out prohibited in California in both consumer and commercial contracts. (For a more detailed discussion, see "Does Your Contract Have a Jury Trial Waiver?"

Grafton admits no exceptions. Thus, even if a clause in a particular case is not unconscionable, it is still unenforceable. Likewise, a jury trial waiver between two sophisticated commercial businesses acting on the advice of silk-stockinged lawyers will fail just as surely as one embedded in the most lopsided agreement. This rule is retroactive, which means it applies even to contracts entered into before August 4, 2005.

The construction industry has been at the forefront of judicial reference clauses in California. Developers use them as a way to control product defect and class action litigation arising in new home construction. Consequently, the recent cases involving judicial reference all arise from construction contracts.

California Code of Civil Procedure section 638 allows for pre-dispute judicial reference if it is part of a "written contract or lease." Courts determine the enforceability of such provisions much as they would any other contract, using standard rules of contract interpretation. Like arbitration, the battle line in judicial reference is usually over "unconscionability."

The leading anti-reference case is Pardee Construction Company v. Superior Court, 100 Cal. App. 4th 1081 (2002). Since then, Pardee has emerged as a notable exception. Every case since Pardee has found the judicial reference clause enforceable. (See Greenbriar Homes Communities, Inc. v. Superior Court, 117 Cal. App. 4th 337 (2004); Woodside Homes of California, Inc. v. Superior Court, 107 Cal. App. 4th 723 (2003); Trend Homes, Inc. v. Superior Court, 2005 Cal. App. LEXIS 1218 (August 2, 2005).)

Rule of thumb: As long as you draft your clause so that it resembles the one enforced in Greenbriar/Woodside/Trend, as opposed to the one stricken in Pardee, you should be alright. We provide some drafting guidelines, below.

The Pros and Cons of Judicial Reference

The advantages of judicial reference (as compared to judicial resolution and arbitration) are:

• As in arbitration, the parties choose the decision-maker

• As in the court system, the parties have full appellate rights

• Like a singly-assigned judge, the referee handles all phases of the litigation and gains familiarity with the parties and the dispute

• Unlike the court system, judicial reference is fast, on par with arbitration

• Unlike a case in the court system, hearings are generally heard in a private facility rather than a public courtroom

• As in arbitration, the parties might be able to use reference to avoid jury trial without actually including a jury trial waiver (which is no longer enforceable after Grafton Partners)

• A case decided by a referee never leaves the judicial system, so, unlike arbitration, judicial reference may be more likely to be enforced against a claim of substantive unconscionability than arbitration, which is sometimes viewed with suspicion by trial judges

• A referee will probably have the power to decide claims involving injunctive relief. That is not true of arbitration in California, because claims seeking injunctive relief under Business & Professions Code section 17200 and the Consumer Legal Remedies Act (Cal. Civ. Code § 1750 et seq.) cannot be arbitrated (Cruz v. PacifiCare Health Systems, Inc., 30 Cal. 4th 303 (2003)

The principal disadvantages of judicial reference are:

• Unlike a case in the court system, but as in arbitration, the parties must foot the bill

• Like arbitration, the judicial reference provision must be voluntary and may be deemed unenforceable if the agreement is unconscionable or otherwise unenforceable

• Judicial reference cannot be used to defeat class actions, because a class action waiver clause will still be unenforceable in California unless it falls within the limited exception laid out in Discover Bank v. Superior Court (Boehr)

In 2004, the California Judicial Council issued a report on judicial reference. In a sample study conducted over a two-year period, it had found that reference had been invoked in only .1% of civil cases. Even then, they were overwhelmingly special references, mostly for discovery and settlement purposes.

Let’s say you want to include a judicial reference clause in your California consumer agreements. How do you go about it?

Most consumer account agreements contain a change-in-terms clause. It typically provides that the consumer is subject to the rules and procedures of the company that are then in effect, as well as any future rules and procedures of which the consumer is notified. If a consumer has such a clause in his or her original account agreement, it may be possible to add a judicial reference provision through that device.

California law approves of change-in-terms provisions so long as the enabling clause in the original customer account agreement authorizes the change. On the one hand, in Perdue v. Crocker National Bank, 38 Cal. 3d 913 (1985), the California Supreme Court considered whether a signature card, signed by every customer at the time a checking account is opened, could accommodate a later change-in-terms provision that added a fee for NSF checks. Perdue holds that the signature card was a contract authorizing the later imposition of NSF charges "subject to the bank’s duty of good faith and fair dealing in setting or varying such charges." (Id., at p. 924.)

On the other hand, in Badie v. Bank of America, 67 Cal. App. 4th 779 (1998), a bank tried to add an arbitration/reference clause using a change-in-terms provision, but the appellate court held it unenforceable. The original signature card authorized the bank to change any existing "term, condition, service or feature" of the customer’s account, but did not contemplate adding new terms. (Id. at p. 803.) Moreover, consumers did not have a real opportunity to opt out of the ADR process. (Id. at p. 806.)

Bottom line: Companies whose account agreements allow for the addition of new terms, and who go about implementing the change properly, should be fine.

If you’ve gotten this far, you may be ready to start drafting. We offer three suggestions:

First, if you do business in states other than California and want to retain your existing ADR options in those states (e.g., arbitration and jury trial waiver), you should consider a binary clause. In other words, the account agreement might have one section labeled "For Residents of States Other than California," and another labeled "For Residents of California."

Second, as with arbitration clauses, resist the temptation to include one-sided provisions that limit consumers’ rights. Things to avoid include limits on damages, exclusion of punitive damages, shortening the statute of limitations, excessive limits on discovery, unequal cost-sharing provisions, provisions that lay venue in a distant forum, and the like. And do not include a jury trial waiver in the "California" section. (Cf. Grafton Partners.)

Third, you should consider these factors that tend to militate for, and against, enforcement of your judicial reference clause:

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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