What Happens to an Arbitration Clause in a Fraudulent Contract?
Arbitration clauses in construction agreements are very common. However, what if a court determines that the contract itself was obtained by fraud?
One example is where one of the parties states that it did not know that it was signing a contract. One party thought it was signing something else. If the party can prove that it was fraudulently led to believe that it was not signing a contract but instead was signing something else, then the contract may be held to be unenforceable. What if there is an arbitration provision in that contract? Do you arbitrate the dispute between the parties or must you seek the civil courts as an arena instead?
A recent California Appellate Court has held that an arbitration agreement in a contract that was obtained by fraudulent means is unenforceable. That is to say that not only is the agreement unenforceable, so is the arbitration provision itself because it was in the unenforceable contract.
Prior cases held that the fraud would have to go to the arbitration provision rather than to the contract as a whole. In other words, one would have to prove that the arbitration provision was entered into as a result of fraud rather than the contract as a whole. This new appellate decision has held otherwise. Although the result is not surprising (anything in an unenforceable agreement should also be unenforceable), this case also explains the law with respect to fraud in the execution of a contract.
Mary Johnson told Andy Jones, a legally blind 79-year-old woman suffering from dementia, that Johnson would help her obtain a reverse mortgage. Andy Jones said that she did not want a reverse mortgage. Johnson gained Jones' trust and friendship through many visits. Johnson finally convinced Jones to accompany her to Adams Financial Services, a loan brokerage. When Jones went there, the brokerage president asked Jones to initial "a lot of papers." Jones told the president of the brokerage that she was not interested in a reverse mortgage. However, she signed the papers because she was told that the papers would enable the brokerage to determine the payoff amount of Jones' current mortgage.
Jones could not read the papers and signed the papers with the assistance of the president of the brokerage and Johnson. Sometime thereafter, a representative of the brokerage went to Jones' home and demanded payment on the $50,000 loan on Jones' home. The demand was based on the papers that Jones had signed. When Jones sued Adams Financial Services, the brokerage demanded arbitration. Jones said that she would not arbitrate because the contract was obtained by fraud (fraud in the inducement and execution of the documents). The court held that, where the fraud goes to the inception or the making of the agreement so that one is deceived as to the nature of what that person is doing (as here where Jones did not know that she was signing a contract), then the contract is void and unenforceable and, therefore, the agreement to arbitrate is also unenforceable under both California and federal law.
The brokerage responded by saying that where one has a reasonable opportunity to discover the real terms of the transactions, or the real nature of his or her act, then the rule of fraud in the execution does not make a written contract void. However, cases have held that one needs to have a reasonable opportunity to discover the real terms of the agreement and what it is that they are doing. In this case, it did not apply because of Jones' physical and mental impairments. Not being able to read the document, and having dementia, did not allow a reasonable opportunity to discover the fraud or to discover the true nature of the act that one is committing.
"This article was originally posted on ww.reevesjournal.com."