When you sign a contract, you expect to be bound by its terms. But what happens when several contracts all relate to one transaction, and they differ slightly in some details – for example, on whether disputes are subject to arbitration?

That question was key to a recent case decided by the California Court of Appeal (Ahern v Asset Management Consultants.)

In 2006, Thomas and Priscilla Ahern sold some property they owned in Los Angeles. Using a tax-advantaged strategy known as a “1032 exchange,” they reinvested some of the proceeds in a tenant in common interest in an Anaheim office building referred to by the court as the Amlap property.

BH & Sons had acquired the Amlap building from iStar CTL I (iStar); Asset Management Consultants (AMC) managed the property.

The private placement memorandum given to investors stated that the total purchase price for the Amlap property was $34,550,000, with AMC to receive a real estate commission of $1.3 million.

The tenant in common investment in the Amlap property was operated pursuant to a cotenancy agreement which said that “all decisions concerning the business and affairs” of the property were to be made by AMC.

It also stated that, except for matters that required a decision by a court, “any dispute arising in connection with the interpretation or enforcement of the provisions of this Agreement … shall be submitted to arbitration.”

In May of 2012, the Aherns sued BH, AMC, and several others, alleging that they had been fraudulently induced to invest in the Amlap property.

They claimed that the offering materials falsely represented the purchase price of the building as $34.55 million plus a $1.3 million commission. They alleged that the true purchase price was $30 million or less, and “what was purported to be a commission was an illegal and secret mark-up of the Property purchase price in which the defendants conspired to inflate the price,” thus diluting the value of the investment.

The defendants asked the Los Angeles County Superior Court to compel the Aherns to arbitrate the dispute, pursuant to the arbitration provisions in the iStar purchase-and-sale agreement and the cotenancy agreement.

The Aherns objected, arguing that the claims were outside the scope of the arbitration provision of the iStar agreement, which they said was expressly limited to disputes between the seller, iStar, and the buyer, BH. It did not cover disputes between BH and the tenant in common investors, they argued.

The trial court disagreed and ordered arbitration based on the iStar agreement.

The arbitrator ruled in favor of BH, finding that the Aherns had breached their representations that they understood the risks involved in investing in the Amlap property. The Aherns were found liable for $399,000.

The superior court confirmed the award and entered judgment in favor of BH.

The Aherns then appealed, and in 2015 the court of appeals ruled that the trial court had erred in compelling arbitration, and vacated the award. It said the purchase and sale agreement between iStar and BH did not establish or govern any relationship between the Aherns and BH.

In 2016 the Aherns filed an amended complaint against the BH parties, making much the same allegations as before.

BH again asked the court to compel arbitration of the dispute, this time based on the arbitration provision in the cotenancy agreement.

The Aherns opposed the petition, arguing that their tenant in common interest in the Amlap property had been acquired through the purchase and sale agreement, which did not contain an arbitration provision.

The cotenancy agreement concerned only the management and operation of the investment after its acquisition, the Aherns argued. Accordingly, the narrow arbitration provision in that agreement did not apply to their fraud and breach of fiduciary duty claims.

The trial court rejected the Aherns’ arguments and granted the motion to compel arbitration. In June of 2020, the arbitrator ruled in favor of BH, and the trial court confirmed the award by the arbitrator.

The Aherns then appealed.

In its latest ruling, the appellate court found that the trial court had again erred in ordering the arbitration.

It noted that the Aherns were suing to recover for alleged injuries they suffered because of misrepresentations and omissions in the marketing and sale of their tenant in common investment in the Amlap property.

Their claims did not arise “in connection with the interpretation or enforcement of the provisions of [the cotenancy agreement],” the justices said, and “should not have been ordered to arbitration.”

It is true, they acknowledged, that “broad arbitration clauses are interpreted to apply to extracontractual disputes between the contracting parties,” provided “they have their roots in the relationship between the parties which was created by the contract.”

But the arbitration clause in the cotenancy agreement was narrowly drawn, not broad in its coverage. In addition, the dispute – about the disclosures made in the purchase and sale agreement – was not “rooted in” the cotenancy agreement.

The justices reversed the trial court’s order confirming the arbitration award and awarded the Aherns their costs on appeal.

There have been several recent appellate cases involving disputes over the applicability of arbitration clauses. There is a lesson to be drawn from these cases by transactional lawyers and by parties to a transaction where arbitration is being considered: drafting such agreements with a better understanding of case law can avoid years of litigation not over the underlying legal issues, but simply to determine who gets to decide those legal issues – litigation that most clients would consider a needless waste of time and money.

By Laurie Murphy