LARRY A. JUDD; AND JULIE N. JUDD v. PAUL J. SINNOTT; SHERRI SINNOTT; AND EDWARD BEATY
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RENDERED:
October 11, 2002; 10:00 a.m.
NOT TO BE PUBLISHED
C ommonwealth O f K entucky
C ourt O f A ppeals
NO.
2001-CA-000496-MR
LARRY A. JUDD; AND
JULIE N. JUDD
APPELLANTS
APPEAL FROM JEFFERSON CIRCUIT COURT
HONORABLE STEPHEN P. RYAN, JUDGE
ACTION NO. 00-CI-003339
v.
PAUL J. SINNOTT; SHERRI SINNOTT;
AND EDWARD BEATY
APPELLEES
OPINION
AFFIRMING
** ** ** ** **
BEFORE:
DYCHE, JOHNSON AND KNOPF, JUDGES.
JOHNSON, JUDGE:
Larry A. Judd and Julie N. Judd (the Judds) have
appealed from an order entered by the Jefferson Circuit Court on
February 6, 2001, which denied their motion to compel arbitration
in a dispute arising out of a sale of real estate.1
Having
concluded that the Judds failed to meet their burden in proving
that the United States Arbitration Act (Federal Arbitration Act)2
applies to the contract in question, and that Kentucky law does
1
While this appeal is interlocutory, it is authorized
pursuant to Kentucky Revised Statutes (KRS) 417.220(1)(a).
2
United States Arbitration Act of 1925, 9 U.S.C. §§ 1-15.
not permit the enforcement of an arbitration clause in a contract
which has been fraudulently induced, we affirm.
The Judds sold their residence to Paul and Sherri
Sinnott (the Sinnotts) pursuant to a contract executed by the
parties on May 15, 1999.
After taking possession of the home,
the Sinnotts discovered serious problems with its plumbing
system.
On May 24, 2000, the Sinnotts filed a complaint in
Jefferson Circuit Court, alleging that they had been fraudulently
induced by the Judds to enter into the contract, and sought
recission of the contract, compensatory damages for their
extensive repair bills, and punitive damages.
Specifically, the
complaint alleged that the Judds had misrepresented and concealed
the defects in the house’s plumbing system.
In support of their
claims, the Sinnotts attached a copy of the disclosure form
completed by the Judds prior to the sale, which stated that the
sellers were not aware of any defect in their house.
The
Sinnotts also asserted a claim against Edward Beaty, alleging
that he was negligent in performing an inspection of the house’s
plumbing.3
In response, the Judds filed a motion to dismiss the
action for a lack of subject-matter jurisdiction because the
Sinnotts had failed to exhaust their remedy of arbitration
contained in the sales contract, which stated:
3
The claim against Beaty is not relevant to this appeal, as
he was not a party to the sales contract which contained the
arbitration clause.
-2-
BINDING ARBITRATION: All claims or disputes
of Sellers, Buyers, brokers, or agents or any
of them arising out of this contract or the
breach thereof or arising out of or relating
to the physical condition of the property
covered by this purchase agreement (including
without limitation, claims of fraud,
misrepresentation, warranty and negligence)
shall be decided by binding arbitration in
accordance with the rules for the real estate
industry, then in effect, adopted by the
American Arbitration Association unless the
parties mutually agree otherwise. Notice of
the demand for arbitration shall be filed in
writing by registered or certified mail with
the other parties to the contract and with
the American Arbitration Association or other
arbitrators which the parties may agree upon
and shall be made within one year after the
dispute has arisen. An actual oral hearing
shall be held unless the parties mutually
agree otherwise. The Kentucky Real Estate
Commission still retains jurisdiction to
determine violations of KRS 324.160. Any
proceeding pursuant to KRS 324.420(1) to
determine damages shall be conducted by an
arbitrator pursuant to this clause and not in
court. By signing below, the agents, on
behalf of themselves and their brokers, agree
to be bound by this arbitration clause, but
are not parties to the contract for any other
purpose. The terms of this Paragraph 15 shall
survive the closing.
The Sinnotts responded to the motion to dismiss by
arguing that the arbitration clause was rendered unenforceable by
KRS 417.050, which provides in part that “[a] written agreement
to submit any existing controversy to arbitration or a provision
in written contract to submit to arbitration any controversy
thereafter arising between the parties is valid, enforceable and
irrevocable, save upon such grounds as exist at law for the
revocation of any contract” [emphasis added].
-3-
Pointing to the
final clause from the above quote, the Sinnotts contended that
their claim of fraudulent inducement constituted grounds for “the
revocation of any contract,” thus relieving them from the terms
of the arbitration agreement.
The Judds, on the other hand,
contended that this clause from KRS 417.050 should be applied
only when the validity of the arbitration clause itself is in
question.
The trial court denied the Judds’ motion to dismiss on
July 21, 2000, stating that whether the contract was fraudulently
induced was an issue of fact for a jury and that it would be
improper to dismiss the action.
The Judds appealed that order,
citing CR4 65.07 as grounds for their interlocutory appeal.
This
Court found the interlocutory appeal to be improper and dismissed
the appeal on October 16, 2000.
The Judds then filed a motion to
compel arbitration in the Jefferson Circuit Court.
The trial
court denied that motion on February 6, 2001, reiterating its
reasoning from the order of July 21, 2000.
This appeal followed.
The Judds first argue that the Federal Arbitration Act
governs the transaction because the real estate sales contract in
question affected interstate commerce; and that pursuant to
Section 2 of the Federal Act, the arbitration clause contained in
the sales contract is binding and enforceable.
The Judds also
argue that even if the Federal Arbitration Act is held not to
4
Kentucky Rules of Civil Procedure.
-4-
apply to this transaction, under Kentucky law the arbitration
clause is still binding and enforceable.
An agreement to arbitrate a dispute arising under a
contract is valid and it is specifically enforceable by the stay
of a judicial proceeding brought in Kentucky if the proceeding
involves an issue referable to arbitration.5
The U.S.
Arbitration Act of 1925 will govern such actions — even in the
courts of this Commonwealth — where the purpose of the action is
to enforce a voluntary arbitration agreement in a contract
evidencing a transaction in interstate commerce.6
In reviewing
whether a contract evidences a transaction in interstate
commerce, courts have employed a “broad definition” of the term
“interstate commerce.”7
As a threshold matter, we must first consider whether
the contract entered into by the Judds and the Sinnotts
contemplated a transaction in interstate commerce.
The Judds
argue that the contract affects interstate commerce because the
transaction was financed in part by an out-of-state lender, Navy
5
Kodak Mining Co. v. Carrs Fork Corp., Ky., 669 S.W.2d 917,
919 (1984).
6
Fite & Warmath Construction Co., Inc. v. MYS Corp., Ky.,
559 S.W.2d 729, 734 (1977); 9 U.S.C. § 2 (providing that: “A
written provision in any . . . contract evidencing a transaction
involving [interstate] commerce to settle by arbitration a
controversy thereafter arising out of such contract or
transaction . . . shall be valid, irrevocable, and enforceable,
save upon such grounds as exist at law or in equity for the
revocation of any contract”).
7
Fite, supra.
-5-
Federal Credit Union located in Maryfield, Virginia, and that
hazard insurance was obtained through this out-of-state lender.
The Judds offered no other proof that the transaction involved
interstate commerce.
Based on this limited evidence of record,
the trial court rejected the Judds’ interstate commerce argument.
From our review of the evidence, we conclude that the evidence
did not compel a finding in favor of the Judds.
Consequently, it
cannot be said that the trial court’s finding was clearly
erroneous.8
The Kentucky cases that have held the Federal
Arbitration Act to be applicable have involved much more
compelling facts.
In Fite, the parties to the contract were
headquartered in different states, employees regularly crossed
state lines to work on the project under contract, and out-ofstate contractors and vendors charged almost $4 million.
In
Kodak Mining, the contracting parties were again incorporated in
different states, the arbitration clause specified that the
arbitrators would be selected by federal judges of different
states, and the activity contemplated by the contract, coal
mining, was an industry that was heavily regulated by federal
law.
The Court in Kodak Mining also emphasized that even local
mining operations had a substantial affect on the national supply
and price of coal.
8
CR 52.01.
-6-
The case sub judice does not include any of these
factors.
Navy Federal Credit Union is an incidental party to the
contract, and it did not play a significant role in negotiating
the contract.
Further, both the Judds and the Sinnotts are
residents of Kentucky; and the house under contract was located
in Kentucky.
Unlike the law concerning the coal mining industry,
real estate and property law are traditionally matters of state
law and state regulation.
Accordingly, the contract between the
Judds and Sinnotts does not sufficiently affect interstate
commerce, so as to compel a finding that it comes under the
auspices of the Federal Arbitration Act.
In support of their contention that Kentucky law
compels arbitration, the Judds argue that KRS 417.050 is nearly
identical to its counterpart in the Federal Arbitration Act and
the Uniform Arbitration Act,9 and that the majority of federal
and state courts have determined that the language in the savings
clause (“save upon such grounds as exist at law for the
revocation of any contract”) applies only where a claim of
fraudulent inducement is made with respect to the agreement to
arbitrate and not to the underlying contract in general.10
The
9
The Uniform Arbitration Act has been largely adopted in
most states, including Kentucky.
10
See Marks v. Bean, Ky.App., 57 S.W.3d 303, 306 (2001)
(citing Prima Paint Corp. v. Flood & Conklin Manufacturing Co.,
388 U.S. 395, 87 S.Ct. 1801, 18 L.Ed.2d 1270 (1967); Quirk v.
Data Terminal Systems, Inc., 379 Mass. 762, 400 N.E.2d 858
(1980); and Jay M. Zetter, J.D., Annotation, Claim of Fraud in
the Inducement of Contract as Subject to Compulsory Arbitration
(continued...)
-7-
Judds also point out that Kentucky law generally favors
arbitration agreements.11
The Judds claim that the trial court
erred by not following the majority doctrine and by not enforcing
the arbitration agreement.
Contrary to the Judds’ position, however, Kentucky
adheres to the minority rule — that the arbitration agreement is
not separable from the overall agreement, and thus a claim that
questions the legitimacy of the contract as a whole also renders
the arbitration clause unenforceable.12
Marks, which was
rendered by this Court on July 20, 2001, involved an identical
fact pattern and the same arbitration clause, which is apparently
used by the members of the Jefferson County Board of Realtors in
their contracts for the sale of a home.13
In that decision, this
Court reasoned that:
The contract executed by the parties is
a standard form drafted by the Louisville
Board of Realtors. Its arbitration clause is
obviously designed to protect member real
estate agents and brokers from litigation.
These facts alone do not address the legal
elements of whether the clause is
enforceable. We believe that the [Appellants]
interpretation of KRS 417.050
10
(...continued)
Clause Contained in Contract, 11 A.L.R. 4th 774 (1982)).
11
Kodak Mining, supra.
12
Marks, supra at 306.
13
The only difference between the two cases is that the
Beans discovered serious problems with the brick veneer of their
Jefferson County home rather than a problem with the plumbing.
The complaint, procedural history, and even the order on appeal
closely resemble each other.
-8-
disproportionately elevates the policy
favoring arbitration over the strong public
policy against fraud. The clear and plain
language of that statute dictates a
legislative intent that innocent parties not
be forced to comply with an arbitration
provision in contracts tainted by fraud. It
creates an explicit exception to the general
enforceability of arbitration clauses: "save
upon such grounds as exist at law for the
revocation of any contract." KRS 417.050
(Emphasis added.) We do not believe the
trial court's application of KRS 417.050 to
the facts in this case in any way harms or
undermines the arbitration process. As noted
in Atcas, supra,
When the making of the agreement itself is
put in issue, as is the result of a claim of
fraud in the inducement, that issue is more
properly determined by those trained in the
law. Issues involving a breach or violation
of the agreement, which are primarily issues
of fact, can be more properly left to the
expertise of those trained in the respective
fields of arbitration. There is ample
encouragement for both approaches within the
terminology of the statute.14
Accordingly, we hold that Kentucky law does not require
the arbitration of a claim where as a part of that claim
fraudulent inducement has been properly alledged.
The Jefferson
Circuit Court was correct in denying the Judds’ motion to compel
arbitration and its order is affirmed.
DYCHE, JUDGE CONCURS IN RESULT ONLY.
KNOPF, JUDGE, CONCURS IN RESULT ONLY AND FILES SEPARATE
OPINION.
KNOPF, JUDGE, CONCURRING IN RESULT:
As the majority
opinion correctly points out, Marks v. Bean, Ky. App., 57 S.W.3d
14
Marks, supra at 307.
-9-
303 (2001), is currently the law of the Commonwealth and dictates
the result in this case.
in that result.
I am compelled, accordingly, to concur
I write separately, however, to register my
dissatisfaction with Marks--a departure from the mainstream of
American arbitration law that I do not believe the General
Assembly intended--and to disassociate myself from any suggestion
that arbitrators are less able than judges to perceive fraud or
more willing to countenance it.
BRIEF FOR APPELLANT:
BRIEF FOR APPELLEES, PAUL AND
SHERRI SINNOTT:
William B. Orberson
William P. Swain
Louisville, Kentucky
Robert W. Grant
Louisville, Kentucky
-10-
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