NEW YORK RESIDENTIAL CONSTRUCTION ALERT

Two New York courts have ruled that mandatory arbitration agreements in residential home improvement contracts are unenforceable.

In Ragucci v. Professional Construction Services (25 A.D.3d 43, 2005), the Appellate Division, 2nd Department, held that a contract for architectural services to

build a home involved "consumer goods" within the meaning of ? 399-c of the New York General Business Law (GBL), which makes makes mandatory arbitration agreements in contracts for "consumer goods" null and void. section ? 399-c defines consumer services to include "services purchased or paid for by a consumer, the intended use or benefit of which is intended for the personal family of household purposes of such consumer." This broad definition, said the court, "compels the conclusion that the subject contract is a contract for the purchase of consumer goods." It also noted that the consumer was not on an "equal footing in bargaining."

A New York trial court in Nassau County held on April 11, 2006, in Baronoffv. Kean Development Co. [2006 WL 948119], a case of apparent first impression, that the Federal Arbitration Act does not preempt GBL 399-c. The court also extended the holding in Ragucci to residential construction contracts.

The dispute arose out of two construction contracts that the Baronoffs entered into with Kean Development to renovate their Long Island and Manhattan residences. Both contracts contained an arbitration clause. When the Baranoffs terminated the contracts, the contractor served an arbitration demand seeking to recover on some unpaid invoices. The Baranoffs served an answer and later filed an order to show cause seeking a permanent stay of arbitration. The court found that the homeowners' stay motion was untimely under state law because it was not made within 20 days of receipt of the demand. However, under New York case law, this rule would not preclude the court from granting a stay if it found that the parties' agreement was illegal on its face. The homeowners argued that New York case law applied here because contracts for residential construction services by a contractor involved "consumer goods" under GBL ? 399-c; therefore the arbitration agreements in these contracts were null and void.

Relying on Ragucci, which applied ? 399-c to architectural services, the court accepted this argument. The contractor argued that even so, the FAA preempted ? 399-c because the construction materials used in performance of the construction contracts came from out of state, proving that the contracts "affected interstate commerce." However, the court rejected the contractor's federal preemption argument. It ruled that it was not enough to have some construction materials from outside the state. That alone did not rise to the level of "affecting commerce" found by the Supreme Court in the Terminix case or by New York's highest court in Diamond Waterproofing Systems, v. 55 Liberty Owners Corp. [793 N.Y.S.2d 831]. To hold otherwise, the court said, would render ? 399-c "a virtual nullity, since [t]aking [the contractor's] reasoning to its logical extreme, any contract for consumer goods, involving any goods from outside of New York, would not receive the intended protection of [?] 399-c."

Jeffrey Cruz, a partner at Thelen Reid & Priest in New York City, said that although New York practitioners were generally surprised by the decision in Ragucci, "the court's reasoning appears sound and consistent with the language of GBL 399-c." He predicted a similar reaction to the Baronoff ruling on the federal pre-emption issue. "We can expect some debate as to whether any construction project can be undertaken without affecting interstate commerce," he said.