The North Carolina Supreme Court found that arbitration under a lender's arbitration agreement would be cost-prohibitive because the agreement provided for an arbitral appeal to a three-member panel and required the losing party to pay the cost of the appeal. Accordingly, the Court held that the arbitration agreement was unenforceable.

In Tillman v. Commercial Credit Loans, Inc., No. 360A06, 2008 WL 201750 (N.C. Jan. 25, 2008), Tillman and Shirley (collectively, Borrowers) each obtained a loan from Commercial Credit Loans (CCL). Both loan agreements contained an arbitration provision that (1) barred class-wide proceedings, (2) carved out foreclosure proceedings and claims totaling less than $15,000, and (3) provided that either party could appeal an arbitration award to a three-arbitrator panel with the party losing on appeal required to pay all expenses of the appeal.

Several years later, the Borrowers filed a putative class action against CCL, alleging that CCL's marketing of credit insurance violated North Carolina law. CCL filed a motion to compel arbitration. The trial court denied the motion on various grounds, including evidence that CCL had sued thousands of North Carolina borrowers in court but never filed a claim in arbitration.

On appeal, the North Carolina Court of Appeals reversed the trial court and remanded the case with instructions to issue an order compelling arbitration. See Tillman v. Commercial Credit Loans, Inc., 629 S.E.2d 865 (N.C. Ct. App. 2006). However, since there was a dissenting opinion, the Borrowers were able to appeal to the North Carolina Supreme Court (the Court).

Before analyzing the arbitration agreement at issue, a majority of the Court adopted a "sliding scale" approach to unconscionability as the applicable standard under North Carolina law. Under the "sliding scale" approach, a party must demonstrate both forms of unconscionability – procedural and substantive – but a strong showing of one may overcome a weak showing of the other.

The Court found that the Borrowers had made the requisite showing of procedural unconscionability, largely because CCL admitted that they would have refused the loan if the Borrowers had refused the arbitration agreement.

Thus turning to the question of substantive unconscionability, the Court first examined whether arbitration under the agreement would be cost-prohibitive. On this issue, the Court agreed with the trial court that under the circumstances, arbitration would be cost-prohibitive because the Borrowers, with their limited financial means, could not risk having to pay the cost of an arbitral appeal.

The Court identified two additional sources of substantive unconscionability. First, the Court found that the arbitration agreement was unilateral in application based on CCL's routine filing of collection lawsuits. Second, the Court found that the bar on class-wide proceedings compounded the other problems by foreclosing the cost savings of a collective proceeding and further manifesting the agreement's unilateral application.

Having determined that the arbitration agreement was both substantively and procedurally unconscionable, the Court held that the agreement was unenforceable and, accordingly, reinstated the trial court order denying CCL's motion to compel arbitration.

There were two dissenting justices who reasoned that the majority's application of the unconscionability doctrine ran afoul of the Federal Arbitration Act (FAA). Specifically, they stated: "Although the majority ostensibly applies general principles of state contract law to render this arbitration agreement unconscionable, in effect the majority finds it unconscionable precisely because it is an agreement to arbitrate."

This case offers valuable guidance for parties who prefer the simplicity and tradition of one-on-one arbitration. First, the Court's discussion of procedural unconscionability highlights the importance of an opt-out provision giving the non-drafting party a right to reject the arbitration agreement. An opt-out provision guards against the argument that there is disparate bargaining power inherent in a consumer transaction by giving full and unfettered say to the non-drafting party to choose to enter into the arbitration agreement.

Second, the Court's concern over CCL's routine filing of lawsuits serves as a reminder that parties should embrace arbitration as a fair and efficient forum for the resolution of all disputes, unless there is some exception grounded in legal necessity. Otherwise, courts may view the arbitration agreement as an attempt to shield one party from litigation rather than the election of a more capable and efficient forum.