|
Proceeding en banc, the Ninth Circuit Court of Appeals splintered on the question of whether a court confronted with an unconscionability challenge to an arbitration clause may consider the circumstances surrounding the formation of the underlying contract. According to an 8-3 majority, the surrounding circumstances (e.g., inequality of bargaining power) are a proper consideration but only if necessary to support a challenge directed exclusively at the arbitration clause.
In Nagrampa v. MailCoups, Inc., No. 03-15955, 2006 WL 3478345 (9th Cir. Dec. 4, 2006), Nagrampa and MailCoups entered into a franchise agreement whereby Nagrampa would operate a MailCoups franchise and disseminate coupons via direct mail. The franchise agreement contained an arbitration clause naming Boston as the venue but permitting MailCoups “to obtain any provisional remedy, including, without limitations, injunctive relief from any court of competent jurisdiction.”
After two unprofitable years, Nagrampa terminated the franchise agreement. MailCoups subsequently filed a demand for arbitration with the American Arbitration Association (AAA). The arbitration demand specified Los Angeles as the venue, but the AAA case manager changed the venue to Boston in accordance with the franchise agreement.
Once venue was changed to Boston, Nagrampa filed suit challenging the validity of the arbitration clause. After the district court and a three-judge appellate panel upheld the arbitration clause, the Ninth Circuit reviewed the matter en banc.
Following en banc review, a majority of the Court held that the arbitration clause was unconscionable and therefore unenforceable. The Court was divided on two principal issues: (1) the proper application of the Supreme Court’s holding in Buckeye Check Cashing, Inc. v. Cardegna, 126 S.Ct. 1204 (2006); and (2) whether the arbitration clause was unconscionable under California law.
Buckeye enunciated the rule that the validity of a contract containing an arbitration clause is a question for the arbitrator “unless the challenge is to the arbitration clause itself.” An 8-3 majority of the Court found it “abundantly clear that Nagrampa’s challenge goes specifically, and only, to the arbitration clause.” Conversely, the dissent found that “Nagrampa clearly challenged the validity of the contract as a whole.”
The Court’s disagreement over the proper application of Buckeye rested largely on whether a party challenging an arbitration clause may prove procedural unconscionability by reference to the circumstances surrounding the formation of the underlying contract. For example, the 8-3 majority construed Buckeye as permitting a court to consider whether the underlying contract is a “contract of adhesion” because, under California law, that proof is “necessary to establish unconscionability of the arbitration provision.”
The second issue of disagreement was whether the arbitration clause was unconscionable under California law. By a 7-4 majority, the Court found that the arbitration clause was unconscionable and therefore unenforceable.
The finding of substantive unconscionability rested on two factors. First, the Court found that the carve-out permitting MailCoups to seek a “provisional remedy” in court created a lack of mutuality that rendered the arbitration clause substantively unconscionable. In discussing this factor, the Court explained that since arbitrators have authority to award injunctive relief, see, e.g., Rule 20D of the National Arbitration Forum Code of Procedure, California courts have found no “legitimate business justification” for a unilateral right to seek relief in court.
As to the second factor, the Court found that the provision for venue in Boston rendered the arbitration clause substantively unconscionable because it imposed a financial hardship on Nagrampa that would effectively preclude her from participating in the arbitration. In reaching this finding, the Court reasoned that it was “unduly oppressive” to place “venue in Boston, Massachusetts, only a few miles away from MailCoups headquarters in Avon, but three thousand miles away from Nagrampa’s home.” A faraway venue is antithetical to the efficiency gains of arbitration because it increases the difficulty and expense of dispute resolution.
The dissenting judges highlighted Nagrampa’s business savvy in describing the majority holding as a “paternalistic endeavor[]” which “carries the seeds of great irony.” In the dissent’s view, the majority holding was ironic because it invoked the unconscionability doctrine to protect the “little guy” but would result “in fewer opportunities for other ‘little guys’ in the future” since “[t]he ever-growing cost of litigation is one of the most serious and uncontrollable risks faced by modern businesses.”
Curiously absent from the Court’s voluminous opinion is any mention of the rule that “[t]he critical juncture for determining whether a contract is unconscionable is the moment when it is entered into by both parties – not whether it is unconscionable in light of subsequent events.” American Software, Inc. v. Ali, 46 Cal.App.4th 1386, 1391 (Cal. Ct. App. 1996) (citing Cal. Civ. Code § 1670.5); see also Overstreet v. Contigroup Companies, Inc., 462 F.3d 409, 412 (5th Cir. 2006).
This rule was germane to the case because Nagrampa was making in excess of $100,000 per year when she entered into the franchise agreement, yet in ruling that the Nagrampa could not afford to travel to Boston, the Court relied on the her financial condition as it stood in the wake of her unprofitable franchise operation.
The entire Court would have found the arbitration agreement fair and enforceable if the parties mutually agreed to arbitrate all disputes and if the location of the arbitration hearing was a reasonably convenient and affordable location. It is wise for parties to include these provisions to avoid having to litigate over such matters.
Subscribe to a free weekly update on ADR case law and
legislation
|