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In affirming a district court order finding that an arbitration agreement was unconscionable and therefore unenforceable, the Ninth Circuit Court of Appeals held that a limitation on liability in the underlying contract was not a proper consideration in deciding the enforceability of the contract's arbitration clause.
In Net Global Marketing, Inc. v. Dialtone, Inc., No. 04-56685, 2007 WL 57556 (9th Cir. Jan. 9, 2007), the district court denied Dialtone's motion to compel arbitration on the ground that the arbitration agreement was unconscionable and therefore unenforceable.
On appeal, the Court applied its recent en banc decision in Nagrampa v. Mailcoups, Inc., 469 F.3d 1257 (9th Cir. 2006) in concluding that the district court properly decided the enforceability of the arbitration agreement. Specifically, the Court reasoned that under Nagrampa, the district court could "look to circumstances external to the arbitration agreement" in deciding the question of procedural unconscionability because Net Global was not alleging that the underlying contract was unconscionable or otherwise unenforceable.
Despite its discussion of Nagrampa, the Court relied on circumstances unique to the arbitration agreement in affirming the district court's finding of procedural unconscionability. Under California law, procedural unconscionability requires a showing of either oppression or surprise. The Court found no oppression but upheld the finding of procedural unconscionability on the basis of surprise, which consisted solely of the fact that the arbitration clause was located on page twelve of a 17-page contract and not demarcated by line breaks or a descriptive section heading.
Turning to the issue of substantive unconscionability, the Court found that the "district court erred in looking to the liability limitation in the Terms of Service for the purpose of examining the substantive unconscionability of the arbitration agreement." This finding was based on the rule that when faced with a contract containing an arbitration clause, a court cannot entertain a challenge to any part of the underlying contract except for the arbitration clause.
Even though the limitation on liability was not a proper consideration, the Court affirmed the district court's finding of substantive unconscionability based on a provision giving Dialtone a unilateral right to modify the arbitration clause. According to the Court, this provision would allow Dialtone to "craft precisely the sort of asymmetrical arbitration agreement that is prohibited under California law as unconscionable."
As this case demonstrates, a limitation on liability and an arbitration clause are ordinarily separate and distinct parts of the underlying contract. Accordingly, where a contract contains an arbitration clause and a limitation on liability, the validity of the liability limitation is a question for the arbitrator. Under Rule 20E of the National Arbitration Forum Code of Procedure, an arbitrator has express authority to rule on the enforceability of any liability limitations.
Even though it is well-established that limitations on liability are not a proper consideration for the court under Prima Paint Corp. v. Flood & Conklin Manufacturing Co., 388 U.S. 395 (1967) and Buckeye Check Cashing, Inc. v. Cardegna, 126 S.Ct. 1204 (2006), some courts continue to rule on the enforceability of liability limitations in contracts containing an arbitration clause. This issue was a source of division within the Florida courts of appeal during the past year. See Alterra Healthcare Corp. v. Bryant, 937 So.2d 263 (Fla. Dist. Ct. App. Sep. 13, 2006).
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