Friday, April 25, 2014

FYI: Cal App Ct Invalidates Arbitration Clause Located on Back of Contract

Sunday, June 16, 2013

The California Court of Appeal, Second District, recently held that an arbitration clause located on the back of a contract to be unenforceable because it was unduly oppressive on consumers.  

Among other reasons, the Court noted that the arbitration clause was not noticeable to consumers, who were told where to sign and were not given an opportunity to see or read the provisions on the back of the contract.  Moreover, it found several terms of the arbitration agreement to favor the seller while placing an unduly harsh burden on the consumer.

A copy of the opinion is available at:http://www.courts.ca.gov/opinions/documents/B237257.pdf.

Plaintiffs ("Consumers") sought to purchase an automobile from a dealership ("Dealer").  One of Dealer's managers presented Consumers with a Retail Installment Sale Contract ("Sale Contract").  The Sale Contract was a preprinted document consisting of one page, 8 ½ by 26 inches, with numerous provisions on both sides.  Consumers signed or initialed the front side in 12 places but were not required to sign or initial anywhere on the back.  The arbitration provision ("Arbitration Clause") was located on the back, at the bottom of the page, outlined by a black box, and was the last provision concerning the purchase of the vehicle.  It permitted either party to choose to decide a dispute "by arbitration and not in court or by jury trial."

According to Consumers, the Sale Contract was allegedly presented "on a take-it-or-leave-it basis" without any negotiation.  The documents were supposedly given to them and they were allegedly told "sign here" in various places on the front side, but not on the back side.  Allegedly, Consumers did not realize that there was an arbitration provision and were supposedly unaware that the Sale Contract had a back side with additional terms. 

Consumers filed a putative class action against Dealer, the assignee to the Sale Contract ("Assignee"), and the manufacturer ("Manufacturer"), asserting numerous violations of California consumer protection law, including the Consumers Legal Remedies Act ("CLRA").  The lower court granted Defendants' motion to compel arbitration as to Dealer and Assignee, but not Manufacturer as it was not party to the Sale Contract.  Also, the lower court granted Dealer's motion to strike the class action allegations.  Consumers appealed, claiming that the Arbitration Clause was unconscionable.

As you may recall, because unconscionablity is a reason for refusing to enforce contracts generally, it is also a valid reason for refusing to enforce an arbitration agreement.  See Armendariz v. Foundation Health Psychcare Services, Inc., 24 Cal.4th 83, 114 (Ca. App. Ct. 2000).  Generally, the party resisting arbitration bears the burden of proving unconscionablity.  See Pinnacle Museum Tower Assn. v. Pinnacle Market Development (US), LLC, 55 Cal.4 223, 246 (Cal. App. Ct. 2012).

Under California common law, unconscionablity consists of both procedural and substantive elements.  Procedural unconscionablity addresses the circumstances of contract negotiation and formation, specifically "oppression or surprise due to unequal bargaining power."  Id.  Substantive unconscionablity concerns whether the terms are "overly harsh or one-sided" in such a way as to "shock the conscience."  Id.  Although both elements must be shown, they need not be present in the same degree.  Instead, they are evaluated on a "sliding scale," meaning the more procedurally oppressive the contract formation was, the less evidence of substantive unconscionablity is required for a court to find the term unenforceable.  Id.

As to procedural unconscionablity, the Appellate Court determined that the Arbitration Clause satisfied the "oppression and surprise" elements.  The Court found the Sale Contract oppressive because it was presented on a take-it-or-leave-it basis with preprinted terms that were non-negotiable.  See Pinnacle, 55 Cal.4th at 246.

Moreover, according to the Court, the "surprise" element was met because the Arbitration Clause was "hidden" within the Sale Contract.  See id.  Recognizing that the Sale Contract was drafted as a single paged document to comply with California law, the Appellate Court observed that no law required the arbitration clause to be on the back where consumers were not required to sign, and the manager did not draw their attention to it.  Although Consumers generally cannot avoid contractual terms by claiming that they failed to read them, this "does not apply to an adhesion contract" where "failure to read the contract helps establish actual surprise."  Bruni v. Didion, 160 Cal.App,4th 1272, 1290-1291 (2008).  Subsequently, the Court found that the Arbitration Clause, which was printed on the back side, was "unnoticeable to buyers who were told where to sign on the front side and were not given an opportunity to see or read the provisions on the back."

As to substantive unconscionablity, the Appellate Court first noted that, although Consumers were required to show a "relatively lower degree" in light of the "high degree" of procedural unconscionablity, a "strong showing of substantive unconscionablity" was made.  Specifically, the Court found the following provisions of the Arbitration Clause to be unconscionable imposing an "unduly oppressive burden on buyers":

1.  Appeals Allowed as to Awards Exceeding $100,000.  Under the Sale Contract, either party may appeal an adverse award exceeding $100,000.  According to the Court, consumers will "rarely benefit" from this provision.  Instead, dealers would be most likely to appeal an adverse award exceeding $100,000.  As such, the Court held that this type of provision has the effect of "benefiting the party with superior bargaining power, here, [Dealer], and places an unduly harsh burden on the weaker party."

2.  Appeals Allowed as to Awards that Includes Injunctive Relief.  The Arbitration Clause allowed either side to appeal if an award against it contains injunctive relief.  However, the Court noted that immediate injunctive relief is often essential to protect consumers against further illegal acts.  See People v. Pacific Land Research Co., 20 Cal.3d 10, 20 (1977).  By allowing Dealer to delay the effect of an injunction by way of an appellate review, the Arbitration Clause is "overly harsh on consumers" and undermines the purpose of the CLRA to protect consumer rights.

3.  Payment of Fees and Costs on Appeal.  As provided in the Arbitration Clause, if either side files a claim and recovers nothing, it "may request a new arbitration" but "shall be responsible for the filing fee and other arbitration costs subject to a final determination by the arbitrators of a fair apportionment of costs."  Noting that the provision leaves Consumers "in the dark" as to the amount to be paid in advance and permits, but does not mandate, apportionment following arbitration, the Court held that such a provision "discourages buyers from pursuing an appeal and enforcing their rights."  Whatever the costs may be, the requirement that the appealing party pays the filing fee and arbitration costs of both sides in advance puts an unduly harsh burden on a consumer.  Additionally, the Court took issue with the fact that the agreement does not provide an effective avenue of relief from unaffordable fees.  See Gutierrez v. Autowest, Inc., 114 Cal.App.4th 77, 91-92 (2003).

4.  Exemption of Self-Help Remedies.  The Arbitration Clause expressly exempts from arbitration "self-help remedies such as repossession."  As to this provision, the Court was concerned that the Arbitration Clause "exempts the most important remedy to the car dealer but does not exempt any of the buyer's remedies, in particular, injunctive relief."  See Flores v. Transamerica HomeFirst, Inc., 93 Cal.App.4th 846, 855 (2001).  In Flores, which involved a mortgage loan agreement, a California appellate court rejected a similar provision, holding that, "by reserving to itself the remedy of foreclosure, [the lender] has assured the availability of the only remedy it is likely to need," maximizing its advantage by avoiding arbitration of its own claims.  Id.  Here, the Court determined that, by subjecting Consumers' remedy of injunctive relief to arbitration, but exempting Dealer's remedy of repossession, the Sale Contract creates an "unduly oppressive distinction in remedies."

5.  "Loser Appeal" Clause.  The "loser appeal" clause permitted an appeal where a party brings a claim and recovers nothing.  Notably, the Court could not say whether the "loser appeal" clause benefits one side more than the other in the absence of statistical evidence, which neither party provided. 

As the Court fund the arbitration provision to be invalid, the Court found no basis for striking the class allegations.

In reaching its determination, the Court found that the issue presented was a matter of law, and could resolve it in the first instance without remand to the lower court.  See Walgreen Co. v. San Francisco, 185 Cal.App.4th 424, 433 (2010).  Furthermore, because the arbitration agreement was "permeated by unconscionablity," it would be "pointless" to remand the case for a determination of severability.  See Armendariz, 24 Cal.4th at 124.

Accordingly, the Appellate Court reversed, and directed the lower court to enter an order denying Defendants' motion to compel arbitration and motion to strike the class allegations in the complaint.



Eric Tsai
McGinnis Wutscher Beiramee LLP
 
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