In Sanchez v. Valencia Holding Company, LLC, No. S199119 (Cal. Sup. Ct. Aug. 3, 2015), the California Supreme Court clarified that, although the Federal Arbitration Act (“FAA”) preempts state laws deeming class action waivers unconscionable, it does not prohibit unconscionability challenges to arbitration clauses.
Plaintiff buyer commenced a class action lawsuit against Defendant automobile dealer over the sale of a car. The automobile sales contract contained an arbitration agreement with a class action waiver clause. The contract also stated that if the class waiver was held unenforceable, the entire arbitration agreement was unenforceable. The trial court denied Defendant seller’s motion to compel arbitration, holding the class waiver, and thus the arbitration agreement, was unenforceable under the express language of the California Consumer Legal Remedies Act (“CCLRA”), which deems such waivers unconscionable. Defendant appealed the denial of the motion to compel arbitration.
Before the Court of Appeal’s decision was filed, the United States Supreme Court issued its landmark decision in AT&T Mobility LLC v. Concepcion (“Concepcion”), holding that the FAA, 9 U.S.C. § 1 et seq., preempts the CCLRA’s unconscionability rule prohibiting class waivers in arbitration agreements. The Court of Appeal thus declined to decide whether the class waiver was enforceable and instead held the arbitration clause as a whole was unenforceable based on several provisions it deemed unconscionable. The Supreme Court of California granted review and reversed.
First, the court clarified that Concepcion and the FAA require that class waivers be enforced, but do not preempt generally applicable state law contract defenses, such as fraud, duress or unconscionability, from applying to other provisions of the arbitration agreement. So long as these defenses do not treat arbitration agreements differently than other contracts, they remain grounds for invalidating arbitration agreements. Concepcion, therefore, does not provide immunity for arbitration agreements from state law unconscionability principles.
Second, the court held that the various formulations for unconscionability in California are merely one standard. The doctrine of unconscionability has both a procedural and a substantive element, and both are required for a court to refuse to enforce a contract or clause as unconscionable. The court clarified that, although previous opinions have described the test as invalidating terms that are “overly harsh,” “unduly oppressive,” or “unfairly one-sided,” these formulations all mean the same thing and every case will ultimately be analyzed according to all of the relevant circumstances.
Third, applying the unconscionability rules, the court conducted a detailed review of the four specific arbitration provisions the Court of Appeal held unconscionable, holding none unreasonably favored defendant. First, the court held a provision allowing appeals of arbitration awards only where the arbitrator’s award is $0 or over $100,000 was not unconscionable because the ability to appeal an award of $0 would favor plaintiff buyer, while the ability to appeal an award of $100,000 would favor defendant seller. Second, a term providing that any grant of injunctive relief was subject to a second arbitration was not unconscionable because forcing the seller to change its practices could have potential broad impacts on defendant’s business, thus the extra protection was justified. Third, the court held that a provision stating that the buyer may bear some costs of appeal was not unconscionable in the context of a consumer contract for a high-end luxury item, particularly where plaintiff did not claim the cost of appellate arbitration was unaffordable. Next, the court held that the provision allowing defendant to self-help remedies, including repossession of the automobile, was not unconscionable because it is an integral part of the business of selling automobiles on credit, and serves a legitimate commercial need.
Finally, the court held unenforceable a clause in the sales contract that provided if the class action waiver was unenforceable, the entire arbitration clause would be unenforceable. The court held this “poison pill” provision did not apply where a trial court erroneously held the class waiver was unenforceable and the error is corrected on appeal.
A version of this post originally appeared in the September 2015 edition of Baker & McKenzie’s International Litigation & Arbitration Newsletter, which is edited by David Zaslowsky and Grant Hanessian.