UNITED STATES – The Supreme Court of California’s August 3, 2015 decision in Sanchez v. Valencia Holding Company, LLC clarifies the extent to which the United States Supreme Court’s Concepcion decision pre-empts California’s unconscionability rule in the context of agreements to arbitrate. In doing so, the California Supreme Court clarified that Concepcion permits the unconscionability rule to be applied to challenge the enforceability of an arbitration clause; the various formulations for unconscionability in California are merely one standard; and, notwithstanding, the class action waiver provision in California’s Consumer Legal Remedies Act has been preempted in the context of arbitration agreements. The decision is notable because, although parties and the lower courts have been applying the Concepcion pre-emption decision to enforce arbitration clauses and class waivers since 2011, the Sanchez case illustrates the extent to which an arbitration agreement may still be held unenforceable as unconscionable in California.

The Sanchez decision arose out of a class action in which the trial court held that a class waiver in an automobile sales contract was unenforceable under the express language of the California Consumer Legal Remedies Act (“CLRA”) and denied the defendant seller’s motion to compel arbitration. Following the trial court’s decision, but 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 (2011) 131 S. Ct. 1740, holding that the Federal Arbitration Act (“FAA”) preempts California state law prohibiting class waivers in consumer arbitration agreements. The Court of Appeal declined to decide whether the class waiver was enforceable and instead held the arbitration clause unenforceable because it was unconscionable. The Supreme Court of California granted review and reversed.

Concepcion

The Supreme Court of California’s decision in Sanchez clarifies the extent to which Concepcion does not preempt California state law. It held that what Concepcion limits is state law discrimination against arbitration whether the law is facially discriminatory or merely disfavors arbitration by imposing procedural requirements as obstacles to arbitration. “Concepcion reaffirmed that the FAA does not preempt generally applicable contract defenses, such as fraud, duress or unconscionability.” In fact, so long as these defenses are “enforced evenhandedly” and do not “interfere with fundamental attributes of arbitration,” the defenses remain grounds for invalidating arbitration agreements. Concepcion, therefore, “does not immunize” adhesive arbitration processes and substantively unconscionable provisions from state law unconscionability principles.

Unconscionability

Accordingly, the California Supreme Court analyzed the automobile sales contract’s arbitration provision under the state standard for unconscionability to determine whether it was enforceable. Sanchez identified the general principle of unconscionability referring to an absence of meaningful choice on the part of one of the parties together with contract terms that unreasonably favor one party; in other words, both procedural and substantive unconscionability must be present. The analysis does not require the presence of unconscionability under these prongs in equal degrees, but invokes a sliding scale such that the more substantively oppressive the contract term, the less evidence of procedural unconscionability is required to hold the term unconscionable, and vice versa. The doctrine has been applied in various formulations to invalidate terms that are “overly harsh,” “unduly oppressive,” “so one-sided as to ‘shock the conscience,’” or “unfairly one-sided.” Despite these different descriptions the Sanchez opinion clarified that these formulations “all mean the same thing” and every case will ultimately be analyzed according to whether the terms are sufficiently unfair in view of all of the relevant circumstances to cause a court to withhold enforcement.

Sanchez Clause

The California Supreme Court then reviewed each aspect of the arbitration clause at issue. First, the court recognized that the seller’s use of a form contract and the buyer’s failure to read it, did not equate to procedural unconcscionability. Notwithstanding, because the seller’s counsel acknowledged at oral argument that the contract met the definition of a contract of adhesion in California, the court held some degree of procedural unconscionability was met. (Justice Chin’s concurring opinion argues that counsel’s statement at oral argument is irrelevant because the burden of proof was on the buyer to establish procedural unconscionability and because he failed to put forth such evidence, this prong was never met.)
Second, under the prong of substantive unconscionability, the Supreme Court analyzed each of the challenged provisions of the arbitration clause and ultimately determined that in view of the relevant circumstances the provisions were not so one-sided as to make them unconscionable. Specifically, the Supreme Court recognized that while many of the provisions facially seemed to favor one party, in application the provisions were not unfair and substantively balanced.

Arbitration Provision Analyzed

 

Supreme Court’s Analysis for Unconscionability  

Both parties have the right to appeal an arbitration award for $0 or more than
$100,000,
but not awards between $0 and $100,000.

While the right to appeal an award of $0 would favor the buyer and the right to appeal an award of more than $100,000 would benefit the seller, both would be outliers in disputes over automobiles sold for $40,000 to $60,000, so the appeal thresholds are not significantly more beneficial to one party.

Both parties have the right
to appeal an award granting injunctive relief, but no right to  appeal an award denying  it.               

 Although the buyer is more likely to seek injunctive relief than the seller, the clause is not substantively unconscionable because an injunctive could have a broader impact on the seller’s business and, therefore, this provision does not unfairly favor one party.

The party choosing to appeal an arbitration award must pay the arbitration filing fees and costs, subject to a final determination by the three-arbitrator panel of a fair cost apportionment.

                     

While this provision has the potential to deter individual consumers from using the appeal process, no evidence was presented demonstrating that this buyer would be deterred, especially given that this was a buyer of a high-end luxury item with substantial financial means.

Both parties retain any rights to go to small claims court and use self-help remedies such as repossession.

          

The right to go to small claims court favors the buyer, while repossession favors the seller and therefore this provision does not unreasonably favor one party.

Both parties waive the right to class action litigation or arbitration .

            

The CLRA’s anti-waiver provision is preempted insofar as it bars class waivers in arbitration agreements covered by the FAA (Concepcion).

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In light of the Sanchez decision, individuals and companies utilizing arbitration agreements in consumer transactions in California should scrutinize the terms of their contracts in order to assess whether the provisions unreasonably favor the drafter. While a single term favoring the drafter or the use of form or adhesive contracts are alone unlikely to tip the balance toward unenforceability, consumers may still raise the unconscionability rule with respect to the arbitration agreement as a whole. Consequently, parties should not presume that Concepcion provides immunity for clauses that favor arbitration but are unfairly one-sided.

*A version of this blog entry also appears on the American Bar Association’s Class Action & Derivative Suits Committee website. Any opinions expressed herein are the author’s and not necessarily those of Baker & McKenzie LLP or any one or more of its clients.

Author

Teresa H. Michaud advises on all aspects of dispute resolution, primarily complex business disputes, class actions, intellectual property and international arbitration. She is the Co-Chair of the North American Class Action Subgroup and practices in both the Consumer Goods & Retail and Technology, Media & Telecom Global Industry Groups. She is admitted to practice in California, Texas and New York, and qualified in England and Wales. She is a Certified Information Privacy Professional/United States (CIPP/US). Teresa is also one of the founding members of our Los Angeles office that opened in 2018.