Reed Smith Client Alerts

On August 3, 2015, the California Supreme Court issued a long-awaited opinion that provides further clarity on the standard of unconscionability needed to invalidate an arbitration agreement. The court determined that its prior formulations of unconscionability, characterized by the terms “overly harsh,” “unreasonably favorable” or “shock the conscious,” were essentially similar. And the court concluded that while the standard of “shock the conscious” is not the only test for unconscionability, an arbitration agreement must be substantially more than a “simple old-fashioned bad bargain” to be deemed unconscionable.

Plaintiff Sanchez filed a putative class action against defendant car dealer Valencia asserting, among other claims, violation of the California Consumer Legal Remedies Act (CLRA), based on allegations that Valencia made false representations to Sanchez regarding the condition of a used Mercedes Sanchez bought from Valencia. The sales contract signed by Sanchez contained a class action waiver and an arbitration clause. Accordingly, Valencia brought a motion to compel arbitration.

The trial court denied the motion to compel arbitration, holding the class waiver unenforceable on the ground that the CLRA expressly provided for class action litigation and forbids class action waivers. After the trial court’s decision, the U.S. Supreme Court held in AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (2011) that the Federal Arbitration Act (“FAA”) preempts state laws that prohibit class action waivers in consumer arbitration agreements. The U.S. Supreme Court did provide that general contract defenses, such as unconscionability, may provide grounds to invalidate arbitration agreements in state courts. On appeal, the Court of Appeal in Sanchez declined to consider whether the class waiver at issue was enforceable, and instead affirmed the trial court’s decision on different grounds—namely, that the arbitration clause was procedurally and substantively unconscionable.

The California Supreme Court reversed the Court of Appeal, and acknowledged that “Concepcion requires enforcement of the class waiver, but does not limit the unconscionability rules applicable to other provisions of the arbitration agreement.” The court agreed with the dealership Valencia that the Court of Appeal erred in finding the agreement unconscionable. The court found that the agreement’s terms were not unreasonably one-sided. Sanchez claimed that the arbitration provision was substantively unconscionable because a party could not appeal an arbitration award unless the award for a party was $0, or against a party in excess of $100,000, or included an award of injunctive relief. The court determined that the $0-award limit favors the buyer and the in-excess-of-$100,000 award favors the dealership, and as such, the provision was reasonably balanced. Moreover, the court acknowledged that though the injunctive relief trigger favors the dealership, such a parameter is commercially justified because of the potential impact injunctive relief would have on the dealership’s overall business.

Sanchez also claimed that the requirement that the party seeking review by three arbitrators must advance the costs could potentially deter a car buyer from appealing an adverse award. The court found that the requirement did not make the agreement unconscionable because Sanchez made no showing that appellate fees and costs in fact would be unaffordable to him as a luxury car buyer or would have a substantial deterrent effect. Further, contrary to Sanchez’s assertion otherwise, the court reasoned that the agreement’s exemption of self-help remedies from arbitration was not unconscionable because it preserves the ability of the parties to go to small claims court, which favors the car buyer. In addition, arbitration is an alternative to litigation, and self-help remedies are, by definition, outside of litigation.

Finally, the court rejected the trial court’s holding (prior to Concepcion) that the class waiver was unconscionable and invalidated the entire arbitration agreement based on a poison pill provision. The court found that “to find the class waiver here unconscionable would run afoul of Concepcion,” concluding that the “CLRA’s anti-waiver provision is preempted insofar as it bars class waivers in arbitration agreements covered by the FAA.”

Under Sanchez, an argument can be made that an arbitration agreement that may be deemed a “bad bargain” on its face for a consumer but contains commercially justifiable provisions, should not be deemed substantively unconscionable.


Client Alert 2015-224