Dear Clients and Colleagues,
Recently, the Court of Appeal, Second Appellate District, Division Eight issued an opinion (which has been certified for publication) invalidating an arbitration clause after determining the the arbitration clause in the contract was unconscionable. Dennison v. Rosland Capital LLC (Cal. Ct. App., Apr. 1, 2020, No. B295350) 2020 WL 1543537. While the Court’s unanimous conclusion the subject contract’s arbitration provision was unconscionable was based on its somewhat compelling facts, the more important part of the decision for those seeking to resolve matters in arbitration deals with how the Court determined it could review the arbitration clause for unconscionability despite a provision specifically delegating to the arbitrator questions of arbitrability and enforceability.
As discussed more fully below, the Court found, when the agreement was reviewed as a whole, the delegation of decisions regarding arbitrability and enforceability to the arbitrator was ambiguous. To understand the Court’s reasoning, two different provisions of the contract are quoted below. The first is from the arbitration clause; the second from the severability clause:
“Customer agrees to arbitrate all controversies between customer and Rosland (including any of Rosland’s current or former officers, directors, managers, members, employees or agents) arising out of or relating in any way to the products or this agreement, including the determination of the scope or applicability of this agreement to arbitrate. . . .”
“The terms and provisions in this Agreement are severable. If any provision of this Agreement is held by a court of competent jurisdiction to be void, invalid, or unenforceable, then that provision will be enforced to the maximum extent permissible and the remaining terms and provisions of this Agreement will continue in full force and effect.”
As the Dennison Court noted, under California law, it is presumed the judge will decide arbitrability, unless there is clear and unmistakable evidence the parties intended the arbitrator to decide arbitrability. (Aanderud v. Superior Court (2017) 13 Cal.App.5th 880, 891-892.) Starting from that position, the Court reasoned that the severability clause’s language italicized above which allowed for a court to pass on the unconscionability of “any provision” of the agreement rendered the delegation of these issues in the arbitration clause ambiguous. As a result, applying the criteria from Aanderud, it found the delegation provision did not “clear and unmistakable evidence the parties intended the arbitrator to decide arbitrability” and found the delegation provision in the arbitration clause did not preclude the Court from determining the issue of unconscionability.
Based on the fact this decision, though presenting little new law, was certified for publication, we make the following recommendations to our clients who conduct business in California or any other state with a similar approach to how issues can be delegated to the arbitrator:
1. Specifically identify the Federal Arbitration Act [9 U.S.C. §§1-16] as the authority under which arbitration will proceed.
Most businesses in California, particularly those in the sharing economy or offering marketplaces, affect an interest in interstate commerce and, as a result, can identify the Federal arbitration Act (“FAA”) as the controlling authority for their arbitration clauses. Note California and several other states have specifically held only the substantive sections of the FAA apply unless the agreement expressly provides otherwise. This is important because most of these same states have held the powerful stay of further court proceedings found in 9 U.S.C. §3 is a “procedural” statute which cannot be invoked unless the arbitration agreement clearly so states. [We recommend to our clients to include not only reference to “substantive and procedural” provisions of the FAA in their agreements, but to also list each section (i.e. §§1-16.]
Over the past several years, the United States Supreme Court has issued a series of decisions reaffirming the favorability of arbitration provisions and removing opportunities for “proactive” courts, both state and federal, to create exceptions to enforcement on various grounds under the FAA.
2. Regardless of whether the FAA or state arbitration statutes apply, make certain no other provision of the agreement allows a Court to pass on issues of applicability or enforceability.
The problem for the party seeking to compel arbitration in Dennison was the ambiguity created by the severability clause when considered with the arbitration clause. It is likely the drafter of the agreement simply used a “standard” severability clause from previously drafted agreements without consideration of its impact on the arbitration clause. Dennison provides a cautionary tale about careful crafting of agreements which include arbitration provisions.
3. Tips to avoid a finding of unenforceability in any venue.
There are a few key pitfalls in crafting arbitration agreements. One most often cited (after lack of conspicuous notice to the other party of his waiver of the right to jury trial) is the lack of reciprocity in application of the arbitration requirement. Make sure your arbitration clause is an agreement that both the customer and you agree to arbitrate any claims arising out of the relationship. If there are particular claims which should be handled in formal litigation, exempt them from arbitration (injunctive relief for trademark violations is a common exclusion from arbitration; unlawful detainer is another).
The same is true with any other aspect of the arbitration agreement. If, as in Dennison, the business would like to have a contractual limitation on the time in which a claim between the parties must be pursued, apply it bilaterally. Obligating your business equally to the client to arbitrate claims is strong evidence of your belief the provision is fair and reasonable and takes a large step towards that clause’s enforceability.
Applying settled principals, the court in Dennison found the fact the agreement was an “adhesion contract” with no ability of the plaintiff to bargain for changes in terms, the print used in the contract was so small it could not be read with the naked eye, that the arbitration clause itself, along with a contractual one-year statute of limitations (which was significantly shorter than that otherwise allowed) were unilateral – applying only to plaintiff – coupled with the fact plaintiff was an octogenarian, all combined to render the arbitration agreement unenforceable.
While an arbitrator may have reached the same conclusion as the trial and appellate courts did in Dennison on its facts, the practical reality of a claimant being compelled to arbitration has value all its own and may prompt an early resolution of the claim before the issue is ever addressed in arbitration. Of course, the best practice is to have an arbitration clause that is above reasoned scrutiny regardless of the venue.
The information provided in this article does not, and is not intended to, constitute legal advice and may not constitute the most up-to-date legal or other information; instead, all information and content provided are for general informational purposes only. If you have any questions or need further information, please contact Paul K. Schrieffer ([email protected]) or Ellin J. Lee ([email protected]).