A recent Washington Supreme Court case, Gandee v. LDL Freedom Enterprises, Inc., No. 87674-6 (Feb. 7, 2013), provides important insights into how Washington courts approach the enforceability of arbitration agreements in the wake of the U.S. Supreme Court’s seminal decision in AT&T Mobility v. Concepcion, 131 S. Ct. 1740 (2011). The Washington Supreme Court found key portions of the arbitration clause in Gandee to be substantively unconscionable because those provisions rendered it economically prohibitive for the plaintiff to vindicate her statutory rights. The court therefore declined to enforce the provisions or allow the parties to rely on severance, waiver or federal preemption arguments to rehabilitate the otherwise defective arbitration agreement. The case signals that Washington may offer a more favorable climate for challenges to arbitration agreements than other jurisdictions. Arbitration agreements should therefore be reviewed and parties should consider incorporating new provisions to bolster the enforceability of such agreements.
Freedom Enterprises (Freedom) is a non-Washington debt adjustment company. Patty Gandee, a Washington resident, entered into a debt adjustment contract with Freedom requiring that all disputes be submitted to binding arbitration within 30 days from the date of the dispute, that arbitration proceedings be held in Orange County, Calif., and that the prevailing party be entitled to fees and costs. The contract also contained a severability clause providing that if any of the binding arbitration clauses were held to be invalid or unenforceable, the remaining provisions would not be affected.
Gandee filed a class action lawsuit alleging that Freedom charged excessive fees in violation of the Washington Debt Adjusting Act and the Washington Consumer Protection Act (Washington CPA). Freedom moved to compel arbitration and Gandee opposed on the basis that the arbitration agreement was unconscionable (and thus unenforceable) because it made it economically unfeasible for her to vindicate her state statutory rights. The trial court agreed, finding that the Federal Arbitration Act (FAA) did not preempt application of Washington unconscionability principles and declaring three of the four clauses of the arbitration agreement substantively unconscionable. The Washington Supreme Court affirmed the trial court.
The Washington Supreme Court acknowledged that both state and federal law strongly favor arbitration and require all presumptions to be made in favor of arbitration, with the party that is challenging arbitration bearing the burden to show that the arbitration clause is unenforceable. Under the FAA, arbitration agreements can nevertheless be invalidated on "such grounds as exist at law or in equity for the revocation of any contract." 9 U.S.C. § 2. Historically, federal and state courts have, relying on this “savings clause,” declined to enforce arbitration agreements that violate applicable state unconscionability principles. Concepcion, however, limits a federal court's ability to create per se rules invalidating arbitration agreements, holding that the FAA preempted a California law rendering class action waivers in arbitration agreements per se unconscionable. Ultimately, Concepcion left open the question whether a court may invalidate an arbitration agreement because its provisions make it economically prohibitive for the plaintiff to vindicate his or her statutory rights.
In Gandee, the Washington Supreme Court concluded that the FAA did not preempt the Washington unconscionability principles that protect the plaintiff’s opportunity to vindicate her statutory rights—and waded into an area that has split two federal circuits in the wake of Concepcion. Gandee effectively followed an approach similar to that of the Second Circuit in In re American Express Merchants' Litigation, 667 F.3d 204 (2d Cir. 2012) (“AmEx III”), in which that court held that when the practical effect of enforcing an arbitration agreement would be to preclude the plaintiff’s ability to vindicate her statutory rights, the agreement is unenforceable as unconscionable. In contrast, the Ninth Circuit, applying Washington law, has rejected the AmEx III rationale and instead concluded that Concepcion forecloses any attempt to invalidate arbitration provisions as categorically unconscionable even if doing so effectively prevents the vindication of either state or federal statutory rights. Coneff v. AT&T, 673 F.3d 1155, 1159 (9th Cir. 2012) (“Although Plaintiffs argue that the claims at issue in this case cannot be vindicated effectively because they are worth much less than the cost of litigating them, the Concepcion majority rejected that premise.”). The Supreme Court has granted certiorari in AmEx III and is expected to issue a decision this term.
Three Clauses Unenforceable Because They Are Unconscionable
The Washington Supreme Court ultimately deemed three of the four clauses to be substantively unconscionable—i.e., they made the arbitration agreement “one-sided or overly harsh,” “shocking to the conscience,” “monstrously harsh” or “exceedingly calloused”—because they effectively prevented plaintiff from vindicating her statutory rights. Those clauses included:
a venue provision stating that arbitration "shall take place in Orange County, California;"
a prevailing party fee provision that would potentially result in a "loser pay" outcome inconsistent with the fee-shifting provisions of the Washington CPA; and
a 30-day private statute of limitations that conflicts with the Washington CPA’s four-year statutory limitations period.
The court declined to sever these provisions from the rest of the agreement and instead found the arbitration agreement unenforceable in total. Although the court acknowledged that courts strive to give effect to the intent of the parties, particularly where there is a severance clause, in this case, the unconscionable terms pervaded the arbitration clause and invalidation was the only remedy. Specifically, the court found that because it was confronted with “a short, four-sentence arbitration clause containing three unconscionable provisions,” severing all three provisions would not preserve the intent of the parties but rather would radically alter it. The court rejected Freedom's alternative offer to waive the objectionable provisions and opined that parties should not be able to draft arbitration agreements with unconscionable terms and then offer to waive them when challenged in court.
In light of the current circuit split regarding the extent to which federal law preempts state law invalidating arbitration agreements as unconscionable because they could prevent a plaintiff from vindicating his or her statutory rights, the Gandee decision offers insight into Washington’s approach. First, Gandee confirms that Washington law may invalidate an arbitration agreement for either procedural or substantive unconscionability, making it relatively easier to sustain a challenge than in other jurisdictions that require a showing of both. Second, the court’s refusal to sever the unconscionable provisions or allow Freedom to waive those provisions and the court’s refusal to find the vindication of statutory rights argument preempted by the FAA suggest a judicial skepticism toward blanket enforcement of mandatory arbitration agreements in contracts with consumers (and, relatedly, employees). The U.S. Supreme Court will review AmEx III this term, and that may resolve the circuit split and offer additional guidance to state courts on these issues. In the meantime, pre-dispute mandatory arbitration agreements with consumers and employees should be reviewed for unconscionability and other concerns in light of Gandee's analysis. Specifically, parties should carefully consider fee-shifting arrangements, venue provisions, choice of law provisions, delegation of gateway arbitrability to the arbitrator and other provisions that could affect the enforceability of an arbitration clause in Washington.
Contact counsel if you have questions about the Gandee case and its impact on your company or questions regarding the current structure of your arbitration agreements.