Federal District Courts Continue to Find Ways to Invalidate Arbitration Clauses Despite the U.S. Supreme Court's Recent Pronouncements in AT&T Mobility LLC v. Concepcion and CompuCredit Corp. v. Greenwood

by Saul Ewing Arnstein & Lehr LLP


A recent federal court decision provides warning that companies should be balanced in drafting arbitration provisions and not include provisions that are "unfairly one-sided" at the expense of the consumer. Otherwise, courts may find the arbitration provision void despite the liberal policy favoring arbitration under the FAA.

On June 1, 2012, the U.S. District Court for the Northern District of California issued a decision in Trompeter v. Ally Financial, Inc., invalidating as "unconscionable" under California law an arbitration clause contained in a consumer contract for the purchase of a vehicle. Plaintiff filed a putative class action against Ally Financial, Inc. ("Ally") alleging that Ally violated California law by recording telephone calls of persons located in California without their consent. Ally moved to compel arbitration under the Federal Arbitration Act, (FAA), 9 U.S.C. § 1 et seq. based on the arbitration clause contained in the retail installment sales contract between plaintiff and the dealer, which contract was assigned to Ally. The court denied Ally's motion to compel arbitration on the grounds that the arbitration clause was procedurally and substantively unconscionable under California law, thereby rendering it void.

The court acknowledged that the "FAA reflects a 'liberal federal policy favoring arbitration agreements.'" (citation omitted). However, relying on limiting language contained in the Supreme Court's decision in AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740, 1746 (2011), the court observed that "the FAA 'permits agreements to be invalidated by 'generally applicable contract defenses, such as fraud, duress, or unconscionability,' but not by defenses that apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue.'" Accordingly, the court engaged in an evaluation of whether the particular arbitration clause was "unconscionable" under California law.

The first prong on the analysis was whether the contract was procedurally unconscionable on the grounds that it was an oppressive contact of adhesion. Finding that the consumer contract had been presented to plaintiff by the dealer on a "take it or leave it basis," the court found that plaintiff had sufficiently established that the contract was procedurally unconscionable.

The second prong of the analysis was whether the arbitration provision was substantively unconscionable on the grounds that it was "unfairly one-sided." Here, the court focused on the specific provisions in the contract that imposed certain mandates to determine whether those mandates favored the consumer, the creditor or were neutral. Specifically, the terms of the arbitration clause provided: 1) a party does not waive the right to arbitrate by engaging in "self-help" remedies (such as repossession); 2) if an arbitration award exceeds $100,000 against a party, that party may request a new arbitration; 3) if the arbitration award included injunctive relief, the enjoined party may demand re-arbitration; and 4) the party requesting a new arbitration would be responsible for all filing and other arbitration costs, subject to a fair apportionment by the arbitrators. In evaluating each of these provisions, the court found as a practical matter that each of the provisions favored Ally at the expense of the plaintiff and, therefore, the arbitration agreement was substantively unconscionable.

The decision in Trompeter provides warning that companies should be balanced in drafting arbitration provisions and not include provisions that are "unfairly one-sided" at the expense of the consumer. Otherwise, courts may find the arbitration provision void despite the liberal policy favoring arbitration under the FAA.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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