Illusoriness Gains In Popularity As An Arbitration Buster

by Stinson Leonard Street - Arbitration Nation
Contact hear more about Lena Dunham than you expect, given the audience for “Girls”, right?  (Read this article for more.)  The same is true, or should be true, for the contract defense of illusoriness.  After decades of disuse, it is popping up more and more often as a defense to the enforcement of arbitration clauses (like in New Mexico and the Fifth Circuit), and therefore qualifies as the “it girl” of arbitration law.  Just last week, the Sixth Circuit issued a new decision, affirming the district court’s denial of a motion to compel arbitration based on its conclusion that the arbitration agreement was illusory.

In Day v. Fortune Hi-Tech Marketing, Inc., 2013 WL 4859781 (6th Cir. Sept. 12, 2013), a number of independent sales representatives sued Fortune, alleging it was running an illegal pyramid scheme.  The parties’ agreement had an arbitration clause.  It also had a separate clause saying that Fortune could modify the agreement at any time, effective upon notice. Fortune moved to compel arbitration, and the district court denied the motion.  The district court concluded the arbitration clause was unenforceable because Fortune had the ability to modify the contract at any time, making its promises illusory and meaning the agreement lacked consideration under Kentucky law.  On appeal, the Sixth Circuit affirmed that ruling.

Relying on Kentucky state court cases from 1912, 1938, and 1949, the Sixth Circuit held that “because the contract lacked consideration, the entire contract, including the arbitration clause, is void and unenforceable.”  The problem, as the district court found, is that “in this case, in effect, [Fortune] promised to do certain things unless it decided not to, and that is by definition illusory.”   The court noted that Fortune could have made its contract enforceable by ensuring that unilateral changes were not effective until a notice period (30 days?) had passed.

The problem that I see with the reasoning in this case is it does not confront the severability doctrine (that began with Prima Paint and extends to Rent-a-Center).  That line of Supreme Court case law holds that in deciding the validity of an arbitration agreement, courts may not consider arguments that attack the validity of the contract as a whole, and instead courts are limited to arguments that identify something invalid in the arbitration agreement itself.  In this case, the invalidity came from the unilateral modification clause, which was outside the arbitration agreement.  The Sixth Circuit did not discuss that argument, so maybe no one argued it.  Alternatively, the Sixth Circuit may have concluded the illusoriness sufficiently affected the arbitration clause (it did say “Defendant could modify the arbitration clause to suit its purposes at any time”) to satisfy the severability doctrine, but that analysis is not set forth.  (To be fair, this case is not set for publication.)

Is illusoriness an up and coming argument for invalidating arbitration agreements?  Yes.  Should drafting parties reduce their risk by ensuring that unilateral modifications are not effective for a certain period of time?  Yes.  Does the party hoping to avoid arbitration need to construct an argument that the illusoriness is specific to the arbitration agreement itself?  That answer should also be yes.

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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