Sued over financing terms, a used car dealer and a financing corporation asked a trial court to compel arbitration based on an arbitration clause in the sales agreement. The trial court disagreed, finding the arbitration clause was unconscionable. The court of appeal reversed the trial court decision, finding some procedural and substantive unconscionability in the contract, but not at a high enough level to prevent compelled arbitration. (Gustavo E. Vasquez v. Greene Motors, Inc., et al. (— Cal.Rptr.3d —-, Cal.App. 1 Dist., March 27, 2013).
Gustavo Vasquez (“Vasquez”) bought a used car on credit and signed a retail installment sales contract. Due to problems finding third party financing, the car dealership, Greene Motors, Inc. (“Greene”) asked Vasquez to sign a second copy of the contract. Green backdated the contract to the date of the original sale, but the backdating resulted in an actual annual percentage rate greater than the disclosed rate in an amount that Vasquez alleged violated Regulation Z. Vasquez sued Greene and the financing corporation for damages, restitution, punitive damages, interest, attorney fees, and an injunction ordering them to avoid repeating this conduct in the future.
Pointing to an arbitration clause in the contract, Greene and the financing corporation asked the trial court to compel arbitration. Vasquez argued the arbitration clause should not be enforced because it was unconscionable. The contract was written on a 26-inch-long piece of paper with dense print on both sides and it required signatures in 10 different places. Vasquez stated that the contract was just one of a stack of other documents he was told to sign and that he was not given an opportunity to read the documents or negotiate their terms. The trial court agreed with Vasquez, finding the arbitration clause unconscionable and denying Greene’s petition to compel arbitration.
California law favors arbitration as a matter of public policy as an efficient dispute resolution tool. The most typical defense against enforcement of an arbitration agreement is unconscionability. Unconscionability has two parts: procedural and substantive. Procedural unconscionability occurs when the process of making the contract involves elements of oppression or surprise arising from unequal bargaining power. A common example of a procedurally unconscionable contract is a non-negotiable form contract such as a licensing agreement a consumer clicks through when acquiring computer software. Such a take-it-or-leave-it agreement is termed an adhesion contract.
Substantive unconscionability relates to the evaluation of the fairness of the contract terms. If they are overly harsh or one sided to the extent that they “shock the conscience,” then the contract is substantively unconscionable. Lack of mutuality in contract terms is a hallmark of substantive unconscionability. An example of lack of mutuality is an employment contract that requires the employee to submit claims against the employer to arbitration, but that allows the employer to go directly to court with claims against the employee. To hold that a contract is unenforceable due to unconscionability, a court must find that the agreement is both procedurally and substantively unconscionable. The level of unconscionability necessary to avoid enforcement of the contract is weighed on a sliding scale: if the court finds the contract process had a high level of procedural unconscionability, only a low level of substantive unconscionability is needed to find the contract unenforceable, and vice versa.
The court of appeal agreed with the trial court that the arbitration agreement was procedurally unconscionable, but only at a “minimal level.” The court observed that a high level of substantive unconscionability would have been necessary to overcome the arbitration clause, but instead, the agreement lacked “significant substantive unconscionability.” The court of appeal directed the trial court to issue an order compelling arbitration under the contract.
Focusing on the elements of procedural unconscionability, the court analyzed the level of oppression in the contract. The court noted that ordinary adhesion contracts are commonplace and necessary in modern life. For instance, in sales transactions that are highly regulated, utilizing a form contract assures compliance with the law, and allowing sales personnel to negotiate and vary the wording of the agreement could put a seller in legal jeopardy. Vasquez attempted to argue that he was not permitted to read the contract, but the court rebuffed this argument. Instead, the court pointed out that Vasquez did not assert that the dealer stopped him from reading it, or that he was required to sign without reading as a condition of purchase. Furthermore, because Greene had asked Vasquez to sign a second, identical contract three days later, Vasquez had ample time to review the form before signing.
The court also found the contract lacked the element of surprise, declining to accept Vasquez’s assertion that the dense text and the placement of the arbitration clause on the back of the contract resulted in the arbitration clause escaping Vasquez’s attention. Automobile sales contracts are highly regulated, and various state and federal laws dictate the content, wording, and even the type size and type color of various sections. This particular contract contained wording above the signature line alerting the signer to the arbitration clause on the back. The clause itself was set apart in a box taking up a third of the back page with a prominent, all caps, bold headline announcing that it contained an arbitration clause, should be reviewed, and “affects your legal rights.” The court observed that many court decisions, including a recent one by the state Supreme Court, decline to find surprise when an arbitration clause is in bold type. The court also rejected Vasquez’s arguments that surprise existed because he failed to read the arbitration clause or because he was not given a copy of the arbitration process rules.
Turning to substantive unconscionability in the contract, the court analyzed the various contract terms challenged by Vasquez, starting with the provision that required him to pay his portion of costs for arbitration. The court stated that in employment contracts, such a provision would be unconscionable on its face, but that in other contexts, courts must make a case-by-case analysis of the particular contract at hand. The court held that because Vasquez did not present evidence that he could not afford arbitration costs, he had not met the burden of proving that this aspect of the contract was substantively unconscionable. Vasquez also challenged the appeal provisions of the arbitration clause, which allowed for a second arbitration under three scenarios: if the first arbitration results in an injunction, an award of $0, or an award of $100,000. The court found that the options for appeal of a $0 award or a $100,000 award were balanced and not unconscionable because the $0 award appeal option created a right more likely to be used by the seller and the $100,000 appeal option created a corresponding right more likely to be used by the buyer. The court conceded that the right to appeal injunctive relief, more likely to be used by the dealer, was one-sided, but not so one sided as to reach the “shocks the conscience” standard required to find unconscionability. The court also declined to find that the requirement that the appealing party pay the costs of a second arbitration was substantively unconscionable, stating that it fell on both parties equally and would benefit the buyer in the event the seller initiates a second arbitration.
Regarding the agreement’s exemptions of repossession and small claims court from arbitration, the court ruled these were not unconscionable because the former would be more likely to be used by the seller and the latter by the buyer, and so were balanced. Additionally, because both repossession and small claims court serve as dispute resolution tools without full court proceedings, they serve the same public policy function as arbitration: promoting speedy, efficient resolution of legal disputes.
Finally, the court quickly rejected Vasquez’s challenge to the agreement’s waiver of class action lawsuit rights and the requirement to arbitrate of public claims on the ground that the US Supreme Court ruled that the Federal Arbitration Act preempted this issue.
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