Arbitration: An En Banc Ninth Circuit, Reversing, Finds Unconscionability (Web)

In Nagrampa v. MailCoups Inc., 469 F.3d 1257 (9th Cir. Dec. 4, 2006), the Ninth U.S. Circuit Court of Appeals, sitting en banc, ruled last month that deciding the validity of a franchise agreement's arbitration clause was for the court, and not for the arbitrator to resolve.

The full circuit court reversed a three-judge Ninth Circuit panel, which had found that a direct mail coupon advertising business franchisee had challenged the entire contract, and not just the validity of the clause itself.

The panel opinion, since withdrawn, affirmed a California federal district court opinion that had sent the case to arbitration under the Federal Arbitration Act.

The franchisee, Northern California resident Connie Nagrampa, filed a suit against the Massachusetts franchiser MailCoups Inc. on grounds of common law misrepresentation and fraud, after having suffered a severe loss–incurring more than $180,000 in personal debt and paying more than $400,000 in franchise fees, according to the opinion-- in establishing and operating the coupon advertising franchise under the franchiser's Super Coups System.

The suit was removed to federal court, and MailCoups moved to stay court proceedings and compel arbitration based on the franchise agreement. The franchiser claimed more than $80,000 in damages upon termination of the franchise agreement. In opposition, Nagrampa argued that the franchise agreement’s arbitration clause was unconscionable.

The Ninth Circuit cited several seminal arbitration cases to back its jurisdiction, including Buckeye Check Cashing Inc. v. Cardegna, 126 S. Ct. 1204, 1209-10 (2006), Doctor’s Assocs. Inc. v. Casarotto, 517 U.S. 681, 687 (1996), and Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 403-04 (1967).

The opinion notes that “the federal courts cannot shirk their statutory obligations” to consider the validity of arbitration provisions “simply because controlling substantive state law requires the court to consider . . . the circumstances surrounding the making of the entire agreement.”

The en banc panel notes that when the crux of the complaint challenges the validity or enforceability of the agreement containing the arbitration provision, then the question of whether the agreement, as a whole, is unconscionable must be referred to the arbitrator. In Nagrampa, however, the en banc panel found that the franchisee had not contested the franchise agreement’s validity, but had focused on the arbitration provision.

The opinion notes that Nagrampa asserted six separate causes of action in her original state filing, “none of which seeks to invalidate the contract as a whole.” The en banc panel opinion, written on behalf of a seven-judge Ninth Circuit majority by Circuit Judge Kim McLane Wardlaw, notes that the franchisee’s fifth and sixth causes of actions directly seek to invalidate the arbitration clause. Therefore, the en banc court concluded that the jurisdiction to be applied is the court’s and not the arbitrators’.

The en banc court agreed with the U.S. District Court's decision to analyze the arbitration clause’s unconscionability, but the Ninth Circuit found that the district court incorrectly applied California law, and reversed and remanded for reconsideration.

The franchisee asserted that as per the California Consumer Legal Remedies Act, Cal. Civ. Code §§1750- 1785, the arbitration clause is substantially one sided, does not fall within the expectations of a franchisee, and is unfair and unconscionable.

But the en banc panel found that the district court misapplied the procedural unconscionability analysis in finding the franchisee's argument nondispositive, and that the lower court erred by only considering substantive unconscionability.

The en banc court considered California law, citing Indep. Ass’n of Mailbox Ctr. Owners Inc. v. Superior Court, 133 Cal. App. 4th 396, 407 (2005), which held, “Franchise agreements are not per se unenforceable, but their provisions can be examined to see if the characteristics of unconscionability are present in part or in whole.” The Ninth Circuit, exercising its diversity jurisdiction to take the case, ruled that it could apply California law to determine whether the arbitration provision was unconscionable.

Under California law, the critical procedural unconscionability factor is how the clause was negotiated and presented. Here, the franchisee said she wasn’t informed of the arbitration provision, which appeared on the agreement’s 25th page.

Moreover, the franchiser had drafted the nonnegotiable contract, and the franchisee’s only choices were to accept it or leave it.

The Ninth Circuit conceded that the franchisee’s evidence of procedural unconscionability was minimal, but it held that it was sufficient to render the arbitration clause procedurally unconscionable. The en banc panel held that the arbitration provision was substantively unconscionable, too, and struck the provision’s forum selection clause, which had forced Nagrampa into arbitrating first in Southern California, and then in Massachusetts, where a decision was issued against her in absentia.
Four judges wrote or joined in–in whole or in part--three dissents. One of the dissents also was a concurrence in part. The dissents focused on the majority’s procedural and unconscionability analysis. All three dissents would have affirmed the U.S. District Court’s unconscionability view.

—By Julie John, CPR Intern