Arbitration: Ninth Circuit Backs a U.S. District Court's Refusal to Compel Because of a 'Surprise' (Web)

In an unpublished opinion, Net Global Marketing Inc. v. Dialtone Inc., No. 04-56685,

(9th Cir. Jan. 9, 2007)(available at http://www.ca9.uscourts.gov/coa/memdispo.nsf/pdfview/010907/$File/04-56685.PDF), the Ninth U.S. Circuit Court of Appeals ruled last month that under the recently decided case of Nagrampa v. Mailcoups Inc., 469 F.3d 1257 (9th Cir. Dec. 4, 2006), the district court properly considered Net Global's allegation that an arbitration agreement was unenforceable, and upheld the district court’s ruling denying Dialtone’s motion to compel arbitration.

The unanimous panel, in citing Nagrampa, held that it is up to the federal courts to decide whether the arbitration provision is invalid when “the crux of the complaint is not the invalidity of the contract as a whole, but rather the arbitration provision itself. . . .” Id. at 1264. The appeals panel affirmed the district court's holding that the arbitration agreement was procedurally and substantively unconscionable and hence unenforceable.

Unconscionability is ultimately a question of law requiring analysis of both the contract’s procedural and substantive aspects, the opinion states. The panel applies a sliding scale, explaining that the “more substantively oppressive the contract term, the less evidence of procedural unconscionability is required to come to the conclusion that the term is unenforceable, and vice versa.” Armendariz v. Foundation Health Psychcare Servs. Inc., 6 P.3d 669, 690 (Cal.2000).

The Ninth Circuit panel agreed with the district court's decision that the arbitration provision meets the California's procedural unconscionability requirement of surprise. The finding is supported by substantial evidence. The arbitration clause was located 12 pages into a 17-page legal document, was not clearly disclosed, could easily have been overlooked, was not initialed or signed by either party. “There was no ‘clear heading’ in the Terms of Service that could refute a claim of surprise,” the opinion notes.
The court then analyzed substantive unconscionability. It found that Dialtone's unilateral modification clause could allow it to “craft precisely the sort of asymmetrical arbitration agreement that is prohibited under California law as unconscionable.”

The Ninth Circuit ultimately applied the sliding scale to hold that “because the unilateral modification clause renders the arbitration provision severely one-sided in the substantive dimension, even moderate procedural unconscionability renders the arbitration agreement unenforceable.”

This opinion, in conjunction with key cases cited by the court including Armendariz; Morris v. Redwood Empire Bancorp, 27 Cal.Rptr.3d 797 (Cal.Ct.App.2005), and Circuit City Stores Inc. v. Adams, 279 F.3d 889 (9th Cir.2002), indicates that a unilateral modification clause will likely amount to substantive unconscionability in the court's eyes.

–Jennie Chen, CPR Intern