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More Rent-A-Center: What about those Unconscionability Attacks? (June 24).

After Rent-A-Center, West Inc. v. Jackson, No. 09-497 (see our previous articles here and here) plaintiffs attacking an arbitration agreement as being unenforceable, invalid, or otherwise unarbitrable, but under a contract delegating the authority to decide this question to the arbitrator, will have to address the specific delegation provision in the pleadings.
Attacks to the arbitration agreement as a whole will go to the arbitrator.

In short:  Rent-a-Center particularizes the pleading standard.

Unconscionability and other attacks on an arbitration agreement are governed by state law. This is stated explicitly in Federal Arbitration Act §2: 

A written provision . . . to settle by arbitration a controversy . . . shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.

This law remains in force after Rent-a-Center. Challenges can be directed at the existence or the validity of the agreement.

The exception, explained in Prima Paint Corp.v. Flood & Conklin Mfg. Co., 388 U. S. 395 (1967), and more recently in Buckeye Check Cashing v. Cardegna, 546 U.S. 440 (2006), is that severability of the arbitration agreement from the rest of the contract is a matter of federal law governed by the FAA, not state law.

Rent-A-Center extends this exception to include severability of the delegation provision within the arbitration agreement. In Rent-A-Center, Associate Justice Antonin Scalia bases his reasoning, characteristically, in the text of FAA §2, specifically focusing on the “controversy." See FAA §2 above.  In this case, the “controversy” is who decides the arbitrability question, and the FAA §2 “written provision” is the delegation provision.

The customary relationship between a sales contract and an arbitration agreement is reproduced here between the arbitration agreement and the delegation clause.

This means that claiming that the delegation provision should not be enforced because the arbitration agreement that contains it is unconscionable will fail. While perhaps counterintuitive, this is the effect of the Court’s interpretation of the FAA's presumption in favor of arbitration, since at least Prima Paint.

Still, attacks to the actual existence of the arbitration agreement will go to the court. This includes fraud and duress. See Buckeye. These claims pertain to whether there was an agreement at all.

The Scalia Rent-A-Center majority opinion mentions, in a footnote, the “manifestation of intent” to form a contract. Manifestation of intent is an objective standard, so it does not matter what someone was thinking, but only whether they acted in a way that appears to be an agreement.  See Restatement (Second) of Contracts §2 cmt. b. 

For unconscionability, the question is whether, given a signed agreement, the person should be bound by it. See Restatement (2d) §208.  Thus, as a matter of contract doctrine, the issues boil down to whether unconscionability is an attack to the existence or the validity of the contract. For Scalia and the majority, unconscionability only touches on the contract's validity, while for Stevens and the dissenters, unconscionability can go to the countract's existence.
While First Options of Chicago Inc. v. Kaplan, 514 U.S. 938 (1995), held that the parties must have “clearly and unmistakably” agreed to arbitrate the question of arbitrability, Justice Scalia in Rent-A-Center says that the clear and unmistakable requirement is only for manifestation of intent–that is, whether the person agreed--and not for validity, which focuses on whether the agreement should be enforced.

The reason for this distinction, according to Scalia, is based on the parties' expectations. His underlying assumption is that if a person signs his or her name to a contract with unfair terms negotiated via an unfair process, but the contract says in clear and unmistakable language that the arbitrator decides challenges to the enforceability or validity of the arbitration clause, then the parties will expect to arbitrate these challenges.

No matter how unfair the arbitration agreement, the person still signed the contract by his or her own free will.

But for dissenter Associate Justice John Paul Stevens, the validity question also is the manifestation-of-intent question.  In fact, Stevens gains support from the comments to Restatement § 208: “[G]ross inequality of bargaining power, together with terms unreasonably favorable to the stronger party . . . may show that the weaker party . . . did not in fact assent or appear to assent to the unfair terms.”  Restatement (2d) Contracts § 208 comment d. (emphasis added).

This argument, that unconscionability can undermine the weaker party's initial manifestation of intent, no longer appears to be available in the wake of the majority Rent-A-Center opinion.

There remains a significant Rent-a-Center question:   Does the case signal the end of unconscionability as a defense to arbitration agreements with delegation provisions?  Well, no. The attack simply has to be more targeted. That is the case’s bright-line rule.

It is unclear, however, which arguments will succeed. It seems fair to presume that there is a risk that courts will split on this point.
Of course, as unconscionability is governed by state law, the challenges will have to be tailored to the specific laws. In most states, unconscionability requires a showing of both procedural and substantive unconscionability.

It is not enough that the bargaining process was unfair; the contract terms also have to be unfair and one-sided  in order for a court to deem the contract invalid. Often these elements relate to each other on a sliding scale--if the contract has high procedural unconscionability, then less substantive unconscionability will be sufficient, and vice-versa.

The more difficult question is how unconscionability will apply to arbitration agreements that have a delegation clause.
In fact, Rent-a-Center does not affect procedural unconscionability arguments, because the same arguments that apply to arbitration agreements in general will also apply to delegation provisions in specific. Common arguments are inequalities in bargaining power, inability to negotiate the terms, and lack of meaningful choice.

Another common procedural unconscionability argument is that the terms are buried within the contract, but this may not work because of the clear and unmistakable standard.

* * *

So, how can a specific delegation provision be substantively unconscionable? Substantive unconscionability depends upon the actual terms of the delegation provision and the facts of the case. Nevertheless, here are a few potential examples of substantive unconscionabilty:

(a)    Incentives for arbitrator to continue the proceedings:

Perhaps the strongest argument for substantive unconscionability is that the arbitrator has a financial incentive to continue the arbitration, so he or she would be biased against finding the arbitration agreement unconscionable.

As a result, because challenges to the arbitration agreement are much more likely to be brought by the weaker party, the delegation provision is substantively biased in favor of the stronger party.

A problem with this argument is that arbitrators are required to be impartial, so a court may be hesitant to invoke potential arbitral bias in deciding these matters.  In addition, arbitrators are well aware that lack of impartiality is a ground for vacatur of an arbitral award.

(b)    Quid pro quo/bargaining:

A possible argument raised by Rent-A-Center original plaintiff Antonio Jackson is that the specific delegation provision was added as part of a quid pro quo made with Rent-a-Center in exchange for broad judicial review.

But when Hall Street Associates v. Mattel, 552 U.S. 1035 (2008), limited the scope of parties’ ability to contract for post-arbitration judicial review, the delegation provision became unfair in favor of Rent-a-Center. Hall Street Associates was decided after the Rent-A-Center contract was signed.  Hall Street Associates held that the FAA §10  grounds for review are exclusive, and that parties may not expand these grounds through contracts.
Unfortunately for Jackson, who raised the issue for the first time in his brief to the Supreme Court, Scalia dismisses the argument without addressing it because Jackson brought it too late.

So if brought properly–and notwithstanding evidentiary issues–it’s possible this argument could work for arbitration agreements made before Hall Street Associates.  In these cases, a weaker party would not have agreed to arbitrate questions of arbitrability if he or she had known that judicial review would be limited.  In such a case, the bargain potentially would have become substantively unfair in Hall Street Associates’ wake.                

(c)    Discovery procedures:

Scalia also hints at two other possible arguments attacking the delegation provision specifically, though he characterizes them as somewhat weak.

First, one could argue that discovery limits during arbitration are unconscionable in relation to the delegation provision because “the limitation upon the number of depositions causes the arbitration of his claim that the Agreement is unenforceable to be unconscionable.” 

But “[t]hat would be, of course, a much more difficult argument to sustain than the argument that the same limitation renders arbitration of his factbound employment-discrimination claim unconscionable,” the opinion states.

Depending on the circumstances, however, limited discovery could make it more difficult to arbitrate a claim against the arbitration agreement.  The problem is one of sharing resources and allocating risk. With limited discovery for claims brought to the arbitrator, the complainant is faced with a dilemma: Assuming some discovery is needed to prove the arbitrability claim,  bringing it potentially will limit even more the amount of discovery allowed for the underlying discrimination claim.

So a plaintiff is faced with the crucial task of assessing the risks and viability of the various claims from the outset, before any discovery occurs. The plaintiff potentially will be less able to fully bring the gateway claim, because he or she will be worrying whether the use of discovery procedures now will result in less available discovery later if the arbitrator determines that the arbitration agreement is valid.

Thus, the plaintiff may be dissuaded from challenging the arbitration agreement, or from challenging it to the fullest extent, so as to preserve the limited discovery procedures for the underlying claim.

(d)    Fee-splitting:

Scalia also notes that one could argue that a fee-splitting provision is unconscionable for the delegation provision.  But he writes: “[T]he unfairness of the fee-splitting arrangement may be more difficult to establish for the arbitration of enforceability than for arbitration of more complex and fact-related aspects of the alleged employment discrimination.”

Yet depending on the arbitrator's fees and the arbitration provider’s administrative costs, this argument could work. If the upfront fees required by the provider organization are high, it could be too costly for the plaintiff to bring this gateway issue.

And since the upfront payments are nonrefundable, if the arbitrator determines that the arbitration provision is invalid and the parties should go to court, the plaintiff has spent much more money than he or she would have if the matter had been decided in court.

* * *

There may be more to come on these factors–and they may not be coming from the Court, parties or counsel.  Some of the issues raised by Rent-a-Center, and by consumer and employee arbitration agreements in general, may become inconsequential if Congress passes the Arbitration Fairness Act, which would outlaw predispute mandatory arbitration agreements in employment and consumer contracts.  The proposal currently is awaiting markup by the House Judiciary Committee.

–David Perechocky, CPR Intern