Unbalanced Arbitration Agreements and Unconscionability

April 21, 2014

Are arbitration clauses that give the parties different remedies or choices of forum inherently unfair or unconscionable?

The United States Court of Appeals for the Tenth Circuit has held that the Federal Arbitration Act (FAA) preempts New Mexico’s common law presumption that arbitration provisions applying primarily or exclusively to the claims of one party are likely unconscionable and unenforceable. THI of N.M. at Hobbs Ctr., LLC v. Patton, 2014 U.S. App. LEXIS 1687 (10th Cir. 2014)).

On admittance to the Hobbs Center nursing home, Mr. Patton signed an arbitration agreement that required both parties to arbitrate disputes arising out of Mr. Patton’s care at the home, with the exception of claims relating to guardianship, or collection or eviction by THI, or disputes valued at less than $2,500. Following the death of her husband, Mrs. Patton elected to file suit against THI for negligence and misrepresentation. THI sought to compel arbitration of the claims. Rejecting Mrs. Patton’s argument that the arbitration agreement was unconscionable, the US District Court for the District of New Mexico ordered arbitration.

Not long after this finding by the district court, in Figueroa v. THI of New Mexico at Casa Arena Blanca, LLC, 306 P.3d 480 (N.M. Ct. App. 2012), the New Mexico Court of Appeals held an identical agreement to be unconscionable, prompting the district court to reverse its decision in Patton, finding that the generally applicable New Mexico unconscionability rule against “grossly unreasonable one-sided contracts,” as applied in Figueroa, fell within the §2 exception of the FAA, according to which agreements to arbitrate “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.”

On appeal, the Tenth Circuit determined that “although a state court can apply general rules of unconscionability to set aside an arbitration agreement covered by the FAA, the unconscionability determination cannot be based on the notion that arbitration is inferior to litigation in court” (Patton at  4-5). Congress enacted the FAA, the court noted, for the purpose of placing agreements to arbitrate on “an equal footing with other contracts,” (AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740, 1745 (2011)), and the FAA itself rejects the view that arbitration is inferior to court proceedings.

In both Patton and Figueroa, unconscionability was found on the grounds that the contract gave the parties disparate remedies to conflict: disputes likely to be brought by the nursing home were allowed to be litigated, while claims most likely to be brought by residents and their families were to be subject to arbitration. According to the Tenth Circuit, the only way such an agreement could be seen as “unfair or unconscionable,” is “by assuming the inferiority of arbitration to litigation” (Patton at 15). However, could not the disparate alternatives available to the parties raise the specter of unconscionability, regardless of what those alternatives consist of, especially when their effect favors the stronger party? Judicial treatment abroad of clauses that allow one party greater choice suggests that this might be the case.

International Trends: Unilateral Option Clauses

 “Unilateral option clauses” raise similar issues to those in Patton. These clauses generally provide one method of dispute resolution to both parties, while giving one of the parties the option to refer a particular dispute to a different forum. While the clause at issue in Patton divided recourse to various forums on the basis of the type of dispute rather than the party, the result is much the same: in those cases, litigation was an option only for those disputes likely to be brought by the stronger party.

Unilateral option clauses most often provide for arbitration as the default mechanism, while giving one party the option of bringing disputes in one or more national courts. This gives the party holding the option the ability to choose between different forums depending on the advantages they provide, and to make such decision after the dispute has arisen, when both the nature of the dispute and the identity of the other party are known. Where such clauses are the result of negotiation between parties, they are merely expressions of party autonomy to adopt specific measures of dispute resolution; as such, unilateral option clauses have been historically well-received, and not considered void unless they infringe on principles of duress or unconscionability. See Deyan Draguiev, “Unilateral Jurisdiction Clauses: The Case for Invalidity, Severability or Enforceability,” 31 J. Int’l Arb. 19 (2014).

Recent decisions have raised questions as to the continued validity of these option clauses. In June 2012, the Russian Supreme Commercial Court found a unilateral dispute resolution clause to be “contrary to the basic principle of procedural equality of the parties, adverse to the nature of the dispute resolution process, and [a] breach [of] the balance between the interests of the parties.” The dispute, between Russian telecommunications company RTK and a Russian subsidiary of Sony Ericsson, arose over a clause that provided generally for arbitration in London under ICC rules, but reserved for Sony the right to apply to any competent court.  This decision came as a surprise, both because the trend in Russian lower courts had favored confirming the validity of such clauses, and because of the court’s failure to explain how the option clause disadvantaged RTK in proceedings. Case No. A40-49223/11-112-401, description available at us.practicallaw.com/6-521-2664, and full text, in Russian, at bit.ly/1loSBDT.

Also in 2012, the French Cour de Cassation found a unilateral option clause void for creating a “potestative” condition contrary to French law.  X v Banque Privée Edmond de Rothschild Europe, Cass. Civ. (1ère) Sept. 26, 2012. A potestative condition is one that makes the performance of the agreement dependent on the occurrence of an event that be brought about only by the actions of one of the contracting parties. The Cour de Cassation also reasoned that this potestative condition was contrary to the purpose of article 23 of the Brussels I Regulation, which sets forth the rules for choice of forum. While the clause in question was a choice of forum clause rather than an arbitration agreement (Mme. X agreed to bring suit in Luxembourg courts, while the bank was entitled to do so in any competent court), the same reasoning would appear to apply to unilateral or unbalanced arbitration clauses as well. See discussion at bit.ly/1mssqgH.

The Court of Appeal of Madrid, however, recently found that the Spanish courts lacked jurisdiction to hear a case between a Spanish and a Dutch company, pointing to the parties’ agreement that disputes relating to unfair competition issues be submitted to the courts of ‘s-Hertogenbosch (Netherlands) or arbitration by the Netherlands Arbitration Institute, while antitrust law issues were to be determined exclusively by the courts of ‘s-Hertogenbosch. According to the court, the agreement−which applied to both parties−was valid and in accordance with international norms. Decision of 18 Oct. 2013 of Court of Appeal of Madrid (Audiencia de Madrid, Sección 28). See discussion at bit.ly/RFFIfH.

While unilateral jurisdiction clauses are widely used and frequently upheld, the recent decisions of the Russian and French courts have created uncertainty, and increased care is called for in drafting such clauses.

- Alexandra Douglas, CPR Legal Intern