On August 3, 2015, the California Supreme Court issued its long-awaited arbitration decision inSanchez v. Valencia Holding Co., LLC, No. B228027.  The Court held that the arbitration provision found in a standard form auto finance and sales contract widely used by auto dealerships and lenders throughout California is not unconscionable.  Not surprisingly, the Court acknowledged the recent U.S. Supreme Court authority holding that the Federal Arbitration Act (“FAA”) preempts conflicting state law, and affirmed that California law must now recognize the enforceability of class action waivers contained in arbitration provisions under the FAA.  Nevertheless, arbitration provisions can be rendered unenforceable, depending on a fact intensive analysis of unconscionability.  The Court refused to apply a uniform, bright-line standard.  The ruling is unlikely to stem the tide of litigation over the enforceability of arbitration provisions in high stakes class action litigation.

In Sanchez, the plaintiff car buyer brought a class action against a dealership alleging violations of California’s consumer protection laws for making false representations about the condition of the car and failing to disclose certain charges and fees.  The defendant moved to compel arbitration under the arbitration provision in the sales contract, which also contained a class action waiver.  The trial court held that the class action waiver was unenforceable because consumers have a statutory right to bring class actions under California law.  The California Court of Appeal affirmed the lower court’s decision.  Meanwhile, many other state and federal courts in California issued conflicting rulings on the enforceability of this same arbitration provision.

In its ruling, the California Supreme Court reversed the Court of Appeal, holding that the arbitration provision containing the class action waiver was enforceable.  The Court affirmed that to show unconscionability a consumer must prove both procedural and substantive unconscionability, based on a sliding scale, with a lower showing of procedural unconscionability requiring a higher showing of substantive unconscionability, or vice versa.  Procedural unconscionability focuses on the presence of oppression or surprise relating to the formation of the contract—i.e., is it a take-it-or-leave-it contract of adhesion, are the key terms buried in the fine print of a long contract, is the consumer given an opportunity to review prior to signing, etc.  Substantive unconscionability focuses on whether particular terms at issue are overly harsh or one-sided in favor of the drafter.

Based on the adhesive nature of the consumer contract alone, the Court found at least some degree of procedural unconscionability.  This contrasts with recent federal authority under the FAA acknowledging that virtually all consumer contracts are contracts of adhesion and holding that this alone does not support a finding of procedural unconscionability.

The Court, however, went on to hold that the terms of the arbitration provision were not substantively unconscionable.  The Court first addressed the appropriate standard, holding that the differing language used by courts such as overly harsh, unduly oppressive, unreasonably unfair, unfairly one-sided, and even “shocks the conscience” all mean the same thing.  According to the Court, to be unconscionable, the degree of unfairness must be “beyond merely a bad bargain”—but how far beyond a bad bargain remains unclear.  This may lead to ongoing confusion and litigation, with courts imposing different and subjective notions of what arbitration terms are sufficiently unfair.  In contrast, the U.S. Supreme Court under the FAA enforces arbitration agreements according to their terms and does not second guess the agreement of the parties.

In holding that the arbitration agreement was not substantively unconscionable, the Court analyzed three separate clauses of the agreement.  The Court first looked at the “appeal” clause, providing that the arbitrator’s award shall be final and binding, except for a right to a new arbitration with a three-arbitrator panel in the event of an initial arbitration award of $0, over $100,000, or an award that includes injunctive relief.

The Court held that this clause does not unduly favor either party because it reasonably allowed a second arbitration only in the event of outlier results and was otherwise balanced.  Since the contract relates to an auto sale usually involving far less than $100,000, allowing a second arbitration for awards above this amount was reasonable.  Though allowing a second arbitration for an award of injunctive relief favors auto dealerships and lenders, additional review is justified given the potential broad impact of injunctive relief on a business.  Further, this term is balanced by the term allowing further review for an award of $0, which favors consumers.

Second, the Court analyzed the clause stating that the party which appeals to a three-arbitrator panel shall be responsible for all arbitration fees and costs subject to a final determination by the arbitrators.  The Court held that a consumer’s inability to afford arbitration fees and costs can be grounds to render an arbitration provision unenforceable, but that the plaintiff in this case failed to make a sufficient showing.  In light of this decision, consumers will likely focus on this argument and seek to invalidate arbitration provisions on the grounds that they cannot afford arbitration.

Third, the Court held that a clause excepting self-help remedies, such as repossession, from arbitration is not substantively unconscionable.  The Court reasoned that while the repossession remedy favors auto dealerships and lenders, this term is balanced by the term excepting small claims court proceedings from arbitration, which favors consumers.  The Court also held that self-help remedies such as repossession are expressly authorized by statute, and are equally unaffected by arbitration or litigation.  The Court also recognized that repossession of collateral is an integral part of the business of selling cars on credit and “fulfils a commercial need.”

Finally, the Court acknowledged that California’s Consumers Legal Remedies Act (“CLRA”) provides a statutory right to a class action that cannot be waived under California law.  However, the Court recognized the U.S. Supreme Court decisions holding that the FAA, when applicable, preempts state laws that limit the ability of parties to agree to the terms of arbitration.  The Court held that the FAA preempts any statutory right under the CLRA to a class action.

This decision marks a grudging acceptance by the California Supreme Court that class action waivers are enforceable under the FAA.  However, the Court’s decision, while favorable to corporate defendants overall, provides fertile grounds for continued litigation over the enforceability of arbitration provisions in consumer contracts generally.