Why it matters

In the latest California Supreme Court decision considering the unconscionability of an arbitration agreement, the state's highest court concluded that the provision was not unconscionable, reversing an appellate panel. Gil Sanchez filed a putative class action suit against Valencia Holding Co. after he purchased a used Mercedes-Benz and the dealer invoked an arbitration agreement in the sales contract that included a waiver of class proceedings. An appellate panel found the arbitration agreement unconscionable. But the California Supreme Court, invoking AT&T Mobility v. Concepcion, held that a plaintiff can't dodge the terms of an agreement by arguing after the fact that the deal was unfair. "The application of unconscionability doctrine to an arbitration clause must proceed from general principles that apply to any contract clause," the court explained. Although set in the context of a consumer contract, the principles of the court's analysis apply with equal weight to arbitration clauses in employment agreements and the decision signals the California Supreme Court's increasing respect for arbitration agreements.

Detailed discussion

When Gil Sanchez purchased a 2006 preowned Mercedes-Benz S500V for $53,498.60, the automobile sales contract he signed with the dealership included an arbitration agreement. The agreement provided that arbitrated awards of $0 or over $100,000 as well as grants (but not denials) of injunctive relief could be appealed to a panel of arbitrators. The agreement also required the party appealing the award to front the costs of the appeal, preserved the rights of the parties to go to small claims court and to pursue self-help remedies, and waived the right to class action litigation or arbitration. If the class waiver was deemed unenforceable, the entire arbitration agreement was unenforceable.

Sanchez filed a putative class action against Valencia Holding Company, alleging that the dealership violated consumer law by making false representations about the condition of the vehicle and illegally failed to itemize charges in the total payment for the car. Pursuant to the arbitration agreement, the defendant moved to compel arbitration. The trial court denied the motion, finding the class waiver—and in turn, the entire agreement—unenforceable.

The U.S. Supreme Court then issued its decision in AT&T Mobility v. Concepcion, ruling that the Federal Arbitration Act (FAA) preempted California's unconscionability rule prohibiting class waivers in consumer arbitration agreements. Valencia appealed to the state appellate court, but a panel affirmed the trial court based on a finding that the arbitration agreement as a whole was unconscionably one-sided.

Relying on Concepcion, the dealership appealed and the California Supreme Court reversed. "[W]e hold that Concepcion requires enforcement of the class waiver but does not limit the unconscionability rules applicable to other provisions of the arbitration agreement," the court wrote. "Applying those rules, we agree with Valencia that the Court of Appeal erred as a matter of state law in finding the agreement unconscionable."

Discussing the general principles of unconscionability, the court noted that the various formulations to express it—"shock the conscience," "unduly oppressive," and "overly harsh," for example—all mean the same thing. "Commerce depends on the enforceability, in most instances, of a duly executed written contract," the court said. "A party cannot avoid a contractual obligation merely by complaining that the deal, in retrospect, was unfair or a bad bargain."

An evaluation of unconscionability "is highly dependent on context," the court added, and the standard must be the same for both arbitration and nonarbitration agreements. "[T]he application of unconscionability doctrine to an arbitration clause must proceed from general principles that apply to any contract clause," the court wrote. "In particular, the standard for substantive unconscionability—the requisite degree of unfairness beyond merely a bad bargain—must be as rigorous and demanding for arbitration clauses as for any contract clause."

Turning to the contract at issue, the court said no dispute existed that it was adhesive, which was sufficient to establish some degree of procedural unconscionability. The court then addressed substantive unconscionability, working its way through the terms of the arbitration provision.

The appeal threshold did not obviously favor the drafting party, the court found, as most disputes would result in awards within the acceptable range of $0 to $100,000. The ability to appeal the grant of an injunction tended to favor the dealership, but the court said an injunction could have "far-reaching" remedies such as a change to business practices, justifying the extra level of protection. The retention of self-help remedies did not contribute to the agreement's unconscionability. While it retained the dealer's powers to repossess, it also preserved the ability of both parties to go to small claims court, the court wrote.

Concerns about the arbitration's appellate filing fees and costs needed to be considered on a case-by-case basis, the court said. Although such fees could have the power to deter consumers from using the appeals process, the court noted that Sanchez purchased a "high-end luxury item" and made no showing that costs would have a substantial deterrent effect in his case.

Here the court distinguished employment cases, quoting a 2003 appellate court decision in Gutierrez v. Autowest, Inc. "A family in search of a job confronts a very different set of burdens than one seeking a new vehicle," the court wrote. "Consumers, who face significantly less economic pressure[,] would seem to require measurably less protection."

The court disposed of arguments about the final element of the arbitration agreement, the class waiver, by simply pointing to Concepcion, despite Sanchez's argument that the Consumer Legal Remedies Act (CLRA) states that the right to a class action is an unwaivable right.

"To find the class waiver here unconscionable would run afoul of Concepcion," the California Supreme Court wrote. "Concepcion's rule that states may not require a procedure that interferes with fundamental attributes of arbitration, 'even if it is desirable for unrelated reasons,' applies equally to requirements imposed by statute or judicial rule. We conclude that the CLRA's anti-waiver provision is preempted insofar as it bars class waivers in arbitration agreements covered by the FAA."

In a lengthy concurring and dissenting opinion, one justice agreed with the majority's outcome but wrote that he would not have considered whether the agreement was unconscionable.

To read the opinion in Sanchez v. Valencia Holding Company, click here.