Last week, the California Supreme Court provided additional guidance as to how to draft an enforceable arbitration agreement and how Courts should analyze whether mandatory arbitration provisions can be held unconscionable and thus unenforceable in Sanchez v. Valencia Holding Co. Case S199119.

Plaintiff Gil Sanchez filed a class action lawsuit against a car dealer, Valencia Holding Company, LLC., alleging violations of the Automobile Sales Finance Act, the Song Beverly Consumer Warranty Act and Public Resources Code Section 42885. In particular, Mr. Sanchez alleged that a Mercedes Benz dealer had misrepresented the condition of the vehicle he purchased and sought to bring a class and representative claims under California Consumer Legal Remedies Act (“CLRA”). The arbitration agreement provided, among other things, that arbitral 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 arbitration agreement also required the party appealing the award to front the costs of the appeal and, inter alia, waive the right to class action litigation or arbitration. The agreement further provided that if the class waiver was deemed unenforceable, then the entire arbitration agreement was unenforceable.

The car dealer moved to compel arbitration. The Trial Court denied the motion, finding the class waiver and, in turn, the entire arbitration agreement unenforceable, on the ground that the CLRA expressly provides for class action or representative litigation and declares the right to a class action to be unwaivable. (See Civ. Code §§1751, 1781.) After the Trial Court’s decision in 2011, the United States Supreme Court held in AT&T Mobility LLC v. Concepcion that the Federal Arbitration Act (FAA) preempts California’s unconscionability rule prohibiting class waivers in consumer arbitration agreements. However, since the Concepcion Court had also reaffirmed that the FAA does not preempt generally applicable contract defenses, such as fraud, duress, or unconscionability, it was unclear as to the precise rules which could apply to determine unconscionability. Under the FAA, these defenses may provide grounds for invalidating an arbitration agreement if they are enforced evenhandedly and do not interfere with fundamental attributes of arbitration. Concepcion was followed by the California Supreme Courts holding in Sonic-Calabasas A, Inc. v. Moreno (Sonic II). That Court’s five-to-two majority opinion conceded that U.S. Supreme Court precedent and the Federal Arbitration Act (FAA) preclude California Courts from striking down arbitration agreements simply because they deny an employee’s state law remedies, in that case access to administrative wage claim (Berman) hearings in lieu of an arbitral process. While the Sonic II Court’s recognized that “Courts cannot impose unconscionability rules that interfere with arbitral efficiency,” it indicated that California courts had the authority to invalidate arbitration agreements that are unfair (unconscionable) to employees, leaving open the question as to the exact rules that apply to determine unconscionability.

In Sanchez, the California Court of Appeal upheld the Trial Court ruling denying arbitration but declined to address whether the class waiver was enforceable. Instead it held that the arbitration appeal provision and the arbitration agreement, as a whole, were unconscionably one-sided. It affirmed the Trial Court’s decision on the grounds that the agreement contained elements of procedural unconscionability, both oppression and surprise. Second, the Court held that four provisions made the agreement unfairly one-sided in favor of Valencia: appeal was only allowed if (1) the award exceeded $100,000; (2) the award included injunctive relief; (3) the appealing party advanced the filing fee and arbitration costs subject to a final award. The fourth objectionable provision was that orders granting repossession of the automobile were exempt from arbitration.

The California Supreme Court reversed and held that Concepcion requires enforcement of the arbitration clause and the class waiver and explained the unconscionability rules applicable to other provisions of the arbitration agreement. The Court held that the Court of Appeal erred as a matter of state law in finding the agreement unconscionable. Importantly, the Supreme Court rejected the argument that if a consumer could prove the contract was an adhesion contract which the consumer could not negotiate, that alone was sufficient to rule it was unconscionable and thus unenforceable.

In opposing arbitration, Sanchez had testified he “was presented with a stack of documents, and was simply told by the Dealership’s employee where to sign and/or initial each one.” The documents (including the purchase contracts) were pre-printed forms and he was not given the opportunity to read any of the documents, nor given an opportunity to negotiate any of the pre-printed-terms. Instead, they were presented to him “on a take-it-or-leave it basis, to either sign them or not buy the car.... there was no question of choice”. He claimed he had no reason to suspect that “hidden on the back of the contracts” was the arbitration clause which prohibited him from being able to sue the Dealership in Court.

The Supreme Court discussed the general provisions of unconscionability and noted that the doctrine of unconscionability has both a procedural and a substantive element, the former focusing on oppression or surprise due to unequal bargaining power, the latter on overly harsh or one-sided results. It emphasized that procedural and substantive unconscionability must both be present in order for a Court to exercise its discretion to refuse to enforce a contract or clause under the doctrine of unconscionability.

The Court ruled that unconscionability requires a substantial degree of unfairness ‘beyond a simple old fashioned bad bargain’. Moreover, under Concepcion the Court held that state law doctrines of unconscionability could not disfavor arbitration as applied by imposing procedural requirements that interfere with ‘fundamental attributes of arbitration,’ especially its “lower costs, greater efficiency and speed, and the ability to choose expert adjudicators to resolve specialized disputes.”

The Court then gave examples of state law rules that were impermissible because they were too one-sided: (1) prohibiting employees from appealing an arbitration award when it was over $50,000; (2) an arbitration agreement between a medical group and a patient that allowed the medical group but not the patient to appeal an award; (3) a provision in a doctor/patient agreement that allowed a party to request a trial de novo in superior Court when the award was over $25,000.

The Court rejected the plaintiff’s contention that adhesion contracts which are presented on a “take it or leave it” basis are per se procedurally unconscionable and also noted that even when a customer is assured it is not necessary to read a standard form contract with an arbitration clause, “it is generally unreasonable, in reliance on such assurances, to neglect to read a written contract before signing it.”

While the Court found the adhesive nature of the contract was sufficient to establish some degree of procedural unconscionability, “a finding of procedural unconscionability does not mean that a contract will not be enforced, but rather that Courts will scrutinize the substantive terms of the contract to ensure they are not manifestly unfair or one-sided.”

In reanalyzing the four provisions found objectionable by the Court of Appeal, the Court found important that the underlying contract was for the purchase of a car not an employment contract. Therefore, the $100,000 minimum threshold for appeals was reasonable, especially since a plaintiff could also appeal if he lost and was awarded nothing.

As to the contract term providing that arbitral grants of injunctive relief are subject to a second arbitration, the Court noted it had previously held that claims seeking injunctive relief designed to protect the public by stopping ongoing practices unlawful under the CLRA and the UCL, respectively, were inarbitrable. Broughton v. Cigna Healthplans (1999) 21 Ca. 4th 1066, 1082-1084, and Cruz v. PacificCare Health Systems, Inc. (2003) 30 Cal. 4th 303, 316. However, the Court left undecided the extent to which Broughton and Cruz remain good law. It held only that, in this case, the arbitration clause was enforceable and, because of the broad impact that injunctive relief may have on the car sellers' business, the extra protection of arbitral review was justified.

The Court next addressed the issue that the consumer might bear some of the costs of appeal. It distinguished consumer contracts from mandatory employment arbitration of unwaivable statutory rights, where arbitration agreements “cannot generally require the employee to bear any type of expense that the employee would not be required to bear if he or she were free to bring the action to Court.”

The Court held that in light of the Legislature’s enactment of a provision allowing for costs to be paid by the consumer in Californian arbitration statutes, particularly CCP § 1284 et seq., the issue of unconscionability of fees and costs in consumer cases must be determined on a case-by-case basis. As the dispute in Sanchez involved a high-end luxury item and nothing in the record suggested arbitration was unaffordable for the plaintiff, the Court concluded that the arbitral appeal fee provision was not unconscionable.

Further, the Court examined the provision allowing the dealer to repossess the car and found nothing unconscionable about exempting from arbitration the self help remedy of repossession. California law also would allow this remedy in arbitration CCP § 1281.8. Therefore, because the remedy of repossession of collateral is an integral part of the business of selling automobiles on credit and fulfills a “legitimate commercial need”, even though this provision favored the dealer, it was not unconscionable.

Finally, the Court ruled on the effect of a “poison pill” provision in the arbitration agreement. The trial court had held, prior to Concepcion, that the class waiver was unconscionable and invalidated the entire arbitration agreement based on a poison pill provision that said: “If a waiver of class action rights is deemed or found to be unenforceable for any reason in a case in which class action allegations have been made, the remainder of this Arbitration Clause shall be unenforceable.” The Supreme Court ruled that the quoted provision was not meant to apply when a trial court erroneously holds the class waiver unenforceable and the error is corrected on appeal: “Because we concluded in light of Concepcion that the FAA preempts the trial court’s invalidation of the class waiver on unconscionability grounds, the agreement’s poison pill provision is inoperable”.