by David G. Wirtes, Jr.
INTRODUCTION
How many of you have encountered this situation? A client comes into your office and describes some sort of wrongdoing in connection with the purchase of a mobile home or an automobile or an insurance policy. You conduct a thorough interview, learn all the details surrounding the transaction and satisfy yourself that there is enough evidence of wrongdoing that it warrants further investigation. Then you start digging into the documents and, lo and behold, there it is, buried somewhere within the boilerplate under an obscure heading like "Alternative Dispute Resolution," you find the language that "all disputes arising out of the contract" or "all disputes relating to the contract" will be resolved by arbitration according to the rules of the American Arbitration Association.
When that occurs, what does the practitioner do? Do you tell the client: "Sorry, you've agreed to arbitration and we don't handle those sorts of matters . . ." Do you plunge right into arbitration proceedings and at the same time notify your E&O carrier? Or, as the first order of business, do you try to determine whether there are any lawful ways to avoid arbitration such as having a trial court declare the arbitration provision unconscionable and, therefore, unenforceable?
What I hope to do today is to offer some thoughts about how to make that step-by-step assessment of whether the arbitration provision in your case will, in fact, be binding upon your client.
STEP-BY-STEP ANALYSIS
First and foremost, bear in mind that under the Federal Arbitration Act, as interpreted in decisions from the United States Supreme Court and the Alabama Supreme Court, traditional contract defenses are available to avoid enforcement of unfair arbitration provisions. 9 U.S.C. § 2 says:
"A written provision in any maritime transaction or a contract evidencing a transaction involving commerce, to settle by arbitration a controversy thereafter arising out of such contract or transaction, or the refusal to perform the whole or any part thereof, or any agreement in writing to submit an existing controversy arising out of such a contract, transaction, or refusal, shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract."
In Doctor's Associates, Inc. v. Cassarotto, 517 U.S. 681 (1996) the United States Supreme Court noted that "generally applicable contract defenses, such as fraud, duress or unconscionability, may be applied to invalidate arbitration agreements without contravening § 2 of the Federal Arbitration Act." In Allied-Bruce Terminix Corp. Inc. v. Dobson, 513 U.S. 265 (1995), the Court held that:
"Section 2 of the FAA gives states a method for protecting consumers against unfair pressure to agree to a contract with an unwanted arbitration provision. States may regulate contracts, including arbitration clauses, under general contract law principles, and they may invalidate an arbitration clause upon such grounds as exist at law or in equity for the revocation of any contract."
1ST - IS THERE A WRITTEN PROVISION IN A CONTRACT?
So, how do you get from point "A" to point "B"? Well, the starting point is to ask whether there is a written provision in a contract concerning arbitration? The first sentence of § 2 of the FAA states that it applies to "a 'written provision' in any maritime transaction or a contract . . ."
In Ex parte Payne, No. 1980062, Sept. 10, 1999 (handout, p. 2-3), the Court granted mandamus and ordered a circuit court to set aside an order compelling arbitration because there was no contract. This occurred under familiar facts - a person attempted to buy a used car, but the retail purchase order she signed said the sale was contingent on her being approved for financing. Since she wasn't approved, no contract was formed and the seller could not therefore invoke the arbitration provision. Since there was a contingency contract and the contingency never occurred, there was no contract.
2nd - DOES THE CONTRACT SUBSTANTIALLY AFFECT INTERSTATE COMMERCE?
Step 2 is to ask whether the maritime transaction or contract at issue involves interstate commerce. Absent a connection with interstate commerce, there is no authority for federal regulation by the Federal Arbitration Act under Congress's Commerce Clause Power. Transactions purely intrastate in nature are not regulated by Federal law.
In Rogers Foundation Repair, Inc. v. Powell, No. 1980717, Nov. 5, 1999 (handout, p. 1), the Court held that a contract by an Alabama corporation to perform repairs on a chimney of an Alabama residence did not have a substantial effect on interstate commerce even though the contract contained a recitation which stated that it did. The Court granted a Petition for Mandamus and reversed a trial court order requiring arbitration upon holding that there was no substantial effect on interstate commerce and therefore that the FAA could not be invoked.
Similarly, in Southern United Fire Ins. Co. v. Knight,, No. 1971559, April 2, 1999 (handout, p. 9), the Court held that an automobile insurance policy issued by an Alabama corporation does not "substantially affect" interstate commerce, so an arbitration provision contained in such a policy will not be enforced.
3rd - WAS THERE AN AGREEMENT BY PLAINTIFF?
The third step in your analysis is to determine whether there is clear and unmistakable evidence of an agreement by the plaintiff to arbitrate? You should determine, for example, whether all of the plaintiffs were parties to the contract. Did a minor enter into a contract with arbitration without consent of his parents? Did a husband sign a new car purchase form, but not the wife? Does the document containing the arbitration provision bear the plaintiff's signature and thereby evidence his agreement to arbitrate or not? Without any signature, what is the evidence that the plaintiff actually agreed to the arbitration provision?
There are many federal decisions holding that arbitration won't be enforced absent evidence the plaintiff signed a document agreeing in writing to arbitration
The results from the Alabama Supreme Court on this issue, on the other hand, are a mixed bag. In Ex parte Rush, 1980328, March 26, 1999 (handout, p. 10), the Court found evidence of an agreement to arbitrate when the homeowner did not sign a "termite protection plan" document containing an arbitration provision, but the homeowner renewed his termite policy with Terminix each year for nine years. The Court concluded that by his course of conduct in renewing the policy, the homeowner impliedly consented to the arbitration provision.
4th STEP - DETERMINE WHO WAS INTENDED TO BE COVERED BY THE ARBITRATION PROVISION
The next step is to determine whether all the wrongdoers are parties to the contract in which the arbitration provision appears? There have been several recent Alabama Supreme Court decisions which have addressed the specificity needed in an arbitration provision before a related party - not a signatory to the contract - may nevertheless invoke the arbitration provision for its own use and benefit.
The basic test for claims against non-signatories is whether the claims against them are "inextricably intertwined" with the claims against the party or parties who did sign the document containing the arbitration provision.
In Universal Underwriters Life Insurance Co. v. Dutton, No. 1971279, March 13, 1999 (handout, p. 11), a consumer purchased a new car and entered into an arbitration agreement with the dealership. The dealership then assigned the car loan to a lender. Included in the sale was a policy of credit life insurance. The consumer then filed a claim against the dealership, the lender assignee and the credit insurance company claiming fraud in connection with the sale of the credit insurance policy. The Alabama Supreme Court enforced the arbitration agreement as to the dealer, its salesman and the lender assignee, but refused to enforce arbitration as to the credit insurance company.
5th STEP - DETERMINE WHAT WAS INTENDED TO BE ARBITRATED
The next means of possibly avoiding the arbitration provision is to scrutinize the scope of what the parties agreed to arbitrate. For example, "disputes arising out of the contract" is narrower in scope than "disputes relating to the contract," which, in turn, is narrower than "any and all disputes between the parties to the contract, their successors and assigns."
On this issue, look at American Bankers Life Assurance v. Rice Acceptance Co., No. 1980833, June 25, 1999 (outline, p. 5). There, the arbitration provision was limited to disputes "as to the meaning or interpretation of this agreement." The Court rejected an attempt to enforce arbitration of the plaintiff's fraud cause of action upon finding that it was not an issue contemplated by what the parties had agreed to arbitrate.
On the other hand, in Selma Medical Center v. Manayan, No. 1971845, April 23, 1999 (handout, p. 8), the Court held that a provision applying to any dispute "that shall arise concerning any aspect of this agreement" was broad enough to cover a claim of fraud with inducement.
6th STEP - CONSUMER WARRANTY?
Once you get past the foregoing threshold questions, the next possible dispositive issue is whether the arbitration provision is contained in a document evidencing a written consumer warranty. A number of courts have found that a consumer cannot be forced to arbitrate a breach of written warranty claim, because regulations issued pursuant to the Magnuson-Moss Warranty Act, 15 USC § 1501, specify that any alternative dispute resolution offered by a written warrantor shall be non-binding. A binding arbitration requirement conflicts with the federal requirement that any arbitration of the warranty claim be non-binding.
The Alabama Supreme Court has gone one step further in ruling that an arbitration provision is void if it violates the Magnuson-Moss Warranty Act. Because the provision is void, the consumer cannot be forced to arbitrate even non-warranty claims the consumer has against the warrantor. See Southern Energy Homes, Inc. v. Lee, No. 1970105, Jan. 8, 1999 (handout, p. 12-13). This rule may have broad applicability to any seller of consumer goods that offers a written warranty, including not only automobile and mobile home manufacturers, but also many mobile home dealers and car dealers who offer their own warranties under state law.
7th STEP - INSURANCE CONTRACT?
The next issue concerns whether the arbitration provision is contained within a contract of insurance. You may or may not be familiar with the argument from American Bankers Ins. Co. of Florida v. Crawford, No. 1980833, June 25, 1999 (handout, p. 5), that the McCarran-Ferguson Act reverse-preempts the Federal Arbitration Act so as to allow the Alabama anti-arbitration statute (Ala. Code § 8-1-41(3) to preclude the enforcement of an arbitration provision in an insurance policy. When the decision in Crawford was originally released by the Alabama Supreme Court, Associate Justice Champ Lyons recused himself and the seat formerly held by Associate Justice Mark Kennedy had not yet been filled by Justice John England.. The vote was 4-3 with Justices Houston, Cook and Johnstone dissenting. Crawford filed an application for rehearing which coincided with the appointment of Justice England. The vote is now apparently evenly split at 4-4 because on October 21, 1999, Chief Justice Hooper entered an Order pursuant to Section 6.10 of Amendment No. 328 of the Alabama Constitution of 1901 appointing retired Court of Criminal Appeals Judge John Patterson for temporary service in that case. Section 6.10 of Amendment No. 328 provides:
"The Chief Justice may assign appellate justices and judges to any appellate court for temporary service and trial judges, supernumerary justices and judges, and retired trial judges and retired appellate judges for temporary service in any court."
Crawford objected to the appointment of Judge Patterson because of a conflicting provision from the Alabama Code, § 12-2-14, which seems to confer authority only upon the Governor to make such appointments when the vote is evenly split in a particular case. § 12-2-14 provides as follows:
"When by reason of disqualification the number of judges competent to sit in a case is reduced to eight or to six and there is equal division among them on any question material to the determination of the case, the facts shall be certified by the Chief Justice, or where he is disqualified, by the judges sitting, to the Governor, who shall thereupon appoint a member of the Bar of the Supreme Court to sit as a judge of said court in the determination of said case."
Other cases like Crawford are now pending before the Alabama Supreme Court. The vote is literally too close to call at this point. But it may ultimately turn out that arbitration provisions will not be enforceable when contained in insurance contracts since those are matters regulated by state law and Alabama's anti-arbitration statute would clearly not allow arbitration in the insurance context.
8th STEP - CONFORM WITH DUE PROCESS PROTOCOL?
The next issue is whether the arbitration provision may be deemed unenforceable because of a failure to comply with the American Arbitration Association's Consumer Due Process Protocol. In footnote of Ex parte Napier, 723 So.2d 49, 52 (Ala. 1998) (handout, p. 13), the Alabama Supreme Court cited the Consumer Due Process Protocol with approval. In my view, the Court was basically dropping a very heavy hint to everyone who wished to draft enforceable and binding arbitration provisions that they should pay close attention to the requirements of the Protocol, else run the risk that a court could be upheld for finding a provision which did not comply with the requirements of the Protocol unenforceable.
By way of background, this "Protocol" is the product of an Advisory Committee composed of both consumer lawyers and business lawyers who recommended to the American Arbitration Association that it adopt a principle called Principle Eleven "special provisions relating to binding arbitration" which states the following:
"Consumers should be given:
- Clear and adequate notice of the arbitration provision and its consequences, including a statement of its mandatory or optional character;
- Reasonable access to information regarding the arbitration process, including basic distinctions between arbitration and court proceedings, related costs, and advice as to where they may obtain more complete information regarding arbitration procedures and arbitrator rosters;
- Notice of the option to make use of applicable Small Claims Court procedures as an alternative to binding arbitration in appropriate cases; and,
- A clear statement of the means by which the Consumer may exercise the option (if any) to submit disputes to arbitration or to court process."
The reporter's Comments of the Advisory Committee basically state that consumers should have clear and adequate notice of the arbitration provision and basic information regarding the process at the time they are called upon to consent to arbitration. The reporter's Comments state: "In all cases, there should be some form of conspicuous notice of the agreement to arbitrate and its basic consequences."
This issue is presently before the Alabama Supreme Court in a case we're handling called SouthTrust Bank National Association v. Williams, Alabama Supreme Court Case No. 1980706. There, SouthTrust Bank unilaterally included an arbitration provision in its depositor's agreement in the form of a bill stuffer it mailed to its bank customers, and the arbitration provision was buried in paragraph 33 on page 10 of a 12-page booklet of fine print. This amended depositor's agreement specifies that arbitration is governed by the provisions of the American Arbitration Association. So we argued to the trial court that SouthTrust defined for itself its own standard of care, including the due process protocol, and that it was therefore bound to provide conspicuous notice at the time of consent of the inclusion of an arbitration provision and of the alternatives available to the consumer, but since it had not done so, it violated its own self-standards. The trial court agreed, so this issue is now squarely before the Alabama Supreme Court on appeal.
9th STEP - ELEMENTS OF UNCONSCIONABILITY?
Failing all of the above, the next step is to examine all the facts and circumstances surrounding the relative sophistication, financial strength and bargaining power of the parties to determine whether the agreement is so unconscionable that it should be deemed unenforceable as a matter of law.
The doctrine of unconscionability is codified in Alabama's version of the Uniform Commercial Code at Ala. Code § 7-2-302 (1975) as follows:
"1. If the court as a matter of law finds the contract or any clause of the contract to have been unconscionable at the time it was made, the court may refuse to enforce the contract, or it may enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause so as to avoid any unconscionable result.
A Similar definition of unconscionability is found in Alabama's Consumer Credit Act at Ala. Code § 5-19-16:
"With respect to a consumer credit sale, consumer lease or consumer loan, if the court as a matter of law finds the agreement or any provision of the agreement to have been unconscionable before, after or at the time it was made, the court may refuse to enforce the agreement, or it may enforce the remainder of the agreement without the unconscionable provision, or it may so limit the application of any unconscionable provision so as to avoid any unconscionable result."
What are the factors the Alabama Supreme Court will review to determine whether a contract or contractual provision is unconscionable? In Lane v. Garner, 612 So.2d 404 (Ala. 1992), the Court listed:
"1) whether one party was unsophisticated and/or uneducated; 2) whether there was an absence of meaningful choice on one party's part; 3) whether the contract terms are unreasonably favorable to one party; 4) whether there was unequal bargaining power among the parties; 5) whether there were oppressive, one-sided or patently unfair terms in the contract."
More recently, in Ex parte Dan Tucker Auto Sales, Inc., 718 So.2d 33 (Ala. 1998) (handout, p. 15), Justice Lyons, in his concurring opinion, wrote:
"Unconscionability, under general principles of Alabama law, can be reduced to a four-part test: 1) whether there is an absence of meaningful choice on one party's part; 2) whether the contractual terms are unreasonably unfavorable to one party; 3) whether there was unequal bargaining power between the parties; and 4) whether the contract contained oppressive, one-sided or patently unfair terms.
I believe that a showing of financial hardship, lack of choice, and one-sidedness could, in a proper case, lead to a finding of unconscionability and a concomitant holding of unenforceability of an arbitration agreement that would not conflict with governing federal law."
In Ex parte Napier, 723 So.2d 49 (Ala. 1998) (handout, p. 13), the Court stated still other factors that might be germane to a determination of unconscionability, including:
"A refusal of a plaintiff's request for assistance after she notified someone that she was unable to see or to understand [the arbitration clause]; [a plaintiff's] inability to obtain the product made the basis of the action from this seller, or from another source, without having to sign an arbitration clause; the oppressiveness or unfairness of the mechanism of arbitration; or the unfairness of a discount or other quid pro quo in exchange for [a plaintiff] accepting an arbitration agreement."
Still further, in Ex parte Parker, 730 So.2d 168 (Ala. 1999), the Court held that "lack of mutuality of a remedy can be one factor, along with others, that a court may consider in determining whether an arbitration clause is unconscionable." It should be noted, however, that in Ex parte McNaughton, 728 So.2d 592 (Ala. 1998), the Court held that a mere absence of a mutuality of remedy, standing alone, does not render an arbitration provision unconscionable. That, of course, is when the seller or lender reserves for itself the right to invoke judicial proceedings, but binds the consumer to arbitration only.
So, what additional factors should you look for when attempting to establish that the agreement would be unconscionable were it enforced against your client?
- Excessive or unreasonable costs to invoke arbitration (e.g., AAA's construction industry dispute resolution rules imposing a financial hardship);
- Hardship imposed because of location of arbitration proceedings;
- Hardship cause by selection/bias of the arbitrator;
- Deprivation of adequate remedies (i.e., no class actions; thwarting of right to rely upon state or federal statutory remedies like Deceptive Trade Practices Act, Title VII, ADEA, etc.) ;
- Was the plaintiff forced to sign the arbitration clause under duress (e.g., at a hospital undergoing emergency surgery)?
The unconscionability argument provides perhaps the best ground for attacking arbitration. The pendulum has begun to swing, so to speak, in courts across the country, as they are beginning to realize just how one-sided and unfair mandatory and binding arbitration provisions can be.
10th STEP - EVIDENCE OF FRAUD?
Finally, you should consider whether the facts suggest fraud in the inducement or execution of the contract. Bear in mind that if you allege fraud in the inducement as to the overall contract, Alabama law holds that that issue would be resolved by the arbitrator. On the other hand, were you to allege that there was fraud solely with respect to obtaining the arbitration provision, that issue would be decided by the court. See Green Tree Financial Corp. v. Wampler, No. 1970983, Aug. 27, 1999 (handout, p. 3).
MAKE SURE CLIENTS UNDERSTAND GRAVITY OF THESE CHANGES
Let me add one final note, however, just as food for thought. There is much evidence from the legislative history which led up to promulgation of the Federal Arbitration Act, that that Act was never intended to apply to consumer transactions and was never intended to apply to insurance transactions. And how could it? The Bill of Rights sets out in the Seventh Amendment that we have a right to trial by jury. In Alabama, our forefathers preserved this right with Article I, Section 11 of our Constitution of 1901 which reads: "The right to trial by jury shall remain inviolate."
Despite those fundamental constitutional protections, dispute resolution is now being privatized. The citizens are no longer empowered to decide right from wrong when they sit on juries; instead, professional decision-makers, typically drawn from the very professions who are accused of wrongdoing in the first place, are now extracting exorbitant fees to render final, binding decisions though they are subject to no accountability (unlike judges who are subject to regulation by the Judicial Inquiry Commission), and lawyers who are subject to regulation by the State Bar Association or politicians who are at least subject regulation by the Ethics Commission. Further, these untrained arbiters are rendering decisions with no requirement of adherence to rules of evidence, rules of civil procedure, rules of professional conduct, discovery or any of the other time- tested and distilled rules which have evolved for peaceful resolution of serious conflicts.
My time is up. Much more could be said. At this point, all I can ask is that you explain to your clients the gravity of what is happening to them. Make sure they know enough come the next election cycle to make an informed choice about their rights and the protection of these basic constitutional rights for the rest of our citizens.
TOWN HALL MEETING
The Consumer Arbitration Steering Committee's Mobile "Town Hall" meeting will be conducted Tuesday, November 30, 1999 at 5:30 p.m. at the Mobile Convention Center, Room 201A/B at 1 South Water Street.
