The California Supreme Court issued its long-awaited decision in Sanchez v. Valencia Holding Company, LLC, on August 3, 2015, reversing a finding by the Court of Appeal that an arbitration provision was unconscionable notwithstanding the U.S. Supreme Court’s decision in AT&T Mobility LLC v. Concepcion. Although the Sanchez court conceded that the Federal Arbitration Act (FAA) preempts certain types of unconscionability challenges to arbitration, it held that other challenges are permitted and must be decided based on state law. The case also rephrased the test for unconscionability in California, doing so in a manner likely to encourage more challenges to arbitration.

Sanchez arose from an automobile dealer’s motion to compel arbitration of a putative class action challenging certain pre-owned vehicle sales transactions. Before Concepcion was decided, the trial court denied the motion on the ground that California’s Consumers Legal Remedies Act (CLRA), under which the plaintiff brought claims, expressly allows class actions and states that its provisions may not be waived.  Because this anti-waiver provision made the class action waiver unenforceable, the trial court found the entire arbitration agreement unenforceable pursuant to the agreement’s severability clause.

The Court of Appeal heard the matter after Concepcion, and decided the case on completely different grounds. It did not reach the question of whether the class action waiver was enforceable, and instead found four provisions of the arbitration agreement unconscionably one-sided:  (1) a right to appeal an arbitration award exceeding $100,000, (2) a right to appeal an arbitration award including injunctive relief, (3) a requirement that the appealing party advance the filing fee and other arbitration costs, and (4) a carve-out of self-help remedies. All of these provisions, according to the Court of Appeal, had “the effect of placing an unduly oppressive burden on the buyer.”

Applying dicta from its decision in Sonic-Calabasas A, Inc. v. Moreno, the California Supreme Court acknowledged Concepcion's ruling that the FAA “circumscrib[es] the ability of states to regulate the fairness of arbitration agreements.” However, the Court also wrote that unconscionability, which is a generally applicable contract defense, may defeat arbitration provided that the theory employed does not treat arbitration agreements differently from other contracts, or “disfavor arbitration as applied by imposing procedural requirements that ‘interfere with fundamental attributes of arbitration’” such as lower costs and speed.

In deciding whether the arbitration contract at issue was unconscionable, the Court rephrased the California test for unconscionability and provided guidance on how it should be applied. The new formulation did not change the sliding-scale analysis or the meaning of procedural unconscionability, but it did restate what is required for substantive unconscionability.  Specifically, the Court noted that several different formulations of substantive unconscionability appear in California cases, such as “overly harsh,” “unduly oppressive,” “so one-sided as to ‘shock the conscience,’” and “unfairly one-sided.”  Quoting its own dicta from Sonic-Calabasas, the court wrote:

“All of these formulations point to the central idea that unconscionability doctrine is concerned not with “a simple bad bargain,” but with terms that are “unreasonably favorable to the more powerful party.” These include “terms that impair the integrity of the bargaining process or otherwise contravene the public interest or public policy; terms (usually of an adhesion [sic] or boilerplate nature) that attempt to alter in an impermissible manner fundamental duties otherwise owed by the law, fine-print terms, or provisions that seek to negate the reasonable expectations of the non-drafting party, or unreasonably and unexpectedly harsh terms having to do with price or other central aspects of the transaction.”

The court qualified this formulation in two important ways. First, because commerce depends on the enforceability of written contracts, “[n]ot all one-sided contract provisions are unconscionable; hence the various intensifiers in our formulations: ‘overly harsh,’ ‘unduly oppressive,’ ‘unreasonably favorable.’” Second, unconscionability must be decided in context, with reference to the “‘commercial setting, purpose, and effect’ of the contract or contract provision.” For example, contracts properly may favor the stronger party when there is a “legitimate commercial need” for a “margin of safety.”

Applying this new standard, the court found a degree of procedural unconscionability based on counsel’s concession at oral argument that the contract was adhesive. Notably, however, the court rejected the argument that the plaintiff’s failure to read the agreement supported a finding of procedural unconscionability, reaffirming the principle that it is unreasonable not to read a written agreement even when discouraged from reading it.

With regard to substantive unconscionability, the Supreme Court rejected the Court of Appeal’s conclusion that the four provisions at issue were unreasonably one-sided. The award-size trigger, contrary to the Court of Appeal’s ruling, allowed appeals not only for awards exceeding $100,000, but also for awards of no relief. Thus, since the average price of the cars at issue was $30,000 and awards exceeding $100,000 were unlikely, the provision did not favor the seller.

With respect to the injunctive-relief appeal trigger and the carve-out for self-help remedies, the court found these were commercially reasonable “margins of safety” even if they favored the seller, since injunctive relief could have a significant impact on a seller’s ongoing business and repossessions are an integral part of the car sales trade. Furthermore, nothing in the agreement prevented the buyer from seeking an injunction preventing repossession. Finally, the Court found that the requirement for an appealing party to advance fees was not unreasonable because the sale at issue involved a luxury car and the buyer made no showing that he could not afford to pay the fees at the time the transaction was consummated.

As for the trial court’s original ruling, the court confirmed Concepcion’s holding that the FAA preempts state-law challenges to class action waivers, specifically holding that “the CLRA’s anti-waiver provision is preempted insofar as it bars class waivers in arbitration agreements covered by the FAA.”

Although it favors arbitration in certain respects and was a good result for the defendant company in the case, it remains to be seen whether on balance Sanchez is good news for all of the other companies who use consumer arbitration agreements. Consumer lawyers may argue that the rephrased substantive unconscionability standard announced in the case is less stringent than the prior “shock the conscience” formulation, which is the standard for substantive unconscionability applied in most other states. It therefore is essential for companies doing business in California to ensure that their clauses employ current best practices, such as ensuring that the cost of arbitration does not exceed the cost of litigation, and avoiding one-sided procedural clauses wherever possible, as we have long counseled clients. Indeed, the arbitration agreement language we typically recommend would have prevented the unconscionability arguments in Sanchez from being raised in the first place.

Ballard Spahr’s Consumer Financial Services Group pioneered the use of pre-dispute arbitration provisions in consumer financial services agreements. It is nationally recognized for its guidance in structuring and documenting new consumer financial services products, its experience with the full range of federal and state consumer credit laws, and its skill in litigation defense and avoidance.

Copyright © 2015 by Ballard Spahr LLP.
(No claim to original U.S. government material.)

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