breach of contract – Paul Porvaznik

When The Unconscionability Doctrine Can Void A Contractual Provision – Illinois Law

I recently litigated the enforceability of a contractual arbitration provision contained in an electrical subcontract for work on a high-end residential project in the Chicago suburbs. The subcontractor fighting arbitration argued that the clause, drafted by the general contractor, was so one-sided against it, that it was unconscionable under Illinois law. [Among other things, the arbitration provision shifted all costs exclusively to the subcontractor.]. The Court disagreed and found that the challenged clause was neither procedurally nor substantively unconscionable.

Two cases – one in Illinois, the other in Arizona [and discussed at length in the Illinois case] – figured prominently in the Court’s granting our motion to enforce the arbitration provision and compel arbitration. Together, the cases (Kinkel v. Cingular Wireless, LLC, 223 Ill.2d 1 (2006), Maxwell v. Fidelity Financial Services, 907 P.2d 51, 58 (Ariz. 1995) provide a useful gloss on what constitutes procedural and substantive unconscionability in the context of a business-to-business contract.

How many Factors: One, Two or ‘Sliding Scale?’

Earlier case law on unconscionability found that a party had to show both procedural and unconscionability in order to void a contract term. Other cases apply a “sliding scale” approach – where if a contract term is heavy on substantive unconscionability, it can be light on procedural unconscionability and vice versa. Kinkel makes clear that either procedural or substantive unconscionability can defeat a given clause. [The case is silent on whether the sliding scale test is still viable.]

Procedural Unconscionability

The procedural unconscionability question turns on whether the challenged term is so difficult to find or read that the party is essentially unaware of it. To determine procedural unconscionability, the Court considers, among other things, the disparity in bargaining power between the drafter of the contract and the party contesting a given term, the circumstances surrounding the formation of the contract and whether a clause is “hidden in a maze of fine print.” [Kinkel at 23 citing to Frank’s Maintenance & Engineering, Inc. v. C.A. Roberts Co., 86 Ill.App.3d 980, 989-90 (1^stDist. 1980)]

A court’s procedural unconscionability calculus also looks at the conspicuousness of the challenged clause, the negotiations relating to the contract, and whether the parties had an opportunity to understand the terms of the contract.

In our case, the Court found that the Subcontract’s arbitration clause was not hard to find, read or understand and appeared prominently in the contract’s text. As a result, the Court found ruled that the arbitration clause was not procedurally infirm.

Substantive Unconscionability

Substantive unconscionability occurs where the cost of vindicating a claim is so steep that a plaintiff’s only reasonable cost-effective means of obtaining legal relief is as a member of a class action. The Court’s substantive unconscionability analysis considers [a] the relative fairness of the obligations assumed, [b] whether terms are so one-sided “as to oppress or unfairly surprise an innocent party,” [c] whether there is “an overall imbalance in the obligations and rights imposed by the bargain, and [d] a significant cost-price disparity.” [Kinkel at 24]

When determining substantive unconscionability, Illinois courts also looks to the secrecy of a contractual arbitration term – that is, can parties disclose the existence or result of an arbitration proceeding? Where a party is contractually obligated to keep arbitration results private, it tips the scale towards substantive unconscionability since this ensures that the pro-arbitration litigant can deny its opponents access to precedent.

In addition, courts are more likely to find unconscionability where a consumer is involved, there is a disparity in bargaining power, and the clause is on a pre-printed form. Moreover, where a party seeks to invalidate an arbitration provision on the ground that the arbitration would be prohibitively expensive, that party has the burden to show the likelihood of incurring those costs.

According to the Seventh Circuit, to meet her burden, the party contesting arbitration must provide some individualized evidence to show she will face prohibitive costs in the arbitration and is financially incapable of meeting those costs. [Livingston v. Associates Finance, Inc., 339 F.3d 553, 557 (7th Cir.2003)]

In our case, the Court did find that the arbitration provision in question was one-sided in our favor and against the opponent. [I disagreed; there were multiple pro-subcontractor provisions in the contract as it was exhaustively negotiated prior to its consummation.] The Court even said that it would never advise a client to agree to it or even itself assent to it. However, the Court quickly [and rightly] noted that its subjective opinion that a contractual clause is perhaps unwise or risky was not the test for substantive unconscionability.

Instead, the crucial question was whether the provision was oppressive, unfairly surprising to the party contesting the term, portrayed an imbalance in obligations and rights or was cost-prohibitive to enforce. The Court did not find that any of these substantive unconscionability hallmarks applied and granted our motion to compel arbitration. [The subcontractor’s Motion to Reconsider is pending.]

Still another factor leading the court to reject our adversary’s substantive unconscionability argument was the freely bargained-for nature of the arbitration clause. This was illustrated by the Subcontract’s multiple line-outs and handwritten notes. The presence of multiple, manual changes revealed that the parties heavily negotiated the terms of the contract.

Take-aways:

Kinkel and the cases it relies on – including Maxwell’s substantive unconscionability formulation, collectively stand for the proposition that a party claiming a contract provision is procedurally or substantively unconscionable bears the burden of establishing the existence of either or both.

Where the parties stand on an equal bargaining footing and there is no consumer nexus to the underlying contract, it is all the more difficult for the party challenging a contract term on the basis of unconscionability.

In the business-to-business setting, assuming the contract at issue isn’t hard to find or understand [and therefore not procedurally unconscionable], the best chance a litigant has of vitiating a contractual arbitration provision is to argue substantive unconscionability: that the term is so one-sided in that it portrays a stark imbalance in rights and obligations and is cost-prohibitive for the party challenging to term to enforce it. An additional plus-factor is where the arbitration clause is subject to non-disclosure such that neither party can reveal the results of arbitration – depriving future litigants from accessing precedent.

Embattled Ex-Congressman Wins Law Firm’s Fee Spat [Ind. Appeals Court]

Perhaps known as much for his chiseled physique, burnished Instagram presence and garish office furnishings as his political acumen, former wunderkind congressman Aaron Schock resigned in 2015 after dual Federal probes unearthed wide-ranging campaign finance infractions.

The twin Federal investigations – a Department of Justice (DOJ) subpoena followed by an FBI lighting raid on Schock’s Peoria IL office – culminated in a grand jury indictment involving some 24 criminal charges most of which centered around Schock using taxpayer money to fund his lavish lifestyle. While Schock pleaded not guilty and was never convicted, his once surging political career cratered in the prosecution’s wake and to date has not recovered.

It is the DOJ’s and FBI’s tandem probes against Schock and his erstwhile campaign committee, Schock for Congress [SFC] that form the backdrop for Bopp Law Firm, P.C. v. Schock, et al., 2020 Ind.App.LEXIS 287 (July 6, 2020). The case illustrates in sharp relief the proof problems a law firm suing a former client for unpaid fees faces when it skimps on engagement letter and billing details.

The Plaintiff law firm [the “Law Firm” or “Firm”] sued Schock and SFC in 2016 to recover nearly $160,000 in unpaid legal bills. After a four-day bench trial, the trial court entered judgment for Schock and SFC. The Law Firm appealed.

Affirming, the Indiana appeals court first dispensed with the Law Firm’s argument that it stated a viable account stated claim. In Indiana, as in other states, a party waives a claim by not presenting it in its operative pleadings. Here, the Plaintiff waited until its post-trial brief to first raise the account stated issue. It was too late. Since account stated was never pled in the complaint or litigated at trial, the Defendants were unable to defend against it. As a result, the trial court correctly found that the Law Firm waived its account stated claim.

The Court then held that even if the Law Firm did timely raise an account stated claim, it still would have lost. In Indiana, a monetary amount on a bill or statement is prima facie evidence of the amount claimed which can be disproved by a defendant. Here, the Defendants disproved the invoice amounts by pointing to the Firm’s multiple block-billing entries where it failed to separate work done for individual clients vs. services provided to related entity clients.

The Court then rejected the Law Firm’s other arguments on appeal.

The Court first noted the Law Firm’s tardy subpoena response led to a subsequent search warrant and raid on SFC’s campaign office. The Court then pointed to the Law Firm’s failure to separate legal work it performed for SFC from the work it did for related individuals and entities. The Court chided this “block-billing” as potentially violative of Rule 1.8(f) of the Indiana Rules of Professional Conduct – the ethics rule that provides that a lawyer can only accept compensation from someone other than the client upon client’s informed consent, and where there is no interference with the lawyer’s independent professional judgment.

While the Court stopped short of finding a Rule 1.8 violation, it used the Rule as a guidepost when assessing the Firm’s billing practices.

Questionable optics was another basis for the appeals court’s ruling. It noted the Firm assumed role of trustee responsible for reviewing and approving all bills, including legal bills, issued to SFC. This put the Firm in the impossible situation of self-policing its own legal bills. [18]

Still another ground on which the Court relied in upholding the trial court was the time entries attributed to attorney Randy Elf – a lawyer who resigned from the Firm after Defendants challenged several of his time entries. The Court agreed with the trial judge that the Firm had an obligation to review all of Elf’s bills. And since the Firm did not, the trial court properly struck all of Elf’s time entries from the universe of recoverable fees.

The Court also credited the testimony of the Defendants’ discovery expert who testified that $30,000 [and not the $90,000-plus charged by the Firm] was reasonable fee for document review and production. The Court conversely discounted the Firm’s rebuttal witness – a Firm lawyer – who testified that the bills were reasonable. The Court noted the Firm’s witness admitted that document review and production did not comprise a large percentage of his practice.

Finally, the Court rejected the Firm’s attempt to recover interest of 1.5% on the unpaid invoices. It upheld the trial court’s determination that the reasonable value of the Firm’s services were $30,000 and that it had already been paid more triple that amount. As a result, the trial court properly found the Defendants did not owe any additional amounts to the Firm.

Afterwords:

Law firms should be sedulous in its engagement letters and billing records and make it clear who is and who is not their client;

Firms should guard against block-billing and take pains to separate work done for individuals versus services provided to related entities;

A claim not pled or litigated at trial will be deemed waived on appeal; and

Law firm should consider hiring an outside auditor to vet legal bills in situations where a firm’s impartiality could be questioned.

Actuarial Firm Owes No Independent Legal Duty to Health Plan; Lost Profits Claim Lopped Off – 2nd Cir.

The Second Circuit appeals court recently examined the contours of New York’s economic loss rule in a dispute involving faulty actuarial services.

The plaintiff health care plan provider in MVP Health Plan, Inc. v. Optuminsight, Inc., 2019 WL 1504346 (2nd Cir. 2019) sued an actuary contractor for breach of contract and negligence when the actuary fell short of professional practice standards resulting in the health plan losing Medicare revenue.

The plaintiff appealed the district court’s bench trial verdict that limited plaintiff’s damages to the amounts it paid the actuary in 2013 (the year of the breach) and denied the plaintiff’s request for lost revenue.

The plaintiff also appealed the district court’s dismissal of its negligence count on the basis that it was duplicative of the breach of contract claim and the actuary owed the plaintiff no legal duty outside the scope of the contract.

Affirming, the Second Circuit first addressed the dismissal of plaintiff’s negligence claim. In New York, a breach of contract claim is not an independent tort (like negligence) unless the breaching party owes a legal duty to the non-breaching party independent of the contract. However, merely alleging a defendant’s breach of duty of care isn’t enough to bootstrap a garden variety contract claim into a tort.

Under New York law, an actuary is not deemed a “professional” for purposes of a malpractice cause of action and no case authorities saddle an actuary with a legal duty to its client extraneous to a contract. In addition, the court found the alleged breach did not involve “catastrophic consequences,” a “cataclysmic occurrence” or a “significant public interest” – all established bases for a finding of an extra-contractual duty.

Next, and while tacitly invoking Hadley v. Baxendale, [1854] EWHC Exch J70, the seminal 19th Century British court case involving consequential damages, the appeals court jettisoned the plaintiff’s lost revenues claim.

Breach of contract damages aim to put the plaintiff in the same financial position he would have occupied had the breaching party performed. “General” contract damages are those that are the “natural and probable consequence of” a breach of contract. Lost profits are unrecoverable consequential damages where the losses stem from collateral business arrangements.

To recover lost revenues as consequential damages, the plaintiff must establish (1) that damages were caused by the breach, (2) the extent of those damages with reasonable certainty, and (3) the damages were within the contemplation of the parties during contract formation.

To determine whether consequential damages were within the parties’ reasonable contemplation, the court looks to the nature, purpose and peculiar circumstances of the contract known by the parties and what liability the defendant may be supposed to have assumed consciously.

The court found that plaintiffs lost revenues were not damages naturally arising from defects in actuarial performance. Instead, it held those claimed damages were twice removed from the breach: they stemmed from plaintiff’s contracts with its member insureds. And since there was no evidence the parties contemplated the defendant would be responsible for the plaintiff’s lost revenues if the defendant breached the actuarial services agreement, the plaintiff’s lost profits damage claim was properly dismissed.

Afterwords:

MVP provides a useful primer on breach of contract damages, when lost profits are recoverable as general damages and the economic loss rule.
The case cements the proposition that where there is nothing inherent in the contract terms or the parties’ relationship that gives rise to a legal duty, the non-breaching party likely cannot augment its breach of contract action with additional tort claims.

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