Tag: procedural unconscionability

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 (1stDist. 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.

 

Contractual Arbitration Clauses and Unconscionability – IL 4th Dist. Case Note

Courts generally favor contractual arbitration clauses. The reason is that they (in theory at least) save litigants’ time and money and also reduce court congestion.

Arbitration provisions appear in varied business settings ranging from franchise agreements and personal services contracts to employment agreements and most everything in between.

Willis v. Captain D’s , 2015 IL App (5th) 140234-U examines an arbitration clause in the employment contract context and whether the clause is expansive enough to cover an employee’s sexual harassment claim involving a co-worker.

There, a plaintiff grocery store cashier signed an employment contract that contained broad arbitration language.  Claiming her co-employee sexually harassed her and the defendant did nothing to stop it, the plaintiff filed multiple state court tort claims without first demanding arbitration. The trial court denied the employer defendant’s motion to compel arbitration finding the plaintiff’s assault and battery claims did not arise out of her employment and were beyond the scope of arbitration.  Defendant appealed.

Held: Reversed

In finding that plaintiff’s claims fell within scope of the arbitration clause, the court announced the key rules that govern arbitrability:

– Under the Illinois Uniform Arbitration Act, 710 ILCS 5/1 et seq., parties are bound to arbitrate the issues they agreed to arbitrate;

– A court (not an arbitrator) decides whether a particular dispute is subject to arbitration;

– The two main arbitrability issues are (1) whether the parties are bound by a given arbitration agreement, and (2) whether an arbitration provision applies to a particular type of controversy;

– Where two parties mutually agree to arbitrate, there is sufficient consideration to bind each side to the arbitration provision;

– Inclusion of the phrase “arising out of” or “related to” in connection with an arbitration agreement denotes broad application of the arbitration agreement;

– An arbitration clause will be deemed procedurally unconscionable where it’s difficult to find, read or understand and where a party didn’t have reasonable opportunity to appreciate the clause;

– Substantive unconscionability will negate an arbitration agreement where it’s terms are blatantly skewed in one side’s favor to the exclusion of the weaker contracting party or where arbitrating would impose substantial costs on a party;

– Continued employment after notice of an arbitration agreement is sufficient consideration to enforce the agreement.

(¶¶ 12-32)

Validating the arbitration clause, the court held that it was supported by consideration. It found the employer’s promise to employ the plaintiff and to keep employing her in exchange for plaintiff signing the employment contract was sufficient to bind the plaintiff to the arbitration agreement.

The court also rejected the plaintiff’s unconscionability arguments. On the procedural unconscionability front, the court found that the plaintiff had two separate occasions to review and accept the arbitration agreement (plaintiff was previously hired a few years ago by the same defendant) and the arbitration language conspicuously appeared in all-caps. It wasn’t buried in a maze of fine print.

Substantively, the court found that the plaintiff failed to support her claim that submitting to arbitration was cost-prohibitive – especially since the court filing fee exceeds the contractual arbitration fee.

The court also found that the arbitration agreement encompassed the plaintiff’s claims. While her assault and battery claims were against an individual employee, her remaining claims against the corporate defendant sounded in negligent hiring, retention and supervision. In light of the arbitration clause’s sweeping language, these claims clearly fell within the reach of the arbitration clause.

Take-aways:

– The court (not an arbitrator) determines whether a dispute is subject to arbitration;

– A promise of employment conditioned on employee signing arbitration agreement will likely meet requirements of a valid contract;

– Broad arbitration language that contains “arising out of” and “related to” phrasing will constitute strong support for a broad application of an arbitration clause.

Unconscionability: Substantive and Procedural – Illinois Case Snapshot

The Case: Rosenbach v. NorStates Bank, 2014 IL App (2d) 131162-U

Facts Summary: Plaintiff LLC member who guaranteed commercial real estate loan sues the lender after lender makes (allegedly) unauthorized loan advances, declares a default against the LLC and seizes over $200,000 of the plaintiff’s personal funds that were pledged to induce the loan to the LLC.  Plaintiff’s claims are for breach of contract and a declaratory judgment action seeking ruling that the commercial guaranty is unconscionable under Illinois law.

Procedural History: Lender moves to dismiss on dual bases that (1) plaintiff’s injury is derivative of injury to the LLC borrower; and (2) commercial guaranty is not procedurally or substantively unconscionable.  Trial court grants motion and plaintiff appeals.

Result: Trial court’s dismissal upheld.  Lender wins, plaintiff LLC member/guarantor loses.

Operative Rules:

To defeat a guaranty claim, a guarantor must establish he suffered a direct injury as a result of a lender’s breach; as opposed to injury that is derivative of the injury suffered by the borrower.  So, if a corporate borrower is damaged due to a lender’s breach, the borrowing entity has a right to sue; not a constituent (individual) member of that borrower (e.g. an officer, shareholder, employee, etc.);

Illinois’ declaratory judgment statute allows a court to make binding declarations of rights in cases where the parties’ dispute has crystallized and they have reached an impasse.  The “dec action” plaintiff must show (1) a tangible legal interest in the subject of the suit; (2) a defendant with an opposing interest to plaintiff’s; and (3) an actual controversy between the parties. 735 ILCS 5/2-701(a);

Illinois recognizes (a) procedural unconscionability; and (b) substantive unconscionability.  The former means there is unfairness during the contract formation stage that deprives one of the parties of freedom of choice.  The latter (substantive unconscionability) looks to the terms of a contract and whether they are so one-sided that they oppress or unfairly burden an innocent party and show an imbalance in obligations among the contracting parties.

Procedural unconscionability factors include whether each party had a chance to understand the terms of the contract, whether key terms were hidden amid “a maze of fine print” and any other circumstances surrounding contract formation.

¶¶ 20-28, 31-35

Application:

Plaintiff’s claimed injuries in the breach of guaranty count were purely derivative of the LLC borrower’s.  The extent of plaintiff’s liability to the lender defendant was tied directly to the borrowing entity’s liability to the lender defendant.  There were no facts pled that showed plaintiff would have any different (in nature or amount) liability to defendant than the underlying corporate borrower.

The court held that loss of a guarantor’s investment is a derivative injury, not a direct one.  As a result, plaintiff’s claims were defeated since he failed to plead a direct (as opposed to flow-through) injury as the result of any lender conduct.

The plaintiff’s unconscionability arguments also failed.  The plaintiff only made conclusory allegations that the guaranty was a pre-printed document, drafted by the lender who had a superior bargaining stance compared to the plaintiff.  These blanket allegations weren’t enough though to show a defect during the formation and execution of the guaranty.

The court also held that even if the guaranty was procedurally unconscionable, the plaintiff would still have to show sustantive unconscionability – that the guaranty terms were inordinately one-sided in favor of the lender (and against the plaintiff) that no court could fairly enforce the guaranty.

Here, the court allowed that the guaranty definitely did favor the lender and the lender was probably in a stronger contracting position than the plaintiff.  Still, the terms weren’t so one-sided that the court should abstain from enforcing them.  In rejecting the plaintiff’s substantive unconscionability argument, the court also cited the fact that the guaranty terms weren’t hidden or hard to understand or any unfair surprise.

Afterwords:

Individual guarantor of a corporate borrower must show separate and distinct injury from the corporate borrower to have standing to sue a lender for breach;

A sophisticated borrower will likely need to show both procedural (formation defects) and substantive unconscionability (unfair or one-sided contract terms) to free himself from a contract he willingly signed.