This case involves a debt adjustment contract between a consumer and a financial institution.[i] In May 2008, the consumer (Gandee) entered into a contract with a company (LDL Freedom Enterprises, Inc.), in which LDL agreed to assist Gandee with financial matters pertaining to consumer loans. Three years later, Gandee sued LDL in Superior Court, asserting violations of the Consumer Protection Act (RCW 19.86, et seq.), and the Washington Debt Adjustment Act (RCW 18.28, et seq.). The contract between LDL and Gandee contained the following arbitration and severability clause:
Arbitration. All disputes or claims between the Parties related to this Agreement shall be submitted to binding arbitration in accordance with the rules of [the] American Arbitration Association within thirty days of the dispute date or claim. Any arbitration proceeding brought by client [Gandee] shall take place in Orange County, California. Judgment upon the decision of the arbitrator may be entered in any court having jurisdiction thereof. Prevailing party in any action or proceeding related to this Agreement shall be entitled to recover reasonable legal fees and costs, including attorneys’ fees which may be incurred.
Severability. If any of the above provisions are held to be invalid or unenforceable, the remaining provisions will not be affected.
LDL moved to compel arbitration and Gandee opposed the motion, contending that the arbitration clause was unconscionable and that LDL had failed to move for arbitration within thirty days as required by the arbitration provision. The trial court agreed and denied LDL’s motion to compel arbitration because it was not “timely brought” and that the arbitration clause was unconscionable. The case was appealed to the Washington Supreme Court.
The Supreme Court first looked at the issue of unconscionability. In Washington, in order to find that an arbitration clause is unconscionable and thus invalid, it must be “substantively” unconscionable. A term is substantively unconscionable where it is “one-sided or overly harsh,” “[s]hocking to the conscience,” “monstrously harsh,” or “exceedingly callous.”[ii] Generally, where the contract contains a severability clause similar to the one set forth above, the non-valid or unconscionable terms are severed from those terms that are appropriate and the contract is enforced without the inappropriate terms. However, where the unconscionable terms “pervade” an arbitration agreement, the Court will “refuse to sever those provisions and declare the entire agreement void.”[iii]
The consumer challenged three aspects of the arbitration agreement. The venue provision requiring that the case arbitration be heard in Orange County, California, the thirty day private statute of limitation provision, and the prevailing party attorneys’ fees clause.
- Venue/Location of the Arbitration: With regard to the venue provision, Gandee argued that holding the arbitration in Orange County, California effectively denied her the ability to vindicate her rights. Courts recognize this type of prohibitive cost challenge to mandatory arbitration clauses. Generally, Washington courts will accept an affidavit describing a party’s personal financial information, as well as the fee schedule from the American Arbitration Association, as sufficient evidence to meet the burden of demonstrating “prohibitive costs.” In this instance, in addition, Gandee indicated what the travel costs, hotel costs and American Arbitration Association fees demonstrated that the cost to litigation in California exceeded the amount of her claim.
- LDL argued that the American Arbitration Association fee did not apply because the clause only required that the arbitration be submitted in accordance with the rules of the American Arbitration Association, not that the American Arbitration Association actually had to administer the arbitration itself. The Court criticized LDL however because it did not provide any information with regard to any other arbitration association and what it would have cost. Thus, the Court found that because LDL failed to factually rebut Gandee’s showing of financial hardship and held that Gandee prevailed on this issue.
- Prevailing Party Attorneys’ Fees: Next, the Court addressed the “loser pays” attorneys’ fees provision, which the consumer argued was one-sided and harsh because Gandee brought her suit under the Consumer Protection Act (CPA) and only the consumer is entitled to attorneys’ fees. Under the arbitration clause, however, attorneys’ fees were awarded to the prevailing party (which could be either party). Thus, the Court reasoned that the “loser pays” provision in the arbitration clause served only to benefit LDL, which effectively chilled Gandee’s ability to bring suit under the Consumer Protection Act. Therefore, the Court found this term in the arbitration clause one-sided, overly harsh, and thus, substantively unconscionable.
- Contract Suit Limitation: With regard to the thirty day private statute of limitations, the Court acknowledged that such contractual statute of limitations are valid, enforceable and will control over general statutes of limitations, unless prohibited by statute. Here, the arbitration clause shortens the statute of limitations from four years, provided by the Consumer Protection Act, to thirty days. The Court held that the statute of limitations provision of only thirty days was unconscionable.
Having found that three of the challenged provisions of the arbitration clause were unconscionable, the Court then went on to determine whether severance of the provisions should apply, or whether to invalidate the arbitration clause as a whole. Finding that the four sentence arbitration clause contained three unconscionable provisions, the Court determined that the entire clause could not be severed from the overall contract. LDL argued, in its brief to the Supreme Court that the Court should nevertheless enforce the arbitration provision because it “waived” any objectionable provisions. The Court found that this offer coming at the appeal was too little too late. The Court ruled that if it allowed such an after the fact waiver to occur, parties would load up their arbitration agreements “full of unconscionable terms, then when challenged in court, offer blanket waiver.” The Court held that the arbitration clause was unenforceable.
The Court then went on to distinguish the Federal Arbitration Act, which preempts state law. Based on federal court cases, the state justices reasoned that the U.S. Supreme Court would agree that this arbitration provision was unconscionable and thus unenforceable.
Comment: What application does this ruling have for construction contractors? Envision the situation in which a small local subcontractor does business with a large out of state general contractor, performing a project in Washington. The arbitration clause in this subcontract provides resolution of disputes in accordance with the American Arbitration Association, has an arbitration locale of Denver, Colorado, containing a prevailing party attorneys’ fees clause, and requires that the contractor bring an action under the arbitration clause within 90 days of the date of the occurrence giving rise to the claim. Under the Gandee case, it very well could be that a court would invalidate such an arbitration clause, considering the cost of arbitrating the case in Denver, Colorado versus in Washington. The American Arbitration Association’s fee, if the dispute exceeds $1 million, is $11,450 without compensation of the arbitrator(s), which could be tens of thousands of dollars if the dispute takes a week or longer to resolve. The court has already ruled that a 180 day private statute of limitations is unconscionable in another case.[iv] If the project involved public works and a bond claim is involved, the Washington Bond Claim statute (RCW 39.08.030) provides only attorneys’ fees to the prevailing claimant and no reciprocal fees to the bonding company or the general contractor. Under the logic of Gandee, since the arbitration clause contains a prevailing party arbitration fee provisions, by including a prevailing party attorneys’ fees provision in the arbitration clause, the court could well find that such a provision has a chilling effect on the subcontractor. The prevailing party attorneys’ fees clause in the bond is one-sided and benefits only the claimant (subcontractor). A “loser pays” two-sided attorneys’ fees provision might be seen as unconscionable under the same logic employed in the Gandee case. Finally, a 90 day statute of limitation, compared with the Bond Claim statute which provides a six year statute of limitations, might be the final straw and the Court could find the entire provision unconscionable as it did in the Gandee case. This is a practice pointer to keep in mind when confronted with an overly harsh and one-sided arbitration provision.
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[i] Gandee v. LDL Freedom Enterprises, Inc., __ Wn.2d __, 293 P.3d 1197 (2013).
[ii] Relying on Adler v. Fred Lind Manor, 158 Wn.2d 331, 344-345, 103 P.3d 773 (2004).
[iii] Adler v. Fred Lind Manor, 153 Wn.2d 358.
[iv] Adler v. Fred Lind Manor, 153 Wn.2d 355-358 (finding that a 180 day private statute of limitations was unconscionable).