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The California Court of Appeal for the Second District recently published two decisions which both held that as long as an arbitration agreement is objectively fair in substance, procedural unconscionability alone is insufficient to deny enforcement. See Basith v Lithia Motors, Inc., (April 21, 2023, B316098) __ Cal.App.5^th __. (Basith), and Fuentes v. Empire Nissan, Inc. (April 21, 2023, B314490 __ Cal.App.5^th __ (Fuentes). Although the factual circumstances underlying each case were very different, the common result serves to illustrate and clarify how the “sliding scale” unconscionability analysis should be applied to arbitration agreements.

Over two decades ago, the California Supreme Court stated the rule, which has been faithfully applied in subsequent cases: In order to avoid enforcement of an arbitration agreement, “Both procedural and substantive unconscionability must be shown . . . but they need not be present in the same degree. Instead they are evaluated on a ‘sliding scale.’ The more substantively oppressive the contract term, the less evidence of procedural unconscionability is required to conclude that the term in unenforceable. Conversely, the more deceptive or coercive the bargaining tactics employed, the less substantive unfairness is required.” (OTO, LLC v. Kho (2019) 8 Cal.5^th 111, 125-126, citing Armendariz v. Foundation Health Psychcare Services, Inc. (2000), 24 Cal.4^th 83, at 114.)

Lawyers and trial courts have been torturing this language for decades. Too often, the distinction between “procedural” and “substantive” became blurred, while the requirement that “both must be shown” was given short shrift. Facts and evidence relating to how an arbitration agreement was presented for signature – procedural issues – were instead mislabeled as “substantive,” under the circumstances of a particular case. But in this age of online employment applications with “take it or leave it” arbitration clauses, allowing procedural objections to masquerade as substantive deficiencies nullifies the element of substantive unconscionability, to the confusion of trial courts and litigants.

As the Second District Court of Appeal phrased it in the first sentence of the Basith opinion, a “twist of fate” occurred this time. On the same day, the same Court was confronted with the same arbitration agreement, by litigants involved in the same industry. The differences in the cases involved only the circumstances by which each plaintiff signed; procedural considerations. The court was thus presented with an opportunity to refine and explain how to properly apply the “sliding scale” analysis of unconscionability. Was it legally justifiable to enforce the agreement in one case and reject it in the other? Did the law require the same decision in both cases? If so, why? If not, why not? The Court framed this “vital question in contract law”, as follows: “[W]hat exactly is California’s test for unconscionability? More precisely, when there is a very high degree of procedural unconscionability, is there any meaningful content to the second element of substantive unconscionability?” (Emphasis original.)

Fuentes

Ms. Fuentes “wet” signed a traditional, paper contract, entitled: “Applicant Statement and Agreement” that included the binding arbitration agreement at issue. Essentially, that agreement required any employment related claim to be decided in binding arbitration. Ms. Fuentes was also required to sign an additional agreement, promising to maintain confidentiality of her employer’s trade secrets. However, the trade secret agreement specified that if a court of competent jurisdiction determined any part to be unenforceable, then it would be severed from the rest of the agreement.

Fuentes attacked the arbitration agreement on five grounds: 1) the small font and blurred print made the arbitration agreement impossible to read before signing; 2) it lacked “mutuality” because the employer was free to take alleged trade secret breaches to court, instead of arbitration; 3) the existence of one contract for arbitration and one for trade secrets is “confusing to a layperson”; 4) Fuentes was the only party to sign the arbitration agreement; and 5) the arbitration agreement did not explain how to initiate arbitration.

Basith

The language of Mr. Basith’s arbitration agreement was virtually identical to the one signed by Ms. Fuentes. However, it was initially presented as part of an online employment application, which Basith signed electronically. After he was hired, he “wet” signed a paper document, entitled, “General Manager Compensation Plan.” That plan included an “Acknowledgement” with a short clause affirming the obligation to arbitrate employment claims.

The undisputed evidence in the Basith case was that his original long form arbitration agreement was part of an interactive “iCIMS” recruitment and tracking system. Applicants such as Mr. Basith signed into an employer website and created a user name and password. They then proceeded through various screens and tasks to apply for employment, including applying their electronic signature to the long form arbitration agreement that was virtually identical to the one signed by Mr. Fuentes. However, Mr. Basith was not asked to sign any trade secret agreement, and Mr. Basith merely argued that the agreement was too lengthy and difficult to understand.

Although the employer appended a “PDF” version of the arbitration agreement to the motion to compel arbitration, there was no evidence before the court to establish such things as font size and appearance of the document as Mr. Basith viewed it from whatever screen he was using at the time of his signature. However, the Court inferred that technology would have made the online image adjustable to a viewer such as Mr. Basith.

Ultimately, the court determined that all of the arguments raised in opposition to arbitration in both cases went to the issue of procedural unconscionability only. The agreements, lengthy though they were, were also objectively fair and in compliance with the Federal Arbitration Act. The only way to deny enforcement in Fuentes case would be to sustain a finding of substantive unconscionability that would apply equallly to Basith, and that would have gone too far. As stated in the Basith opinion: “Our holding is that, unless we are to imperil the vast online world of take-it-or-leave-it contracts, substantive unconscionability must retain meaningful independent content. For that reason, the contracts here and in Fuentes are valid and enforceable, despite their procedural unconscionability.”

Dissent

Justice Stratton dissented, relying primarily on similarities in the Fuentes case to the circumstances in Davis v. TWC Dealer Group, Inc. (2019) 41 Cal.App.5^th 662. The dissenting opinion emphasized that legibility issues, particularly in the Fuentes case, put the employee in the position of consenting to promises that they could not know even if they wanted to, because the contract was unreadable.

Takeaways

The court was unwilling to brand virtually identical arbitration agreements as enforceable in one instance, but substantively unconscionable in another. The Fuentes and Basith decisions are important because they stand for the proposition that true substantive unconscionability is an indispensable requirement for avoiding enforcement of an arbitration agreement. As long as there is no substantive unconscionability in an arbitration agreement, trial courts should enforce, irrespective of how much procedural unconscionability is alleged to exist. Employers who want to resolve disputes in arbitration should first draft scrupulously fair agreements. Employer’s attorneys seeking to compel arbitration may be better served by first arguing the objective fairness and lack of substantive unconscionability in their clients’ arbitration agreements, before attacking subjective arguments on what did or did not happen when the employee signed.

For more information or specific guidance, please contact Kellie Christianson.