U.S. Supreme Court to Decide Whether California Courts Have Discretion to Not Enforce Arbitration Agreements With Substantively Unconscionable Provisions


By: Allison Shrallow

In 2013, a California district court denied Defendants’ Motion to Compel Arbitration in a case entitled Thomas Zaborowski, et al. v. MHN Government Services, Inc., et al.   This case involved an arbitration agreement which: (1) required Plaintiffs to initiate arbitration within 6 months, (2) allowed Defendants to unilaterally choose a pool of potential arbitrators, (3) called for Plaintiffs to pay significant forum costs, (4) permitted the prevailing party to recoup its attorneys’ fees and costs, and (5) prevented the arbitrator from awarding punitive damages. The Court found each of these provisions to be substantively unconscionable. Relying on the California Supreme Court case, Armendariz v. Foundation Health Psychcare Services, the court held that it had the discretion to either sever the unconscionable provisions or refuse to enforce the entire agreement if the agreement was so permeated with unconscionability that it was not severable. Notwithstanding the agreement’s severability clause, the court refused to sever the offending provisions, opting instead to find the entire agreement unenforceable.

In a 2-1 opinion, The Ninth Circuit Court of Appeals affirmed, finding the district court acted within its discretion in declining to sever the unconscionable provisions from the agreement.   Judge Gould wrote a separate opinion, concurring in the opinion insofar as it found that the agreement was both procedurally and substantively unconscionable; however, he dissented to the opinion with respect to the court’s finding that the district court did not abuse its discretion in not severing the unconscionable provisions. Relying on the United States Supreme Court case, AT&T Mobility LLC v. Concepcion—decided nearly a decade after Armendariz—Judge Gould concluded that the district court’s reliance on the discretionary severability rule in Armendariz had a disproportionate impact on arbitration agreements and as such should be preempted by the Federal Arbitration Act, which espouses a general policy favoring enforcement of arbitration agreements.

On October 1, 2015, the United States Supreme Court granted Defendants’ Petition for Writ of Certiorari. In their petition, Defendants contended that arbitration agreements in California stand on unequal footing with other contractual agreements: “for contracts generally, California courts honor the parties’ stated preference of severing invalid terms, as opposed to invaliding the entire agreement, whereas, the District Court failed to honor the parties agreement to arbitrate their disputes and in the event any terms of an agreement are deemed unconscionable, to excise the offending terms, and still honor the parties’ agreement to arbitrate.” Under Armendariz, a court may determine that an arbitration agreement is permeated by an unlawful purpose based on the mere existence of two or more unconscionable provision and simply refuse to enforce it on that basis. This, Defendants argue, results in California courts improperly applying a harsher standard, favoring nonenforcement of arbitration agreements, in direct conflict with the FAA, which was enacted “in response to widespread judicial hostility to arbitration agreements.” Further, Defendants argued, by ignoring the severability clause, reflecting the parties’ agreement that, rather than invalidating an entire agreement, only those provisions found to be unconscionable should be struck; California courts ignore the fundamental principle that arbitration is a matter of contract.

The United States Supreme Court will determine whether the purported “California arbitration-only severability rule” is preempted by the FAA. As of today, no oral argument date has been set.