ARBITRATION LEGITIMACY — UNCONSCIONABILITY

Guest blogger Rick Freeman contributes commentary about a recent San Antonio Court of Appeals opinion about the enforceability of arbitration clauses.

In my last article I discussed the need for fairness in arbitration agreements. Failure to have fair terms in the arbitration agreement or failure to provide a fair arbitration proceeding will result in a perceived lack of legitimacy in the arbitration result. If arbitration results are not perceived to be legitimate determinations of the disputes, arbitration as a dispute resolution method will ultimately fail.

A recently decided case by the San Antonio Court of Appeals highlights one large area of perceived unfairness and illegitimacy.

In the recently decided case of Olshan Foundation Repair Company v. Ayala, [No. 04-04-00829-CV], the San Antonio Court of Appeals ruled that an arbitration provision, specifically because of its high cost, was unconscionable and therefore unenforceable.

I will leave it to you to read the relatively short opinion and dissent, but I will summarize the facts and arguments.

The Ayalas hired Olshan to do repairs on their foundation. The repairs cost $22,000. Arbitration was compelled. The cost of arbitration as required by the contract was estimated by AAA at $63,000. The Ayalas owed $33,000 of that amount. They were invoiced by AAA and the invoice was due and payable upon receipt.

At a second hearing, the trial court ruled that the cost of the arbitration (almost 50% of the annual income of Mr. Ayala and almost 3 times the cost of the repairs) was unconscionable. The court denied the arbitration on the basis of the unconscionable cost.

The San Antonio Court of Appeals affirmed the trial court’s decision. The Court specifically stated that the cost of the arbitration was “shocking” to them. The dissent argued that unconscionability, as of the time of the making of the contract, was not proved by the Ayalas and that arbitration should be compelled.

This type of unfairness is regularly seen in arbitration provisions. Although the high cost of arbitration effectively eliminates the rights of many individuals to litigate their claims, this is the first appellate decision that I am familiar with that has ruled the arbitration provision to be unenforceable, specifically because of the cost.

The U.S. Supreme Court case of Green Tree Fin. Corp. and the Texas Supreme Court case of FirstMerit Bank both hold that the cost could make arbitration unconscionable, but in those cases, the Courts ruled that the evidence of cost presented was only of a possibility of unconscionable cost. Both Courts rules that evidence of a possibility is not enough to overturn the arbitration provision.

It will be interesting to see if the Texas Supreme Court decides to accept the Olshan case for its determination.

Suffice it to say, costs like in Olshan are the kind that cry out to be ruled unconscionable. In addition, any arbitration clause that effectively denies individuals the ability to litigate their claim because of high costs, ought to be declared unconscionable. Otherwise, what we have is a dispute system that is decided by income and not the facts.

More and more of the arbitration clauses I am seeing effectively shut off individuals from the right to litigate a claim because of the high cost of the arbitration. If arbitration provisions that price people out of the ability to arbitrate are upheld by the Courts, the legitimacy of an entire dispute resolution system will suffer greatly.

And, in my opinion, the system will ultimately fail because of its lack of legitimacy.