Texas Supreme Court Rejects More Arguments Against Arbitration

The Texas Supreme Court just issued another decision in the law governing agreements to arbitrate, once again granting mandamus in order to force a case into arbitration. The opinion addresses several of the “hot” issues often raised by parties seeking to avoid arbitration, although perhaps these issues are cooling at this point.

The Ripple Family entered into an agreement with a Retailer to purchase a manufactured home. The agreement contained an agreement to arbitrate, and it clearly stated that although it was between the Ripples and the Retailer, it also inured to the benefit of the Manufacturer of the home. However, it further states that the Manufacturer had the right to opt-out of an arbitration initiated by either the Ripples or the Retailer by giving notice within 20 days of being notified of the arbitration.

Sadly, the Ripples had lots of problems with their home, and they filed a lawsuit against both the Retailer and the Manufacturer based on common law and Texas’ Residential Construction Liability Act (“RCLA”). Both the Retailer and the Manufacturer moved to compel arbitration, and the trial court denied the motion. In response to the Petition for Mandamus (filed by both Retailer and Manufacturer), the Ripples argue that 1) no agreement to arbitrate exists, 2) the signed arbitration agreement lacks consideration, 3) the agreement is unconscionable, and 4) the Manufacturer, as a nonsignatory to the arbitration agreement, cannot take advantage of it.

The Court makes short shrift of the Ripples’ argument that no agreement to arbitrate existed, since one in fact did exist, between the Ripples and the Retailer. The Court also found that the agreement between the Ripples and the Retailer was supported by consideration, since as it was part of a larger transaction between them it did not need to be supported by independent consideration. The Ripples’ next argument, however, is a bit more interesting.

The Ripples argue that there was no consideration for their purported agreement to arbitrate with the Manufacturer, with whom they had no direct contractual relationship, and who had the right to unilaterally choose to opt-out of arbitration. The Court was unbothered by the first prong, since the Manufacturer was clearly a third-party beneficiary of the Ripples’ contract with the Retailer. Under Texas law, a third party beneficiary to an arbitration agreement can enforce the agreement so long as the contract itself is supported by consideration, that is between the directly contracting parties; in other words, no independent consideration needs to exist between the third party beneficiary and the party seeking to avoid arbitration.

The second prong to the Ripples consideration argument, however, required more deft maneuvering. The Court acknowledges that under Texas law an agreement to arbitrate is illusory if one party retains a unilateral, unrestricted right to terminate it. However, according to the Court, that rule does not apply to a third-party beneficiary to an agreement to arbitrate. Thus, while the Retailer’s right to opt out, had it existed, would have rendered the contract illusory, the Manufacturer could still opt out, since it was not a direct party to the contract. Again, for consideration purposes, the Court looks only to the directly contracting parties.

I am unsure as yet whether or not this analysis is wholly inconsistent with the Fifth Circuit’s from a couple weeks ago. At first it seemed that the two cases result in wholly differing rules of law, but I suppose they may not, since in both cases the key inquiry it to the effect of the opt-out on the direct contract. In other words, had the Ripples’ agreement with the Retailer said something like “the Manufacturer will also be bound to arbitrate” when the Manufacturer in fact retained the right to opt-out, the direct agreement between Retailer and Ripples would have been unsupported by consideration. However, since the direct agreement between the Ripples and the Retailer itself grants the Manufacturer the opt-out right, the Fifth Circuit case we discusses last week does not apply, I suppose.

Finally, the Ripples argue that the arbitration agreement was unconscionable, since it gave the Manufacturer the right to opt-out which the Ripples did not have, and since the parties’ bargaining power was terribly disparate. The Court was unpersuaded by both arguments. At least most of the Court – Justice O’Neill, in a concurring opinion, writes that the purported agreement was in fact unconscionable as between the Ripples and the Manufacturer since the Manufacturer could opt out. However, she thought that the doctrine of equitable estoppel gave the Manufacturer the right to demand arbitration notwithstanding the inadequacy of its contractual right, so she concurred in the Court’s judgment.

In re: Palm Harbor Homes, ___ SW3d ___ (Tex. 2006) (Cause No. 04-0490)

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