"Unconscionability" and Other Issues in Mandatory Arbitration Clauses

by Gerard Panaro, BOL Guru

With Supreme Court and lower court endorsements, mandatory arbitration agreements still seem to be quite popular. According to one publication, "a large percentage of the United States workforce is covered by some sort of alternative dispute resolution (ADR) or arbitration agreement." The paper states that a 1997 survey of Fortune 1000 companies found that more than 23% of the respondents used ADR for nonunion employment dispute resolution. (Source: http://www.littler.com/publications/ch19.pdf).

Nonetheless, plaintiffs continue to contest mandatory arbitration policies on a variety of grounds, and that is one reason to think carefully before adopting one: before you ever get to arbitration, you may have to litigate the enforceability of the arbitration agreement, which may or may not be upheld. But even if it were 100% certain that mandatory arbitration would be upheld, there are still reasons to consider whether such a policy should be adopted or not. 1

This article focuses on two issues: challenges to mandatory arbitration policies as "unconscionable" under state contract law; and whether the oft-stated arguments against litigation are, really, reasons for the employer rather to prefer it to arbitration. It is not the intent of this article to denigrate arbitration agreements, or to suggest that employers should not adopt them; it is the intent to recommend strongly that for the reasons discussed (and many others not discussed for practical reasons of time and space), employers should not blindly or unthinkingly adopt such policies, or implement them just because hundreds or even thousands of other companies have done so.

State arbitration and contract law
When drafting (or reviewing or updating) an arbitration policy, the employer has not only to consider whether it comports with the requirements the Federal Arbitration Act and federal court decisions have imposed (e.g., arbitration must supply the same rights, remedies that statutes afford; employee can't be forced to pay costs of arbitration), but also whether the policy complies with state arbitration and contract law.

In two recent cases, for example, federal courts in New York and Tennessee refused to enforce mandatory arbitration clauses because the courts found them to be "unconscionable" under state laws dealing with ordinary contracts (an agreement to arbitrate, in addition to being an agreement to arbitrate, is also an ordinary contract).

New York case on unconscionability. In Brennan v. Bally Total Fitness, 198 F.Supp.2d 377, 88 FEP Cases (BNA) 335 (S.D.N.Y., 2002), the plaintiff sued her former employer, Bally, under Title VII and the ADA for sexual harassment and disability discrimination. Relying on the fact that the plaintiff signed an arbitration agreement (called the Employee Dispute Resolution Procedure, EDRP), Bally moved to dismiss the complaint and compel arbitration in accordance with the Federal Arbitration Act. The court denied the motion, concluding that the agreement to arbitrate was "unconscionable and therefore unenforceable." 2

The arbitration agreement was included in a 16-page document that employees, including the plaintiff, were given in the context of a seminar on sexual harassment. They were told to sign it, without any explanation, and that if they did not sign it, they would not be considered for promotion. The meeting was run by an attorney for Bally.

According to the court, the lawyer distributed the agreement to employees as soon as a video on sexual harassment ended, told them to review the document, sign and return it. The lawyer spent about five minutes presenting the document to the employees. He did not explain what it was or why the employees had to sign it, except to state that it contained internal procedures for filing complaints. He did not mention the words "arbitration" or "alternate dispute resolution." The court further found that the lawyer never discussed the contents of the document or told the employees why they had to sign it. He neither offered them a sufficient opportunity to review the document, nor recommended that they show it to an attorney before signing it. The plaintiff said that because she was worried about losing her job, she promptly signed and returned the agreement. She said that she did not understand the legal significance of the document, nor was she told that it would affect her pending complaint against her previous supervisor. She claimed that if she did know this, she would not have signed it.

Since the time the plaintiff signed the agreement, Bally twice unilaterally modified it. The plaintiff said she had no recollection of ever being notified of or receiving copies of these modifications.

Ordinary contract law applies to arbitration agreements. In explaining its holding, the court said that when deciding whether to compel arbitration, a court must first consider whether there is an agreement to arbitrate. Courts apply generally accepted principles of contract law to determine whether parties have agreed to arbitrate. This is so even in the case of arbitration agreements under the Federal Arbitration Act. An agreement to arbitrate that was the product of economic duress or coercion is invalid. Similarly, a party will not be bound by an arbitration agreement that is unconscionable. The court gave this definition of "unconscionability": "An unconscionable contract is one which is so grossly unreasonable or unconscionable in the light of the mores and business practices of the time and place as to be unenforceable according to its literal terms." (Internal quotations om. and spelling of "unenforceable" corrected.) A contract is unconscionable when there is an absence of meaningful choice on the part of one of the parties together with contract terms which are unreasonably favorable to the other party. These questions are decided on a case-by-case basis.

"To determine whether a contract was validly formed," the court said, it "should focus on evidence of high pressure or deceptive tactics, the use of fine print in the contract, and any disparity in experience and education, i.e. bargaining power, between the parties." The court cited one decision's statement that: "Typical contracts of adhesion are standard-form contracts offered by large, economically powerful corporations to unrepresented, uneducated, and needy individuals on a take-it-or-leave-it basis with no opportunity to change the terms."

"While inequality in bargaining power between employers and employees is not alone sufficient to hold arbitration agreements unenforceable," the court noted, citing the Supreme Court's decision in Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20, 33, 111 S.Ct. 1647, 114 L.Ed.2d 26 (1991), "such inequality, when coupled with high pressure tactics that coerce an employee's acceptance of onerous terms, may be sufficient to show that an employee lacked a meaningful choice." Second, as noted, a contract is substantively unconscionable when its terms are unreasonably favorable to the party against whom unconscionability is claimed.

Applying these legal principles to the facts of the case, the Brennan court found that the arbitration agreement was both procedurally and substantively unconscionable; procedurally, because the plaintiff had no meaningful opportunity to consider it; substantively, because of some of its terms (see footnote 3).

Procedural unconscionability. On the "meaningful choice" issue, the court noted these facts: the Bally lawyer used high pressure tactics to coerce the employees into signing the agreement. He gave the employees no more than fifteen minutes to review a sixteen-page single-spaced document, and never mentioned or suggested that the employees could review it at home or with an attorney. He threatened the employees that those would did not sign the document would not be promoted. He did not address the impact the EDRP would have on pending complaints against the company. At the end of the sexual harassment seminar, he asked aloud whether each employee, including the plaintiff, had signed the agreement. "As a result of these pressure tactics, [the plaintiff] reasonably felt that she had no choice but to sign the EDRP or she would lose her job." (However, the court did agree in a footnote that "continued employment and promotion constitute valid consideration for agreeing to alternate dispute resolution.")

The court further found that the "significant disparity in bargaining power that existed between the parties" also contributed to the plaintiff's lack of a "meaningful choice" in deciding whether to sign the agreement: she was an unrepresented, single mother who was then pregnant with twins, and lacked other adequate means of support. She was deepndent on her job for the health insurance it provided, and was particularly afraid of losing her health coverage because of her high-risk pregnancy. Bally, on the other hand, noted the court, was "a large corporation with offices nationwide" and was represented at the meeting by an in-house attorney.

Substantive unconscionability. On the substantive issue, the court found that the arbitration agreement likewise was unconscionable because Bally employees lost their right to pursue certain damages remedies, agreed to a cap on certain damage awards and accepted a shorter limitations period for bringing claims. (Although this court said that these particular terms were not unreasonable or unconscionable, other courts have held that they invalidate a mandatory arbitration agreement in the employment context.) The agreement was further unreasonably favorable to Bally because its terms allowed Bally to unilaterally modify the contract at any time, thus binding employees to a contract they may never have seen; and because with respect to the plaintiff in particular, it denied her the right to proceed in court on her pending sexual harassment claim against the company.

Tennessee case on unconscionability of arbitration agreement. The court in Cooper v. MRM Inv. Co., 199 F.Supp.2d 771 (M.D.Tenn., 2002) likewise found the arbitration agreement in that case to be unconscionable under Tennessee law. In Cooper, the arbitration agreement was part of the plaintiff's employment contract.4 MRM Investment Company was a Kentucky Fried Chicken franchise. The plaintiff alleged constructive discharge due to sexual harassment. She sued under both Title VII and the Tennessee Human Rights Act. MRM moved to compel arbitration, which motion the court denied. The plaintiff argued that the arbitration agreement was unenforceable because it required her to pay a portion of the costs associated with arbitration. The court agreed.

Agreement must satisfy three conditions. The court began its analysis by stating that even though arbitration of discrimination claims can be enforced, such an agreement must satisfy at least three conditions:

The employee cannot be required to forfeit any substantive rights as a condition of employment
The waiver of any rights (substantive or procedural), must be both knowing and clear.
"Finally, and most fundamentally, an agreement to arbitrate Title VII rights must comport with the principles of contract law. In deciding whether the arbitration agreements are enforceable, state-law contract principles control."

In connection with this latter point, the court said: "A contractual agreement to arbitrate may be invalidated by a showing of fraud, duress, mistake, unconscionability or any other ground upon which a contract may be set aside." There must also be adequate consideration and mutual assent.

Like the New York court, Tennessee law examines both the "meaningful choice" and "substantive terms" issues. However, the Cooper court said, "In Tennessee we have tended to lump the two together and speak of unconscionability resulting when the inequality of the bargain is so manifest as to shock the judgment of a person of common sense, and where the terms are so oppressive that no reasonable person would make them on one hand, and no honest and fair person would accept them on the other."

Tennessee law also disfavors "contracts of adhesion": "a 'standardized form offered to consumers ... on essentially a 'take it or leave it' basis, without affording the consumer a realistic opportunity to bargain and under such conditions that the consumer cannot obtain the desired product or service except by acquiescing to the form of the contract.'"

Contracts of adhesion. In Cooper, the court found that the arbitration agreement was a contract of adhesion because the plaintiff was the "weaker party," had no "realistic choice as to its terms," and the agreement itself was a standardized form drafted by KFC attorneys and offered on a take-it-or-leave it basis. She either had to accept the job based on the terms outlined in the KFC arbitration agreement, or she had to find another job. "Especially in today's economy," the court added, "the choice to 'leave it' often amounts to no choice at all. ? Hence, the KFC Arbitration Agreement is a contract of adhesion."

The KFC arbitration agreement was also unconscionable, the court held, for at least two reasons: "The pressure facing a prospective employee coupled with the uniform incongruity in bargaining positions between the employer and employee," and there was no language in the KFC agreement advising the plaintiff she was giving up her right to trial by jury. The waiver of the right to trial by jury must be knowing and clear. "If the employee is not clearly made aware of the rights she is waiving, that waiver is not only invalid, but the entire agreement is rendered unduly oppressive."

What is truly surprising about the Cooper decision, and unusual in these cases, is that the court went beyond the "meaningful choice" criterion and stated flatly that if the employees (or even KFC's own lawyers!) had any choice, they would never sign such an agreement: If the ordinary employee were informed of the consequences of signing the arbitration agreement, and if that employee had a choice, she would not sign that agreement. However, in the employment context, the employee simply has no choice. ? Additionally, the attorneys that drafted the KFC Arbitration Agreement would certainly never sign that agreement if they were in Plaintiff's shoes. Thus, considering all of the surrounding circumstances, this Court finds that not only would an ordinary person be shocked by the oppressive terms of this Arbitration Agreement, but no honest and fair person would accept these terms, knowing the full ramifications of doing so.

Employee can't be required to pay. The court also agreed with the plaintiff's argument that the arbitration agreement was invalid because it required her to pay a portion of the arbitration fees. Requiring the plaintiff to pay for the right to vindicate her federal substantive rights would amount to an insurmountable obstacle, the court said. Although the KFC agreement was silent on the parties' responsibilities for fees and costs, it did specifically state that the American Arbitration Association's rules would govern the arbitration proceedings.5 These rules impose a number of fees and costs that the plaintiff would have to bear as the "initiating party." "Requiring a party to pay fees and costs, over and above what that party would have to pay in a court, may deprive that party of the right to vindicate his or her rights," the court said.

Lessons of the unconscionability cases. Just the above two cases alone appear to present a somewhat long list of difficult - if not insurmountable - hurdles for manda-tory arbitration agreements to overcome if they are to be upheld if challenged in court. Perhaps the worst obstacle is that even if the employer drafts "the perfect arbitration agreement,"
incorporating every term and all the advice and suggestions given in the opinions, and omitting all the objectionable terms, it still cannot be certain that the agreement will be upheld by every court, under every circumstance. The employer must consider:

The "weakness", "unequal bargaining power," sophistication, etc. of its workforce and even, perhaps, of individual employees. For example, the above discussion suggests that while an arbitration agreement might be upheld vis-?-vis an inhouse attorney, it might be upheld against a cleaning person.
The size, strength of the company (again, going to balance between the parties). This can be particularly difficult, if not impossible, for national or multinational corporations (e.g., Bally Fitness Centers)
The diversity, even inconsistency, among various federal district and courts of appeals in terms of what those courts find acceptable or fatal to arbitration agreements.
All the circumstances surrounding the presentation of the agreement: who drafted it, how well was it explained, how much time were the employees given to study it, were they allowed to consult an attorney, were they well-educated enough to understand what they were doing?
Striking a balance between imposing arbitration as a term or condition of employment (OK) vs. presenting the agreement on a "take-it-or-leave it" basis (not OK)

Other issues. There are other questions to think about and answer with a mandatory workplace arbitration policy, in addition to all those raised by the two cases discussed. For example, if the employer were to use the same arbitration service, or the same few arbitrators over and over, that could form the basis of a legal challenge on the ground that it gave an unfair advantage to the employer.

With litigation, cases are assigned to judges at random; neither party has any control or influence over who the judge is. But in arbitration, the parties select the judges. Moreover, a judge's record is public, so that once the parties know who the judge is, they can look up his or her record, see how s/he decides cases, and form a judgment as to whether the judge is likely to be sympathetic or unsympathetic to the plaintiff's or defendant's claims, arguments and defenses. Because arbitration is private, such information is generally lacking about arbitrators. In this sense, an employer who uses the same firm and the same arbitrators over and over will arguably have an (unfair) advantage.

A way out of the dilemma. One way out of the dilemma, of course, is to forego mandatory arbitration agreements. Does this mean negotiating scores, hundreds or even thousands of individual agreements to arbitrate? It may. One question to consider is whether this is any more difficult than complying with, promulgating, and/or implementing any number of other employee benefits, whether it be keeping track of payroll information, sick and vacation days, reasonable accommodations for people with disabilities, health benefits, pension benefits, etc. Another question, of course, is: Is it worth it? Arguably, the benefit of avoiding jury trials, with their potential for passion, prejudice, bias, ignorance and awards in the hundreds of thousands, or millions, of dollars does make individually negotiating voluntary arbitration agreements preferable.

Another potential solution is to forego arbitration altogether and use nonbinding mediation. More typically, however, mediation is used in conjunction with arbitration: in other words, the first step is for the parties to try to work out things for themselves; if that fails, engage in nonbinding mediation; if that fails, go to mandatory arbitration.

Are the disadvantages of litigation really so? Another question that should certainly be considered in deciding whether to opt for arbitration or not is this: Are the oftcited, so-called disadvantages, drawbacks, delays and risks of litigation really so, from the employer's point of view, and from the perspective of the company's strategy either to avoid or to win employment discrimination claims? The thesis here is this: The daunting risks and obstacles of litigation may actually benefit and favor the employer, in terms of making it all the more difficult for employees to contest their dismissals, thereby dissuading them from doing so in the first place.

Consider these statistics: "The EEOC declines to sue the employer in the vast majority of charges it receives each year. In fiscal year 2000, for example, the EEOC received 79,896 charges of employment discrimination, yet it filed only 291 lawsuits and intervened in only 111 others. In other words, the commission chose not to sue the employer in 99.5 percent of the charges filed. Likewise, the EEOC accounted for only 1.9 percent of the 21,032 employment discrimination lawsuits filed in fiscal year 2000." 6 Further considering that there are approximately 100,000,000 employees in this country, the fact that there were only 21,000 discrimination cases filed in 2000 seems to give the employer pretty good odds of never being sued. Considering further that perhaps literally 90% or more of lawsuits are settled before they ever get to trial, and taking into account the number of times that courts rule in favor of the employer on summary judgment, or even that juries find for the employer, the employers' odds would appear even better.

On the other hand, under a workplace arbitration policy, every single employee has every incentive to sue over any adverse action, because the employer must pay for the arbitration, it is (allegedly) much simpler, quicker and more "informal" than litigation, the employer still may lose.

Everyone is familiar with the saying that "Justice delayed is justice denied." Applied to the employment context, are the delays of litigation - which can literally stretch into years - really an advantage to the employer, if such delays have the effect of causing the employee to accept a much lower settlement than s/he might otherwise win after trial, or giving up altogether because s/he has run out of money, patience or both? In short, Are the alleged disadvantages and drawbacks to litigation actually an advantage to the employer which it loses by opting for arbitration?

Summary and conclusion
Mandatory arbitration agreements continue to be challenged and litigated, despite all the courts' endorsements and enforcements of them. Arbitration agreements, in addition to being about arbitration and having to comply with federal and state arbitration statutes, are also ordinary contracts and must therefore also comply with standard, ordinary contract law, including valid offer, acceptance, consideration, mutual assent, and knowledge of the terms. An arbitration agreement, like any contract, can be voided for fraud, duress, mistake, adhesion and/or unconscionability.

Mandatory arbitration agreements may be challenged both on the ground that, in the employment discrimination context, they do not comport with the requirements court impose on such agreements and on ordinary contract principles. Arbitration agreements have successfully been challenged on grounds of unconscionability, which would appear to raise significant barriers to their enforcement, court opinions upholding them notwithstanding.

One way to avoid these problems is to forego mandatory arbitration in favor of individually negotiated, voluntary arbitration agreements, or in favor of non-binding mediation and/or arbitration. However, employers also have to consider whether any arbitration policy is, in fact, for that employer, preferable to taking one's chances in court.

1 Interestingly enough, the Ninth Circuit, on remand of the Circuit City case from the Supreme Court found the arbitration clause that was the subject of the Court's decision to be unenforceable because it was uncon-scionable because it was substantively one-sided (Circuit City Stores, Inc. v. Adams, 279 F.3d 889 (9th Cir.2002).

2 Interestingly enough, Bally's arbitration agreement had been upheld by two other courts. The Brennan court, however, found both decisions unpersuasive because they were only one-page unpublished orders, not binding on this court, there was no evidence that the agreements in the other cases were the same as the one before this court, and because of the circumstances of the specific plaintiff in Brennan.

3 The court did not quote the agreement in its entirety in its opinion. However, in footnotes, it did note the following terms:

"Each Party shall bear one-half the reasonable expenses of the arbitration, except that this provision shall not apply to the Employee in circumstances where the Employee asserts a statutory anti-discrimination claim based on State or Federal law." (Bold in original.)

"Based on this EDRP, the Employer also reserves the right to initiate a claim involving a Dispute with the Employee. Based on such election by the Employer, the Employee shall be given written notice stating in detail the nature of the Employer's claim. This notice must be postmarked within the time limit set forth in Paragraph 4.1. Within thirty (30) calendar days of the Employer forwarding such written notice to initiate this EDRP, the Employer and Employee shall hold an in-person meeting in an attempt to informally resolve the Dispute."

"Should the EEOC or other administrative agency initiate any action with respect to any Covered Dispute, Employee waives any right to individual damages or other relief as a result of such action, as Employee's right to damages or other relief, if any, shall be determined solely under this EDRP."

"The Employer will give a copy of this EDRP to the Employee a) at the time the Employee makes applica-tion for employment, b) for current employees, as soon as this EDRP is adopted by the Employer, or c) at any time, upon Employer's receipt of a written request for a copy of this EDRP from Employee. Further, the Employer immediately shall post at all affected Bally facilities any amended EDRP, and any af-fected Employee will be provided with a copy of the EDRP upon Employer's receipt of a written re-quest for a copy of the amended EDRP."

"Except as otherwise set forth herein, this EDRP can be modified or revoked only by a writing, signed by both the Employee and the president or a representative of the Employer specifically set forth in Article 6.1., that references this EDRP and specifically states an intent to modify or revoke this EDRP."

"Except as otherwise provided in this EDRP, any mediation shall be in accordance with the Rules for the Resolution of Employment Disputes of the American Arbitration Association (AAA) in effect at the time of receipt from the other party of written notice of the Dispute."

"Except as otherwise provided in the EDRP, any arbitration shall be in accordance with the Rules for the Resolution of Employment Disputes of the American Arbitration Association (AAA) in effect at the time of receipt from the other party of written notice of the Dispute."

"Each party shall bear one-half the reasonable expenses of the arbitration, except in circumstances in which the Dispute by the Employee involves a claim in which the Employee asserts a statutory anti- discrimina-tion claim based on State or Federal law, the Employer shall be solely responsible for the expenses of the arbitration (other than Employee's attorneys' fees, if any, and personal expenses of the Employee, including the expenses of any Employee witnesses)."

4 As quoted in the court's opinion, the agreement provided: ... KFC and I agree to use confidential binding arbitration for any claims that arise between me and KFC, its related companies and/or their current or for-mer employees. Such claims would include any concerning compensation, employment including, but not limited to any claims concerning (sexual harassment), or termination of employment ... In any arbitration, the prevailing rules of the American Arbitration Association and, to the extent not inconsistent, the prevail-ing rules of the Federal Arbitration Act will apply.

5 The AAA has rules specifically for employment cases. Go to www.adr.org and click on "Rules" (top left of page) and go to National Rules for the Resolution Employment Disputes, Effective January 1, 2001

6 Source: Brian Clarke, "Demise of employment arbitration greatly exaggerated," (Business Journal, Janu-ary 25, 2002, http://triad.bizjournals.com/triad/stories/2002/01/28/editorial3.html)

First published in HR Advsior Sep/Oct 2002, v. 8 #5.

About the Author:
Gerard P. Panaro has more than 25 years' experience in employment law and is available to assist readers on an individual basis. You may reach him at 202-861-1314. Mr. Panaro is of counsel with Howe & Hutton, in the Washington, DC office.

First published on BankersOnline.com 12/8/03