Steve Block, Foster Pepper PLLC, USA

Arbitration clauses can’t be unconscionable, at least within the Ninth Circuit.

As with many other industries, shipping and logistics contracts quite frequently contain mandatory arbitration clauses designed to expedite and avoid the higher costs of court litigation. Such private dispute resolution also empowers parties to select industry-conversant arbiters; agree to terms and rules that are more appropriate and convenient than standard court rules (including confidentiality); end matters conclusively with one hearing (i.e., no appeals); choose the timing and places of proceedings; and generally have more say so over the process. It’s blessed and promoted by the Federal Arbitration Act (the FAA), a statute whose court interpretation over the years shows the strong inclination of government and the judiciary toward docket-clearing, private determinations of who was right and who was wrong. Many states have similar statutes on their books.

Generally, one party can force arbitration on another only of the two previously agreed in a contract to settle their disputes in that manner, although they can always agree to do so later if they want. But then issues can, and often do, arise as to whether there ever was a binding agreement to arbitrate. Whether or not parties contractually agreed to arbitrate must be determined by a court, which will apply specialized principles of contract interpretation to rule whether an arbitrator or another court takes over.

One aspect of the enforceability of any contract term is known as “conscionability.” Even if parties technically agreed to something in an otherwise enforceable contract, courts won’t enforce it if doing so would offend general notions of fair play. However, defeating a term you earlier signed on for isn’t easy. To be unconscionable, a contract term has to be so extremely unjust, or so lopsided in favor of one party, that good conscience prohibits its enforcement because, well, no one in their right mind would’ve agreed to it in the first place – all else being equal.

While law varies on the concept from state to state, some jurisdictions have established elements a party claiming contract unconscionability must prove before a contract will be nixed. California says that a term must be “both procedurally and substantively unconscionable” before its courts will preclude its enforcement.

Judicial preference for enforcement of contractual arbitration clauses recently came to a head with a party’s claim that it was unfairly strong-armed into agreeing to one in a logistics contract. Ocean carrier Hanjin Shipping Company prepared and submitted to motor carrier Elite Logistics Corporation a port services contract which contained a mandatory arbitration clause. It was a “take it or leave it” deal, with no negotiations undertaken to determine the terms. Hanjin’s contract contained provisions whereby Hanjin could collect penalties from Elite if its drivers didn’t timely show up for pickups or return empty containers. Elite entered into the contract and began operations. It later got upset when Hanjin collected those penalties on weekends and holidays and, speaking for some others similarly situated, sued the ocean carrier in the U.S. District Court for the Central District of California seeking to rescind the penalties.

In response, Hanjin moved the court to compel arbitration of Elite’s beef per the contract term. Elite opposed the motion, claiming the arbitration clause was unconscionable. The trial court agreed and retained jurisdiction. Hanjin took it up to the Ninth Circuit Court of Appeals, which covers the country’s western states. In a decision that could have potentially significant implications on the enforceability of arbitration agreements, the Ninth Circuit affirmed the district court, ruling that the district court properly refused to enforce the arbitration clause.

While the FAA by its design preempts state law, such preemption is limited to state laws that have a “disproportionate impact on arbitration.” State law regarding contract unconscionability, ruled the court, doesn’t. California law could govern the arbitration clause’s enforceability in this context.

Hanjin’s “take it or leave it” contract is known in the law as a “contract of adhesion,” one by which one party is telling the other how it’s going to be if you want to do business with us. When a party pushes a contract of adhesion on another, California focuses most intently on “the core concern of the unconscionability doctrine,” i.e., “the absence of meaningful choice on the part of one of the parties together with contract terms which are unreasonably favorable to the other party.” This is enough to satisfy the procedural unconscionability element of the analysis.

Substantive unconscionability deals with actual unfairness, and is centered on mutuality. In California, “[a]greements to arbitrate must contain at least a modicum of bilaterality to avoid unconscionability.” The Hanjin flunked that test too. Under the contract, Elite had 30 days to dispute an invoice (which is far shorter than the Golden State’s four-year statute of limitations); and then only fifteen days to pay an invoice or seek arbitration. The arbitration panel wouldn’t have certain powers a court would to maintain the status quo pending adjudication. The Ninth Circuit found these points substantively too burdensome to impose on a contract party.

Especially if other jurisdictions embrace the Ninth Circuit’s logic, this decision could render contracting a more complex process. There might have to be more specific negotiation of terms that could be at the heart of a dispute, as well as of arbitration clauses themselves. It could also give industry players an option to litigate despite previous arbitration agreements when they feel they could do better in court (public policy matters being a prime subject for such feelings). The cottage arbitration industry could be impacted, and the demand on judges to hear more transportation and logistics cases could heighten. Still, in a complex industry such as ours, gaarbitration should remain a consideration for all concerned.

Ref: Elite Logistics Corporation, et al. v. Hanjin Shipping Co., Ltd., 2014 WL 4654383 (9th Cir. 2014).