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Ninth Circuit Court of Appeals Affirms District Court Ruling Finding that Arbitration Clause was Unconscionable under California Law

In Elite Logistics Corporation v. Hanjin Shipping Co., Ltd., (Case 12-56238), the Ninth Circuit Court of Appeals affirmed the decision of the Central District of California, holding that the arbitration clause in the carriage contract was unconscionable under California law and therefore, denied Hanjin Shipping Co., Ltd.'s ("Hanjin") motion to compel arbitration.

A contract is unconscionable when the terms are so extremely unjust or overwhelmingly one sided in favor of the party with superior bargaining power that they are contrary to good conscience. Under California law, a contract clause is unconscionable if it is determined to be both procedurally and substantively unconscionable. Procedural unconscionability generally takes the form of a contract of adhesion in California, in which the contract drafted by the party with superior bargaining strength is imposed on the other without the opportunity to negotiate the terms. Under California law, substantive unconscionability focuses on the one-sidedness or overly harsh effect of the contract term or clause.

The carriage contract at issue in this case included an arbitration clause, which Hanjin sought to enforce in the District Court. The District Court held that the arbitration clause in the carriage contract was unconscionable under California law and denied Hanjin's motion to compel arbitration. On appeal, the Ninth Circuit Court of Appeals stated that whether an arbitration agreement is procedurally unconscionable depends on the manner in which the contract was negotiated and the circumstances of the parties at the time. The District Court found that Elite Logistics Corporation ("Elite") did not take part in any contract negotiations and had no choice but to sign the agreement if it wished to conduct business with Hanjin. Elite was faced with a "take it or leave it" proposition and as a result the contract was procedurally unconscionable under California law. The District Court also found that the contract was substantively unconscionable under California law because the invoiced party, Elite, was only given thirty (30) days to dispute an invoice, rather than the four (4) years provided under California law. By putting the burden to dispute the invoice on the invoiced party in such a short period the contract was inherently one-sided. Accordingly, the Ninth Circuit Court of Appeals affirmed the decision of the District Court finding the carriage contract to be unconscionable.

The Ninth Circuit Court of Appeals also affirmed the District Court's decision by finding that the Federal Arbitration Act ("FAA") did not preempt California's procedural unconscionability rules. The Court noted that the FAA may preempt state laws that have a disproportionate impact on arbitration; however, the FAA cannot be read to immunize all arbitration agreements from invalidation if the agreements are considered unconscionable under state law, as was the case here. Therefore, the District Court correctly determined that the FAA could not preempt California's rules and properly held the carriage contract to be unconscionable and the arbitration clause to be unenforceable.

In a short Dissent, Justice Smith rejected the Majority's interpretation of the FAA, stating that the Supreme Court has held that the FAA preempts certain state law contract defenses that have a disproportionate effect on arbitration clauses. Furthermore, Justice Smith stated that the District Court did not have sufficient facts to engage in the required analysis of California law to determine whether the contract was in fact unconscionable, as the parties were not permitted to engage in factual discovery prior to the District Court voiding the arbitration clause. The dissenting justice argued that he would remand the matter back to the District Court to develop a factual record that would permit the Court to engage in a thorough analysis of the carriage contract to determine if in fact it was unconscionable.

To read a copy of the Ninth Circuit's majority decision as well as the dissenting opinion click here.

For more information about the Court's decision and how it may apply to specific facts and circumstances, please do not hesitate to contact us at info@chaloslaw.com.

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