I recently litigated the enforceability of a contractual arbitration provision contained in an electrical subcontract for work on a high-end residential project in the Chicago suburbs. The subcontractor fighting arbitration argued that the clause, drafted by the general contractor, was so one-sided against it, that it was unconscionable under Illinois law. (Among other things, the arbitration provision shifted all costs exclusively to the subcontractor.) The court disagreed and found that the challenged clause was neither procedurally nor substantively unconscionable.
Two cases — one in Illinois, the other in Arizona (and discussed at length in the Illinois case) — figured prominently in the court’s granting our motion to enforce the arbitration provision and compel arbitration. Together, the cases (Kinkel v. Cingular Wireless, LLC, 223 Ill.2d 1 (2006), Maxwell v. Fidelity Financial Services, 907 P.2d 51, 58 (Ariz. 1995) provide a useful gloss on what constitutes procedural and substantive unconscionability in the context of a business-to-business contract.
How many factors: one, two or ‘sliding scale?’
Earlier case law on unconscionability found that a party had to show both procedural and substantive unconscionability in order to void a contract term. Other cases apply a “sliding scale” approach — where if a contract term is heavy on substantive unconscionability, it can be light on procedural unconscionability and vice versa. Kinkel makes clear that either procedural or substantive unconscionability can defeat a given clause. (The case is silent on whether the sliding scale test is still viable.)
Procedural unconscionability
The procedural unconscionability question turns on whether the challenged term is so difficult to find or read that the party is essentially unaware of it. To determine procedural unconscionability, the court considers, among other things, the disparity in bargaining power between the drafter of the contract and the party contesting a given term, the circumstances surrounding the formation of the contract and whether a clause is “hidden in a maze of fine print.” [Kinkel at 23 citing Frank’s Maintenance & Engineering, Inc. v. C.A. Roberts Co., 86 Ill.App.3d 980, 989-90 (1st Dist. 1980)]
A court’s procedural unconscionability calculus also looks at the conspicuousness of the challenged clause, the negotiations relating to the contract, and whether the parties had an opportunity to understand the terms of the contract.
In our case, the court found that the subcontract’s arbitration clause was not hard to find, read or understand and appeared prominently in the contract’s text. As a result, the court found ruled that the arbitration clause was not procedurally infirm.
Substantive unconscionability
Substantive unconscionability occurs where the cost of vindicating a claim is so steep that a plaintiff’s only reasonable cost-effective means of obtaining legal relief is as a member of a class action. The court’s substantive unconscionability analysis considers (a) the relative fairness of the obligations assumed, (b) whether terms are so one-sided “as to oppress or unfairly surprise an innocent party,” (c) whether there is “an overall imbalance in the obligations and rights imposed by the bargain, and (d) a significant cost-price disparity.” (Kinkel at 24.)
When determining substantive unconscionability, Illinois courts also look to the secrecy of a contractual arbitration term — that is, can parties disclose the existence or result of an arbitration proceeding? Where a party is contractually obligated to keep arbitration results private, it tips the scale toward substantive unconscionability since this ensures that the pro-arbitration litigant can deny its opponents access to precedent.
In addition, courts are more likely to find unconscionability where a consumer is involved, there is a disparity in bargaining power, and the clause is on a pre-printed form. Moreover, where a party seeks to invalidate an arbitration provision on the ground that the arbitration would be prohibitively expensive, that party has the burden to show the likelihood of incurring those costs. According to the 7th U.S. Circuit Court of Appeals, to meet her burden, the party contesting arbitration must provide some individualized evidence to show she will face prohibitive costs in the arbitration and is financially incapable of meeting those costs. (Livingston v. Associates Finance, Inc., 339 F.3d 553, 557 (7th Cir. 2003).)
In our case, the court did find that the arbitration provision in question was one-sided in our favor and against the opponent. (I disagreed; there were multiple pro-subcontractor provisions in the contract as it was exhaustively negotiated prior to its consummation.) The court even said that it would never advise a client to agree to it or even itself assent to it. However, the court quickly (and rightly) noted that its subjective opinion that a contractual clause is perhaps unwise or risky was not the test for substantive unconscionability.
Instead, the crucial question was whether the provision was oppressive, unfairly surprising to the party contesting the term, portrayed an imbalance in obligations and rights or was cost-prohibitive to enforce. The court did not find that any of these substantive unconscionability hallmarks applied and granted our motion to compel arbitration. The subcontractor’s motion to reconsider is pending.
Still another factor leading the court to reject our adversary’s substantive unconscionability argument was the freely bargained-for nature of the arbitration clause. This was illustrated by the subcontract’s multiple line-outs and handwritten notes. The presence of multiple, manual changes revealed that the parties heavily negotiated the terms of the contract.
Takeaways
Kinkel and the cases it relied on including the Maxwell substantive unconscionability formulation, collectively stand for the proposition that a party claiming a contract provision is procedurally or substantively unconscionable bears the burden of establishing the existence of either or both.
Where the parties stand on an equal bargaining footing and there is no consumer nexus to the underlying contract, it is all the more difficult for the party challenging a contract term on the basis of unconscionability.
In the business-to-business setting, assuming the contract at issue isn’t hard to find or understand (and therefore not procedurally unconscionable), the best chance a litigant has of vitiating a contractual arbitration provision is to argue substantive unconscionability: that the term is so one-sided in that it portrays a stark imbalance in rights and obligations and is cost-prohibitive for the party challenging to term to enforce it. An additional plus-factor is where the arbitration clause is subject to non-disclosure such that neither party can reveal the results of arbitration — depriving future litigants from accessing precedent.