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California law permits court to remove provision that made agreement unfair
An arbitration agreement should be enforced, even though, as originally written, the contract was "one-sided," the California Court of Appeal ruled. Under state law, the court could rewrite the agreement to exclude the one provision that made it unfair and order enforcement of the remainder of the contract.
In November 2010, Wilson Farrar began discussions with the founder and president of Direct Commerce Inc., a company that developed and marketed software, to join the company as vice president of business development. At the time, Farrar was unemployed, but she had worked in sales and business development for 22 years and had been vice president of sales in a number of companies. She said she was experienced in negotiating contracts.
The parties negotiated for several months over Farrar's job title and duties, compensation, bonuses, and stock options. On Jan. 6, 2011, Farrar signed a contract that included a confidentiality agreement and an agreement to arbitrate all work-related disputes, except for disputes regarding trade secrets arising out of the confidentiality agreement.
Four years later, Direct Commerce terminated Farrar's employment, and in June 2015, she sued the company, alleging breach of contract, wrongful termination and failure to pay wages owed.
[SHRM members-only toolkit: Involuntary Termination of Employment in the United States]
Direct Commerce sought to compel arbitration of Farrar's claims, but the trial court denied the request.
The lower court concluded that the arbitration agreement was both procedurally and substantively unconscionable. Unconscionability refers to an absence of meaningful choice on the part of one of the parties together with contract terms that are unreasonably favorable to the other party. Unconscionability has both a procedural and a substantive element, with procedural unconscionability focusing on the parties' unequal bargaining power, while substantive unconscionability looks at the fairness of the provisions in the agreement. Both procedural and substantive unconscionability must be present for a court to refuse to enforce a contract.
The trial court ruled that the agreement was procedurally unconscionable because Farrar "had no meaningful choice whether or not to accept" it. The trial court also ruled that the agreement was substantively unconscionable because it excluded only claims arising out of the confidentiality agreement. Those claims would most likely be brought by the company against Farrar, and the company would be allowed to litigate those claims. On the other hand, Farrar would be required to arbitrate any claims she was likely to bring against the company.
Direct Commerce appealed the trial court's judgment refusing to order arbitration of Farrar's claims. The appellate court reversed that decision.
Definition of Unconscionability
The appellate court disagreed with the trial court and found no procedural unconscionability, noting that Farrar had extensive experience in sales and business development and said she was experienced in contract negotiations. The parties therefore were "roughly equal" in bargaining power, the court said.
An evaluation of substantive unconscionability, the court noted, is highly dependent on context. The court must examine all of the agreement's substantive terms as well as the circumstances of its formation to determine whether the overall bargain was "unreasonably one-sided."
The court concluded that the agreement's "carve-out" for confidentiality claims did make it substantively unconscionable. Those were the types of claims the company was most likely to bring, while the claims that Farrar was likely to bring had to be arbitrated. Thus, the agreement as written was impermissibly one-sided.
However, the court went on to note that, under California law, if a court finds one or more of a contract's provisions to be unconscionable, it may strike those provisions while enforcing the remainder of the agreement. In this case, the court said, "the one aspect in which the arbitration provision is substantively unconscionable is readily remedied—by severing out the exception for claims arising from the confidentiality agreement." The court ordered the parties to arbitrate Farrar's claims.
Farrar v. Direct Commerce Inc., Calif. Ct. App., No. A146944 (March 23, 2017).
Professional Pointer: The appellate court here could certainly have found the arbitration agreement unenforceable. The law permits a court to rewrite the agreement; it doesn't require the court to do so. To ensure enforceability, all agreements should be carefully drafted and reviewed by counsel.
Joanne Deschenaux, J.D., is a freelance writer in Annapolis, Md.
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