Opinion ID: 150389
Heading Depth: 2
Heading Rank: 2

Heading: Applicable Principles of California Law

Text: Under California law ( see Note, Terms and Conditions at 3 (the provisions of this Note will be governed by Federal laws and the laws of the State of California, without regard to conflict of laws rules)), contracts that are exculpatory may be unconscionable and unenforceable. The California Civil Code provides as follows: All contracts which have for their object, directly or indirectly, to exempt anyone from responsibility for his own fraud, or willful injury to the person or property of another, or violation of law, whether willful or negligent, are against the policy of the law. Cal. Civ.Code § 1668 (West 1985) (emphases added). This principle is often a consideration in the justifications for class action lawsuits. Discover Bank v. Superior Court, 36 Cal.4th 148, 156, 30 Cal.Rptr.3d 76, 113 P.3d 1100, 1105 (2005) ( Discover Bank ). Frequently numerous consumers are exposed to the same dubious practice by the same seller so that proof of the prevalence of the practice as to one consumer would provide proof for all. Individual actions by each of the defrauded consumers is often impracticable because the amount of individual recovery would be insufficient to justify bringing a separate action; thus an unscrupulous seller retains the benefits of its wrongful conduct. A class action by consumers produces several salutary by-products, including a therapeutic effect upon those sellers who indulge in fraudulent practices,.... Id. (internal quotation marks omitted) (emphasis added). A company which wrongfully exacts a dollar from each of millions of customers will reap a handsome profit; the class action is often the only effective way to halt and redress such exploitation. Id. (internal quotation marks omitted); see, e.g., Amchem Products, Inc. v. Windsor, 521 U.S. 591, 617, 117 S.Ct. 2231, 138 L.Ed.2d 689 (1997). Discover Bank involved a class action brought by a credit card holder alleging that the issuer, Discover Bank (or the Bank), had a practice of representing to cardholders that late payment fees would not be assessed if payment was received by a certain date, whereas in actuality they were assessed if payment was received after 1:00 p.m. on that date, thereby leading to damages that were small as to individual consumers but large in the aggregate. 36 Cal.4th at 152, 30 Cal.Rptr.3d 76, 113 P.3d at 1103. The applicable credit card agreement provided, inter alia, that either the cardholder or the Bank could elect arbitration; that in the event of such an election, neither side would have the right to litigate the dispute in court; and that neither could conduct arbitration as a member or representative of a class. See id. at 153-54, 30 Cal.Rptr.3d 76, 113 P.3d at 1103. The trial-level court initially, applying Delaware law, granted a motion by the Bank to compel arbitration on an individual basis. Upon reconsideration following the decision in Szetela v. Discover Bank, 97 Cal.App.4th 1094, 118 Cal. Rptr.2d 862 (2002) ( Szetela ) (finding a virtually identical arbitration provision unconscionable under California law), cert. denied, 537 U.S. 1226, 123 S.Ct. 1258, 154 L.Ed.2d 1087 (2003), the court held the class action waiver clause unenforceable; it concluded that the plaintiff was required to submit to arbitration but that he could seek to do so on a class basis. On appeal by the Bank, the court of appeal did not rule on unconscionability but held that the California rule that class arbitration waivers are sometimes unconscionable was preempted by the FAA. See generally Discover Bank, 36 Cal.4th at 155, 30 Cal. Rptr.3d 76, 113 P.3d at 1104-05. The California Supreme Court reversed the preemption ruling, noting, inter alia, that at least under some circumstances, the law in California is that class action waivers in consumer contracts of adhesion are unenforceable, whether the consumer is being asked to waive the right to class action litigation or the right to classwide arbitration. Id. at 153, 30 Cal.Rptr.3d 76, 113 P.3d at 1103 (emphases added). Pointing out that under FAA § 2 a state court may refuse to enforce an arbitration agreement based on generally applicable contract defenses, such as fraud, duress, or unconscionability, id. at 165, 30 Cal.Rptr.3d 76, 113 P.3d at 1111-12 (internal quotation marks omitted), the Discover Bank Court noted that California law, like federal law, favors enforcement of valid arbitration agreements, id. at 163, 30 Cal.Rptr.3d 76, 113 P.3d at 1110 (internal quotation marks omitted); but California law abhors contracts that are unconscionable, whether or not they involve arbitration. The Court concluded that the FAA did not preempt the California principle that unconscionable arbitration waiver clauses are unenforceable because the principle that class action waivers are, under certain circumstances, unconscionable as unlawfully exculpatory is a principle of California law that does not specifically apply to arbitration agreements, but to contracts generally. In other words, it applies equally to class action litigation waivers in contracts without arbitration agreements as it does to class arbitration waivers in contracts with such agreements. Id. at 165-66, 30 Cal.Rptr.3d 76, 113 P.3d at 1112 (emphases added). Accordingly, since California law place[s] arbitration agreements with class action waivers on the exact same footing as contracts that bar class action litigation outside the context of arbitration, Shroyer v. New Cingular Wireless Services, Inc., 498 F.3d 976, 990 (9th Cir.2007) ( Shroyer ) (emphasis in original), we reject ACS's contention that the FAA preempts California principles as to the conscionability of class arbitration waivers.
We turn next to the standard by which courts determine, under California law, whether a contract clause is unconscionable. As described in Discover Bank, the California doctrine of unconscionability has both a procedural and a substantive element, the former focusing on oppression or surprise due to unequal bargaining power, the latter on overly harsh or one-sided results. Discover Bank, 36 Cal.4th at 160, 30 Cal.Rptr.3d 76, 113 P.3d at 1108 (internal quotation marks omitted). The component of surprise arises when the challenged terms are hidden in a prolix printed form drafted by the party seeking to enforce them. Nyulassy v. Lockheed Martin Corp., 120 Cal.App.4th 1267, 1281, 16 Cal.Rptr.3d 296, 306 (2004) (internal quotation marks omitted). However, surprise need not be shown [w]here an adhesive contract is oppressive. Id. (internal quotation marks omitted). Oppression arises from an inequality of bargaining power that results in no real negotiation and an absence of meaningful choice.... Nagrampa v. MailCoups, Inc., 469 F.3d 1257, 1280 (9th Cir. 2006) (en banc) ( Nagrampa ) (internal quotation marks omitted); see, e.g., Szetela, 97 Cal.App.4th at 1100, 118 Cal.Rptr.2d at 867 (a clause is oppressive [w]hen the weaker party is presented the clause and told to `take it or leave it' without the opportunity for meaningful negotiation). The procedural element of an unconscionable contract generally takes the form of a contract of adhesion, which, imposed and drafted by the party of superior bargaining strength, relegates to the subscribing party only the opportunity to adhere to the contract or reject it. Discover Bank, 36 Cal.4th at 160, 30 Cal. Rptr.3d 76, 113 P.3d at 1108 (internal quotation marks omitted). Under California law, [a] contract of adhesion is defined as a standardized contract, imposed upon the subscribing party without an opportunity to negotiate the terms. Shroyer, 498 F.3d at 983 (internal quotation marks omitted). Ordinary contracts of adhesion, although they are indispensable facts of modern life that are generally enforced..., contain a degree of procedural unconscionability even without any notable surprises, and `bear within them the clear danger of oppression and overreaching.' Gentry v. Superior Court, 42 Cal.4th 443, 469, 64 Cal.Rptr.3d 773, 165 P.3d 556, 573 (2007) ( Gentry ) (quoting Graham v. Scissor-Tail, Inc., 28 Cal.3d 807, 818, 171 Cal.Rptr. 604, 623 P.2d 165, 171 (1981)), cert. denied, 552 U.S. 1296, 128 S.Ct. 1743, 170 L.Ed.2d 541 (2008). The fact that alternative contracts were potentially available does not mean that the contract is not one of adhesion. See, e.g., Szetela, 97 Cal.App.4th at 1100, 118 Cal.Rptr.2d at 867 ([A] contract might be adhesive even if the weaker party could reject the terms and go elsewhere.) (internal quotation marks omitted). Substantively unconscionable terms may take various forms, but may generally be described as unfairly one-sided. Discover Bank, 36 Cal.4th at 160, 30 Cal.Rptr.3d 76, 113 P.3d at 1108 (internal quotation marks omitted). These include terms that are superficially even-handed. For example, although the arbitration clause in Discover Bank precluded the Bank, as well as the cardholder, from participating in classwide arbitration or pursuing claims in a representative capacity, the Court noted that such class action or arbitration waivers are indisputably one-sided. Although styled as a mutual prohibition on representative or class actions, it is difficult to envision the circumstances under which the provision might negatively impact Discover [Bank], because credit card companies typically do not sue their customers in class action lawsuits.... Such one-sided, exculpatory contracts in a contract of adhesion, at least to the extent they operate to insulate a party from liability that otherwise would be imposed under California law, are generally unconscionable. Id. at 161, 30 Cal.Rptr.3d 76, 113 P.3d at 1109 (internal quotation marks omitted); see also Cohen v. DirecTV, Inc., 142 Cal. App.4th 1442, 1455, 48 Cal.Rptr.3d 813, 823 (2006) (a class action waiver is indisputably one-sided if the more powerful party would have no occasion to use the class action device in disputes with its customers) (internal quotation marks omitted). Although the California courts inquire into both procedural unconscionability and substantive unconscionability, the two aspects need not be present in the same degree. Essentially a sliding scale is invoked which disregards the regularity of the procedural process of the contract formation, that creates the terms, in proportion to the greater harshness or unreasonableness of the substantive terms themselves. (15 Williston on Contracts (3d ed. 1972) § 1763A, pp. 226-227....) In other words, the more substantively oppressive the contract term, the less evidence of procedural unconscionability is required to come to the conclusion that the term is unenforceable, and vice versa. Armendariz v. Foundation Health Psychcare Services, Inc., 24 Cal.4th 83, 114, 99 Cal.Rptr.2d 745, 6 P.3d 669, 690 (2000) ( Armendariz ) (emphasis added); see, e.g., Gentry, 42 Cal.4th at 469, 165 P.3d at 572 (same); Dean Witter Reynolds, Inc. v. Superior Court, 211 Cal.App.3d 758, 768, 259 Cal.Rptr. 789, 795 (1989) ( Dean Witter Reynolds ) (Presumably both procedural and substantive unconscionability must be present before a contract will be held unenforceable. However, a relatively larger degree of one will compensate for a relatively smaller degree of the other.). In Dean Witter Reynolds, which involved a class action waiver provision invoked against a challenge to the legality of a $50 account-termination fee charged by a brokerage firm for self-directed individual retirement accounts, the firm concede[d] for purposes of argument that some measure of substantive unconscionability might be present, i.e., that the challenged fees might be `too high,' 211 Cal.App.3d at 768, 259 Cal.Rptr. at 795. But the court concluded that the class action waiver was enforceable because there was no procedural unconscionability, stating that the `oppression' factor of the procedural element of unconscionability may be defeated, if the complaining party has a meaningful choice of reasonably available alternative sources of supply from which to obtain the desired goods and services free of the terms claimed to be unconscionable. Id. at 772, 259 Cal.Rptr. at 798. Stating that [w]e do not hold or suggest ... that any showing of competition in the market place as to the desired goods and services defeats, as a matter of law, any claim of unconscionability, id., 259 Cal.Rptr. at 797-98 (emphases in original), the court ruled that procedural unconscionability had not been shown in the case before it, given that the plaintiff was a self-described sophisticated investor, was an attorney who specializ[ed] in class action litigation involving financial institutions, id., 259 Cal.Rptr. at 798, and had known of, but consciously declined to explore, potential alternatives, see id. at 762, 259 Cal.Rptr. at 791. Taking account of its Dean Witter Reynolds decision nearly two decades later, the court in Gatton v. T-Mobile USA, Inc., 152 Cal.App.4th 571, 585, 61 Cal. Rptr.3d 344, 355-56 (2007) ( Gatton ), cert. denied, ___ U.S. ___, 128 S.Ct. 2501, 171 L.Ed.2d 786 (2008), declined to rule that a finding of procedural unconscionability was precluded simply by the availability of alternatives. The Gatton court acknowledged that [w]here the plaintiff is highly sophisticated and the challenged provision does not undermine important public policies, a court might be justified in denying an unconscionability claim for lack of procedural unconscionability even where the provision is within a contract of adhesion. 152 Cal.App.4th at 585 n. 8, 61 Cal.Rptr.3d at 355 n. 8 (emphases added). But it noted that there are provisions so unfair or contrary to public policy that the law will not allow them to be imposed in a contract of adhesion, even if theoretically the consumer had an opportunity to discover and use an alternate provider for the good or service involved. Id. at 585, 61 Cal.Rptr.3d at 355. The Gatton court concluded that absent unusual circumstances, use of a contract of adhesion establishes a minimal degree of procedural unconscionability notwithstanding the availability of market alternatives. If the challenged provision does not have a high degree of substantive unconscionability, it should be enforced. But ... courts are not obligated to enforce highly unfair provisions that undermine important public policies simply because there is some degree of consumer choice in the market. Id., 61 Cal.Rptr.3d at 355-56 (footnote omitted) (emphases added). In the face of such highly unfair provisions, [t]he adhesive nature of the contract alone justifies scrutiny of the substantive fairness of the contractual terms. Id. at 586 n. 9, 61 Cal.Rptr.3d at 356 n. 9. In sum, [b]ecause California courts employ a sliding scale in analyzing whether the entire arbitration provision is unconscionable, even if the evidence of procedural unconscionability is slight, strong evidence of substantive unconscionability will tip the scale and render the arbitration provision unconscionable. Nagrampa, 469 F.3d at 1281 (emphasis added); see, e.g., Armendariz, 24 Cal.4th at 114, 99 Cal.Rptr.2d 745, 6 P.3d at 690. In Discover Bank, the Court noted that [c]lass action and arbitration waivers are not, in the abstract, exculpatory clauses, 36 Cal.4th at 161, 30 Cal.Rptr.3d 76, 113 P.3d at 1108, and that not ... all class action waivers are necessarily unconscionable, id. at 162, 30 Cal.Rptr.3d 76, 113 P.3d at 1110. But when the waiver is found in a consumer contract of adhesion in a setting in which disputes between the contracting parties predictably involve small amounts of damages, and when it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money, then, at least to the extent the obligation at issue is governed by California law, the waiver becomes in practice the exemption of the party from responsibility for [its] own fraud, or willful injury to the person or property of another. (Civ.Code, § 1668.) Under these circumstances, such waivers are unconscionable under California law and should not be enforced. 36 Cal.4th at 162-63, 30 Cal.Rptr.3d 76, 113 P.3d at 1110 (emphases added). A provider's insistence on an arbitration provision that gives it the opportunity to overcharge its customers by small amounts while denying the customers any effective way to recover violates fundamental notions of fairness and is not only substantively unconscionable, it violates public policy by granting [the provider] a `get out of jail free' card while compromising important consumer rights. Id. at 160, 30 Cal. Rptr.3d 76, 113 P.3d at 1108 (other internal quotation marks omitted). The potential for millions of customers to be overcharged small amounts without an effective method of redress cannot be ignored. Id. (other internal quotation marks omitted). Summarizing Discover Bank and subsequent California appellate decisions interpreting it, the Ninth Circuit in Shroyer has discerned a standard three-part inquiry in order to determine whether a class action waiver in a consumer contract is unconscionable.... Under this three-part inquiry, courts are required to determine: (1) whether the agreement is a consumer contract of adhesion drafted by a party that has superior bargaining power; (2) whether the agreement occurs in a setting in which disputes between the contracting parties predictably involve small amounts of damages; and (3) whether it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money. Shroyer, 498 F.3d at 983 (internal quotation marks omitted). For the reasons that follow, we conclude that the answers to these three inquiries here lead to a conclusion of unconscionability.
In the present case, ACS contends that a ruling that the Note is unconscionable under California law is precluded by the facts that 1) [Fensterstock] was an attorney who specialized in complex financial transactions when he entered the Note; 2) he has not alleged that there were no loans on the market that did not include a class arbitration waiver; 3) he claims enormous damages of thousands of dollars; and 4) he has not alleged that he, an attorney, was surprised by the class arbitration waiver of the Note he signed. (ACS brief on appeal at 12-13; see, e.g., id. at 19-25.) Most of these proposed rationales are foreclosed by the authorities discussed in Part II.B.2. above. It is true that Fensterstock has not alleged that he was surprised by the class arbitration waiver clause in the Note; and one would surely expect that, as a practicing attorney, he would, before signing, have read the Note's five pages of terms and conditions, including the arbitration provision, the first paragraph of which was printed entirely in capital letters. But, as discussed above, where the clause is oppressive, procedural unconscionability may exist even in the absence of surprise. Nor, under California law as it has evolved in the past two decades, is a lack of procedural unconscionability established by Fensterstock's failure to allege that there were no alternative sources for consolidation loans that did not contain class arbitration waiver clauses. Even if Fensterstock could have obtained a consolidation loan elsewhere, he has asserted that he had no meaningful opportunity to negotiate with EFP terms different from those appearing in its preprinted form comprising the loan application and the Note's Terms and Conditions Statement, and that those terms were presented, by a party that had superior bargaining power, on a `take it or leave it' basis (Complaint ¶ 41). ACS does not dispute that characterization of the parties' relative bargaining power; nor does it dispute the assertion that the waiving of class arbitration or class action was not subject to negotiation. And such a clause presented to the weaker party on a take-it-or-leave-it basis without the opportunity for meaningful negotiation is, under California law, oppressive, and hence satisfies the requirement that there be at least a minimal showing of procedural unconscionability. ACS's argument, relying on Dean Witter Reynolds, that the Note cannot be considered procedurally unconscionable because Fensterstock was legally sophisticated (ACS brief on appeal at 21) is unpersuasive. At the time he applied to EFP for the consolidation loan, Fensterstock was just three years out of law school. And although the expertise he had gained through representing clients in financial transactions may show that he was well aware of the presence of the Note's class action and class arbitration waiver clause, we have seen nothing in his education, experience, or expertise to suggest that he had any-meaningful opportunity to negotiate that clause out of the contract. Finally, ACS's argument that Fensterstock claims `enormous' damages of `thousands of dollars' (ACS brief on appeal at 13; see Complaint ¶ 36) is an effort to escape the thrust of the California cases that consistently find it substantively unconscionableand intolerable as a matter of public policyto permit a party with superior bargaining power to use class action or class arbitration waiver clauses to insulate itself from remedial action when it is alleged to have deliberately cheat[ed] large numbers of consumers out of individually small sums of money, Discover Bank, 36 Cal.4th at 163, 30 Cal.Rptr.3d 76, 113 P.3d at 1110. ACS argues that the district court misapplied Discover Bank because Fensterstock has alleged damages that are not small but enormous. We disagree. What Fensterstock characterizes as enormous is not his present loss but rather the lump-sum payment that will be required of him  [a]t the end of the repayment period i.e., a quarter of a century from nowas it will amount to thousands of dollars instead of $335.00 as stated in the Note (Complaint ¶ 36 (emphases added)). These assertions as to the total monetary impact at the end of Fensterstock's 29-year loan period do not remove his claim from the category of cases in which the relatively small amount of damages suffered by customers individually makes it economically impractical for them to prosecute individual actions. The complaint clearly indicates that from Fensterstock's first 16 payments a total of $263.19 had been misallocated-an average of less than $17 a month. Borrowers aware of the alleged misallocations early in their respective loan repayment periods could not be expected to bring suit individually with respect to such small sums. ACS has estimated, based on Fensterstock's allegation that the challenged practice cost him $263.19 in connection with his first 16 payments, that over the life of his 29-year the loan, Fensterstock's damages would total some $6,300. This calculation of future damages is largely speculative, as a borrower might, by design or fortuity, have a greater proportion of his payments arrive precisely on their respective due dates, thereby avoiding the alleged misallocations to interest; or a borrower could elect to pay off the entirety of the loan early. Even assuming no such changes and no change in ACS's alleged misallocations, however, ACS's $6,300 figure is misleading because it suggests that the value of the claim asserted by Fensterstock includes losses that have not yet occurred. Moreover, even if we could attach a value to Fensterstock's right to avoid future losses ( i.e., the approximate value of an injunction) the present value of that right is much less than the total loss that Fensterstock will eventually suffer over 29 years. Further, given statute-of-limitations considerations, it seems unlikely that a borrower could wait until the end of his repayment period, allowing the total of misallocated payments to grow, and successfully sue with respect to the totality of the sums misallocated. For example, a fraud claim accrues upon the victim's discovery of the fraud, see Hobart v. Hobart Estate Co., 26 Cal.2d 412, 436-37, 159 P.2d 958, 971-72 (1945), and Fensterstock's complaint suggests that the alleged misallocations may be discoverable by borrowers from the monthly statements sent to them by ACS ( see Complaint ¶ 30 ([e]ach month, [Fensterstock] receives a statement summarizing his most recent payment); id. ¶ 32 (such a statement shows how much of Fensterstock's payments ha[s] been applied to interest and how much has been applied to principal)). And contract claims might be deemed subject to the doctrine of contractual severability. Armstrong Petroleum Corp. v. Tri-Valley Oil & Gas Co., 116 Cal.App.4th 1375, 1388, 11 Cal.Rptr.3d 412, 423 (2004); see id., 11 Cal.Rptr.3d at 422 (where performance of contractual obligations is severed into intervals, ... an action attacking the performance for any particular interval must be brought within the period of limitations after the particular performance was due). Thus, we see no validity in any suggestion that the sum recoverable by an individual victim of the alleged misallocations would be enormous. In sum, the California three-part test is met on the record in the present case. The Note is a standardized consumer contract of adhesion drafted by a party that had superior bargaining power; the disputes as to the allocation of monthly loan payments between principal and interest predictably involve small amounts of damages; and it is alleged that EFP and ACS are deliberately carrying out a scheme to cheat large numbers of borrowers out of individually small sums of money. We conclude that the district court properly ruled that the Note's class action and class arbitration waiver clause is unconscionable.