Texas Supreme Court looks at ‘unconscionability’ of arbitration agreements in cotton farming case

by John Chapman

Under the Federal Arbitration Act, an agreement to arbitrate that is valid under general state law principles and involves interstate commerce is “valid, irrevocable, and enforceable.” 9 U.S.C. § 2. Of course, the party seeking to compel arbitration under the FAA must first establish that the dispute falls within the scope of an existing agreement to arbitrate. Once that is established, the burden then shifts to the party opposing arbitration to raise an affirmative defense to the agreement’s enforcement.

Although the FAA preempts any state law defense that conflicts with the FAA’s objectives, state law defenses are available to declare an arbitration agreement itself unenforceable on “such grounds as exist in law or in equity for the revocation of any contract.” 9 U .S.C. § 2 (the saving clause). In construing the savings clause, courts have emphasized that the state law defense has to be a defense the state applies to “any” contract, as opposed to a defense that only applies to an arbitration agreement. A state law that singles out arbitration agreements for unfavorable treatment is considered to be contrary to federal policy in favor of arbitration and thus preempted by the FAA.

Accordingly, a court may not construe an arbitration agreement differently from how it would construe contracts generally under state law, nor may a court rely on the uniqueness of an arbitration agreement as a basis for a state-law holding that enforcement would be unconscionable. However, if the circumstances would render any contract unconscionable under the applicable state law, the circumstances are appropriate to invalidate the agreement to arbitrate as well. See In re Poly–America, 262 S.W.3d 337, 348 (Tex. 2008).

“Unconscionable” arbitration agreements are not enforceable

One defense that many states recognize as a valid defense to the enforceability of “any contract” is “unconscionability.” A contract will not be enforced that is so one-sided and grossly unfair as to be deemed “unconscionable.” The Texas Supreme Court recently considered whether an arbitration agreement was unconscionable in Venture Cotton Co-op. v. Freeman, No. 13–0122 (Tex. Sup. Ct. June 13, 2014).

The case involved claims by two groups of cotton farmers that they were fraudulently induced to sell cotton through a cooperative marketing pool. The farmers sued to rescind the contracts. The defendant, a cotton cooperative-marketing association, moved the trial court to compel arbitration of the farmers’ claims. The defendant relied on arbitration agreements found in the contracts signed by the farmers.

The arbitration agreement provided that “all disputes will be resolved pursuant to binding arbitration pursuant to the arbitration rules of the American Cotton Shippers Association.” Among other things, those arbitration rules only allow the recovery of attorney fees if allowed by the parties’ written agreement. Here, the agreement provided that the defendant marketing associations could recover its fees but contained no similar provision for the farmers to recover their fees.

The cotton farmers argued that the arbitration agreement was unconscionable in several respects. They claimed that the American Cotton Shippers Association Arbitration Rules were one-sided and designed to foster arbitrator bias and that the rules’ summary procedures further denied them adequate discovery and preparation time. They also contended that the arbitration was too expensive and that its prospective cost would prevent them from vindicating their rights in the arbitral forum. Finally, they argued that the agreement and ACSA rules violated Texas state public policy by illegally eliminating their statutory right to attorney’s fees and other remedies under the Texas Consumer Protection–Deceptive Trade Practices Act.

Agreeing with the trial court, the court of appeals found the agreement was enforceable. However, the Texas Supreme Court has reversed in part and remanded for further proceedings to determine whether the arbitration agreement is unconscionable. Venture Cotton, No. 13–0122.

Agreement to arbitrate a statutory claim may not require party to forego the rights and remedies provided by that statute

The Texas Supreme Court agreed with the farmers that the arbitration clause was incapable of limiting the farmers’ statutory rights under the DTPA. When parties agree to arbitrate a statutory claim, “a party does not forego the substantive rights afforded by the statute; it only submits to their resolution in an arbitral, rather than a judicial, forum.” Mitsubishi Motors Corp. v. Soler Chrysler–Plymouth, Inc., 473 U.S. 614, 628 (1985). Thus, the Texas Supreme Court has observed that “[a]n arbitration agreement covering statutory claims is valid so long as ‘the arbitration agreement does not waive substantive rights and remedies of the statute and the arbitration procedures are fair so that the [plaintiff] may effectively vindicate his statutory rights.’ “ Poly–America, 262 S.W.3d at 352.

Although the DTPA rights at issue are allowed by the statute to be waived by contract if certain conditions are met, the Texas Supreme Court agreed with the farmers that the arbitration agreement did not satisfy the necessary requirements to constitute a valid waiver of DTPA rights. However, the court found that arbitration was nonetheless appropriate. Rather then rendering the entire agreement to arbitrate unenforceable, the Texas Supreme Court held that only the purported waiver of DTPA rights was unenforceable. Thus, the purported waiver should be severed out and the dispute sent to arbitration.

One-sided attorney fee provision is not a sufficient, independent reason to invalidate arbitration agreement

In Venture Cotton, the Texas Supreme Court disagreed with the lower courts as to whether the arbitration agreement was unconscionably one-sided because it provides for only the defendant marketing association to recover attorney’s fees. The Texas Supreme Court that, because parties are generally free to contract for attorney’s fees as they see fit, a contract that expressly provides for one party’s attorney’s fees, but not another’s, is not unconscionable per se. (Returning to the notion that agreeing to arbitration should not involved the waiver of statutory rights, the Texas Supreme Court’s opinion does seem to suggest that the farmers would be allowed to seek attorney fees in arbitration despite the terms of the agreement). The court concluded:

Questions of waiver, illegality, remedies, and attorney’s fees often relate to the broader, container contract, rather than the separable agreement to arbitrate, and, as such, are matters entrusted to the arbitrators. […] In summary, we conclude that a contract that fails to provide reciprocal rights to attorney’s fees is not unconscionable per se. We further disagree with the court of appeals’ opinion to the extent it uses the contract’s “one-sided” attorney’s fees provision as an independent reason to hold the arbitration agreement unconscionable.

Venture Cotton, No. 13–0122.

So when is an agreement to arbitrate unenforceable?

In Venture Cotton, the Texas Supreme Court noted that unconscionability “is not easily defined.” At least when Texas state law applies, we now know that: (a) an attempt to require arbitration of statutory claims may not limit the rights available under that statute (unless the terms of the statute itself allow such a limitation and are complied with); and (b) “one-sided” attorney’s fees provision is not an independent reason to hold an arbitration agreement unconscionable.

Courts usually analyze unconscionability issues “in light of a variety of factors, which aim to prevent oppression and unfair surprise …” Poly–America, 262 S.W.3d at 348. In short, unconscionability determinations are made in “light of [a contract’s] setting, purpose, and effect.” See Venture Cotton, No. 13–0122, quoting RESTATEMENT (SECOND) OF CONTRACTS § 208, cmt. a. The Uniform Commercial Code provides that a court should afford the parties a reasonable opportunity to present evidence as to a contract’s commercial setting, purpose and effect to aid the court in evaluating the defense. The issue involves a highly fact-specific inquiry into the circumstances of the bargain, such as the commercial atmosphere in which the agreement was made, the alternatives available to the parties at the time and their ability to bargain, any illegality or public-policy concerns, and the agreement’s oppressive or shocking nature. See Venture Cotton, No. 13–0122.

In addition to their complaint about the agreement’s limitation of statutory remedies, the farmers in Venture Cotton also contend they could not effectively vindicate their rights through arbitration because of arbitrator bias, the lack of adequate discovery under the arbitration’s summary procedures, the exorbitant cost of the arbitration itself, and other inequities in the arbitral process. The Texas Supreme Court noted that the court of appeals has yet to consider these additional concerns. The court of appeals’ judgment, affirming the trial court’s order denying arbitration, was reversed, and the case was remanded to the court of appeals for consideration of the remaining arguments.

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* Michael Heygood, James Craig Orr, Jr. and Eric Pearson are all Board Certified in Personal Injury Trial Law — Texas Board of Legal Specialization.

** Michael Heygood, James Craig Orr, Jr. and Eric Pearson were selected to the Super Lawyers List, a Thomson Reuters publication, for the years 2003 through 2014

by John Chapman

John Chapman is a licensed attorney with experience in complex commercial litigation (including securities fraud, RICO, shareholder oppression, and derivative actions) and personal injury litigation.