Authors: Himanshu Raghuwanshi* and Krishnanunni U**
| Jurisdiction: United States |
Topics: Designation of Arbitrators Arbitrators and Arbitral Tribunals |
INTRODUCTION
Recently, in Trout v. Organización Mundial de Boxeo Inc., the U.S. Court of Appeals for the First Circuit invalidated an arbitration agreement on the ground that it was unconscionable.[1] Specifically, the Court held that the unilateral arbitrator appointment clause was unconscionable because it gave the Organización Mundial de Boxeo Inc. (“World Boxing Organization” or “WBO”) unfettered discretion to choose any arbitrator of its choice, even including its own employees.[2] The court identified that such unilateral appointment powers can lead to the appointment of biased arbitrators, thereby undermining the arbitration proceeding.[3]
In this article, the authors rely on Trout and other U.S. court judgments to analyze the issue of ‘unconscionability’ through the lens of party autonomy, an integral part of arbitration. The lingering air of uncertainty around the validity of unilateral arbitrator appointment clauses is evident from the wavering stance taken by different US courts. A careful analysis of the relevant judicial decisions reveals the considerations that are necessary to determine whether a unilateral arbitrator appointment clause is unconscionable in both domestic and international arbitration agreements, as envisioned by U.S. law.
RELEVANT JUDICIAL DECISIONS
U.S. courts have time and again dealt with the question of whether unilateral arbitrator appointment clauses in domestic arbitration proceedings are unconscionable. However, with no guidance from the Supreme Court and in light of the existence of differing state laws, the jurisprudence is inconsistent amongst different jurisdictions.
In the context of employer-employee disputes, U.S. courts have frequently held that unilateral arbitrator appointment mechanisms are invalid. For example, in Murray v. United and Commercial Workers Union,[4] the Fourth Circuit held that an appointment mechanism which required arbitrators to be selected from a list unilaterally prepared by the employer was unconscionable.[5] In Murray, the employees were required to sign the arbitration agreement as a condition for employment.[6] Further, in Beltran v. Aupaircare, the Tenth Circuit held that a clause was unconscionable because only Aupaircare was allowed to select the arbitrator.[7] The court, applying California state contract law and the Californian Supreme Court judgment in Sonic-Calabasas v. Moreno[8], held that a unilateral appointment clause in a contract of adhesion is unconscionable.
According to Gary Born, outside of the context of either consumer or employment-contracts, only arbitrator appointment mechanisms that are “manifestly inequitable” are invalid.[9] This appears to be true in a number of jurisdictions across the United States. The U.S. District Court for the District of Oregon, in Willis v. Nationwide Debt Settlement Group,[10] and the U.S. District Court for the Western District of Kentucky, in Davis v. Global Client Solutions,[11] held that unilateral arbitral appointment mechanisms are not unconscionable. Both courts noted that the agreement provided for an independent arbitrator and that it was premature to assume that the appointing party would choose a biased arbitrator despite the contract requiring otherwise. Moreover, in Davis, the Court observed that Sections 5 and 10 of the Federal Arbitration Act (“FAA”) adequately protected the interests of the plaintiffs by providing legal recourse against a biased arbitrator.[12] Section 5 allows a party to challenge the appointment of a biased arbitrator and Section 10 provides for the remedy of vacatur in case the arbitrator was biased.
On the other hand, courts in certain jurisdictions have conducted a more searching inquiry of contracts containing unilateral arbitrator appointment clauses. The Supreme Court of Alabama, in Harold Allens Mobile v. Butler,[13] a commercial case involving the sale of goods, found an arbitration agreement to be invalid to the extent that it allowed only the seller to choose the arbitrator. The court held that the weight of authorities favored a finding that the arbitration clause was unconscionable because it offended fundamental notions of fairness.
KEY CONSIDERATIONS
The judicial precedents on unilateral arbitrator appointment clauses focus on concepts such as party autonomy and unconscionability.
1) Party Autonomy – “Arbitration is a matter of contract” with party autonomy at its core.[14] Moreover, Section 5 of the FAA explicitly recognizes parties’ right to adopt an arbitrator appointment mechanism of their choice.[15] However, party autonomy is not unbridled, and the safeguards specified in Section 2 of the FAA effectively restrict party autonomy. Section 2 allows a court to invalidate an arbitration clause if it violates “grounds as exist at law or in equity for the revocation of any contract”.[16] One such ground is unconscionability which is generally invoked by courts while dealing with unilateral arbitrator appointments.
2) Unconscionability – There is no uniform definition of “unconscionability” because U.S. state laws on unconscionability differ. Although the courts have based unconscionability on different state contract laws, a palpable pattern can be traced with regard to its applicability due to most state laws imbibing the concept from Section 2-302 of the Uniform Commercial Code (“UCC”).[17] Unconscionability, is generally categorized as procedural unconscionability and substantive unconscionability.[18] Procedural unconscionability pertains to the ‘oppression’ of one party by the other during the formation of the contract.[19] Substantive unconscionability is when the terms of the contract are unreasonable and are skewed in favor of one party to such an extent that it “shocks the conscience.”[20]
As discussed, U.S. courts have observed that employees are generally devoid of any choice while signing an employment contract. This is an example of procedural unconscionability and explains the reluctance of U.S. courts to validate a unilateral arbitrator appointment clause in an employment contract. However, in commercial cases, courts have recognized a balance in bargaining power of the parties, thereby tilting the inquiry towards ‘substantive unconscionability’.
RECONCILING THE APPROACHES
1. Domestic Scenario
While party autonomy is an integral feature of arbitration, the doctrine of unconscionability ensures that the proceeding is not biased against any single party. Both are necessary to safeguard the rights and interests of all stakeholders. As discussed, procedural unconscionability is more likely to exist in employment contracts as opposed to commercial proceedings. Consequently, courts have invalidated unilateral arbitrator appointment clauses in employment contracts.
In commercial arbitrations, party autonomy assumes particular significance as parties rely on their business acumen to enter into contracts that suit their diverse needs. Thus, unconscionability should be analysed differently in cases concerning commercial contracts and courts should be wary of the cardinal principle of party autonomy. In addition, the analysis should be focused on substantive, rather than procedural, unconscionability.
2. International Scenario
Article II(3) of the New York Convention mandates enforcing an international commercial arbitration agreement unless it is “null and void, inoperative or incapable of being performed.”[21] While this article embodies the principle of presumptive validity, it also allows a court to invalidate an arbitration agreement on the basis of any internationally recognized contractual defence. Even though unconscionability is recognized as a general contractual defence,[22] its application to international arbitration agreements is unsettled in the U.S. In part, this is because the U.S. Supreme Court has yet to render an opinion on the issue. Some U.S. courts accept unconscionability as a ground for non-enforcement[23] while others have excluded its applicability.[24] However, unconscionability is recognized in most legal systems and it is only logical to extend its ambit to international arbitration agreements.[25]
As discussed, procedural unconscionability is not as relevant in domestic commercial arbitration. It is even less of an issue in international commercial arbitration matters. However, substantive unconscionability is still relevant in international commercial arbitration and some courts have rendered unilateral arbitrator appointment mechanisms invalid on this basis, particularly in standard form contracts.[26]
The substantive federal contract law as derived from section 2 of the FAA,, consisting of generally-accepted principles of contract law, will govern the validity of an international arbitration contract.[27] As discussed above, the UCC is fundamental in understanding the doctrine of unconscionability at the state law level. Therefore, judicial pronouncements discussed in this article, though based on state laws, are relevant in the international stage as they accentuate the considerations that a US court will take into account while determining the validity of a unilateral arbitrator appointment clause.
THE WAY FORWARD
U.S. courts that have invalidated unilateral appointment clauses in commercial cases have typically grounded their decision on notions of fairness.[28] However, the skepticism that notions of fairness are violated is vitiated by the fact that an appointed arbitrator should be independent of the parties involved. Furthermore, all arbitrators are expected to conduct arbitration proceedings in a fair and impartial manner.[29] Failure to meet this expectation can trigger the legal remedy of vacatur, as provided for in Section 10(a) of the FAA,[30] or set aside, based on the laws at the seat of the arbitration. Thus, the interests of the prejudiced parties are sufficiently protected even if the arbitrator is biased.
Invalidating an arbitrator appointment clause by virtue of it giving unilateral power to a party is not necessary to safeguard fairness in the proceedings. However, such an invalidation can be justified if the clause itself provides for the selection of a non-independent arbitrator, as was the case in Trout where the court invalidated the unilateral appointment clause that allowed the appointment of WBO’s own employees as arbitrators. In such a scenario, continuing with the arbitration proceeding would have been futile due to the high probability of the award getting vacated.
The decision in Trout is flawed to the extent that it completely nullified the unilateral appointment clause without considering the cardinal principle of party autonomy. A middle ground could have been reached if the court had precluded WBO from appointing its own employees as arbitrators while retaining the unilateral appointment power of WBO. Such an approach would have presented a reasonable compromise between party autonomy and unconscionability.
[1] Trout v. Organización Mundial de Boxeo, Inc., 965 F.3d 71 (10th Cir. 2020).
[2] Id. at 81.
[3] Id.
[4] Murray v. United and Com. Workers Union, 289 F.3d 297 (4th Cir. 2002).
[5] Id. at 303.
[6] Id. at 300.
[7] Beltran v. Aupaircare, Inc., 907 F.3d 1240 (10th Cir. 2018).
[8] Sonic-Calabasas A., Inc. v. Moreno, 311 P.3d 184 (Cal. 2013).
[9] Gary Born, International Commercial Arbitration 1808 (3d ed. 2020).
[10] Willis v. Nationwide Debt Settlement Grp., 878 F. Supp. 2d 1208 (D. Or. 2012).
[11] Davis v. Glob. Client Sols., No. 3:10-CV-322-H, 2011 WL 4738547 (W.D. Ky. Oct. 7, 2011).
[12] 9 U.S.C. §§ 5, 10.
[13] Harold Allen’s Mobile Home Factory Outlet, Inc. v. Butler, 825 So.2d 779 (Ala. 2002).
[14] AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011).
[15] 9 U.S.C. § 5.
[16] 9 U.S.C. § 2.
[17] Jane P. Mallor, Unconscionability in Contracts between Merchants, 40 Sw. L.J. 1065, 1065 (1986).
[18] M Neil Browne & Lauren Biksacky, Unconscionability and the Contingent Assumptions of Contract Theory, Mich. St. L. Rev. 211, 219 (2013).
[19] Mallor, supra note 14, at 1071.
[20] OTO, L.L.C v. KHO, 447 P.3d 680 (Cal. 2019).
[21] Convention on the Recognition and Enforcement of Foreign Arbitral Awards, art. II(3), June 10, 1968, 21 U.S.T. 2517, 330 U.N.T.S. 38.
[22] Amy J. Schmitz, Consideration of “Contracting Culture” in Enforcing Arbitration Provisions, 81 St. John’s L. Rev. 123, 139 (2007).
[23] TWI Lite Int’l, Inc. v. Anam Pac. Corp., Nos. C-96-2323 SI, C-96-2664 SI, 1996 WL 637843 (N.D. Cal. Oct. 24, 1996).
[24] Bautista v. Star Cruisers, 396 F.3d 1289 (11th Cir. 2005).
[25] Gary Born, International Commercial Arbitration 756 (3d ed. 2020).
[26] E.g., Beltran v. Aupaircare, Inc., 907 F.3d 1240 (10th Cir. 2018).
[27] Gary Born, International Commercial Arbitration 536 (3d ed. 2020); Copape Produtos de Pétroleo Ltda v. Glencore Ltd, No. 11 Civ. 5744 LAK, 2012 WL 398596 (S.D.N.Y. Feb. 8, 2012).
[28] E.g., Harold Allen’s Mobile Home Factory Outlet, Inc. v. Butler, 825 So.2d 779 (Ala. 2002).
[29] Am. Arb. Ass’n, The Code of Ethics for Arbitrators in Commercial Disputes (2004).
[30] 9 U.S.C. § 10(a).
* Himanshu Raghuwanshi is a law student at Nalsar University of Law, Hyderabad. He is extremely interested in Arbitration, Tax and Commercial law. He is also passionate about mooting and debating.
** Krishnanunni U is a law student at Nalsar University of Law, Hyderabad. He shares a deep penchant for Tech, Arbitration and Commercial law. He is extremely enthusiastic about mooting and also enjoys participating in mediation events.