Fifth Circuit Holds Arbitration Provision Illusory and Unenforceable

The Fifth Circuit Court of Appeals has held in an unpublished opinion that an arbitration provision in a multilevel marketing program contract which could be amended at the sole discretion of one party and bound the other party “upon notice” was illusory and unenforceable.

In Juan Torres v. S.G.E. Management, L.L.C., No. 09-20778, (5^th Cir., October 5, 2010), Ignite operated as a subsidiary of a retail provider of electricity in Texas. Ignite relies on a multilevel marketing program which recruits people to invest money to purchase an Ignite Services Program (ISP) through a current member of Ignite. Once a person purchases an ISP, he becomes an Independent Associate (IA). Juan Ramon Torres and Eugene Robison (plaintiffs) purchased ISPs from Ignite and became IAs. In order to become members of Ignite, plaintiffs signed an agreement which contained an arbitration clause. Plaintiffs sued Ignite’s parent company, Stream Energy, and number of other defendants (collectively Ignite) in district court alleging that Ignite’s marketing program constituted an illegal pyramid scheme. Ignite filed a motion to dismiss for improper venue based on the arbitration clause in the parties’ agreement. The district court granted Ignite’s motion to dismiss the case and plaintiffs appealed.

Plaintiffs argued the arbitration clause was illusory and thus unenforceable because Ignite could amend the clause “in its sole discretion” and effective immediately. Applying Texas law, the Court explained that “an arbitration agreement can be illusory if a party can unilaterally avoid the agreement to arbitrate.” The Court then determined whether Ignite could, in fact, amend the arbitration clause in its sole discretion and whether such an amendment would become effective immediately. A Terms and Conditions clause in the parties’ contract conflicted with a Policies and Procedures clause because it provided that amendments made by Ignite would be effective upon 30 days’ notice, while the Policies and Procedures section provided that amendments would become binding “upon notice.” The agreement stated, “that ‘in the case of any conflict’ between the Policies and Procedures and other parts of the agreement, ‘these Policies and Procedures will prevail.’” According to the Court, “these provisions conflict, and the provision in the Policies and Procedures governs. Thus, any amendment to the agreement binds the IAs ‘upon notice.’”

Finally, the Court examined In re Halliburton Co., 80 S.W.3d 566 (Tex. 2002), J.M. Davidson, Inc. v. Webster, 128 S.W.3d 223 (Tex. 2003), and In re AdvancePCS Health, L.P., 172 S.W.3d 603 (Tex. 2005), decided by the Texas Supreme Court and the Fifth Circuit decision in Morrison v. Amway Corp., 517 F.3d 248 (5th Cir. 2008), which considered the validity of an arbitration clause under Texas law. According to the Court:

Here, the arbitration clause may be eliminated or modified “upon notice,” and the agreement contains no clause preventing a modification from applying to disputes arising before the modification. The circumstances are similar to those in Morrison. As in Morrison, “[t]here is nothing in any of the relevant documents which precludes amendment to the arbitration program . . . from eliminating the entire arbitration program or its applicability to certain claims or disputes.” And like Morrison, “[t]here are no Halliburton type savings clauses which preclude application of such amendments to disputes which arose . . . before the amendment.” Ignite essentially could renege on its promise to arbitrate by merely posting an amendment to the agreement on its website.

The Fifth Circuit held that Ignite’s promise to arbitrate under the terms of the agreement was hollow and the arbitration provision in the parties’ contract was illusory and unenforceable. The Court reversed the district court’s order dismissing the case for improper venue and remanded the case.

Disputing blogged here about In re 24R, Inc., a recent Texas Supreme Court case which also examined In re Halliburton Co. We also blogged here about Morrison v. Amway Corp. when it was decided.

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