Fifth Circuit Rules on Cost as a Basis for Not Arbitrating

Yesterday, the Fifth Circuit handed down an opinion stemming from a Mississippi case (link is to .pdf file) weighing in on the notion that prohibitive expense of arbitration can be a basis for a court’s refusal to compel arbitration on unconscionability grounds. The Court reversed the district court refusal to compel arbitration in this case, finding that the party seeking to avoid arbitration (a chicken farmer named Gertrude Overstreet) proved that she was destitute now, but did not offer evidence of her financial condition back at the time she entered into the contract that contained the arbitration clause.

The legal question at issue all started with a U.S. Supreme Court case from 2000 where that Court noted that “the existence of large arbitration costs could preclude a litigant . . . from vindicating her federal statutory rights in the arbitral forum.” Green Tree Fin. Corp. – Alabama v. Randolph, 531 U.S. 79, 90, 121 S.Ct. 513, 522 (2000) (otherwise known as ‘the other Green Tree case, so as not to confuse it with the more famous Green Tree opinion where the Supreme Court wrote about class actions in arbitration). While the Supreme Court did not allow that Green Tree plaintiff to avoid arbitration, it held that avoidance was theoretically possible if the unconscionable costs could be properly proven. Typically, this has since been done by focusing on how much the arbitration in question would cost. The Texas Supreme Court has subsequently acknowledged that substantial costs and fees associated with the arbitral forum can render an arbitration agreement unconscionable. In re: FirstMerit Bank, NA, 52 S.W.3d 749, 756 (Tex. 2001).

Guest blogger Rick Freeman has blogged about this issue before on this blog. Rick’s post discussed the Johnny Luna case out of Houston, where the Texas First Court of Appeals held that arbitration would be unconscionable because of its extreme costs, especially considering the amount of money at stake. That case has now been argued before the Texas Supreme Court, so we should get a ruling from that court at some point on this very issue.

The Fifth Circuit, however, beat the Texas Supreme Court to the punch yesterday. Applying Georgia law, the Circuit found that unconscionability analysis must consider the conditions between the parties as they existed at the time of the contract, and not at the time of the potential arbitration. The Circuit glossed over the evidence that Ms. Overstreet’s arbitration would cost $29,000.00 and that Ms. Overstreet had no income or property and subsisted on food stamps; instead, the Court noted that Ms. Overstreet provided no evidence that she was poor back in 2001, when she entered into the contract with the arbitration clause, and thus she had not met her burden to establish unconscionability.

Texas law on unconscionability seems similar to Geogia law (as qupted by the Fifth Circuit) on this question of when in the parties’ economic relationship unconscionability must be evaluated:

In any event, the basic test for unconscionability is whether, given the parties’ general commercial background and the commercial needs of the particular trade or case, the clause involved is to one-sided that it is unconscionable under the circumstances existing when the parties made the contract. The principle is one of preventing oppression and unfair surprise and not of disturbing allocation of risks because of superior bargaining power.

In re: FirstMerit Bank, NA, 52 S.W.3d 749, 757 (Tex. 2001) (emphasis added). Therefore, it seems clear that Texas practitioners asserting the high cost of arbitration as a basis for avoiding arbitration must now prove up their clients’ economic status at the time of the contract’s execution, as opposed to at the time of the arbitration.

Finally, a curious thought: all of this is an issue because arbitration is terribly expensive. Suppose, in the future, the AAA cuts its fees dramatically and makes arbitration as inexpensive as the court system. Could a future litigant still urge that 2006 arbitration clauses should be avoidable on cost grounds, since back at the time of execution arbitration was still expensive? Based on today’s Fifth Circuit analysis, I would think the answer should be yes.

Overstreet v. Contigroup Companies, Inc., ___ F.3d ___ (5th Cir. 2006) (Cause No. 05-60953)

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