High Costs of Arbitration

Rick Freeman Commentary

Following up on my article last week regarding the Olshan case – in which the San Antonio Court of Appeals found that the high cost of the required arbitration to be “shocking” and unconscionable and therefore the arbitration provision was unenforceable – I want to examine two appellate cases decided in 2004 that discuss substantive unconscionablity.

In the first case, Pine Ridge Homes, Inc. v. Stone, the Dallas Court of Appeals evaluated the fairness of an arbitration provision in a contract involving the purchase of a house. In this case, the home purchasers, the Stones, paid $5,000 in earnest money and signed a contract to purchase a house from Pine Ridge Homes. The contract included an arbitration provision. Pine Ridge Homes refused to agree with the proposed mortgage company to include the statutorily required retainage provision. Because of this refusal the mortgage company refused to provide financing for the house. The Stones canceled the contract to purchase the house and requested that their $5,000 earnest money be returned. Pine Ridge Homes refused to return the money.

The arbitration provision in question provided that the party who demanded arbitration had to pay all arbitration fees for both parties. The court examined the contract provisions and determined that Pine Ridge Homes had a remedy that did not require arbitration — keeping the earnest money. The Stones, on the other hand, had no remedy without going through arbitration. So the Stones would be required to pay the arbitration fees for both sides in any dispute they brought while Pine Ridge Homes could retain the earnest money and never pay any arbitration fees. Based on this one-sidedness, the appellate court ruled that the arbitration provision was so unfair and one-sided that it was unconscionable and therefore unenforceable.

In the second case, In Re Johnny Luna, the Houston 1st Court of Appeals ruled that the arbitration provision in this employment setting was substantively unconscionable. In this case, Johnny Luna, the employee was required to sign an arbitration agreement in order to go to work for Poly America. The arbitration provision required that any and all job-related disputes be arbitrated. Luna was injured on the job and filed a workers compensation claim. Poly America then fired Luna. Luna filed suit alleging wrongful discharge and retaliation due to his filing a workers compensation claim.

Poly America demanded arbitration. Luna objected on the basis that the cost to him of the arbitration was so high that it effectively prevented him from asserting his legal rights. In addition, Luna alleged that the arbitration agreement limited the remedies that he should have had under the Labor Code wrongful discharge and retaliation statute. First, the Court evaluated the substantive effect of each of Luna’s allegations individually. I recommend that you read the Court’s opinion for its discussion of the substantive effect of each of Luna’s individual allegations.

The Court then evaluated the arbitration provisions when taken as a whole. The Court ruled that the arbitration agreement, when taken as a whole, was substantively unconscionable and therefore unenforceable because of the combination of its high costs to Luna and its limitation on the statutorily available remedies available to Luna.

These two cases along with Olshan, when read together, provide a “road map” to those drafting arbitration agreements.

1. Arbitration cannot be so expensive that it effectively defeats the ability of a party to litigate its claim.
2. Arbitration costs cannot be placed completely on one party while allowing the other party a remedy that does not require arbitration.
3. The arbitration provision should not significantly eliminate statutorily provided rights or remedies of a party, especially if some of the other “unfair” provisions are also contained in the arbitration provision.

In other words, when considered as a whole, there needs to be some indicia of fairness and lack of one-sidedness in the arbitration provision. If there is some fairness in the arbitration provision, it is unlikely that the arbitration provision will be declared substantively unconscionable.