What is Substantive Unconscionability
Substantive unconscionability is an affirmative defense to enforcement of a contract. It applies to contracts that have an imbalance of rights and obligations applying to each party, as viewed from the perspective of the weaker party. While courts are reluctant to void contracts to which parties agreed, even long ago, there is a narrow circumstance when enforcing the "unequal" provisions of a contract will not pass judicial scrutiny . For a contract to be deemed substantively unconscionable, and therefore voidable, courts generally require a seminal finding that the contractual terms are so one sided as to be oppressive or overly harsh to the detriment of the weaker party. Under the specific circumstances of each case, courts analyze whether the contract shocks the conscience or is, as a matter of policy, "offensively one sided." The unfair surprise for the victimized party may have resulted from their illiteracy, ignorance, low bargaining power, or lack of commercial sophistication, any number of which findings may warrant protection measures for one party over another.
Underlying Principles of Unconscionability
The doctrine of unconscionability is codified in the Uniform Commercial Code ("UCC"), adopted in each state. Specifically, sales of goods are governed by Article 2 of the UCC. With respect to contracts between merchants, the Texas version of UCC Section 2.302(1) addresses unconscionable contracts or clauses: If the court as a matter of law finds the contract or any clause of the contract to have been unconscionable at the time it was made the court may refuse to enforce the contract, or it may enforce the contract without the unconscionable clause, or it may limit the application of the unconscionable clause to avoid an unconscionable result. It is not required that contracts for the sale of goods include a clause on unconscionability in order for such contracts to be enforceable. Robicheaux v. Lentini, 319 S.W.2d 687, 688 (Tex. 1958) ("Lentini I"). Rather, the UCC’s unconscionability provisions apply generally to all contracts. Lentini I, 319 S.W.2d at 688. The commercial reasonableness of a contract or clause in a contract is evaluated under the "the totality of the circumstances." Id.
Courts have held that the equitable doctrine of unconscionability allows them to deal with the unconscionable by either denying them their contractual rights or limiting their application. Id. at 688-89; see also American Properties, Inc. v. Jefferson Assocs., 713 S.W.2d 435, 440 (Tex. App. – Houston [14th Dist.] 1986, writ ref’d n.r.e.) (balancing the interests of both parties).
Traits of a Substantively Unconsionable Contract
Courts will typically look for the following circumstances to determine whether a contract is substantively unconscionable. Contracts that contain numerous overly-harsh terms may be deemed substantively unconscionable. Courts will consider the reasonableness of the term in light of the commercial setting. If the agreement was used on a large scale and the problem was widespread, this may weigh in favor of finding substantive unconscionability.
Multiplicity of harsh terms may also lead courts to find substantive unconscionability where there is a pattern of unfairness. A lopsided or "one-way" clause, considered alone, is not likely to render a contract unconscionable; however, multiple examples of this type of clause are considered in the "totality of the circumstances," as they are considered "highly indicative" of unconscionability under California law.
A provision is substantively unconscionable if it is so one-sided as to be oppressive to the other party. The presence of other harsh provisions in the same agreement may be used to show that the contract is unconscionable. Some courts have held that the following provisions, among others, are unconscionable:
Each element of an unconscionable contract must be present to find a contract unenforceable. Courts often look for inequity between the parties in both the rights and obligations each party bears. A court may also consider the relative bargaining strength of the parties. Contracts of adhesion that deny fundamental rights, such as the right to alter existing law, are likely to be found unconscionable, especially if they would harm the public.
Where there is significant disparity in bargaining power and wealth, the contract is possible evidence of substantive unconscionability. Contracts of adhesion are routinely found to be unenforceable where there is only one party to negotiate the contract. A contract of adhesion does not necessarily render a contract unconscionable. Courts may consider whether the parties had an opportunity to read the contract. When an unsophisticated party is unaware of the contract terms, a court may find that the contract is unconscionable. In contrast, when a party has an opportunity to read the contract but decides not to, a court will not likely find the contract unconscionable.
Unconscionability Case Examples
Over the years, courts have wrestled with the issue of substantive unconscionability. For example, in 1981, in Truta v. Avis Rent-A-Car System, Inc., 106 Cal.App.3d 176 (1980), the California Court of Appeal invalidated a one-sided arbitration clause in a rental car agreement, finding that the clause was unconscionable because it would unfairly limit the cost-effective enforcement of consumer rights. Nonetheless, in 1990, the California Court of Appeal upheld an arbitration clause in another new car sales contract in a case captioned Little v. Auto Stiegler, Inc., 200 Cal.App.4th 965 (2011). The arbitration clause in Auto Stiegler provided that(b) finally, nor does the cost or the availability of the forum make (the consumer’s) rights illusory. An automobile dealership, one of many defendants in this class action, does not possess an overwhelming bargaining advantage vis-à-vis an ordinary consumer. It may spend a great deal to advertise its name and its automobiles, but when GTOs and other models roll into the used-car market, they are worth only as much as the consumer will pay for them. Even if the dealership might possess greater bargaining power in other circumstances, arbitral proceedings pursuant to the agreement will take no more than 60 days from the time of notice and will cost no more than filing fees in court. These proceedings in no way deprive consumers of rights they normally would possess. Nor do they preclude the opportunity to vindicate such rights in a level playing field. The agreement provides for "a fast and low-cost method of resolving disputes." It is silent on but does not foreclose the possibility of a summary adjudication motion or other expeditious remedies in arbitration, such as "disposition by facts established" under Code of Civil Procedure section 431.30. And an order compelling arbitration does not necessarily leave a consumer with no rights at all: the agreement provides that a class action may be maintained in court, with a pre-existing arbitration demand not barring the class action. In 2006, J. Alexander’s Rests., Inc. v. Tzeng, 185 P.3d 806 (Colo.2008), a restaurateur franchisor sought to enforce an arbitration provision in a contract with a mid-sized public accounting firm that made a franchisee waive its right to a jury trial outside of the arbitration process. The restaurateur also asked a Colorado state court to strike the contract in its entirety on the grounds that the entire agreement, including the arbitration provision, was procedurally and substantively unconscionable. The court of appeals in J. Alexander’s reaffirmed the traditional procedural and substantive unconscionability tests adopted in earlier cases, which required that both procedural and substantive unconscionability must be present before a court will disturb the terms of the contract. The Court then turned to the issue of whether the arbitration provision was unconscionable under both tests. On the procedural unconscionability issue, J. Alexander’s characterized the plaintiffs as "commercial entities engaged in negotiated business transactions," where the extent of the alleged imbalance of bargaining power was the disparity that one group of businesses (plaintiffs) possessed greater economic resources than the other group (defendant franchisor). The Court pointed to no precedent for holding that price disparity among sophisticated business entities (in this case, CPA firms and large restaurant chains) created a new kind of procedural unconscionability, and declined to adopt such a theory. On the substantive unconscionability issue, J. Alexander’s argued that "the Franchise Agreement does not extinguish all or any of a franchisee’s rights" because, following the parties’ arbitration, a franchisee may file an action in the appropriate state or federal court to enforce its rights. According to J. Alexander’s, the forum selection clause did not "subvert the legitimate procedural purpose of arbitration." J. Alexander’s also argued that the reciprocal discovery provision did not render the Franchise Agreement unconscionable because the Colorado Arbitration Act requires that arbitrators provide for "full and fair discovery adequate to a fair hearing." Id. at 820. The Court found that neither argument undermined the conclusion that the Arbitration Provision was substantively unconscionable. The court of appeals explained that the Franchise Agreement "relinquishes the franchisee’s right to seek any remedy other than what may be obtained in an arbitration proceeding." J. Alexander’s did not dispute this, conceding that "the waiver of a judicial forum for the resolution of disputes is significant," but instead attempted to minimize this concession by asserting that "the waiver is not entirely without value" because the arbitration provision allowed the franchisor to retain rights the franchisee waived. Id. at 821. The court of appeals disagreed with this analysis and determined that the one-sided nature of the provision tipped the scale toward unconscionability: The Franchise Agreement between the sophisticated parties involved here waives legal remedies, which forces the franchisee to rely solely on the wisdom of the arbitrator (or a court of appeals reviewing only for an abuse of discretion) for fairness or correctness. Such a waiver significantly diminishes one of the most important characteristic of court-based adjudication, namely, the availability and enforceability of rights. A waiver of legal remedies also reduces the chances of full, fair, and final settlements among sophisticated parties. Id. at 822.
Difference Between Procedural and Substantive Unconscionability
When analyzing the validity of an alleged unconscionable contract, a contract must first be examined for procedural unconscionability (i.e., how and when negotiations occurred and the relative bargaining power of the parties) and then substantive unconscionability (i.e., whether the terms of the contract are so excessively unfair as to be unconscionable). Jones v. Frank White’s Plantation, Inc., 989 So. 2d 928, 931-32, 934-35 (Ala. 2008).
Procedural unconscionability focuses on the circumstances surrounding the transactions, such as whether each party had a reasonable opportunity to understand the transaction and whether the important terms were hidden in a maze of fine print. Rivas v. Open Door Community Health Centers, 222 Cal.App.4th 1309, 1318 (Cal. Ct. App. 2014)) (citing Gutierrez v. Autowest, Inc., 114 Cal.App.4th 105 , 119 (Cal. Ct. App. 2003)). Procedural unconscionability requires a finding of some degree of unfairness either in the bargaining process or in the resulting substantive terms of the contract. Armendariz v. Foundation Health Psychcare Servs., 6 P.3d 669, 682 (Cal. 2000).
Substantive unconscionability examines whether there is a gross inequality of bargaining power and whether the provision reflects the "absent meaningful choice." Armendariz, 6 P.3d at 685; see also Rivas, 222 Cal.App.4th at 1318. Substantive unconscionability focuses on the terms of the contract and whether they are "so one-sided as to shock the conscience." Jones, 989 So. 2d at 934-35. If the contractual terms are so "outrageously unfair as to shock the conscience" or "so ostentatiously inequitable that they may be styled as oppressive," then they are procedurally unconscionable. Id. (citations omitted).
Substantive Unconscionability and Effects on Contracts
A finding of substantive unconscionability can have a number of impacts on how a contract is enforced. Depending on the nature of the unconscionability, such impacts may include the right to reformation or rescission of the contract. For example, a party might be entitled to reform an unconscionable fee provision to a more reasonable amount based on the reasonable fee for legal services in their area. Alternatively, the party might be able to seek rescission of a contract, allowing the parties to terminate the contract and restore the parties to their pre-contract positions. There are limits to how much a court can alter an unconscionable provision of a contract. Although a court cannot revise the contract in a way that creates a new contract for the parties, a court can reform the agreement to a point where it truly reflects a meeting of the minds on a fair, balanced agreement.
Avoiding Substantive Unconscionability in Contracts
To reduce the risk of entering into a contract that may be deemed substantively unconscionable, parties should take proactive steps during the negotiation process to ensure that the agreement is fair and balanced.
One way to avoid potential substantive unconscionability is to have both parties engage in meaningful negotiations about the terms. This may involve making adjustments to the terms or providing additional consideration in exchange for certain provisions.
It is important for the party that is expected to benefit from the so-called adhesive contract to give some additional consideration to the other party. Without offering something to entice the other side to enter into the contract, there will be a presumption that the contracting party is not actually entering into the contract on a voluntary basis. The Court considers this as one of the most important factors when addressing substantive unconscionability.
It is also advisable for all provisions of the contract to be relatively equal in their effects on the parties. For example, in Landers v Salient Partners LLC, the Delaware Supreme Court held that an arbitration clause could not be enforced because it placed all disputes with revenue sharing arbitrarily in the hands of the manager, leaving the investors with no remedy.
Moreover, if the contract limits any party’s ability to pursue a remedy , such as in a binding arbitration clause, those limitations should be considered in determining substantive unconscionability. Courts look to whether each party has sufficient opportunity to engage in meaningful actions to remedy the alleged breach of contract.
It is also critical that Contract provisions are mutually reciprocal. Just as one party cannot benefit excessively from the terms and terms of the agreement may not be arbitrary, the clause in question cannot apply to ‘some members of a class without any reason." In Opus N.V. v. Aescuvest P’rship a general partner of a limited partnership entered into an agreement with a number of limited partners which contained a jury waiver clause. The contract also allowed the general partner to unilaterally assign its rights to the limited partnership. When one of the limited partners sought to enforce the jury waiver clause after being sued in Delaware, that court found that the clause was substantively unconscionable because the burden of the clause was more objectionable to the limited partners who did not benefit from the clause than the general partner.
Finally, for businesses and organization that are looking to have others enter into an adhesive contract, it is imperative that these contracts are revisited periodically to ensure that they remain fair and balanced.