Is Your Arbitration Agreement Unconscionable?

Kentucky courts continue to closely scrutinize consumer contracts, particularly those involving arbitration provisions. In light of recent federal and state court decisions, however, the framework for analyzing the enforceability of arbitration agreements has shifted. Courts can no longer target arbitration provisions for disfavored treatment on grounds not applied to other contractual terms. See N. Kentucky Area Dev. Dist. v. Snyder, 570 S.W.3d 531, 537 (Ky. 2018) (citing Kindred Nursing Ctrs. Ltd. P’ship v. Clark, 137 S. Ct. 1421, 1425, 197 L. Ed. 2d 806 (2017)). Stated differently, an arbitration provision in a consumer contract cannot be automatically stricken as unconscionable. The Kentucky Court of Appeals recently employed a recalibrated framework in Green v. Frazier, 2020-CA-0781-MR, 2021 WL 2878360 (Ky. App. July 9, 2021), review granted (Oct. 20, 2021). The result remained unchanged – the arbitration agreement was held to be unenforceable.

The Green case involved a dispute related to Mr. Frazier’s purchase of a new pickup truck from Green’s Toyota of Lexington. Id. at *1. About a year after the purchase, Mr. Frazier returned to the same dealership for a routine service visit. Id. at *3. While waiting for his vehicle, Mr. Frazier became interested in another truck on the lot, and spoke with a salesperson about trading his current truck for the newer model. Id. When the salesperson provided an estimate for the trade-in value of his current truck, Mr. Frazier was surprised by the low amount. The dealership explained that the low trade-in value reflected the fact that Mr. Frazier’s truck had been involved in an accident, at the dealership, prior to the date of Mr. Frazier’s initial purchase. Id.

Mr. Frazier, obviously upset by the undisclosed accident, filed a lawsuit in Powell Circuit Court. Id. In response to the complaint, Green’s Toyota moved to dismiss and compel arbitration pursuant to the terms of the Purchase Contract, Arbitration Addendum, and Acknowledgment all signed by Frazier. Id. Green’s Toyota argued that the arbitration provisions were presented in numerous locations and it was undeniable that the claims must be submitted to arbitration.

For example, the Purchase Contract, two paragraphs above the signature line, stated: “Purchaser has read and agreed to the terms on the reverse side, including the ARBITRATION AGREEMENT provided for in Paragraph 17.” The referenced Paragraph 17, on the reverse side of the page, included an arbitration provision which required disputes to be resolved by binding arbitration in Lexington, Kentucky. The Court noted, however, that the provision was exceptionally difficult to read: “The type face is so blurry and small that we had to use a magnifying glass to read its terms. Despite our best efforts, however, there are a few instances where we are unable to decipher the printed text.” Id. n.2.

Green’s Toyota contended that even if Paragraph 17 was too difficult to read, Mr. Frazier also agreed to the unambiguous terms of the Arbitration Addendum and Acknowledgment page. Id. at *7. The Addendum required disputes be resolved through binding arbitration in Lexington, Kentucky. Id. at *2. The Addendum added, within the same paragraph, that “no party to this Agreement shall have the right to recover in any proceeding nor shall the arbitrators have the authority to award any party consequential or punitive damages.” Id. Furthermore, a separate one-page Acknowledgment included a similar provision requiring disputes be submitted to arbitration in Lexington, Kentucky. Id.

After a fact-specific inquiry, the Court of Appeals affirmed the circuit court’s refusal to compel arbitration, albeit for different reasons. The Court of Appeals held the circuit court’s reliance on Mortgage Electronic Registration Systems, Inc. v. Abner, 260 S.W.3d 351 (Ky. App. 2008), to hold that the arbitration provision was substantively unconscionable was no longer applicable. Id. at *6. Accordingly, the Court of Appeals reframed the issue as follows:

Therefore, instead of focusing on the fact that the limitation of damages provision appears in the arbitration clause, we must determine whether a limitation on damages provision in a consumer contract for the sale of goods, like the present, renders the contract unenforceable on the ground of unconscionability.

Id. As applied in this case, this question was conclusively answered in the affirmative.

The Court of Appeals started its analysis by considering whether Mr. Frazier was challenging (1) the validity of the agreement to arbitrate, or (2) the validity of a provision of the contract that would render the entire contract unenforceable. Here, the Court of Appeals determined it was only being asked to review the validity of an arbitration provision, not the entire agreement; thus, it was within the Court’s jurisdiction. Id. at *5. If it was the latter, the arbitrator would have jurisdiction to determine whether the agreement as a whole were unconscionable. Id.; see also Genesis Healthcare, LLC v. Stevens, 544 S.W.3d 645 (Ky. App. 2017).

Next, the Court reiterated the fundamental rule that “a written agreement duly executed by the party to be held, who had an opportunity to read it, will be enforced according to its terms.” Id. (quoting Schnuerle v. Insight Commc’ns. Co., L.P., 376 S.W.3d 561, 575 (Ky. 2012)). Of course, unconscionability is a narrow exception to this fundamental rule:

There are two types of unconscionability: procedural and substantive. “Procedural, or ‘unfair surprise,’ unconscionability ‘pertains to the process by which an agreement is reached and the form of an agreement[.]’ ” Schnuerle, 376 S.W.3d at 576 (quoting Conseco, 47 S.W.3d at 343 n.22). “It includes, for example, the use of fine or inconspicuous print and convoluted or unclear language that may conceal or obscure a contractual term.” Energy Home, Div. of Southern Energy Homes, Inc. v. Peay, 406 S.W.3d 828, 835 (Ky. 2013). “Substantive unconscionability ‘refers to contractual terms that are unreasonably or grossly favorable to one side and to which the disfavored party does not assent.’ ” Valued Services of Kentucky, LLC v. Watkins, 309 S.W.3d 256, 263 (Ky. App. 2009) (quoting Conseco, 47 S.W.3d at 343 n.22). Substantive unconscionability is determined by examination of “the commercial reasonableness of the contract terms, the purpose and effect of the terms, the allocation of the risks between the parties, and similar public policy concerns.” Schnuerle, 376 S.W.3d at 577 (quoting Jenkins v. First American Cash Advance of Georgia, LLC, 400 F.3d 868, 876 (11th Cir. 2005)).

Id. at *5.

In considering the substantive unconscionability of the arbitration provision, the Court turned to Kentucky’s Uniform Commercial Code (UCC). The UCC contemplates that an agreement may include an exclusion of consequential damages; however, the UCC also states that any such damages waiver should not be unconscionable. Id. at *6. For example, a waiver of consequential damages for personal injuries is considered to be prima facie unconscionable. Id. Although the Court of Appeals stated that “limitation of damages provisions in consumer contracts of adhesion are not per se unconscionable,” it concluded, without explanation, that the provision was substantively unconscionable. Id. at *7. Critically, the instant case only involved a claim of commercial injuries.

In a more detailed explanation, the Court of Appeals held that the waiver of consequential damages was also procedurally unconscionable. The Court stated that the limitation of damages was “a matter of grave importance to an ordinary consumer.” Id. As a result:

[A] consumer contract which seeks to exclude damages that would otherwise be available to the buyer such as those falling within Kentucky’s Consumer Protection Act, must do so clearly, concisely, and noticeably such that there can be no doubt that the consumer understands the rights he is giving up by signing the contract.

Id.

In a final blow to Green’s request to compel arbitration, the Court of Appeals refused to sever the limitation of damages provision and enforce the arbitration agreement, stating that “we do not believe fairness sanctions such a result in this case.” Id. at *8.

The Court of Appeals opinion ultimately achieved the same result as the circuit court – invalidating an arbitration agreement because it contained a limitation on consequential damages. The opinion also stands for the proposition, perhaps unintentionally, that any waiver of consequential damages in a consumer contract may be considered substantively unconscionable. The Supreme Court of Kentucky granted a discretionary review and will review the case de novo.