Articles Posted in Litigation/Business Trials/Business Lawsuits/Business Litigation

An arbitration clause is a part of a contract which requires that any dispute between the parties be handled in arbitration, rather than trial courts. An increasing number of companies are implementing these clauses and requiring everyone from their employees to their customers to sign them. The goal is to prevent class actions from forming and taking the company to court for large sums of money. However, these clauses are not always enforceable and many plaintiffs have found ways around them.

An unconscionable contract is a contract that is unenforceable in a court of law. Arbitration agreements may be found unconscionable on “such grounds as exist at law or in equity” to revoke a contract. There are two types of contractual unconscionability: procedural and substantive. Procedural unconscionability addresses the fairness of the bargaining process, which “is concerned with ‘unfair surprise’, fine print clauses, mistakes or ignorance of important facts”. Substantive unconscionability, on the other hand, determines the fairness of the terms of the contract itself. For example, a contract may be considered substantively unconscionable if its terms favor one party too heavily over another.

An arbitration agreement may be substantively unconscionable if the fees and costs to arbitrate are so excessive as to “deny a potential litigant the opportunity to vindicate his or her rights.” In such cases, it is up to the plaintiff to prove to the court that the arbitration would be prohibitively expensive.

First, the plaintiff has to present evidence concerning the cost to arbitrate. The evidence provided “must be based on specific facts showing with reasonable certainty the likely costs of arbitration.” Second, the plaintiff “must show that based on their specific income/assets, they are unable to pay the likely costs of arbitration.” The third and final consideration for the court is whether the arbitration agreement allows for a party to avoid or reduce the costs of arbitration based on financial hardship.

One case that exemplifies this is Clark v. Renaissance West in Arizona. The plaintiff sued the nursing home for medical malpractice, alleging that it was due to their negligence that he formed a pressure ulcer which required surgery and long term care to remedy. Clark had signed a contract with the nursing home that included an arbitration clause but he argued that the clause was unenforceable and took the case to trial. The trial court ruled that the arbitration clause was, indeed unconscionable, and the appellate court agreed after Renaissance West appealed the lower court’s decision.

Most arbitration clauses state that the company will choose and pay for arbitration. In this case however, the contract called for three arbitrators in the event that the parties could not agree on one, and for both parties to split the arbitration fees, regardless of who won the case. Clark brought in an expert who testified that, based on the complexity of Clark’s case, they could be in arbitration for at least five days (assuming an 8-hour day). Taking that into consideration, arbitration alone would have cost Clark about $22,800. Since Clark is retired and living on a fixed income, such an exorbitant amount is clearly beyond his means.

The appellate court’s decision is a mixed blessing for plaintiffs trying to avoid unfair arbitration provisions. On the one hand, the plaintiff won and the arbitration clause has been rejected. On the other hand, this case has proven the lengths to which plaintiffs must go in order to prove that the arbitration clause is unconscionable.

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The Seventh Circuit has affirmed most of a district court ruling involving an Illinois partnership dispute involving claims for fraud, excessive partnership distributions and fraud in a trademark application for a corporate logo. The cases highlights that partnership disputes can result in very time consumer and expensive litigation when there is no clear-cut written partnership agreement. In this case, the victorious defendants were awarded substantial attorneys fees.

The case arose out of the following facts. Three individuals Swift, Schaltenbrand, and Siddle joined together as partners to operate a mail-order pharmacy, divide the profits from that business, and eventually sell the book of customers to another pharmacy. After some initial success, the partners began taking profit distributions that far exceeded the partnership’s profits and according to the Seventh Circuit did not square with any formula. All of the partners according to the Seventh Circuit’s description of the facts seemed pleased to strip the enterprise of monies and to even take out loans to do that:

Soon after the partnership started gaining steam, however, the partners began exploiting their informal arrangement for personal gain. Swift, Siddle, and Schaltenbrand repeatedly requested andreceived) profit distributions that far exceeded the amounts to which they were entitled under the agreement.
Despite the fact that the partnership was a money‐losing  enterprise,  the  partners  continually found the funds for distributions. For example,
evidence presented to the court indicated that, from 2005 to 2009,
the partnership operated at a net loss of over$400,000. During this same period,
however, Swift, Schaltenbrand, and Siddle received  nearly  $4  million  in  combined distributions.

Swift even persuaded Schaltenbrand to take out loans to facilitate
these unjustified  payments  to  the  partners.  For  his part, Swift concealed his excessive demands (which he knew had
no  basis  in  the  actual  profitability  of  the  partnership) commingling them with DeliverMed’s requests for  cost reimbursements.
Swift and Schaltenbrand each became aware of  the  other’s  excessive
distributions, but neither of them cared. So long as each
partner was able to obtain his own unjustified share of
partnership funds, no one made a fuss.
However, when a dispute erupted between the partners
Swift sued Schaltenbrand and Siddle claiming that
they had taken more money than the allegedly
agreed upon percentages and that he was therefore
entitled to larger distributions and owed money.

The district court listened to 14 days of testimony before ruling in favor Schaltenbrand and Siddle holding that Swift never properly included fraud claims, wasn’t a credible witness and couldn’t support his damages claims for greater distributions with evidence of a contract setting the agreed upon percentages. The court also invalidated a copyright registration that Swift’s marketing company obtained for a logo used by the partnership, finding that Swift knowingly misrepresented a material fact in the application to register a copyright in the logo.

The Seventh Circuit affirmed in part, agreeing that Swift did not prove Schaltenbrand and Siddle breached any obligation to provide him with a certain percentage of the distributions or even that such an obligation or contract to provide set percentages existed. The Seventh Circuit also found Swift waived fraud claims by failing to include them in the final pretrial order. The Seventh Circuit held that the district court erred by invalidating the copyright registration without first consulting the Register of Copyrights as to the significance of the inaccurate information. The Copyright Act requires courts to perform this “curious procedure” before invalidating a registration based on a fraud on the Copyright Office. The Seventh Circuit remanded the case so that Register could be notified and the issue decided based on the requirements of the statute.

You can view the entire opinion here.

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