The Hawai‘i Supreme Court recently ruled (again) that an arbitration agreement was not enforceable after finding that certain provisions were “unconscionable.” The decision follows a prior, similar ruling by the court in the same case, but the earlier decision was overturned by the U.S. Supreme Court and sent back to the Hawai‘i justices for reconsideration. While we wait to see if the decision will again be appealed to the U.S. Supreme Court, the decision contains cautions for employers that have or are considering arbitration agreements.
The Narayan Case
The lawsuit (Narayan v. Ritz-Carlton Development Co.) was filed by individuals who purchased units in a luxury condominium development on Maui against the project’s development and management companies and others. The developer sought to compel arbitration of the purchasers’ disputes pursuant to an arbitration clause contained in the condominium declaration, which was incorporated by reference into the purchase contracts. In a June 2015 opinion, the Hawai‘i Supreme Court ruled that the arbitration clause was not enforceable because the parties did not have an “unambiguous” intention to submit disputes to arbitration. According to the court, an ambiguity arose about the parties’ intentions because the purchase agreements indicated certain disputes would be resolved in court. The court also found some of the provisions within the arbitration clause were unfair.
U.S. Supreme Court Says Not So Fast
The defendants appealed the Hawai‘i Supreme Court’s decision to the U.S. Supreme Court. In a two-sentence opinion issued in January 2016, the U.S. Supreme Court vacated (overturned) the Hawai‘i Supreme Court’s decision, ordering reconsideration of the case in light of 2015 decision that concerned the Federal Arbitration Act (the FAA). The FAA requires state courts (like the Hawai‘i Supreme Court) to place arbitration contracts “on equal footing with all other contracts.” In other words, courts cannot impose additional requirements on arbitration agreements that do not exist for other types of agreements. Thus, if other contracts did not require an “unambiguous” intention to be enforceable, the court could not impose such a requirement on arbitration agreements.
Round 2 – Still Unenforceable
After the U.S. Supreme Court’s decision, we predicted that after reconsideration, the Hawai‘i Supreme Court would again conclude the arbitration agreement was unenforceable. The prediction proved accurate. In a July 2017 decision, the Hawai‘i Supreme Court again ruled that the arbitration clause in the condominium declaration was unenforceable, albeit for a different reason.
Obviously concerned about the U.S. Supreme Court’s instruction to comply with the FAA, the Hawai‘i Supreme Court’s most recent decision focused exclusively on unconscionability—a doctrine that applies generally to all contracts. Unconscionability is a defense a party can raise to enforcement of a contract when that party seeking to avoid the contract (1) did not have a meaningful choice about accepting the contract and were unfairly surprised due to the manner in which the offensive terms found their way into the agreement, and (2) the terms of the contract are unreasonably favorable to the other party.
The court found the first prong of the unconscionability doctrine was satisfied because the arbitration clause was drafted by the party with “superior bargaining strength” and the purchasers were required to conform to the terms if they wanted to purchase a condominium unit. The court also found that the arbitration clause, which was found near the end of the 36-page condominium declaration, contained terms that were unfair to the condominium purchasers.
Provisions Declared Unconscionable
The Hawai‘i Supreme Court took aim at three specific provisions in the arbitration clause.
Damages Limitation: The arbitration clause prohibited the arbitrator from awarding “punitive, exemplary, or consequential damages.” The court concluded that this limitation on the types of damages that could be awarded was unenforceable when combined with the fact that there was in “inequality of bargaining power” between the developer that drafted the condominium declaration and the purchasers. The court reasoned, “It would create an untenable situation if parties of superior bargaining strength could use adhesionary contracts to insulate ‘aggravated or outrageous misconduct’ from the monetary remedies that are designed to deter such conduct.”
Discovery: The arbitration clause also limited the types of “discovery” the arbitrator could order. Discovery is general term that refers to various methods for parties to obtain information from each other and third parties in preparation for the arbitration hearing. In the arbitration clause at issue, the arbitrator could not order depositions or other types of discovery unless the parties agreed in writing. The court explained that some limitations on discovery are enforceable and can “serve an important purpose” in arbitration. However, the court said this provision went too far because it placed “severe limitations on discovery” that would hinder the purchasers’ ability to prove their claims and violated Hawai‘i’s arbitration statute, which gives arbitrators considerable discretion in permitting discovery. The court concluded that such limitations, whether in arbitration or litigation, were unconscionable.
Confidentiality: The arbitration clause also prohibited parties, witnesses and the arbitrator from disclosing the “facts of the underlying dispute” or the “contents or results of any negotiations, mediation, or arbitration” without the prior written consent of all parties, with some exceptions. The court concluded that confidentiality provisions are not per se unconscionable; however, when combined with the limitations on discovery, the provision could deprive the purchasers of the ability to obtain information necessary to pursue their claims. Thus, the court ruled that the confidentiality provision was unconscionable.
Statute of Limitations: As a side note, the condominium purchasers also argued that a provision in the arbitration clause that shortened the period in which the parties could bring claims was unfair. The Hawai‘i Supreme Court declined to decide that issue because there was no indication that the purchasers’ claims against the developer would have been barred by the shortened limitations provision.
Unfair Provisions Can’t Be Severed
Importantly, a finding that certain provisions of an agreement are found unconscionable does not automatically result in the entire agreement being unenforceable. Generally, the problematic provisions can be “severed” while the remainder of the agreement is enforced. The defendants argued the Hawai‘i Supreme Court should have done that. The request was rejected. The court explained that “where unconscionability so pervades the agreement, the court may refuse to enforce the agreement as a whole.” The court concluded that was the case, and thus, the entire arbitration provision was unenforceable. Narayan v. Ritz-Carlton Development Co., SCWC-12-819 (Haw. July 14, 2017)
Although Narayan did not involve an employment arbitration agreement, the unconscionability analysis applied by the Hawai‘i Supreme Court could be raised by parties seeking to avoid all types of arbitration agreements, including in the employment setting. Thus, employers should pay attention. If your company’s arbitration agreements contain limitations on damages or discovery, or contain confidentiality clauses, they may be in jeopardy. A review by experienced counsel familiar with the Narayan decision is advisable. Employers should stay tuned, though, because the defendants in the Narayan case appealed the earlier decision to the U.S. Supreme Court and could do so again. The U.S. Supreme Court could say that the Hawai‘i justices got this one wrong the second time.
Amanda M. Jones is a partner in Cades Schutte’s Litigation Department. She is currently the editor of Hawai‘i Employment Law Letter, where this article first appeared. In that role, she is also a member of Employers Counsel Network.