On August 3, to the relief of car dealerships and auto finance companies, the California Supreme Court upheld a standard arbitration clause from an automotive purchase agreement by a 6-1 majority decision in Sanchez v. Valencia Holding Co., LLC, which reversed both the trial court and Court of Appeal’s rulings invalidating the entire arbitration agreement.

Sanchez was a class action filed in March 2010, and involved the 2008 purchase of a pre-owned Mercedes S500V.  The purchase agreement contained an arbitration clause with a number of provisions contested in the lawsuit.  First, the agreement stated, “If a dispute is arbitrated, you will give up your right to participate as a class representative or class member on any class claim you may have against us including any right to class arbitration or any consolidation of individual arbitrations.”  Second, the agreement also made appeals to an arbitrator panel available for all awards of $0 or over $100,000 and grants (but not denials) of injunctive relief.  Third, the agreement made the appealing party responsible in advance for arbitration costs “up to a maximum of $2,500, which may be reimbursed” at the arbitrator’s discretion.  Fourth, the agreement exempted repossession from arbitration.

Plaintiff Sanchez sought to bring class claims for numerous alleged problems with his purchase of the vehicle, and the dealer moved to compel arbitration solely on an individual basis.  The trial court denied the dealer’s motion finding the agreement was procedurally and substantively unconscionable, declaring that the right to a class action may not be waived.  The Court of Appeal did not reach the class waiver issue, but still affirmed the trial court decision because the arbitration provision had “the effect of placing an unduly oppressive burden on the buyer.”

California’s highest court recognized the United States Supreme Court’s 2011 holding in AT&T Mobility LLC v. Concepcion that “the Federal Arbitration Act preempts California’s unconscionability rule prohibiting class waivers in consumer arbitration agreements,” but “does not preempt ‘generally applicable contract defenses’, such as fraud, duress, or unconscionability.”  Concepcion was decided after the Sanchez trial court ruling, but prior to the Court of Appeal’s decision.  After evaluating the terms of the arbitration agreement at issue, the California Supreme Court’s 28-page majority opinion sided with the appellant dealership regarding the agreement’s validity.

The Sanchez Court performed a rigorous analysis of case law on unconscionability, recognizing that “an evaluation of unconscionability is highly dependent on context,” but that it “requires a substantial degree of unfairness beyond ‘a simple, old-fashioned bad bargain.’ Although the arbitration agreement at issue was found to be an adhesion contract (i.e., “take it or leave it”) and thus was “sufficient to establish some degree of procedural unconscionability,” the Court was not convinced that it was substantively unconscionable due to any of the four aforementioned provisions, and thus ruled in favor of the dealership.

Although California plaintiffs’ attorneys will undoubtedly try to distinguish their own cases from the Sanchez plaintiff in order to have arbitration provisions in auto sales contracts deemed unconscionable, this decision presents a significant shift in favor of arbitration in consumer disputes.  However, as we previously noted, the Consumer Financial Protection Bureau has expressed a high degree of skepticism regarding arbitration agreements in consumer financial services contracts.  Pursuant to section 1028(b) of the DoddFrank Wall Street Reform and Consumer Protection Act enacted in 2010, the CFPB may prohibit, condition, or limit the use of arbitration provisions in such contracts if it finds that doing so is “in the public interest and for the protection of consumers.”  As such, the CFPB may have the last word when it issues its long-anticipated regulation of arbitration agreements.

Troutman Sanders LLP has extensive experience in drafting and enforcing arbitration agreements in the financial services industry and will continue to monitor litigation and CFPB activity in this area.