December 2, 2015

Eliminating California's obstacles to freedom of contract

By Deborah J. La Fetra Senior Attorney

Supreme Court briefing is now underway in one of this Term’s major arbitration cases: MHN Government Services, Inc. v. Zaborowski. The case will determine whether the California Supreme Court’s severability rule—used almost exclusively to invalidate arbitration contracts—will survive scrutiny under the Federal Arbitration Act. The Ninth Circuit’s application of California law to invalidate an entire arbitration contract that contained some discrete, unconscionable provisions (e.g., relating to costs and a waiver of punitive damages), violated the parties intent in a particularly acute manner because the contract contained an explicit severability clause.

Severability allows courts to line out provisions of contracts that are determined to be invalid. In California, state statutes specifically authorize courts to sever invalid provisions so long as they do not alter the fundamental nature of the agreement between the parties. But the California Supreme Court rule announced in Armendariz v. Found. Health Psychcare Svcs., Inc. says that if there is more than one invalid provision, those provisions are deemed to “permeate” the contract, requiring the court to strike it down in its entirety.

Today, PLF filed its amicus brief urging the Court to invalidate the anti-arbitration severability rule. While permitting severance of a single, discrete invalid provision, Armendariz offers no logical justification (beyond the presumption of permeation) for refusing to sever two, three, or more provisions, if the subject matter of those provisions are also sufficiently discrete from the primary subject of the contract. As the Third Circuit memorably explained in Spinetti v. Service Corp. Int’l, “You don’t cut down the trunk of a tree because some of its branches are sickly.”

PLF’s brief also addresses another aspect of Armendariz, with which the severability rule works in concert. Compounding the effect of the severability rule is that, in many cases, one of the two “unconscionable” aspects of the contract is a “lack of mutuality.” This is a California contract doctrine (explicitly rejected by most other states) that Armendariz requires of all arbitration contracts. Under Armendariz, California courts demand that arbitration contracts—but not other contracts—have “mutual” provisions such that both parties stand in precise equivalence. A lack of mutuality is deemed unconscionable, and thus provides the first strike against an arbitration contract. And one strike is all the contracting parties get. If any other provision is found unconscionable, the Armendariz “permeation” rule requires that the arbitration contract be invalidated in its entirety.

The Supreme Court recognizes multiple benefits to arbitral resolution of disputes: lower costs, greater efficiency and speed, and the ability to choose expert adjudicators to resolve specialized disputes. The Armendariz doctrines, combining a demand for mutuality and a uniquely narrow approach to severability, ignore these benefits and, by improperly invalidating contracts, damages the rule of law itself. As it has in so many other cases coming from the California courts, the Supreme Court should strike down California’s anti-arbitration rules, and restore the freedom of contract.

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