“An agreement to arbitrate may be unenforceable if pursuing a claim in arbitration is so cost prohibitive that it prevents a party from vindicating its rights.” With that opening sentence, the Texas Supreme Court in Lennar Homes of Texas, Inc. v. Rafiei, 687 S.W.3d 726 (Tex. 2024), recently rendered an opinion worth noting by all residential contractors, including in New Hampshire, who insert arbitration clauses with fee-splitting provisions in their contracts as a strategy for discouraging claims.
In Lennar a homeowner sued his builder for personal injuries that he blamed on a construction defect, seeking in excess of $1,000,000 in damages. The parties’ contract had an arbitration clause, one which expressly delegated “issues of formation, validity or enforceability” of the contract to the arbitrator rather than the courts to decide. The builder asked the court to compel arbitration, and the homeowner responded that the twin provisions for arbitration and for delegation of enforceability issues to the arbitrator “are unconscionable because arbitration was prohibitively costly and would prevent him from pursuing his claims.” He pointed to the AAA’s Administrative Fee Schedules, under which it would cost him over $8,000 to present his case to the arbitrator.
The lower court agreed with him, as did a divided panel of the Texas Court of Appeals – even though he hadn’t presented evidence that he couldn’t afford the cost. That missing element persuaded the Texas Supreme Court to send the matter back to the lower court for a ruling on ability to pay – but it also announced the test for a finding of unconscionability:
“To determine unconscionability, a court must first consider ‘a comparison of the total costs of the two forums’ and decide ‘whether that cost differential is so substantial as to deter the bringing of claims.’ . . . A proper unconscionability analysis further requires a comparison of the relevant costs between litigating in court and in arbitration and of the claimant’s ability to pay an arbitration provision as unconscionable due to the difference in such costs.”
Because arbitrators charge for their time and administering bodies like the AAA charge for their services, arbitration can be expensive, and often much of the expense must be paid up front. The dilemma faced by an indigent party trying to avoid arbitration arises when the unconscionability issue is delegated to the arbitrator to decide; a filing fee (typically amounting to several thousand dollars) and perhaps a deposit to cover the arbitrator’s anticipated time must be paid just to have the arbitrator resolve this threshold issue! Recognizing this Catch-22, most courts, like our own federal court, hold that when a plaintiff “argues that the delegation clause is unconscionable . . . it is for the court, not the arbitrator, to resolve her challenges to the delegation clause.” Rosen v. Genesis Healthcare, LLC, 2021 WL 411540 (D.N.H. Feb. 5, 2021).
No New Hampshire case has yet found such a delegation provision unconscionable due to financial hardship. But the unconscionability tests applied by our courts generally align with those in Texas and elsewhere. The First Circuit Court of Appeals has noted that “if the terms for getting an arbitrator to decide the issue are impossibly burdensome, that outcome would indeed raise public policy concerns. If arbitration prevents plaintiffs from vindicating their rights, it is no longer a ‘valid alternative to traditional litigation.’” Awuah v. Coverall North America, Inc., 554 F.3d 7, 12 (1st Cir. 2009). It’s fair to predict that our courts will be of the same view.
A final word of caution: Contractors should not assume that if a homeowner ever seeks to avoid arbitration by pleading poverty, they can just offer to pay all of the arbitration expenses and keep the claim out of court. That didn’t work in Lim v. TForce Logistics LLC, 8 F.4th 992, 1004 (9th Cir. 2021) (“TForce states that it has already filed the arbitration demand in Los Angeles and agreed to pay all arbitration fees. But, as the district court correctly recognized, waiving unconscionable elements of the delegation clause does not change the analysis of whether the delegation clause, as drafted, is unconscionable.”).
In Lennar a homeowner sued his builder for personal injuries that he blamed on a construction defect, seeking in excess of $1,000,000 in damages. The parties’ contract had an arbitration clause, one which expressly delegated “issues of formation, validity or enforceability” of the contract to the arbitrator rather than the courts to decide. The builder asked the court to compel arbitration, and the homeowner responded that the twin provisions for arbitration and for delegation of enforceability issues to the arbitrator “are unconscionable because arbitration was prohibitively costly and would prevent him from pursuing his claims.” He pointed to the AAA’s Administrative Fee Schedules, under which it would cost him over $8,000 to present his case to the arbitrator.
The lower court agreed with him, as did a divided panel of the Texas Court of Appeals – even though he hadn’t presented evidence that he couldn’t afford the cost. That missing element persuaded the Texas Supreme Court to send the matter back to the lower court for a ruling on ability to pay – but it also announced the test for a finding of unconscionability:
“To determine unconscionability, a court must first consider ‘a comparison of the total costs of the two forums’ and decide ‘whether that cost differential is so substantial as to deter the bringing of claims.’ . . . A proper unconscionability analysis further requires a comparison of the relevant costs between litigating in court and in arbitration and of the claimant’s ability to pay an arbitration provision as unconscionable due to the difference in such costs.”
Because arbitrators charge for their time and administering bodies like the AAA charge for their services, arbitration can be expensive, and often much of the expense must be paid up front. The dilemma faced by an indigent party trying to avoid arbitration arises when the unconscionability issue is delegated to the arbitrator to decide; a filing fee (typically amounting to several thousand dollars) and perhaps a deposit to cover the arbitrator’s anticipated time must be paid just to have the arbitrator resolve this threshold issue! Recognizing this Catch-22, most courts, like our own federal court, hold that when a plaintiff “argues that the delegation clause is unconscionable . . . it is for the court, not the arbitrator, to resolve her challenges to the delegation clause.” Rosen v. Genesis Healthcare, LLC, 2021 WL 411540 (D.N.H. Feb. 5, 2021).
No New Hampshire case has yet found such a delegation provision unconscionable due to financial hardship. But the unconscionability tests applied by our courts generally align with those in Texas and elsewhere. The First Circuit Court of Appeals has noted that “if the terms for getting an arbitrator to decide the issue are impossibly burdensome, that outcome would indeed raise public policy concerns. If arbitration prevents plaintiffs from vindicating their rights, it is no longer a ‘valid alternative to traditional litigation.’” Awuah v. Coverall North America, Inc., 554 F.3d 7, 12 (1st Cir. 2009). It’s fair to predict that our courts will be of the same view.
A final word of caution: Contractors should not assume that if a homeowner ever seeks to avoid arbitration by pleading poverty, they can just offer to pay all of the arbitration expenses and keep the claim out of court. That didn’t work in Lim v. TForce Logistics LLC, 8 F.4th 992, 1004 (9th Cir. 2021) (“TForce states that it has already filed the arbitration demand in Los Angeles and agreed to pay all arbitration fees. But, as the district court correctly recognized, waiving unconscionable elements of the delegation clause does not change the analysis of whether the delegation clause, as drafted, is unconscionable.”).
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