Barrett v. McDonald Investments, Inc.

ALEXANDER, J.,

concurring.

[¶ 24] I join the Court’s opinion. The Barretts’ life savings and Laurence’s signature on the agreement were procured by what are asserted to be knowingly fraudulent representations by McDonald and Sullivan regarding the nature and quality of the Manulife investment.

[¶ 25] As an alternative basis to affirm, I would hold that when a contract is asserted to have been procured as a result of a fraud perpetrated by a contracting party with a significantly superior bargaining position, a compulsory arbitration clause may be avoided, allowing the fraud claim to be heard by the court. It would be a perverse result to allow McDonald and Sullivan to procure Laurence Barrett’s signature and the Barretts’ life savings by fraud, drain half the value from their retirement funds, and then enforce the fraudulently procured contract to cut off the Barretts’ access to the courts and force them to arbitrate their claim before a securities industry organization.

[¶26] Nearly forty years ago, and despite an articulate dissent by Justice Black, the United States Supreme Court held that the Federal Arbitration Act, 9 U.S.C.A. §§ 1-16 (West 1999 & Supp. 2004), required that when a contract contains a mandatory arbitration clause, a claim of fraud in the inducement of the contract must be resolved by an arbitrator, not the courts. Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 403-04 , 87 S.Ct. 1801 , 18 L.Ed.2d 1270 (1967). A1984 opinion, Southland Corp. v. Keating, 465 U.S. 1 , 104 S.Ct. 852 , 79 L.Ed.2d 1 (1984), held that the Federal Arbitration Act was applicable to the states and limited the capacity of the state legislatures and courts to invalidate arbitration clauses in contracts and allow claims to be brought directly to court. Id. at 10-16 , 104 S.Ct. 852 . A 1987 opinion, Shear son/American Express Inc. v. McMahon, 482 U.S. 220 , 107 S.Ct. 2332 , 96 L.Ed.2d 185 (1987), held that fraud claims by investors asserted under federal or *153 state statutes designed to protect investors must be resolved by arbitrators in accordance with mandatory arbitration clauses, preempting statutory protections and judicial remedies enacted by Congress. Id. at 228-38 , 107 S.Ct. 2332 .

[¶27] The passage of time and events, particularly the increased use of contracts of adhesion containing mandatory arbitration clauses to avoid judicial enforcement of federal and state anti-discrimination and consumer protection laws, is leading many appellate courts to distinguish and weaken the significance of these precedents from an earlier time in the development of arbitration law. See, e.g., Ticknor v. Choice Hotels Int’l, Inc., 265 F.3d 931, 941-42 (9th Cir.2001), cert. denied, 534 U.S. 1133 , 122 S.Ct. 1075 , 151 L.Ed.2d 977 (2002) (overruling prior decisions that adhesion contract principles could not be invoked to avoid arbitrability of disputes); Sphere Drake Ins. Ltd. v. Clarendon Nat’l Ins. Co., 263 F.3d 26, 31-32 (2d Cir.2001) (interpreting Prima Paint to allow a trial of the arbitrability issue when a party alleges and provides some evidence that a contract is void, rather than voidable, or that the arbitration clause itself is voidable pursuant to New York law that fraud in the inducement makes a contract voidable); Willems v. U.S. Bancorp Piper Jaffray, Inc., 2005 MT 37, ¶¶ 1, 27-28 , 326 Mont. 103 , 107 P.3d 465, 470 (holding, in a consolidated action for mismanagement of investments, that an arbitration clause was not enforceable when investment advisors had a fiduciary duty to explain the consequences of the arbitration clause and did not do so).

[¶28] One factor promoting increased caution in enforcing mandatory arbitration clauses is the capacity of many arbitrators to ignore laws adopted to protect consumers and employees. The arbitrators of the securities industry groups to whom investor claims are referred are advised by their self-regulating organizations that they need not follow the law in their arbitration decisions. See Kenneth R. Davis, The Arbitration Claws: Unconscionability in the Securities Industry, 78 B.U. L. REV. 255, 302-03, 319 (1998). Although the advice that the securities industry may give its arbitrators authorizing them to ignore the law in their decision-making may seem notable, it reflects statutory and court-approved standards for judicial review of arbitration decision-making. An arbitrator “is under no duty to resolve a dispute in compliance with the parties’ legal rights.” Paul D. Carrington & Paul Y. Castle, The Revocability of Contract Provisions Controlling Resolution of Future Disputes Between the PaRies, 67 LAW & CONTEMP. PROBS. 207, 217 (2004). The Maine Uniform Arbitration Act states that “the fact that the relief was such that it could not or would not be granted by a court of law or equity is not ground for vacating or refusing to confirm the award.” 14 M.R.S.A. § 5938(1) (2003). Interpreting this law, we have held that courts may not vacate an arbitration award merely because the arbitrator erred in interpreting the applicable law. Union River Valley Teachers Ass’n v. Lamoine Sch. Comm., 2000 ME 57, ¶¶5, 11 , 748 A.2d 990, 991, 993 ; Cape Elizabeth Sch. Bd. v. Cape Elizabeth Teachers Ass’n, 459 A.2d 166, 174 (Me.1983); see also Bennett v. Prawer, 2001 ME 172, ¶¶8-9 , 786 A.2d 605, 608-09 ; Dep’t of Transp. v. Maine State Employees Ass’n, SEIU Local 1989, 606 A.2d 775, 777 (Me.1992).

[¶ 29] This view of arbitration as a process above the substantive law and not bound by it developed in the middle of the last century, when most arbitration agreements, as in Prima Paint, arose from collective bargaining agreements, construction contracts, or other transactions between parties, usually businesses, *154 of relatively equal bargaining power. 7 The last quarter of the century saw enactment of many federal and state anti-discrimination and consumer protection laws. At the same time, businesses greatly expanded imposition of unnegotiated, mandatory arbitration clauses in consumer transactions and employment agreements between parties of significantly unequal bargaining power. Carrington and Castle characterize this latter development as an “epidemic of arbitration clauses in contracts of adhesion.” Carrington & Castle, The Revocability of Contract Provisions, 67 LAW & CONTEMP. PROBS. at 217.

[¶ 30] The combination of exemption of arbitration awards from review for errors of law, imposition and enforcement of mandatory arbitration clauses, and limitation of arbitrations to internal securities industry forums 8 invites the wholesale flouting of federal and state laws designed to protect investors and provide them with judicially enforceable remedies against fraud and abuse. There has been increased recognition in the past five years of the need for greater vigilance to protect investors from fraud, theft, and financial manipulation in the securities industry. That increased vigilance calls into question whether courts can continue to enforce mandatory arbitration clauses in fraudulently obtained contracts that force injured investors to arbitrate before industry groups and bar injured investors from accessing judicial remedies authorized by law to protect them. See Blythe v. Deutsche Bank AG, No. 04 Civ. 5867(SAS), 2005 WL 53281 , at **5-6, 2005 U.S. Dist. LEXIS 292 , at **18-24 (S.D.N.Y. Jan. 7, 2005) (stating, as dictum, that a fraudulently obtained contract with a mandatory arbitration clause might be enforced against an innocent party, but holding that the court would refuse to enforce a mandatory arbitration clause in a tax shelter investment scheme where there were elements of mutual fraud in dealings by the parties). See generally David S. Schwartz, Correcting Federalism Mistakes in Statutory Interpretation: The Supreme Court and the Federal Arbitration Act, 67 LAW & CONTEMP. PROBS. 5, 44 (2004) (suggesting that at least five members of the present court have taken positions inconsistent with maintaining the preemptive effect of the Southland opinion). See also Willems, 2005 MT 37, ¶¶ 27-28 , 107 P.3d at 470 ; Rivera v. Clark Melvin Secs. Corp., 59 F.Supp.2d 297, 304 (D.P.R.1999); Woodyard v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 640 F.Supp. 760, 766-67 (S.D.Tex.1986); Davis, The Arbitration Claws, 78 B.U. L. REV. at 317-27.

[¶ 31] Pursuant to the Federal Arbitration Act, arbitration agreements are valid and enforceable except “upon such grounds as exist at law or in equity for the revocation of any contract.” 9 U.S.C.A. § 2 (West 1999). The validity of arbitration agreements is judged by applying “ordinary state-law principles that govern the formation of contracts.” First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 944 , 115 S.Ct. 1920 , 131 L.Ed.2d 985 (1995). *155 Generally applicable state law contract defenses, “such as fraud, duress, or uncon-scionability, may be applied to invalidate arbitration agreements.” Doctor’s Assocs., Inc. v. Casarotto, 517 U.S. 681, 687 , 116 S.Ct. 1652 , 134 L.Ed.2d 902 (1996); Ticknor, 265 F.3d at 941-42 .

[¶ 32] Pursuant to Maine law, fraud in the inducement of a contract may void or vitiate the contract. Delahanty v. Chicoine Motor Sales, Inc., 151 Me. 429, 433-34 , 120 A.2d 714, 716-17 (1956); Dubie v. Branz, 146 Me. 455, 460 , 73 A.2d 217, 220 (1950). Separately, when a court finds a contract or any clause in a contract “to have been unconscionable at the time it was made the court may refuse to enforce the contract, or it may enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result.” 11 M.R.S.A. § 2-302(1) (1995). A contract of adhesion is a standardized contract that is imposed and drafted by a party with a superior bargaining position, and that gives the other party only the choice to accept or reject the contract. Dairy Farm Leasing Co. v. Hartley, 395 A.2d 1135 , 1139-40 n. 3 (Me.1978); Irwin v. UBS Painewebber, Inc., 324 F.Suppüd 1103, 1108 (C.D.Cal.2004); Annendariz v. Found. Health Psychcare Servs., Inc., 24 Cal.4th 83 , 99 Cal.Rptr.2d 745 , 6 P.3d 669, 689 (2000); Melody Home Mfg. Co. v. Barnes, 741 S.Wüd 349, 355 (Tex.1987). A contract of adhesion is not per se unconscionable, but the defense of unconsciona-bility may be asserted to a contract of adhesion “exacted by the overreaching of a party.” Dairy Farm Leasing Co., 395 A.2d at 1139 -40 n. 3.

[¶ 33] In deciding claims of unconsciona-bility, courts consider a variety of factors that may be indicative of procedural or substantive unconscionability. Jenkins v. First American Cash Advance of Ga. LLC, No. 03-16329, 2005 WL 388269, at **5-6 , 2005 U.S.App. LEXIS 2922, at **15-16 (11th Cir. Feb. 18, 2005); Al-Safin v. Circuit City Stores, Inc., 394 F.3d 1254, 1258-59 (9th Cir.2005); Ferguson v. Countrywide Credit Indus., Inc., 298 F.3d 778, 783 (9th Cir.2002). In Kloss v. Edward D. Jones & Co., 2002 MT 129, ¶ 30 , 310 Mont. 123 , 54 P.3d 1, 8-9 , cert. denied, 538 U.S. 956 , 123 S.Ct. 1633 , 155 L.Ed.2d 506 (2003), the Montana Supreme Court suggested eight factual issues that should be addressed in determining whether a mandatory arbitration clause in a contract of adhesion may be unconscionable:

1. Are potential arbitrators disproportionately employed in one or the other party’s field of business?

2. Do arbitrators tend to favor “repeat players” as opposed to workers or consumers who are unlikely to be involved in arbitration again? In other words, is there a tendency by arbitrators to avoid decisions which will result in the loss of future contracts for them services?

3. What are the filing fees for arbitration compared to the filing fees in Montana’s district courts?

4. What are arbitrators’ fees? Do they make small claims prohibitive? Do they discriminate against consumers or workers of modest means?

5. Are arbitration proceedings shrouded in secrecy so as to conceal illegal, oppressive or wrongful business practices?

6. To what extent are arbitrators bound by the law?

7. To what extent are arbitrators bound by the facts?

8. What opportunity do claimants have to discover the facts necessary to prove a claim such as a company’s business practices?

*156 Id.; see also Faber v. Menard, Inc., 367 F.3d 1048, 1053 (8th Cir.2004) (suggesting five criteria to consider as cited in Home Fed. Sav. & Loan Ass’n v. Campney, 357 N.W.2d 613, 618 (Iowa 1984)).

[¶ 34] Here, the Barretts were not advised of and did not specifically agree to the arbitration terms of the fraudulently procured contract. The contract was presented on a take-it-or-leave-it basis; McDonald Investments was favored by greatly disparate bargaining power; the arbitrators are not bound by the law; and the arbitration process is managed by internal securities industry organizations.

[¶ 35] The contract between the Barretts and McDonald Investments is a contract of adhesion, and it appears to be procedurally unconscionable, considering the factors discussed above. See Circuit City Stores, Inc. v. Adams, 279 F.3d 889, 892-95 (9th Cir.2002), cert. denied, 535 U.S. 1112 , 122 S.Ct. 2329 , 153 L.Ed.2d 160 (2002); Irwin, 324 F.Supp.2d at 1108.

[¶ 36] Substantive unconscionability or unfairness “ ‘focuses on the terms of the agreement and whether those terms are so one-sided as to shock the conscience.’ ” Ferguson, 298 F.3d at 784 (quoting Kinney v. United Healthcare Sens., Inc., 70 Cal.App.4th 1322, 1330 , 83 Cal.Rptr.2d 348 (Cal.Ct.App.1999)); see also Al-Safin, 394 F.3d at 1261 . An agreement to procure someone’s life savings, obtained by knowingly fraudulent representations, is the essence of substantive unconscionability or unfairness that provides a valid defense against enforcement of the agreement, separate from the fraud defense. I would hold that the Barretts may bring their fraud claim and their defenses of fraud in the inducement and unconscionability directly to court, whether the arbitration clause is ambiguous or not.

. An unscientific review of annotations to the Federal Arbitration Act, 9 U.S.C.A. §§ 1-16 (West 1999 & Supp.2004) and the Maine Uniform Arbitration Act, 14 M.R.S.A. §§ 5927-5949 (2003), suggests that the vast majority of arbitration cases that reached appellate courts before 1975 or 1980 involved one of these three categories of business relationships.

. See Hooters of America, Inc. v. Phillips, 173 F.3d 933, 938-40 (4th Cir.1999) (declining to enforce arbitration clause in employment contract because arbitration forum and processes controlled by employer were one-sided and unfair).