Arbitration or litigation: Making sure your agreement doesn't miss the mark

Arbitration is a popular way for companies to manage disputes, avoid costly litigation, and maintain control over how conflicts are resolved. California is the most litigious state, with plaintiffs' attorneys routinely filing seemingly meritless claims and threatening putative class actions against businesses. Without proven and enforceable arbitration provisions, businesses are forced to litigate these claims in court, generating substantial legal bills and potentially extraordinarily large and disproportionate jury verdicts. Many businesses assume they have a valid and binding arbitration agreement only to find out (often too late) that it does not hold up under California law due to the state's robust consumer protection laws. As ubiquitous as arbitration provisions are, courts frequently scrutinize them, and a poorly drafted or improperly implemented provision will likely be found nonbinding. Indeed, even well-drafted provisions often face litigation. This article explores key considerations for businesses to enhance the likelihood that their arbitration provisions will be enforceable, including:

Clear and conspicuous language,

Explicit and informed consent,

Unconscionable terms,

California specific arbitration statutes, and

Governing law and scope.

Ensure clear and conspicuous language

California courts require arbitration provisions to be unambiguous and noticeable to avoid being deemed unconscionable. Vague or hidden terms will not be enforceable. Arbitration provisions must clearly and explicitly state that parties waive their right to a jury trial (and/or the right to litigate as a class action). Provisions should avoid legal jargon whenever possible and should ensure the language is both accessible and comprehensible to the average consumer.

Obtain explicit and informed consent

Consent is key to any enforceable arbitration agreement. In California, implied consent or agreements tucked into fine print often fail judicial scrutiny. Businesses should secure an affirmative and documented agreement to an arbitration provision - whether through a signed document, an electronic acknowledgment, or a conspicuous "I Agree" checkbox. A business should present the terms to the consumer before finalizing any transaction. Courts frequently uphold arbitration provisions contained within a clearly hyperlinked "Terms and Conditions" link immediately below or adjacent to a "Place Order" or "Complete Transaction" button. In this instance, the text of the hyperlink needs to stand out from the page, often in a different color font or with some form of emphasis such as bolding or underlining. Hyperlink text should not be smaller than the font surrounding it, and best practices dictate a slightly larger font.

Avoid unconscionability traps

California courts frequently invalidate arbitration provisions that are unconscionable. Unconscionability includes two prongs: procedural (unfair process) and substantive (unfair terms). Procedural unconscionability focuses on how the provision is presented to the consumer. In most online transactions, procedural unconscionability is lessened because the consumer is not under pressure to buy a product. Substantively, it is important to make sure the terms are balanced, meaning both parties should bear similar obligations. For example, requiring only the consumer to arbitrate while allowing the business to litigate in court is likely to be found unconscionable. While this is a case-by-case situation, careful consideration and review should be given to arbitration provisions to make sure they are commercially reasonable and balanced.

Comply with California-specific statutes

California imposes unique statutory requirements that can derail arbitration provisions. The California Arbitration Act (CAA) governs alongside the Federal Arbitration Act (FAA), but state-specific rules often take precedence unless preempted. For example, the FAA favors arbitration, whereas arbitration may not be compelled under the CAA if the parties are involved in related litigation, despite a valid arbitration clause. Further, the CAA provides additional grounds for vacating an arbitration award compared to the FAA. Consulting legal counsel to reconcile state and federal law is critical.

Specify governing law and scope

Ambiguity about which law governs or what disputes are covered can lead to enforceability disputes. Clearly state whether the FAA or CAA applies - FAA designation can bolster enforceability by preempting some California restrictions. Define the scope of arbitrable issues broadly but precisely, such as "all disputes arising out of or relating to this agreement," to avoid carve-outs that invite litigation.

Regularly update and review arbitration provisions

Laws evolve, and so should arbitration provisions and processes. California's legal landscape frequently shifts with new legislation and court rulings. Likewise, consumer attorneys are constantly creating new ways to challenge arbitration provisions. Businesses should conduct frequent (e.g., at a minimum, yearly) reviews to ensure their arbitration provisions comply with current standards. For multistate businesses, tailor California-specific provisions (or at a minimum, ensure compliance with California law) to avoid a one-size-fits-all approach that might falter locally.

Conclusion

A well-crafted arbitration provision is a powerful tool for businesses, but in California, enforceability hinges on careful drafting, transparent consent, and compliance with state-specific nuances. By prioritizing clarity, fairness, and adaptability, businesses can avoid the costly realization that their arbitration agreement does not do what they thought it did. The stakes are high, as litigation can drain resources and expose companies to unpredictable jury awards. Investing in enforceable arbitration provisions and practices upfront is not just prudent, it is a strategic necessity in California's legal environment.