In an important decision which will impact the enforceability of mandatory
arbitration contracts in California, the United States Court of Appeals for the Ninth Circuit,
interpreting California law, found a complex alternate dispute resolution scheme to be
procedurally and substantively unconscionable where the Rules governing disputes were
not unilateral, the Rules required two pre-arbitration stages of mediation before a body
influenced by the drafting organization and where the Rules governing disputes were not
attached to the agreement.
This decision was reached in the case of Pokorny v. Quixtar, Inc. (2010) Daily
Appellate Report, page 5810 (“Pokorny Case”). In the Pokorny Case, a group of
distributors signed a series of Independent Business Owner Agreements with Amway
Corporation for the marketing and sale of a variety of products. That group later sued
Quixtar, Inc. (as successor in interest to Amway Corporation) ("Quixtar") in a class action
alleging the operation of an illegal pyramid scheme in violation of the Racketeer Influenced
and Corrupt Organizations Act (“RICO”), 18 U.S.C. § 1961 et seq., and California Business
and Professions Code §§ 17200 et seq. and 17500 et seq.
Quixtar and the other defendants moved to dismiss the class action or to stay the
action and compel the plaintiffs to resolve their claims through Quixtar’s ADR process.
The Quixtar ADR process was referred to in an agreement to arbitrate contained in the
Independent Business Owner Agreements (signed annually by each plaintiff) which
incorporated Dispute Resolution Procedures found in Quixtar’s Rules of Conduct.
Under the Quixtar ADR process (which the plaintiffs did not comply with), the
plaintiffs would have been required to follow a three-step ADR process. As the first step
in the three part process, the Rules of Conduct required an aggrieved plaintiff to attempt to
resolve any dispute it had with Quixtar through a non-binding process of “Informal
Conciliation.” During Informal Conciliation, Quixtar’s Business Conduct and Rules
Department would work with the affected parties to resolve the dispute. Quixtar equated
Informal Conciliation to a “standard commercial mediation.” If Informal Conciliation did
not resolve the dispute, the Rules of Conduct next required the plaintiff to initiate a second,
non-binding process of “Formal Conciliation” by requesting a hearing before the
Independent Business Owners’ Association International (“IBOAI”) Hearing Panel. As for
the IBOAI panel, it was limited to certain Independent Business Owners which had
reached a high level of sales (platinum level)1. The IBOAI panel would then issue a
recommendation which Quixtar (only) could accept, reject or modify. If that stage (based
on the response from Quixtar to the IBOAI recommendation) did not result in a resolution,
binding arbitration was to occur before a Quixtar trained arbitrator with JAMS, or if the
plaintiff objected, then an arbitrator with the American Arbitration Association. The
arbitration had to occur no sooner than 90 days after the claim was made or the completion
of Formal Conciliation, whichever was later, and no more than two years after the issue
arose. In addition, the Rules of Contract were not attached to the Independent Business
Owner Agreement. Also, the ADR process was unilateral in that Quixtar was not
necessarily obligated to go through the process for its own claims under the Independent
Business Owner Agreements and the ADR process rules contained a confidentially clause,
among other things.
The District Court denied the Quixtar parties’ Motion on the basis that the ADR
process was procedurally and substantively unconscionable. The Quixtar parties then filed
a timely interlocutory appeal based on their contention that the District Court should not
have applied California law and that it erred in holding that the ADR provisions were
unconscionable under California law.
The Court of Appeal affirmed the decision of the Trial Court in a published opinion
which was released on April 20, 2010. In its holding, the Court of Appeal first determined
that California law did apply as the forum desired by Quixtar, Michigan, did not have a
legitimate interest in the application of its law to the case and its interpretation of the
governmental interest analysis required the application of California law. Thereafter, the
Court, applying California law, held that the ADR process was procedurally and
substantively unconscionable. See, Davis v. O’Melveny & Myers (9th Cir. 2007) 485 F.3d
In its holding, the Court of Appeal rejected Quixtar’s arguments that the ADR
process appeared in the plain text of the Independent Business Owner Agreements, that the
IBOAI Board negotiated the rules of the ADR process and that the plaintiffs could have
decided to not sign the Independent Business Owner Agreements. The Court of Appeal
also found the ADR process to be unconscionable because (i) it was unilateral, i.e., the
plaintiffs, not Quixtar, were required to go through non-binding mediation and Quixtar
alone could accept or reject the recommendations of the IBOAI panel, (ii) there was a
shortened statute of limitations (two years from initiation of the process), (iii) there were
confidentiality requirements, (iv) certain rules in the ADR process were not attached to the
form Independent Business Owner Agreement, (v) the arbitrator had the discretion to shift
costs against the losing party which could not be imposed in a civil action under California
1 None of the plaintiffs were members of the IBOAI or eligible for election to that body.
procedural law and (vi) the arbitrator would be selected from a panel of JAMS arbitrators
which had taken Quixtar training (although there was an opt out for an Arbitrator from the
American Arbitration Association).
Of note to the authors is that the Court of Appeal in the Pokorny Case did not cite
the recent California Court of Appeal decision in Young Seok Suh v. Superior Court (2010) 181
Cal.App.4th 1504 which similarly held that the American Health Association arbitration
rules, which barred claims for consequential, exemplary, incidental, punitive or special
damages, were procedurally and substantively unconscionable. Nevertheless, the Pokorny
Case sends a clear message that the Courts will take an active role in examining complex
arbitration contracts for being procedurally and substantively unconscionable. Arbitration
clauses which are unilateral, limit damages or lessen statute limitation periods, and/or
permit one party to influence the training or selection of neutrals, are particularly suspect
and will be subject to significant scrutiny.
About the Authors: Edward F. Morrison, Jr. is the founding partner and Brett C. Drouet is
a partner of The Morrison Law Group, a professional corporation. Their biographies can be
viewed at the website www.morrisonlawgroup.com.
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