Last year, a California court struck down the arbitration provision in a law regarding dealership sales contracts.

The dealer in that case has appealed. But for now, the arbitration provision in the LAW 553-CA-ARB sales contract and potentially similar arbitration contract provisions are not enforceable in California. 

While state-court decisions in one state have no legal weight elsewhere in the U.S., some state courts may follow the reasoning of the California Court of Appeal and similarly find the arbitration provision unenforceable.

This article discusses how dealers can try to protect themselves. But first, a quick primer on why this is important.

The struck-down California arbitration provision contains a class-action waiver that prohibits consumers from participating in a class action against a dealer. The U.S. Supreme Court in 2010 held that class-action waivers in arbitration agreements are enforceable.

In some states, such as California, the law allows consumers to cancel a sale contract for technical violations of consumer-protection statutes.

Think about it: A class of 2,500 customers over a few years rescinding sale contracts at an average of $20,000 a pop is $50 million, less the diminished value of the returned vehicles. A case like this could easily make a dealer scream “Uncle.”

But some courts view these class-action waivers as they once did jury waivers: with disdain. They have become hostile to the notion that a consumer may not want to pursue a small financial claim because it doesn’t make economic sense for him to file a lawsuit on his own behalf. Yet his ability to participate in a class action is barred by a waiver in an arbitration agreement, leaving him with no real remedy.

Since the U.S. Supreme Court has deprived state courts of the ability to invalidate arbitration provisions due to the existence of the class-action waiver clause alone, courts have found other grounds to invalidate arbitration provisions containing class-action waivers.

In invalidating the arbitration provision in California, the court cited “unconscionability” in declaring the provision unenforceable because it was allegedly one-sided or unfair. 

The court held that because the consumer didn’t know the sale contract contained an arbitration provision and the appeal and self-help provisions in the agreement favored the dealership, the entire arbitration provision was unenforceable.

Short of rewriting the agreement or deleting certain provisions (try explaining that to a lender asked to finance a deal), dealers can’t do anything about the appeal and self-help provisions that the California court didn’t like.

But in many states, as in California, unconscionability is not present unless the arbitration provision in the sale contract is both a surprise to the consumer and contains one-sided, unfair terms.

It’s a balancing test. The more surprise there is, the less unfairness there must be for a court to invalidate the contract.  And whether the arbitration provision is a surprise to the consumer is within the control of the dealer.

As a result, some dealers are considering drawing the customer’s attention to the provision, underlining the reference to the arbitration provision on the front side of the contract and requiring the customer to initial the form next to that reference.  Another approach is to show the arbitration provision to customers, ask them to read it, then initial each copy. 

Where law permits, some dealers are even considering adopting an acknowledgement for customers to sign, certifying they were informed that either party is permitted to demand arbitration of any claims arising from the transaction, was given the opportunity to read the arbitration provision in its entirety and finally, that he or she did read it and agreed to its terms.

The more proactive the dealer, the better chances of successfully enforcing arbitration against a litigious consumer who joins a class action demanding multimillion-dollar settlements.

To make sure they comply with their state law, dealers should consult their attorney before adopting or modifying any arbitration agreement or procedures.  In the meantime, form and finance companies should take the California message to heart and amend their arbitration provisions accordingly.

Attorney Christian Scali is a litigation partner in Arent Fox’s auto-industry group.