Background

Arbitration agreements are frequently found in direct seller consultant contracts. Therefore, court decisions related to these agreements are of considerable interest to DSA members.

On April 20, 2010, a U.S. Ninth Circuit Court of Appeals three-judge panel upheld a 2007 U.S. Northern District of California’s decision that invalidated a requirement that disputes between Quixtar (Amway) and its distributors be resolved through Amway’s mandatory “Alternative Dispute Resolution (ADR)” process.

The Ninth Circuit panel found that California law should be applied to the case and that the ADR provisions were unconscionably one-sided in favor of Quixtar.

This decision is the latest development in a series of legal actions between three former Amway distributors and the company. There were two main underlying charges by the former distributors. The first claim was that Amway products are priced “so high that any profit through resale is virtually impossible.” Secondly, the plaintiffs alleged that Amway and its senior Independent Business Owners (IBOS) induce junior IBOs to purchase business support materials with the main purpose of the purchases being to recruit and register new IBOs and not to assist the IBOs in conducting their own successful Amway businesses.

The Ninth Circuit Court decision does not speak to the core claims of the plaintiffs.

Amway has responded to the court decision by saying that it expected the ruling and it continues to believe the allegations of the former distributors have no merit.

“The Ninth Circuit historically has been skeptical of contract arbitration. The decision is merely a procedural step on a long road to trial. In fact the original motion ruling that Quixtar appealed in this case was written more than two years ago. Since that time, concerns about the arbitration process have been fully addressed,” according to a prepared statement from Amway.

Applicability of California Law

The Ninth Circuit Court agreed with “the district court that California law applies, because Quixtar has failed to establish that Michigan has a legitimate interest in the application of its law under the circumstances of this case” (p. 5984).

In addressing the issue of whether California law should apply in determining whether the ADR agreements between the former-distributors and Quixtar were unconscionable, the Court applied the Federal Arbitration Act (FAA). The Ninth Circuit Court upheld the district’s court decision that California law should apply, since the question of whether the ADR agreements were unconscionable did not fall within the ADR agreement’s choice of law clause (p. 5985).

Unconscionability of ADR Agreements

Applying California law, the Ninth Circuit Court reviewed the conscionability of the ADR agreement on procedural and substantive grounds. The Ninth Circuit subsequently found that the district court properly determined that the ADR agreement was unenforceable, because it was procedurally and substantively unconscionable (pp. 5988-6003).

Quixtar did not dispute that it occupied a superior bargaining position to that of the former distributors. Nor did Quixtar dispute that the plaintiffs did not individually participate in the negotiation of the terms of the ADR agreements, or that the agreements were presented to the plaintiffs on a “take-or-leave-it” basis. The Court found these facts to be quintessentially characteristic of a procedurally unconscionable agreement (p. 5989).

The Court rejected Quixtar’s arguments that the terms of the ADR agreements were procedurally conscionable, since they were negotiated with the Independent Business Owners Association International, the agreement appeared in plain text on the front pages of the registration agreement, and the plaintiffs could have refused to become Quixtar distributors. (pp. 5989-5990).

The Court then focused on the substantive unconscionability of the ADR agreement. The Court found the non-binding conciliation provisions of the ADR agreement to be overly favorable to Quixtar. The Court also held that the binding arbitration portion of the agreement and the confidentiality requirements in IBO’s Rules of Conduct were unconscionable. Additionally, the Court found the Rules of Conduct included “a fee-shifting clause that unfairly exposes IBOs to a greater financial risk in arbitrating claims than they would face if they were to litigate those same claims in federal court” (p. 6002).

Quixtar contended the former distributors had the burden of establishing that arbitration of their claims in accordance with the Quixtar ADR process would expose them to actual financial hardship, rather than a mere risk of such hardship, and that they failed to do so. The Court rejected this argument (p. 6003).

The case will be remanded to the district court for trial.

Conclusion

It should be stressed this is a procedural ruling, not a trial verdict, making the final adjudication of the former distributors’ allegations far from complete. This decision focused on the key issue of whether or not the former IBOs (plaintiffs) were required to go into arbitration.

This is an issue of interest to many DSA members, and a matter that will be discussed by the Lawyers Council. DSA will continue to monitor any subsequent proceedings and update the Lawyers Council as warranted.