Rosita Smith v. JEM Group, Inc. 737 F. 3d, 636 (9th Circuit Dec. 12, 2013)

The Ninth Circuit Court of Appeals recently addressed important questions concerning the ability of attorneys in Washington State to require clients to arbitrate disputes concerning the legal services rendered. The Court held that: (1) the question of the ability to arbitrate in an attorney retainer agreement is for the court to decide, regardless of whether the challenge to the arbitration clause itself is raised as a distinct claim in the complaint; and (2) an arbitration clause in an attorney retainer agreement is unenforceable if the attorney fails to disclose it fully.

Plaintiff Rosita Smith was the lead plaintiff in a proposed class action against JEM and others.
JEM had solicited Smith, offering debt settlement services. Smith signed a 4 page, fine print attorney retainer agreement. No explanation of the arbitration agreement was furnished, and the instruction on the document’s cover page was not informative. Defendants all moved to compel arbitration pursuant to the retainer agreement. Smith opposed the motion, contending that the arbitration clause was unconscionable. The District Court ruled on the motion and held the provision to be unenforceable.

On appeal, JEM argued that an arbitrator, not the District Court, should have determined whether the arbitration clause was unconscionable. JEM reasoned that, because the “crux” of the complaint was that the contract was invalid as a whole, and the complaint did not specifically attack the arbitration clause as unconscionable, an arbitrator should have decided the unconscionability challenge to enforcement of the agreement.

The Ninth Circuit Court disagreed, stating that “‘the question of arbitrability is for the court to decide regardless of whether the specific challenge to the arbitration clause is raised as a distinct claim in the complaint’ so long as ‘the plaintiff’s challenge to the validity of an arbitration clause is a distinct question from the liability of the contract as a whole…’” (quoting Bridge Fund Capital Corp.v. Fastbucks Franchise Corp., 622 F.3d 996, 998 (9th Cir. 2010)). JEM reasoned that the arbitration clause could not have been the crux of the complaint because the challenge to the clause was first made when Smith opposing the motion to compel arbitration.

After holding that it was proper for the District Court to rule on the validity of the arbitration clause, the Ninth Circuit turned to plaintiff’s claim that the arbitration provision was unconscionable. Under Washington law, a contractual provision is unenforceable if it is procedurally unconscionable. Nelson v. McGoldrick, 127 W.2d 124, 896 P.2d 1258, 1264 (1995) (en banc). The attorney must disclose the inclusion of an arbitration clause, which is a material term, to the same degree that all material terms in the attorney fee agreement are disclosed. The Ninth Circuit ruled that this arbitration clause was unconscionable because it was effectively buried in the document, and was never explained either within the document or otherwise.

Smith v. JEM is a reminder that Washington state attorneys who wish to require clients to arbitrate disputes must be careful to make the arbitration provision conspicuous and must take steps to fully disclose the provision to the client. The failure to do so means that the dispute will be decided in court, potentially by a jury, rather than by a potentially more favorable arbitrator. This lesson should be heeded by attorneys in other states as well given the persistence of client challenges to arbitration provisions on unconscionability grounds.