Arbitration Wars and the UCC – Unconscionability and Limits on the Arbitrator’s Powers

A recent California appeals court decision highlighted some interesting issues concerning the interplay between arbitration and the Uniform Commercial Code.

The case is J.C. Gury Company v. Nippon Carbide Insurance (USA) Inc. (2007) 152 Cal. App. 4th 1300, 62 Cal. Rptr. 118. Here, a manufacturer brought an arbitration proceeding against its supplier (Nippon Carbide). Apparently the manufacturer had encountered problems with the supplier's product after the supplier moved its production operations from Japan to China. The contract contained an arbitration agreement. The arbitration clause provided that the arbitrator would not have the power to change, modify or alter any expressed term of the contract. The contract also contained a fairly standard limited warranty and a limited remedy providing that the buyer's sole recourse was the replacement of the defective product.

In the arbitration proceeding the buyer sought consequential damages greatly in excess of the replacement costs, and attacked the warranty and remedy limitations as unconscionable. The arbitrator concluded that the exclusion of consequential damages would be unconscionable, based upon the lengthy course of dealing between the parties, the absence of any discussion concerning a warranty disclaimer or damage limitation and Nippon Carbide's superior bargaining position.

Nippon Carbide sought to overturn the arbitration award based on a claim that it was in excess of the arbitrator's powers. Its argument was founded on the contract clause prohibiting the arbitrator from varying the terms of the contract.

The court ruled against the manufacturer, noting that Nippon Carbide had never raised this issue with the arbitrator. By failing to raise a claim of limited powers with the arbitrator, Nippon Carbide had waived its right. In so doing it unequivocally submitted the issue of unconscionably to the arbitrator, and could not thereafter complain about the result.

The obvious moral of the story: it is imperative to raise all issues directly concerning the arbitrator's powers at the actual hearing.

But the case raises some other interesting issues. For example, was the manufacturer best served by an arbitration clause in this commercial context? Would it have done better if it had been able to bring its claim before a court, especially a federal court sitting in diversity jurisdiction? In that context would it have obtained a more favorable forum for consideration of the concept of unconscionability?

A second interesting issue: the court stated, with virtually no analysis, that an arbitrator's determination of “unconscionability” would in fact violate the arbitration agreement’s prohibition on the arbitrator modifying or altering the contract. This implies or suggests that the parties are free to indirectly waive the unconscionability protections of the Uniform Commercial Code by their use of an arbitration clause of the type found here. Did the court fully intend this result? Under the analysis suggested by this court, a party using an arbitration agreement could be free to impose contractual terms that would otherwise be oppressive, burdensome and unconscionable under the standards of the Uniform Commercial Code.