Arbitration agreements have always been a tricky proposition. They can help dealers avoid millions of dollars’ worth of damages and legal fees resulting from class-action lawsuits. They also offer a means to quickly and cost-effectively resolve consumer disputes. But what if a customer refuses to sign the agreement? And if they do sign, how do you know it will hold up in court?

The answers are not yet known, but the ruling in a case that concluded earlier this year shed some light on how courts will view such contract provisions going forward. Back in 2006, Vincent and Liza Concepcion signed up for a new service plan with AT&T Mobility. They found they had to pay the sales tax on phones the provider said were free. The Concepcions sued, charging AT&T with deceptive advertising. Their suit became a class action, but the contract the Concepcions signed contained a clause that limited the signees’ recourse to individual arbitration. AT&T sought to have the case dismissed.

The company’s request was denied by the U.S. District Court of Southern California and the Ninth Circuit Court of Appeals, but the U.S. Supreme Court ruled in its favor. In a 5-4 decision, the court found that such agreements are enforceable under the Federal Arbitration Act of 1925.

The ruling was good news for dealers who employ arbitration agreements. However, it did not eliminate all questions regarding the enforceability of arbitration agreements.

In a case filed last year by a car buyer against a California Mercedes-Benz dealership, the Second District Court of Appeals found the arbitration provision unenforceable due to a number of clauses. That’s why it’s important that you make the following considerations before giving arbitration agreements a second look:

Understand the Risks: Some states, like California, have more case law and controversy involving arbitration provisions than others. That means you must be aware of the level of legal acceptance or controversy regarding such agreements in your state. 

Arbitration Terms Must Be Reasonable and Fair: This is a key consideration for all arbitration agreements in all states. Aside from reviewing whether the process of agreeing to an arbitration provision is fair, courts will also consider whether the substance of the arbitration terms is fair. Is the buyer aware of the provision, and does he or she have a chance to review it and negotiate the terms? Do the terms unreasonably favor the seller?

An example of process fairness is whether arbitration is truly a negotiable term with buyers. If it is, then a term that gives a perceived benefit to just one party (i.e., the seller) may be tolerated as part of typical negotiations — but only if the overall arbitration provision seems reasonable. So, if obtaining financing is predicated on the buyer agreeing to the arbitration provision, the agreement will appear unfair or heavyhanded because the buyer has no choice but to agree to it.

At a minimum, the seller should explain that the contract has an arbitration provision. They also should direct the buyer’s attention to the provision, provide an opportunity for them to review it, and provide an option for them to reject the arbitration provision without losing financing. Notices and reminders in the contract also are helpful in proving that the buyer knew about the arbitration provision and that he or she could reject the provision without losing financing.

Dealership Practices Must Remain Compliant: A fair and well-crafted arbitration agreement will still come under intense scrutiny if the facts of the case involve dealer deception or other misconduct. That was the case in the previously mentioned suit brought by a car buyer against Mercedes-Benz of Valencia (Calif.).

The suit alleged that the dealership violated several California laws. Among the charges, the car buyer, Gilbert Sanchez, claimed the dealership told him he had to pay to have his vehicle certified if he wanted to qualify for a lower interest rate. The fee, however, was used to pay for a vehicle service contract. Additionally, he claimed the dealership charged him for new tires when not all of the tires were new.

The contract also indicated Sanchez made a $15,000 down payment when he actually paid only $10,000. Sanchez later paid the difference
unknowingly, according to court documents.

Perhaps the issues involved in the case can be explained as buyer misunderstanding, miscommunication between the parties or simple dealer mistakes. But those misunderstandings, combined with other allegations, made the dealer look bad, and cast suspicion on all of the dealer’s business practices, including its arbitration terms. It’s unlikely that a court will allow a dealer to use arbitration as a shield to prevent a buyer, or a group of buyers, from redress for perceived dealer misconduct.

The U.S. Supreme Court’s Concepcion ruling was a victory for dealers, but it didn’t eliminate all questions surrounding the enforceability of arbitration agreements. But if all considerations are made, arbitration provisions can go a long way in helping dealers avoid lengthy and costly legal battles.

Chip Zyvoloski is senior attorney for Indirect Lending at Wolters Kluwer Financial Services. E-mail him at [email protected].