Arbitration agreement found unconscionable by containing waiver of substantial rights: MORTGAGE ELECTRONIC REGISTRATION SYSTEMS, INC. VS. ABNER (COA 7/25/2008)

DATE RENDERED: 7/25/2008

The trial court denied appellant’s motion to compel arbitration finding the arbitration agreement to be unconscionable. This appeal ensued.

Appellants are correct that Kentucky law favors arbitration agreements. In fact, in 1984, Kentucky adopted the KUAA, codified at Kentucky Revised Statutes (KRS) Chapter 417. KRS 417.050 provides that “a written agreement to submit any existing controversy to arbitration between the parties is valid, enforceable and irrevocable, save upon such grounds as exist at law for the revocation of any contract.”

However, while “any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration,”
the existence of a valid arbitration agreement as a threshold matter must first be resolved by the court.
The court -not an arbitrator- must decide whether the parties have agreed to arbitrate based on fundamental principles governing contract law. See
Louisville Peterbilt, Inc. v. Cox, 132 S.W.3d 850 (Ky. 2004).

Here, contrary to Appellants’ argument, Appellees are not simply claiming that the mortgage contract as a whole is unconscionable, but rather that the arbitration clause itself is unconscionable and unenforceable. The Supreme Court in
Prima Paint Corporation v. Flood and Conklin Manufacturing Company, 388 U.S. 395, 403, 87
S.Ct. 1801, 18 L.Ed.2d 1270 (1967) commented while claims of fraud are to be submitted to an arbitrator, claims that specifically attack the arbitration provision are to be judicially determined.   And indeed, the trial court specifically stated that it had considered the arbitration clause separately from the remaining contract in reaching its decision to deny arbitration.

Under the provisions of KRS 417.050, an arbitrable dispute is subject to the compulsory arbitration provision except where the agreement may be avoided “upon such grounds as exist at law or in equity for the revocation of any contract.” One of the equitable grounds upon which an arbitration clause may be deemed unenforceable is unconscionability.

While a bargain is not unconscionable merely because the parties to it are unequal in bargaining position,
an arbitration clause that contains a “substantial waiver of a parties’ rights’ is unenforceable.” 

As noted by Appellees herein, not only would a successful rescission void the mortgage and eliminate all charges and fees, they may be entitled to statutory damages for any TILA
(Truth in Lending Act) disclosure violation, as well as enhanced statutory damages for violations of HOEPA
(Home Owner Equity Protection Act).

The COA conclued the arbitration provision contained in Appellees’ contract clearly prevents them from meaningfully pursuing any statutory claims.
Although an arbitrator can resolve claims under TILA and HOEPA,  the provision herein explicitly prohibits the arbitrator from modifying the contract or awarding anything other than actual damages. As such, Appellees could in no manner recover any statutory damages to which they may be entitled.
Held that because the arbitration clause deprives Appellees of any substantive remedies, the trial court properly ruled that it is unconscionable and unenforceable.

Digest by Michael Stevens, ed.

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