Hawaii Finds Arbitration Agreement With “Severe Limitations on Discovery” is Unconscionable, By Liz Kramer*

Hawaii issued a bold arbitration decision this month. It applied its state contract law to conclude that the parties did not form a clear arbitration agreement, but even if they did, it was unconscionable because it prohibited both discovery and punitive damages.  Narayan v. The Ritz-Carlton Dev. Co., Inc., __ P.3d __, 2015 WL 3539805 (Haw. June 3, 2015).

Kapalua Bay Beach

The plaintiffs purchased the first condos in a development in Kapalua Bay.  The developer defaulted on loans, however, and it or its agent withdrew over a million dollars from the association’s operating fund.  The plaintiffs sued for breach of fiduciary duty and other claims.

In response, the developer moved to compel arbitration.  It argued that the plaintiffs’ purchase agreements incorporated the condominium declaration, which had an arbitration clause.  The trial court denied the motion to compel, but the intermediate court of appeals reversed.  The Hawaii Supreme Court found the intermediate court gravely erred and the plaintiffs did not have to arbitrate their claims.

Under Section 2 of the FAA, the Hawaii Supreme Court applied state law to decide whether an arbitration agreement existed and whether it was valid.

On the first question, the Hawaii Supreme Court found the parties did not form an agreement to arbitrate, because the purchase agreement was ambiguous regarding the parties’ intent to arbitrate.  Notably the purchase agreements themselves did not mention arbitration and instead stated that the venue for any action shall be in Hawaii state court.  The arbitration clause was only included in the separate condominium declaration.  The court found “it is facially ambiguous whether those disputes would be consigned to arbitration in Honolulu pursuant to the condominium declaration or the [state court] pursuant to the purchase agreement.”  The court’s analysis applied Hawaii case law that appears to create different (and higher) standards for proving the existence of an arbitration agreement than the standards required to prove other contracts.  But, Hawaii avoided any FAA preemption problem by offering up a second, independent basis for its refusal to enforce the arbitration clause: unconscionability.

The court also found the arbitration agreement unconscionable under Hawaii law.  It found it was procedurally unconscionable because the plaintiffs could not negotiate it, it was “buried in an auxiliary document,” and it was ambiguous.  With respect to substantive unconscionability, the court focused on three provisions of the arbitration agreement.  The arbitration agreement provided that the arbitrator could order the parties to exchange copies of “nonrebuttable exhibits” and witness lists, but “the arbitrator shall have no other power to order discovery or depositions unless and then only to the extent that all parties otherwise agree in writing.”  The arbitration agreement  also precluded parties from “disclos[ing] the facts of the underlying dispute…without prior written consent of all parties.” The Hawaii Supreme Court concluded that “if the arbitration clause were enforced as written, the [plaintiffs] would have virtually no ability to investigate their claims, and thus, would be deprived of an adequate alternative forum.”  Furthermore, the arbitration agreement precluded punitive damages, which the court found “substantively unconscionable” in a contract of adhesion.

If there is a continuum of state arbitration decisions, varying from hostile to arbitration on one end to rubber-stamping of arbitration on the other end, I think Hawaii just situated itself on the very hostile end, even further than California and Missouri.  But, this case offers a reminder of two important rules for drafters of arbitration clauses: make the agreement to arbitrate very clear and easy to find; and do not overreach when inserting arbitration provisions that favor your client.

------------------------
* Liz Kramer is a partner at Stinson Leonard Street LLP where she handles complex commercial disputes, often in the construction and franchise contexts.  After litigating arbitrability on many occasions, Liz began blogging about arbitration law at www.arbitrationnation.com in addition to her law practice in 2011.  Her blog has been recognized as one of the best in the nation by the ABA Journal for the past three years and educates thousands of lawyers each month about the Federal Arbitration Act and its interpretation.