NC COA: Tillman Substantive Unconscionability Test No Longer Valid

The North Carolina Court of Appeals' unanimous decision in Torrence v. Nationwide Budget Finances dramatically reshapes the law governing the unconscionability of arbitration clauses.  The Court of Appeals held that the United States Supreme Court’s recent rulings regarding arbitration clauses in AT&T Mobility LLC v. Concepcion and American Express Co. v. Italian Colors Restaurant have undermined North Carolina Supreme Court’s reasoning in Tillman v. Commercial Credit Corp., the leading North Carolina case on the unconscionability of arbitration clauses.  If Torrence stands, it will eliminate the current test for determining whether an arbitration clause is substantively unconscionable and, by extension, the entire test announced in Tillman regarding the unconscsionability of arbitration clauses.

This case arises out of the relationship between two borrowers, James Torrence and Tonya Burke, and County Bank of Rehoboth Beach, an FDIC insured Delaware bank that offered short-term consumer loans in North Carolina.  In 2003 and 2004, the borrowers obtained eighteen loans or loan renewals from County Bank.  The borrowers signed an identical note and disclosure agreement in connection with each loan or renewal which contained an agreement to arbitrate all disputes that arose from the loans and a waiver of the borrower’s right to participate in a class action related to the loans.  The National Arbitration Forum ceased conducting arbitrations shortly after the borrowers signed the loan agreements.

The borrowers subsequently brought claims against the defendants alleging violations of North Carolina’s Consumer Finance Act, the North Carolina unfair trade practice laws, and North Carolina usury laws.  The plaintiffs sought to have the matter certified as a class action.  The defendants responded by filing an answer, a motion to dismiss due to lack of personal jurisdiction, and a motion to compel arbitration.

 The trial court denied the motion to compel arbitration, denied the motion to dismiss, and granted a motion certifying the action as a class action.  The trial court denied the motion to compel arbitration based, in part, on the grounds that the arbitration agreements were procedurally and substantively unconscionable.  The defendants immediately appealed the trial court’s order.

 After reviewing the applicable cases, the Court of Appeals found itself “in the difficult position that the holdings of the North Carolina Supreme Court in Tillman conflict with those of the United States Supreme Court in Concepcion and Italian Colors.”
 The United States Supreme Court’s opinions, which were both issued after Tillman, rejected the various factors the North Carolina Supreme Court utilized in Tillman to determine that an arbitration clause was substantively unconscionable.  These factors were (1) prohibitively high arbitration costs; (2) an arbitration clause that is excessively one sided and lacking mutuality; and (3) a provision in the arbitration agreement which prohibited joinder of claims and class actions.

The Court of Appeals determined that the trial court should not have focused on the potential for prohibitively high arbitration costs because, in Italian Colors, the United States Supreme Court rejected the Second Circuit’s approach which focused on the cost of developing evidence which the parties could use to support their claims.  The reasoning of Italian Colors was construed by the Court of Appeals “as eliminating the type of cost analysis applied by the North Carolina Supreme Court in Tillman.”
 The one sided nature of an arbitration agreement was no longer a valid ground for finding the arbitration clause to be unconscionable because the United States Supreme Court “in Concepcion was dismissive of the idea that an arbitration agreement, apart from any other form of contract, could be found unconscionable based upon its adhesive nature.”  Given that most consumer contracts are now contracts of adhesion, “the one-sided quality of an arbitration agreement is not sufficient to find it substantively unconscionable.”

 Finally, the United States Supreme Court’s opinions in both Concepcion and Italian Colors precluded using the presence of a class action waiver in an arbitration agreement as a ground for finding the agreement to be substantively unconscionable.  Such an arrangement is not unconscionable because parties are able to “‘effectively vindicate’ their rights in the context of a bilateral arbitration.”

 After applying Concepcion and Italian Colors, there were no remaining grounds to find the arbitration agreement at issue to be substantively unconscionable.  Because under Tillman a contract must be both procedurally and substantively unconscionable to be declared unenforceable, the lack of substantive unconscionability required the reversal of the trial court’s order.

As the Court of Appeals’ analysis focused on the Tillman factors generally and not the specifics facts of this case, this case could spell the end of the Tillman test and broaden the ability of corporations to utilize arbitration clauses in consumer contracts.  However, given that the opinion finds that a North Carolina Supreme Court opinion is no longer applicable and will have a large impact on consumer transactions across the state, it is likely that the North Carolina Supreme Court will weigh in on Tillman’s continuing viability before this case is over.