09-1562 | Omnilex

Testo completo

UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT

August Term, 2009

(Argued: November 18, 2009
Decided: July 12, 2010)

Docket No. 09-1562-CV

JOSHUA G. FENSTERSTOCK, an individual, on his own
behalf and on behalf of all similarly situated,

Plaintiff-Appellee,

\- V. -

EDUCATION FINANCE PARTNERS, a California corporation,

Defendant,

AFFILIATED COMPUTER SERVICES, INC., a Delaware
Corporation,

Defendant-Appellant.

Before: KEARSE, CABRANES, and STRAUB, Circuit Judges.

Appeal by Affiliated Computer Services, Inc., from an
order of the United States District Court for the Southern
District of New York, Thomas P. Griesa, Judge, denying its motion
to compel arbitration, holding arbitration clause of promissory
note unconscionable under California law because of class-action
and class-arbitration waiver provision. See 618 F. Supp. 2d 276
(2009) .

Affirmed.

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ORIN KURTZ, New York, New York (Karin E. Fisch,
Abbey Spanier Rodd & Abrams, New York, New
York, Alan E. Sash, Mclaughlin & Stern, New
York, New York, on the brief), for
Plaintiff-Appellee.

EDWARD K. LENCI, New York, New York (Hinshaw &
Culbertson, New York, New York, on the
brief) , for Defendant-Appellant.

KEARSE, Circuit Judge :

Plaintiff Joshua G. Fensterstock commenced this action
asserting state-law claims on behalf of himself and others
similarly situated, alleging that defendants Education Finance
Partners ("EFP") and Affiliated Computer Services, Inc. ( "ACS") ,
have engaged in fraudulent and deceptive practices in connection
with the solicitation, consolidation, and servicing of student
loans. ACS appeals from an order of the United States District
Court for the Southern District of New York, Thomas P. Griesa,
Judge, denying its motion (which was joined by EFP) to stay the
action and compel Fensterstock (a) to submit his claims to
arbitration, and (b) to do so on an individual basis, not a class
basis, in accordance with the terms of his loan agreement with
EFP. The district court denied defendants' motion on the ground
that, under California law, the arbitration clause of the
agreement is unconscionable and therefore unenforceable. On
appeal, ACS contends principally that the arbitration clause is
not unconscionable under California law, or that if it is, then
California law is preempted by the Federal Arbitration Act
("FAA") , 9 U. S.C. § 1 et seq., under which the clause is not

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unconscionable. For the reasons that follow, we disagree and
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affirm the order of the district court.

# I. BACKGROUND

The factual assertions in the complaint and in the
submissions with respect to the motion to compel arbitration,
accepted as true for the purposes of this appeal, show the
following. Fensterstock is an attorney who graduated from law
school in 2003 and was admitted to practice law in New York State
in 2004. EFP, a California corporation headquartered in
California, specializes in private student loans and is the holder
of Fensterstock's consolidated loan. ACS is a corporation that
services loans for EFP.

A. Fensterstock's Loan and the Allocation of His Payments

In mid-2006, Fensterstock responded to a solicitation
from EFP offering to consolidate his student loans in a single
loan. Fensterstock executed an EFP "Private Consolidation Loan
Application and Promissory Note" (the "Note"), and he received a
loan in the principal amount of $52,915.49 at a fixed rate of
interest equal to 9.32% per annum. The Note, defining "you" and
"your" to "mean Union Bank of California, N.A. pursuant to
agreements with Education Finance Partners, Inc., and assigns, "
and defining "I" and "me" as the borrower (Note, Terms and
Conditions Statement at 1), provided, inter alia, that " [t]his

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Note will be deemed to have been made in California, and your
decision on whether to lend me money will be made in California"
and that "the provisions of this Note will be governed by Federal
laws and the laws of the State of California, without regard to
conflict of laws rules" (id. at 3) .

Fensterstock's repayment period began on October 14, 2006;
he was to repay the loan over a period of approximately 29 years,
with 348 monthly payments of $440.74, each due on the 14th of the
month, for a total of $153,377.52 including interest (see
Complaint 1 29), plus one final payment of $335 (see id. 11 3,
36) due on October 14, 2035. The Note stated that payments would
"be applied first to charges, costs and fees, next to unpaid
interest, and then to Principal." (Note, Terms and Conditions
Statement at 3.)

Beginning October 14, 2006, Fensterstock made timely
payments on the loan; he was not subject to any charges, costs, or
fees. Through December 2007, he had paid a total of $7,051.84.
According to what Fensterstock refers to as " [t]he Amortization
Schedule" (e.g., Complaint 1 32), a total of $476.58 of that
amount should have been applied to reduce the loan's unpaid
principal (see id.). After learning that only $213.39 had been
applied to principal (see id.), Fensterstock inquired of ACS and
was informed that when his payment was received prior to the 14th
day of the month in which it was due, his entire payment was
treated as a payment of interest only (see id. 11 2, 57) .

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B. The Complaint and the Motion To Compel Arbitration

In April 2008, Fensterstock commenced the present action
on behalf of himself and others similarly situated, asserting
claims under California law (a) against EFP and ACS for breach of
contract, fraud, and unfair business practices, and (b) against
EFP for false and deceptive advertising practices. The complaint
alleges that EFP engaged in a scheme of deception by intentionally
failing to disclose to borrowers that unless their payments were
received on the precise day of the month on which they were due,
EFP and ACS would alter the Amortization Schedule's prescribed
apportionment of the payment between interest and principal,
"divert [ing] the entire payment to themselves as interest" and
thereby "prevent [ing] borrowers from paying off the principal of
their loans." (Complaint | 2.) The complaint alleges that,
through December 2007, the amount of Fensterstock's payments that
had been misallocated to interest totaled $263.19, and that if
misallocations (referred to by Fensterstock as the "hidden
penalty" or the "Amortization Penalty" (e.g., id. | 2 et seq. ) )
continued at that rate, Fensterstock would "be required to make an
enormous lump-sum payment" at the end of his repayment period,
"amount [ing] to thousands of dollars, not $335.00 as stated in the
Note." (Id. | 36.) Premising subject matter jurisdiction on
class action diversity of citizenship, see 28 U.S.C. § 1332 (d) ,
the complaint alleges that the value of the aggregate claims of
all class members will exceed $5 million. (See Complaint | 4.)

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The complaint alleges that the case should be certified as
a class action because, inter alia, the class is so numerous that
joinder of all members is impracticable and the relatively small
amount of damages suffered by each class member may make it
economically impractical for class members to prosecute
individual actions. (See id. (1 10, 15.) The complaint also
alleges that although the Note contains an arbitration clause
stating that "' [c]laims made as part of a class action or other
representative action [are subject to arbitration], and the
arbitration of such Claims must proceed on an individual (non-
class, non-representative) basis'" (id. [ 39 (quoting Note, Terms
and Conditions Statement at 4) (alterations in Complaint) ), the
clause is part of a contract of adhesion and should be declared
void as against public policy (see, e.g., Complaint 11 40-43) .

ACS, subsequently joined by EFP, moved for an order
staying the action and compelling Fensterstock to submit his
claims to arbitration and to pursue them on an individual, rather
than a class, basis. It attached to its motion, inter alia, a
copy of the Note, whose arbitration clause begins as follows:

ARBITRATION OF DISPUTES. PLEASE READ THIS
ARBITRATION PROVISION CAREFULLY. IT PROVIDES THAT
EITHER YOU OR I CAN REQUIRE THAT ANY CONTROVERSY OR
DISPUTE BE RESOLVED BY BINDING ARBITRATION (EXCEPT
FOR MATTERS THAT ARE EXCLUDED FROM ARBITRATION AS
SPECIFIED BELOW) . ARBITRATION REPLACES THE RIGHT TO
GO TO COURT, INCLUDING THE RIGHT TO A JURY AND THE
RIGHT TO PARTICIPATE IN A CLASS ACTION OR SIMILAR
PROCEEDING.

(Note, Terms and Conditions Statement at 3.) To the extent
pertinent here, the clause goes on to provide as follows :

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Agreement to arbitrate: You and I agree that either
you or I may, without the other's consent, require
that any Claims between you and me be submitted to
mandatory, binding arbitration except for certain
matters excluded below. This arbitration provision
is made pursuant to a transaction involving
interstate commerce, and shall be governed by, and
enforceable under, the Federal Arbitration Act (the
"FAA") , 9 U.S.C. §1 et seq., and (to the extent State
law is applicable), the State law governing this
transaction.

Claims subject to Arbitration include, but are not
limited to:

\* Claims made as part of a class action or other
representative action, and the arbitration of such
Claims must proceed on an individual (non-class,
non-representative) basis. If you or I require
arbitration of a particular Claim, neither you, me
[sic], nor any other person may pursue the Claim in
any litigation, whether as a class action, private
attorney general action, other representative action
or otherwise.

Severability, survival :

If any portion of this arbitration provision
is deemed invalid or unenforceable, the remaining
portions shall nevertheless remain in force.

(Id. at 3-4.) Defendants contended that, in light of these
provisions, the FAA required the court to stay the action and
compel Fensterstock to submit his claims, individually, rather
than on a class basis, to arbitration.

Defendants disputed the complaint's allegations that the
Note was a contract of adhesion whose terms Fensterstock had "had
no meaningful choice" (Complaint | 41) but to accept, and
disputed his contention that the arbitration clause is
unconscionable and against public policy. They pointed out,

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inter alia, that when Fensterstock entered into the loan agreement
he was a practicing lawyer seeking to consolidate his existing
loans, not a student whose education might be interrupted absent a
loan. They also argued that Fensterstock was an unusually
sophisticated borrower, submitting as evidence, inter alia, a June
2, 2008 printout of the description of Fensterstock on the
internet website of the law firm with which he was associated,
which stated as follows :

Joshua G. Fensterstock practices primarily in
the area of real estate law; including, negotiating
contracts, drafting commercial leases, and
representing clients at closings of purchases and
sales of residential and commercial properties.
Joshua is also involved in the firm's corporate
practice.

Before joining Isaacs & Associates, Joshua was
employed as an associate at a firm where he
represented lenders at the closings of purchases of
residential and commercial properties. Prior to his
work in the private sector, Joshua served as counsel
to the Nassau County Comptroller.

Joshua was admitted to practice law in
New York (2d Dep't) in 2004 and received his B.S.
magna cum laude from the State University of New York
at Albany in 1999, where he majored in business
administration.

(Declaration of Edward K. Lenci dated June 5, 2008, Exhibit D; see
also id. (June 2, 2008 printout of Fensterstock's description of
himself on the LinkedIn website, stating that his " [s]pecialties"
include "diverse financing transactions including bridge loans,
revolving credit facilities, sale-leasebacks, and leasehold
mortgage loans") .)

Fensterstock opposed the motions, arguing principally that
the arbitration clause is unconscionable. He also contended that

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ACS lacked standing to seek arbitration because it was not a
party to the Note. ACS, in response, argued that the nature of
Fensterstock's claims against ACS -- including breach of the
contract between Fensterstock and EFP -- estopped him from making
the standing argument.

C. The Decision of the District Court

In an Opinion dated March 24, 2009, reported at 618
F. Supp. 2d 276, the district court denied defendants' motions to
stay the action and compel arbitration. The court noted that
although the FAA generally requires the court to stay a pending
federal action in order to enforce an arbitration agreement
between the parties, that requirement does not apply if the
agreement to arbitrate is unenforceable on grounds such as fraud,
duress, or unconscionability. See 618 F. Supp. 2d at 278. Applying
California law to the question of enforceability, the district
court noted that the Supreme Court of California had

held that when an arbitration clause requires a
consumer to waive the right to bring claims on behalf
of a class, that waiver is unconscionable if (1) the
waiver is found in a consumer contract of adhesion,
(2) in a setting in which disputes between the
contracting parties predictably involve small amounts
of damages, and (3) it is alleged that the party with
the superior bargaining power has carried out a
scheme to deliberately cheat large numbers of
consumers out of individually small sums of money.
Under such circumstances, the waiver is both
procedurally and substantively unconscionable. It
is procedurally unconscionable because it is found in
a contract of adhesion, in which the party with
superior bargaining power drafts [] the contract and
requires the [other] party to either accept or reject
the contract in full. . . . It is substantively
unconscionable because such waivers "are indisputably

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one-sided" because they operate to insulate a
potential defendant from liability since any one
plaintiff's damages will usually be too small to
justify bringing an individual claim.

Id. at 279 (quoting and citing Discover Bank v. Superior Court, 36
Cal. 4th 148, 161-63, 113 P.3d 1100, 1108-10 (2005)).
The
district court found that the Note in the present case met all of
those criteria. The district court rejected defendants'
contention that the Note's arbitration clause could not be found
unconscionable given Fensterstock's sophistication, stating that
although California courts had

occasionally declined to find procedural
unconscionability in contracts of adhesion based on
the sophistication of a party and the availability of
alternative contracts "free of the terms claimed to
be unconscionable, "

618 F. Supp.2d at 279 (quoting Dean Witter Reynolds, Inc. v.
Superior Court, 211 Cal. App. 3d 758, 772, 259 Cal. Rptr. 789,
798 (1st Dist. 1989) ), "'the sophistication of a party, alone,
cannot defeat a procedural unconscionability claim, '" 618
F. Supp. 2d at 279-80 (quoting Nagrampa v. MailCoups, Inc., 469 F.3d
1257, 1283 (9th Cir. 2006) (en banc) ) . The district court stated
that defendants had made "no showing here that plaintiff could
have obtained a consolidation loan that did not contain a similar
class action arbitration provision," 618 F. Supp.2d at 279. The
court also rejected defendants' contention that the damages
suffered by individual class members would be sufficiently large
to justify pursuit of their claims individually. See id. at 280.
Having found the arbitration clause unconscionable, the

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district court saw no need to reach the question of whether ACS
had standing to compel arbitration.

## D. The Issues on This Appeal

ACS has appealed. EFP, although it joined ACS's motion in
the district court, has not appealed. Accordingly, there is no
longer any contractual challenge to Fensterstock's entitlement to
litigate his claims against EFP in the district court -- whether
asserted against both EFP and ACS or against EFP alone -- and to
litigate them on a class basis.

ACS principally contends on appeal that the district court
erred in concluding that the arbitration clause is unconscionable
under California law or, alternatively, in failing to rule that
the arbitration clause is not unconscionable under the FAA and
that the FAA preempts California law. Fensterstock, in addition
to defending the district court's holdings, contends that ACS
lacks standing to compel him to arbitrate his claims against ACS
because ACS is not a party to the Note.

Like the district court, we need not reach the issue of
standing because, even assuming that ACS has standing, we conclude
for the reasons that follow that the class arbitration waiver is
unconscionable and unenforceable under California law according to
principles that are applicable to contracts generally, and that
California law is therefore not preempted by the FAA.

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A. The FAA and the Enforceability of Arbitration Agreements

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Southland Corp. v. Keating, 465 U.S. 1, 12-16 (1984) .

To the extent pertinent to this appeal, $ 2 of the FAA
provides, in essence, that in any contract evidencing a
transaction involving interstate commerce, a written provision
agreeing to submit to arbitration a controversy arising out of the
contract or transaction "shall be valid, irrevocable, and
enforceable, save upon such grounds as exist at law or in equity
for the revocation of any contract." 9 U.S.C. § 2 (emphasis
added) . FAA §§ 3 and 4 provide generally that if an action is
brought in federal court on an issue that is referable to
arbitration under such an agreement, the court, upon a timely
motion by a proper party, is to stay the action until completion
of arbitration in accordance with the terms of the agreement, see
id. § 3, and is to order that "arbitration proceed in the manner
provided for in such agreement, " id. § 4. See generally Stolt-
Nielsen S.A. v. AnimalFeeds International Corp., 130 S. Ct. 1758,
1773-75 (2010) ("Stolt-Nielsen"). Congress' purpose in enacting
the FAA "was to reverse the longstanding judicial hostility to
arbitration agreements
and to place arbitration agreements
upon the same footing as other contracts." Gilmer v.

Interstate/Johnson Lane Corp., 500 U.S. 20, 24 (1991); see, e.q.,

Volt Information Sciences, Inc. v. Board of Trustees of Leland
Stanford Junior University, 489 U.S. 468, 478-79 (1989) ( "Volt") ;

" [T]he interpretation of an arbitration agreement is
generally a matter of state law, " Stolt-Nielsen, 130 S. Ct. at
1773, and the FAA "contains no express pre-emptive provision, nor
does it reflect a congressional intent to occupy the entire field
of arbitration, " Volt, 489 U.S. at 477. However,

even when Congress has not completely displaced
state regulation in an area, state law may
nonetheless be pre-empted to the extent that it
actually conflicts with federal law -- that is, to the
extent that it stands as an obstacle to the
accomplishment and execution of the full purposes and
objectives of Congress.

Id. (internal quotation marks omitted) . Section 2 precludes state
laws -- " ' whether of legislative or judicial origin'" -- that
invalidate arbitration provisions on any basis that is "applicable
only to arbitration provisions." Doctor's Associates, Inc. v.
Casarotto, 517 U.S. 681, 685, 687 (1996) ( "Doctor's Associates")
(quoting Perry v. Thomas, 482 U.S. 483, 492 n.9 (1987) (emphasis
in Doctor's Associates) ) . But "generally applicable contract
defenses, such as fraud, duress, or unconscionability, may be
applied to invalidate arbitration agreements without contravening
§ 2." Doctor's Associates, 517 U.S. at 687 (emphases added) .

## B. Applicable Principles of California Law

### .. Arbitration Agreements and Agreements in General

Under California law (see Note, Terms and Conditions at 3
("the provisions of this Note will be governed by Federal laws
and the laws of the State of California, without regard to
conflict of laws rules") ), contracts that are exculpatory may be

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unconscionable and unenforceable. The California Civil Code
provides as follows:

All contracts which have for their object, directly
or indirectly, to exempt anyone from responsibility
for his own fraud, or willful injury to the person or
property of another, or violation of law, whether
willful or negligent, are against the policy of the
law.

Cal. Civ. Code § 1668 (West 1985) (emphases added) .

This principle is often a consideration in "the
justifications for class action lawsuits." Discover Bank v.
Superior Court, 36 Cal. 4th 148, 156, 113 P.3d 1100, 1105 (2005)
("Discover Bank") .

Frequently numerous consumers are exposed to the same
dubious practice by the same seller so that proof of
the prevalence of the practice as to one consumer
would provide proof for all. Individual actions by
each of the defrauded consumers is often
impracticable because the amount of individual
recovery would be insufficient to justify bringing a
separate action; thus an unscrupulous seller retains
the benefits of its wrongful conduct. A class action
by consumers produces several salutary by-products,
including a therapeutic effect upon those sellers who
indulge in fraudulent practices,

Id. (internal quotation marks omitted) (emphasis added) .

"A
company which wrongfully exacts a dollar from each of millions of
customers will reap a handsome profit; the class action is often
the only effective way to halt and redress such exploitation. "
Id. (internal quotation marks omitted); see, e.g., Amchem
Products, Inc. v. Windsor, 521 U.S. 591, 617 (1997) .

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Discover Bank involved a class action brought by a credit
card holder alleging that the issuer, Discover Bank (or the
34 "Bank" ) ,

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had a practice of representing to cardholders that
late payment fees would not be assessed if payment
was received by a certain date, whereas in actuality
they were assessed if payment was received after
1:00 p.m. on that date, thereby leading to damages
that were small as to individual consumers but large
in the aggregate.

36 Cal. 4th at 152, 113 P.3d at 1103. The applicable credit card
agreement provided, inter alia, that either the cardholder or the
Bank could elect arbitration; that in the event of such an
election, neither side would have the right to litigate the
dispute in court; and that neither could conduct arbitration as a
member or representative of a class. See id. at 153-54, 113 P.3d
at 1103. The trial-level court initially, applying Delaware law,
granted a motion by the Bank to compel arbitration on an
individual basis. Upon reconsideration following the decision in
Szetela v. Discover Bank, 97 Cal. App. 4th 1094, 118 Cal. Rptr. 2d
862 (4th Dist. 2002) ("Szetela") (finding a virtually identical
arbitration provision unconscionable under California law), cert.
denied, 537 U.S. 1226 (2003), the court held the class action
waiver clause unenforceable; it concluded that the plaintiff was
required to submit to arbitration but that he could seek to do so
on a class basis. On appeal by the Bank, the court of appeal did
not rule on unconscionability but held that the California rule
that class arbitration waivers are sometimes unconscionable was
preempted by the FAA. See generally Discover Bank, 36 Cal. 4th at
155, 113 P.3d at 1104-05.

The California Supreme Court reversed the preemption
ruling, noting, inter alia, that

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at least under some circumstances, the law in
California is that class action waivers in consumer
contracts of adhesion are unenforceable, whether the
consumer is being asked to waive the right to class
action litigation or the right to classwide
arbitration.

Id. at 153, 113 P.3d at 1103 (emphases added). Pointing out that
under FAA § 2 "a state court may refuse to enforce an arbitration
agreement based on generally applicable contract defenses, such as
fraud, duress, or unconscionability, " id. at 165, 113 P.3d at
1111-12 (internal quotation marks omitted), the Discover Bank
Court noted that "California law, like federal law, favors
enforcement of valid arbitration agreements, " id. at 163, 113 P.3d
at 1110 (internal quotation marks omitted) ; but California law
abhors contracts that are unconscionable, whether or not they
involve arbitration. The Court concluded that the FAA did not
preempt the California principle that unconscionable arbitration
waiver clauses are unenforceable because

the principle that class action waivers are, under
certain circumstances, unconscionable as unlawfully
exculpatory is a principle of California law that
does not specifically apply to arbitration
agreements, but to contracts generally. In other
words, it applies equally to class action litigation
waivers in contracts without arbitration agreements
as it does to class arbitration waivers in contracts
with such agreements.

Id. at 165-66, 113 P.3d at 1112 (emphases added) .

Accordingly, since California law "place [s] arbitration
agreements with class action waivers on the exact same footing as
contracts that bar class action litigation outside the context of
arbitration, " Shroyer v. New Cingular Wireless Services, Inc., 498
F.3d 976, 990 (9th Cir. 2007) ("Shroyer") (emphasis in original) ,

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we reject ACS's contention that the FAA preempts California
principles as to the conscionability of class arbitration waivers.

## 2. Unconscionability Under California Law

We turn next to the standard by which courts determine,
under California law, whether a contract clause is unconscionable.
As described in Discover Bank, the California doctrine of
unconscionability "has both a procedural and a substantive
element, the former focusing on oppression or surprise due to
unequal bargaining power, the latter on overly harsh or one-sided
results." Discover Bank, 36 Cal. 4th at 160, 113 P.3d at 1108
(internal quotation marks omitted). "The component of surprise
arises when the challenged terms are hidden in a prolix printed
form drafted by the party seeking to enforce them. " Nyulassy v.
Lockheed Martin Corp., 120 Cal. App. 4th 1267, 1281, 16 Cal. Rptr.
3d 296, 306 (6th Dist. 2004) (internal quotation marks omitted) .
However, "surprise need not be shown" " [w]here an adhesive
contract is oppressive." Id. (internal quotation marks omitted) .
"Oppression arises from an inequality of bargaining power that
results in no real negotiation and an absence of meaningful choice
Nagrampa v. MailCoups, Inc., 469 F.3d 1257, 1280 (9th
11

Cir. 2006) (en banc) ( "Nagrampa") (internal quotation marks
☒

omitted) ; see, e.g., Szetela, 97 Cal. App. 4th at 1100, 118 Cal.
Rptr. 2d at 867 (a clause is oppressive " [w]hen the weaker party
is presented the clause and told to 'take it or leave it' without
the opportunity for meaningful negotiation") .

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The procedural element of an unconscionable contract
generally takes the form of a contract of adhesion,
which, imposed and drafted by the party of superior
bargaining strength, relegates to the subscribing
party only the opportunity to adhere to the contract
or reject it.

Discover Bank, 36 Cal. 4th at 160, 113 P.3d at 1108 (internal
quotation marks omitted) . "Under California law, [a] contract of
adhesion is defined as a standardized contract, imposed upon the
subscribing party without an opportunity to negotiate the terms. "
Shroyer, 498 F.3d at 983 (internal quotation marks omitted) .
"Ordinary contracts of adhesion, although they are indispensable
facts of modern life that are generally enforced . . . , contain a
degree of procedural unconscionability even without any notable
surprises, and 'bear within them the clear danger of oppression
and overreaching. '" Gentry v. Superior Court, 42 Cal. 4th 443,
469, 165 P.3d 556, 573 (2007) ("Gentry") (quoting Graham v.
Scissor-Tail, Inc., 28 Cal. 3d 807, 818, 623 P.2d 165, 171
(1981) ), cert. denied, 128 S. Ct. 1743 (2008). The fact that
alternative contracts were potentially available does not mean
that the contract is not one of adhesion. See, e.g., Szetela, 97
Cal. App. 4th at 1100, 118 Cal. Rptr. 2d at 867 ("[A] contract
might be adhesive even if the weaker party could reject the terms
and go elsewhere. ") (internal quotation marks omitted) .

"Substantively unconscionable terms may take various
forms, but may generally be described as unfairly one-sided. "
Discover Bank, 36 Cal. 4th at 160, 113 P.3d at 1108 (internal
quotation marks omitted). These include terms that are
superficially even-handed. For example, although the arbitration

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clause in Discover Bank precluded the Bank, as well as the
cardholder, from participating in classwide arbitration or
pursuing claims in a representative capacity, the Court noted that

such class action or arbitration waivers are
indisputably one-sided. Although styled as a mutual
prohibition on representative or class actions, it is
difficult to envision the circumstances under which
the provision might negatively impact Discover
[Bank], because credit card companies typically do
not sue their customers in class action
lawsuits. . . . Such one-sided, exculpatory
contracts in a contract of adhesion, at least to the
extent they operate to insulate a party from
liability that otherwise would be imposed under
California law, are generally unconscionable.

Id. at 161, 113 P.3d at 1109 (internal quotation marks omitted) ;
see also Cohen v. DirecTV, Inc., 142 Cal. App. 4th 1442, 1455, 48
Cal. Rptr. 3d 813, 823 (2d Dist. 2006) (a "class action waiver is
indisputably one-sided" if the more powerful party "would have no
occasion to use the class action device in disputes with its
customers") (internal quotation marks omitted) .

Although the California courts inquire into both
procedural unconscionability and substantive unconscionability,
the two aspects

need not be present in the same degree. "Essentially
a sliding scale is invoked which disregards the
regularity of the procedural process of the contract
formation, that creates the terms, in proportion to
the greater harshness or unreasonableness of the
substantive terms themselves." (15 Williston on
Contracts (3d ed. 1972) § 1763A, pp. 226-227 . . . . )
In other words, the more substantively oppressive the
contract term, the less evidence of procedural
unconscionability is required to come to the
conclusion that the term is unenforceable, and vice
versa.

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Armendariz v. Foundation Health Psychcare Services, Inc., 24 Cal.
4th 83, 114, 6 P.3d 669, 690 (2000) ( "Armendariz") (emphasis
added) ; see, e.g., Gentry, 42 Cal. 4th at 469, 165 P.2d at 572
(same) ; Dean Witter Reynolds, Inc. v. Superior Court, 211 Cal.
App. 3d 758, 768, 259 Cal. Rptr. 789, 795 (1st Dist. 1989) ( "Dean
Witter Reynolds") ("Presumably both procedural and substantive
unconscionability must be present before a contract will be held
unenforceable. However, a relatively larger degree of one will
compensate for a relatively smaller degree of the other. ") .

In Dean Witter Reynolds, which involved a class action
waiver provision invoked against a challenge to the legality of a
$50 account-termination fee charged by a brokerage firm for self-
directed individual retirement accounts, the firm "concede [d] for
purposes of argument that some measure of substantive
unconscionability might be present, i.e., that the challenged fees
might be 'too high, '" 211 Cal. App. 3d at 768, 259 Cal. Rptr. at
795. But the court concluded that the class action waiver was
enforceable because there was no procedural unconscionability,
stating that "the 'oppression' factor of the procedural element of
unconscionability may be defeated, if the complaining party has a
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meaningful choice of reasonably available alternative sources of
supply from which to obtain the desired goods and services free of
the terms claimed to be unconscionable." Id. at 772, 259 Cal.
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Rptr. at 798. Stating that " [w]e do not hold or suggest
that any showing of competition in the market place as to the
desired goods and services defeats, as a matter of law, any claim

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of unconscionability, " id., 259 Cal. Rptr. at 797-98 (emphases in
original), the court ruled that procedural unconscionability had
not been shown in the case before it, given that the plaintiff was
a self-described "sophisticated investor, " was an attorney who
"specializ [ed] in class action litigation involving financial
institutions, " id., 259 Cal. Rptr. at 798, and had known of, but
consciously declined to explore, potential alternatives, see id.
at 762, 259 Cal. Rptr. at 791.

Taking account of its Dean Witter Reynolds decision nearly
two decades later, the court in Gatton v. T-Mobile USA, Inc., 152
Cal. App. 4th 571, 585, 61 Cal. Rptr. 3d 344, 355-56 (1st Dist.
2007) ("Gatton"), cert. denied, 128 S. Ct. 2501 (2008), declined
to rule that a finding of procedural unconscionability was
precluded simply by the availability of alternatives. The Gatton
court acknowledged that

[w] here the plaintiff is highly sophisticated and the
challenged provision does not undermine important
public policies, a court might be justified in
denying an unconscionability claim for lack of
procedural unconscionability even where the provision
is within a contract of adhesion.

152 Cal. App. 4th at 585 n.8, 61 Cal. Rptr. 3d at 355 n.8
(emphases added) . But it noted that

there are provisions so unfair or contrary to public
policy that the law will not allow them to be imposed
in a contract of adhesion, even if theoretically the
consumer had an opportunity to discover and use an
alternate provider for the good or service involved.

Id. at 585, 61 Cal. Rptr. 3d at 355. The Gatton court concluded
that

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absent unusual circumstances, use of a contract of
adhesion establishes a minimal degree of procedural
unconscionability notwithstanding the availability of
market alternatives. If the challenged provision

does not have a high degree of substantive
unconscionability, it should be enforced. But
courts are not obligated to enforce highly unfair
provisions that undermine important public policies
simply because there is some degree of consumer
choice in the market.

Id., 61 Cal. Rptr. 3d at 355-56 (footnote omitted) (emphases
added). In the face of such highly unfair provisions, " [t]he
adhesive nature of the contract alone justifies scrutiny of the
substantive fairness of the contractual terms." Id. at 586 n. 9,
61 Cal. Rptr. 3d at 356 n.9. In sum,

[b]ecause California courts employ a sliding scale in
analyzing whether the entire arbitration provision is
unconscionable, even if the evidence of procedural
unconscionability is slight, strong evidence of
substantive unconscionability will tip the scale and
render the arbitration provision unconscionable.

Nagrampa, 469 F.3d at 1281 (emphasis added) ; see, e.g.,
Armendariz, 24 Cal. 4th at 114, 6 P.3d at 690.

In Discover Bank, the Court noted that " [c]lass action and
arbitration waivers are not, in the abstract, exculpatory
clauses, " 36 Cal. 4th at 161, 113 P.3d at 1108, and that "not
all class action waivers are necessarily unconscionable, "
id. at 162, 113 P.3d at 1110.

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But when the waiver is found in a consumer contract
of adhesion in a setting in which disputes between
the contracting parties predictably involve small
amounts of damages, and when it is alleged that the
party with the superior bargaining power has carried
out a scheme to deliberately cheat large numbers of
consumers out of individually small sums of money,
then, at least to the extent the obligation at issue
is governed by California law, the waiver becomes in
practice the exemption of the party "from

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responsibility for [its] own fraud, or willful injury
to the person or property of another. " (Civ. Code,
§ 1668.) Under these circumstances, such waivers are
unconscionable under California law and should not be
enforced.

36 Cal. 4th at 162-63, 113 P.3d at 1110 (emphases added) .
A
provider's insistence on an arbitration provision that gives it
the opportunity to overcharge its customers by small amounts while
denying the customers any effective way to recover "violates
fundamental notions of fairness" and "is not only substantively
unconscionable, it violates public policy by granting [the
provider] a 'get out of jail free' card while compromising
important consumer rights." Id. at 160, 113 P.3d at 1108 (other
internal quotation marks omitted). "The potential for millions of
customers to be overcharged small amounts without an effective
method of redress cannot be ignored." Id. (other internal
quotation marks omitted) .

Summarizing Discover Bank and subsequent California
appellate decisions interpreting it, the Ninth Circuit in Shroyer
has discerned a standard

three-part inquiry in order to determine whether a
class action waiver in a consumer contract is
unconscionable. . . . Under this three-part inquiry,
courts are required to determine: (1) whether the
agreement is a consumer contract of adhesion drafted
by a party that has superior bargaining power; (2)
whether the agreement occurs in a setting in which
disputes between the contracting parties predictably
involve small amounts of damages; and (3) whether it
is alleged that the party with the superior
bargaining power has carried out a scheme to
deliberately cheat large numbers of consumers out of
individually small sums of money.

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Shroyer, 498 F.3d at 983 (internal quotation marks omitted) . For
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the reasons that follow, we conclude that the answers to these
three inquiries here lead to a conclusion of unconscionability.
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3.
. The Note in the Present Case
5
In the present case, ACS contends that a ruling that the
Note is unconscionable under California law is precluded by the
facts that
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1\) [Fensterstock] was an attorney who specialized in
complex financial transactions when he entered the
Note; 2) he has not alleged that there were no loans
on the market that did not include a class
arbitration waiver; 3) he claims "enormous" damages
of "thousands of dollars"; and 4) he has not alleged
that he, an attorney, was surprised by the class
arbitration waiver of the Note he signed.
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(ACS brief on appeal at 12-13; see, e.g., id. at 19-25.) Most of
these proposed rationales are foreclosed by the authorities
discussed in Part II.B.2. above.
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It is true that Fensterstock has not alleged that he was
"surprised" by the class arbitration waiver clause in the Note;
and one would surely expect that, as a practicing attorney, he
would, before signing, have read the Note's five pages of terms
and conditions, including the arbitration provision, the first
paragraph of which was printed entirely in capital letters. But,
as discussed above, where the clause is oppressive, procedural
unconscionability may exist even in the absence of surprise.
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Nor, under California law as it has evolved in the past
two decades, is a lack of procedural unconscionability established
by Fensterstock's failure to allege that there were no alternative

arbitration waiver clauses. Even if Fensterstock could have
obtained a consolidation loan elsewhere, he has asserted that he
had no meaningful opportunity to negotiate with EFP terms
different from those appearing in its preprinted form comprising
the loan application and the Note's Terms and Conditions
Statement, and that those terms were presented, by a party that
had "superior bargaining power, " on a "'take it or leave it'"
basis (Complaint 1 41). ACS does not dispute that
characterization of the parties' relative bargaining power; nor
does it dispute the assertion that the waiving of class
arbitration or class action was not subject to negotiation. And
such a clause presented to the weaker party on a take-it-or-leave-
it basis without the opportunity for meaningful negotiation is,
under California law, oppressive, and hence satisfies the
requirement that there be at least a minimal showing of procedural
unconscionability.

ACS's argument, relying on Dean Witter Reynolds, that the
Note cannot be considered procedurally unconscionable because
Fensterstock was "legally sophisticated" (ACS brief on appeal
at 21) is unpersuasive. At the time he applied to EFP for the
consolidation loan, Fensterstock was just three years out of law
school. And although the expertise he had gained through
representing clients in financial transactions may show that he
was well aware of the presence of the Note's class action and
class arbitration waiver clause, we have seen nothing in his

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education, experience, or expertise to suggest that he had any
meaningful opportunity to negotiate that clause out of the
contract.

Finally, ACS's argument that Fensterstock claims
"'enormous'" damages of " 'thousands of dollars'" (ACS brief on
appeal at 13; see Complaint | 36) is an effort to escape the
thrust of the California cases that consistently find it
substantively unconscionable -- and intolerable as a matter of
public policy -- to permit a party with superior bargaining power to
use class action or class arbitration waiver clauses to insulate
itself from remedial action when it is alleged to have
"deliberately cheat [ed] large numbers of consumers out of
individually small sums of money, " Discover Bank, 36 Cal. 4th at
163, 113 P.3d at 1110. ACS argues that the district court
misapplied Discover Bank because Fensterstock has alleged damages
that are not small but enormous. We disagree.

What Fensterstock characterizes as "enormous" is not his
present loss but rather the "lump-sum payment" that will be
required of him "[a]t the end of the repayment period" -- i.e., a
quarter of a century from now -- as it will amount to "thousands of
dollars" instead of "$335.00 as stated in the Note" (Complaint
1 36 (emphases added) ) . These assertions as to the total monetary
impact at the end of Fensterstock's 29-year loan period do not
remove his claim from the category of cases in which the
relatively small amount of damages suffered by customers
individually makes it economically impractical for them to

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prosecute individual actions. The complaint clearly indicates
that from Fensterstock's first 16 payments a total of $263.19 had
been misallocated -- an average of less than $17 a month. Borrowers
aware of the alleged misallocations early in their respective loan
repayment periods could not be expected to bring suit individually
with respect to such small sums.

ACS has estimated, based on Fensterstock's allegation
that the challenged practice cost him $263.19 in connection with
his first 16 payments, that over the life of his 29-year the loan,
Fensterstock's damages would total some $6,300. This calculation
of future damages is largely speculative, as a borrower might, by
design or fortuity, have a greater proportion of his payments
arrive precisely on their respective due dates, thereby avoiding
the alleged misallocations to interest; or a borrower could elect
to pay off the entirety of the loan early. Even assuming no such
changes and no change in ACS's alleged misallocations, however,
ACS's $6,300 figure is misleading because it suggests that the
value of the claim asserted by Fensterstock includes losses that
have not yet occurred. Moreover, even if we could attach a value
to Fensterstock's right to avoid future losses (i.e., the
approximate value of an injunction) the present value of that
right is much less than the total loss that Fensterstock will
eventually suffer over 29 years.

Further, given statute-of-limitations considerations, it
seems unlikely that a borrower could wait until the end of his
repayment period, allowing the total of misallocated payments to

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grow, and successfully sue with respect to the totality of the
sums misallocated. For example, a fraud claim accrues upon the
victim's discovery of the fraud, see Hobart v. Hobart Estate Co.,
26 Cal. 2d 412, 436-37, 159 P.2d 958, 971-72 (1945), and
Fensterstock's complaint suggests that the alleged misallocations
may be discoverable by borrowers from the monthly statements sent
to them by ACS (see Complaint 1 30 (" [e]ach month, [Fensterstock]
receives a statement summarizing his most recent payment") ; id.

1 32 (such a statement shows how much of Fensterstock's "payments
ha [s] been applied to interest" and how much "has been applied to
principal") ) . And contract claims might be deemed subject to "the
doctrine of contractual severability. " Armstrong Petroleum Corp.
V. Tri-Valley Oil & Gas Co., 116 Cal. App. 4th 1375, 1388, 11
Cal. Rptr. 3d 412, 423 (5th Dist. 2004); see id., 11 Cal. Rptr. 3d
at 422 ("where performance of contractual obligations is severed
into intervals, . . . an action attacking the performance for any
particular interval must be brought within the period of
limitations after the particular performance was due"). Thus, we
see no validity in any suggestion that the sum recoverable by an
individual victim of the alleged misallocations would be enormous.

In sum, the California three-part test is met on the
record in the present case. The Note is a standardized consumer
contract of adhesion drafted by a party that had superior
bargaining power; the disputes as to the allocation of monthly
loan payments between principal and interest predictably involve
small amounts of damages; and it is alleged that EFP and ACS are

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deliberately carrying out a scheme to cheat large numbers of
borrowers out of individually small sums of money. We conclude
that the district court properly ruled that the Note's class
action and class arbitration waiver clause is unconscionable.

# C. Severability

As indicated in Part I.B. above, the Note contains a
severability provision stating that "[i]f any portion of this
arbitration provision is deemed invalid or unenforceable, the
remaining portions shall nevertheless remain in force." (Note,
Terms and Conditions Statement at 4.) In light of that clause,
counsel for ACS stated at the oral argument of this appeal that

if the court decides that the class arbitration
waiver is unconscionable, our position is that it
could be excised from the arbitration agreement
overall, and the case could be referred to
arbitration.

Despite our receipt of postargument letters from ACS, it is not
entirely clear whether its position on this question has changed
in light of the Supreme Court's recent decision in Stolt-Nielsen.
However, we read that decision to foreclose an order compelling
arbitration on a classwide basis in this case.

The Stolt-Nielsen Court considered an arbitration clause
that was "'silent'" as to whether the arbitration proceedings
could be conducted on a class basis, meaning, according to the
parties' stipulation, that " 'no agreement . . . ha [d] been reached
on that issue. '" 130 S. Ct. at 1766. The Court concluded that
since there was no agreement on arbitration on a class basis, the

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courts had no authority to compel arbitration on that basis. It
noted that

[w] hether enforcing an agreement to arbitrate or
construing an arbitration clause, courts and
arbitrators must "give effect to the contractual
rights and expectations of the parties. "
In
this endeavor, as with any other contract, the
parties' intentions control.

Id. at 1773-74 (quoting Volt, 489 U.S. at 479) (other internal
quotation marks omitted). It reiterated that " [a]rbitration is
simply a matter of contract between the parties; it is a way to
resolve those disputes -- but only those disputes -- that the parties
have agreed to submit to arbitration, " Stolt-Nielsen, 130 S. Ct.
at 1774 (quoting First Options of Chicago, Inc. v. Kaplan, 514
U.S. 938, 943 (1995) (emphases in Stolt-Nielsen) ), and emphasized
that the courts "must not lose sight of the purpose of the
exercise: to give effect to the intent of the parties, "
Stolt-Nielsen, 130 S. Ct. at 1774-75 (citing Volt, 489 U.S. at
479) . The Court stated that " ' [n]othing in the [FAA] authorizes a
court to compel arbitration of any issues, or by any parties, that
are not already covered in the agreement, '" Stolt-Nielsen, 130 S.
Ct. at 1774 (quoting EEOC v. Waffle House, Inc., 534 U.S. 279, 289
(2002) (emphasis in Stolt-Nielsen) ), and hence "a party may not be
compelled under the FAA to submit to class arbitration unless
there is a contractual basis for concluding that the party agreed
to do so, "
Stolt-Nielsen, 130 S. Ct. at 1775 (emphasis in
original) .

Thus, the FAA embodies a preference not so much for

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arbitration as for the enforcement of arbitration agreements, and

the Stolt-Nielsen Court concluded that

consistent with our precedents emphasizing the
consensual basis of arbitration, we see the question
as being whether the parties agreed to authorize
class arbitration. Here, where the parties
stipulated that there was "no agreement" on this
question, it follows that the parties cannot be
compelled to submit their dispute to class
arbitration.

Id. at 1776 (emphasis in original) .

In the present case, the Note's arbitration clause is not
silent but expressly states that "the arbitration of . . . Claims
must proceed on an individual (non-class, non-representative)
basis."
(Note, Terms and Conditions Statement at 4 (emphasis
added) .) Thus, the parties plainly did not agree that arbitration
may be conducted on a classwide basis, and we do not see that an
order for classwide arbitration can be premised on the Note's
severability provision: Our conclusion that a given agreement is
invalid and unenforceable does not mean that the parties in fact
reached the opposite agreement. Thus, excising the Note's class
action and class arbitration waiver clause leaves the Note silent
as to the permissibility of class-based arbitration, and under
Stolt-Nielsen we have no authority to order class-based
arbitration.

Because the agreement forbidding Fensterstock to pursue
his present claims on a classwide basis is unconscionable under
California law, and because the parties did not agree that
arbitration could proceed on such a basis, we affirm the district

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court's denial of ACS's motion to stay the present action and

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compel arbitration.

CONCLUSION

have considered all of ACS's

arguments

this appeal

and, except as indicated above, have

found them

be without

merit. The

order

of the district court

is affirmed.

August Term, 2009 Argued: November 18, 2009 Decided: July 12, 2010 Docket No.… v. - EDUCATION FINANCE PARTNERS, a California corporation

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