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Originally from  World Arbitration and Mediation Review (WAMR) 2003 - PDF

WAMR Vol 14 No. 2

Preview Page Arbitration Provision Held Substantively Unconscionable
In a recent opinion, the U.S. District Court for the Northern District of California denied
a motion to compel arbitration and held that an arbitration clause in an electronic agreement was
substantively unconscionable under California law. Comb v. PayPal, Inc., 218 F.Supp. 2d 1165
(N.D. Cal. Aug. 30, 2002).
In Comb v. PayPal, Inc., plaintiffs and other entitles not named in the suit, entered into an
electronic disbursement agreement with PayPal, the defendant, an online payment service, under
which defendant allowed businesses or private individuals to send and receive money via the
Internet. Accountholders authorized PayPal to send money from either their checking or credit
card accounts to an intended recipient. PayPal accessed the funds and immediately made them
available to the recipient. Recipients had to be members of PayPal to access payments. Interest
accrued on customer funds and transaction costs served as the main source of PayPal’s revenue.
PayPal’s clients alleged that, because of a tremendous growth in PayPal’s accountholders
(an increase from about 10,000 customers to about a million in five months), PayPal failed to
provide an adequate number of customer service representatives to address clients’ questions and
issues. This circumstance led to the company’s inability to maintain and manage customer
accounts as required under federal and state law. The electronic agreement between PayPal and
its customers contained an arbitration clause, which disallowed the consolidation of claims and
selected California as the forum of choice for PayPal. Customers were required to read the entire
agreement.
Plaintiffs filed a motion for injunctive relief on behalf of a purported nationwide class of
customers for alleged violations of state and federal law. PayPal moved to compel individual
arbitration pursuant to the arbitration clause contained in its standard User Agreement. The
district court found the electronic agreement substantively unconscionable and refused to grant
PayPal’s motion to compel arbitration. After examining the agreement, the court concluded that
it was unconscionable because it was a contract of adhesion. A contract of adhesion is a
“standardized contract, which, imposed and drafted by the party of superior bargaining strength,
relegates the subscribing party to only the opportunity to adhere to the contract or reject it.”
Armendariz v. Foundation Health Psychcare Serv., 24 Cal.4th 83, 113, 99 Cal.Rptr.2d 745, 6
P.3d 669 (2000). In the court’s opinion, the defendant’s claim that the availability of other
competitors in the marketplace defeated the plaintiffs’ assertion of unconscionability did not hold
because the availability of goods or services was not the relevant test for unconscionability in
disputes between an unsophisticated consumer and a large financial institution. The court also
found that provisions in the agreement granting PayPal sole discretion to restrict accounts,
withhold funds, and to undertake its own investigation of a client’s account (among others) were
one-sided and substantively unconscionable because PayPal had not shown anything to justify
the one-sidedness of the agreement. Additionally, the prohibition of PayPal customers from
consolidating claims was substantively unconscionable because most claims were likely to be for

small amounts of money. The prohibition raised the possibility that millions of customers would
be overcharged small amounts and would not have an effective method of redress. The court