NMSC Clarifies Framework for Substantive Unconscionability

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Earlier this week the New Mexico Supreme Court published its fourth precedential opinion this year, Peavy v. Skilled Healthcare Group, Inc. Justice Bacon, writing for a unanimous Court, clarified the framework for deciding whether a contract is substantively unconscionable, holding that when the terms of a contract are one-sided on its face, the court should allow evidence to justify that the agreement is fair and reasonable.

Background

In 2007, Beverly Peavy was admitted to a skilled nursing facility, where she lived until her death in 2010. Part of her admission included a 78-page agreement about her care. The agreement provided that all disputes would be subject to arbitration. However, it contained an exception: suits by the nursing home to collect money owed by patients could be litigated.

After her death, Ms. Peavy’s estate filed a wrongful death lawsuit against the nursing home. The home sought to compel arbitration, and the estate responded that the agreement to arbitrate could not be enforced because its one-sidedness made it unconscionable because patients had to arbitrate the claims they were most likely to bring, but the home was allowed to litigate the claims it was most likely to bring. The home then presented evidence to support its position that the collections exception to the arbitration clause was unreasonable. The district court, unpersuaded, ruled against the nursing home. On appeal, the New Mexico Court of Appeals affirmed.

Unconscionability in New Mexico

Unconscionability is an affirmative defense to contract enforcement. It can be analyzed from both the substantive perspective and the procedural perspective.  Although the presence of both forms of unconscionability increases the likelihood of a court invalidating the agreement, there is no requirement that both forms be present. In this case, the district court had found that the contract was not procedurally unconscionionable, and the parties did not dispute that on appeal.

A long line of New Mexico cases have held that clauses similar to the one at issue here are substantively unconscionable. In particular, New Mexico cases have consistently found arbitration agreements to be unfairly and unreasonably one-sided when they unjustifiably require the non-drafting party to arbitrate its likeliest claims, while allowing the drafting party to pursue its likeliest claims through litigation. There is no bright-line rule, however, and each agreement must be examined on a case-by-case basis.

This case, however, had less to do about the one-sidedness of the language. Instead, the nursing home argued that it was entitled to prevent evidence that the arbitration clause was fair and reasonable, and that the district court erred in finding that its evidence had failed to make that showing. The court cleared up any confusion about the framework:

We conclude that under New Mexico conscionability law a presumption of unfair and unreasonable one-sidedness arises when a drafting party excludes its likeliest claims from arbitration, while mandating the other party arbitrate its likeliest claims.  …  We emphasize, however, that this presumption may be overcome by an evidentiary showing that justifies the one-sidedness of the arbitration agreement.  

Peavy, slip op. ΒΆ 19

Applying this approach, the Court concluded that the Agreement was unconscionable. Because the Agreement was substantively unconscionable on its face, the burden was on the nursing home to provide evidence that the agreement was actually reasonable and fair. But it had failed to do so.

The nursing home provided the testimony of one witness, Ms. Correa, who was involved with their collections efforts. Ms. Correa testified that the home had never litigated a collections matter, that the debts owed were typically less than $10,000 but occasionally were as high as $76,000, that she believed litigating claims under $10,000 was not economically viable, and that she believed arbitration of those claims also was not feasible. The court rejected much of these claims as speculative, unsupported by actual evidence of costs and probative only of Ms. Correa’s personal beliefs. Moreover, if true, the arguments would apply to all low-value claims, not just collections claims. And Ms. Correa, who had not been tendered as a corporate representative, lacked authority to speak on the nursing home’s behalf that it would not sue for the smaller debts more common of their residents. Reviewing Ms. Correa’s testimony, the Court concluded that it did not justify why it would be reasonable and fair to except high-value collections claims from arbitration. Agreeing with the district court and the court of appeals, it affirmed.

Good Framework But What About the Standard of Review?

This is a great opinion. It creates a clear and explicit framework for the district courts to apply to this type of matter going forward. To my mind, as an appellate lawyer, it does leave an open question. If a contract is facially ambiguous, an evidentiary hearing is held to allow the defending party the opportunity to overcome the presumption that the agreement is substantively unconscionable. This suggests that at least part of the analysis is a question of fact. And indeed, the court of appeals treated it that way, framing the question as “whether Defendants presented sufficient evidence to show why … the collections exclusion was not unfairly one-sided and was justified.”

The NMSC opinion takes a different approach. It provides the standard of review that “[q]uestions regarding substantive unconscionability present questions of law that are also reviewed de novo.” And its analysis does not simply affirm the lower court’s ruling as supported by substantial evidence. Rather, it comments on the credibility of the witness, and weighs her testimony to arrive at its own conclusion. This strikes me as incorrect. In this case, however, it makes no difference, as the district court would surely have been affirmed under a substantial evidence standard of review.

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