The Delaware Court of Chancery recently issued a magnum opus on the topic of rescinding a contract based on unconscionability. James v. National Financial, LLC, C.A. No. 8931-VCL (Del. Ch. Mar. 14, 2016). This opinion is destined to be the definitive work on this aspect of Delaware law and should be of interest to those engaged in commercial litigation.
This opinion has much to commend it and deserves a more extensive synopsis, but for purposes of this short blog post I will focus on the court’s mini-treatise on unconscionability in the context of a contract. This 72-page opinion is a sequel to a prior decision in this case which imposed penalties for discovery violations. That decision was highlighted on these pages. A separate article could be written based on the scholarly analysis the court provided about the legal aspects of the “working poor’s plight” and how they are taken advantage of by consumer finance companies. In this case, the interest rate charged for a modest loan was more than 800%. Despite the defendant’s attempt to characterize it as something else, the court used equitable powers that focus on substance over form to determine that the essence of the disputed transaction was a payday loan that Delaware recently prohibited by statute–but that was only one part of the unconscionability analysis.
Contract Principles Addressed
The court explained that the doctrine of unconscionability is an exception to the broad support for freedom of contract in Delaware law. Delaware law is strongly inclined to respect the voluntary agreement of parties and will only interfere “upon a strong showing that dishonoring the contract is required to vindicate a public policy interest even stronger than freedom of contract.” Generally, “parties who sign contracts and other binding documents or authorize someone else to execute those documents on their behalf, are bound by the obligations that those documents contain.” Slip op. at 21. Unconscionability in the context of contracts has been defined as a contract “such as no man in his senses and not under delusion would make on the one hand, and no honest or fair man would accept, on the other.”
The court provides extended definitions and historical explanations of the concept of unconscionability with citations to copious legal sources. The court referred to the definition in the Uniform Commercial Code at Section 2-302. Although technically limited in scope to the sale of goods, Delaware decisions have also applied Section 2-302 more broadly. See footnote 10.
The court observed that unconscionability is a concept that is used sparingly and requires that a court find that “the party with superior bargaining power used it to take unfair advantage of his counterpart.” Moreover, the terms must be so one-sided as to be oppressive. The court identified ten factors that guide the analysis of unconscionability. See Slip op. at 24-25.
The court also explained the difference between substantive unconscionability and procedural unconscionability. The concept of substantive unconscionability tests the substance of the exchange. An agreement is substantively unconscionable if the terms evidence a gross imbalance that “shocks the conscience.” This means a bargain on terms “so extreme as to appear unconscionable according to the mores and business practices of the time and place.”
By contrast, procedural unconscionability refers to the procedures that led to the contract with a goal of evaluating whether seemingly lopsided terms might have resulted from arms’-length bargaining. The court focuses on whether the weaker party could make a meaningful choice. The concept is “broadly conceived to encompass not only the employment of sharp bargaining practices and the use of fine print and convoluted language, but also a lack of understanding and an inequity of bargaining power.”
The two dimensions of unconscionability are not two separate prongs but rather the analysis is unitary and it is generally agreed that “if more of one is present, then less of the other is required.” Of the ten factors based on the Fritz case, six relate to substantive unconscionability.
The court conducted a thorough and probing examination and application of the six factors that apply to substantive unconscionability, as well as the four factors that are used to analyze procedural unconscionability. See Slip op. at 46-47.
The court explained that if a contract is found unconscionable, the proper remedy it to declare it invalid because it is void. See Restatement (Second) of Contracts, Section 208, cmt. g.
The court found that the defendant was using an interest-only, non-amortizing installment loan to evade Delaware’s Payday Loan Law. The court then went on to observe applicable equitable principles that include: “equity regards substance rather than form,” and also equity enforces the rights and duties which “spring from the real relations of the parties.” In substance, the court found that the disputed loan in this case, in essence, was a payday loan which was in violation of the applicable Delaware statute.
Although it will not be covered in this short blog post, the court’s opinion provides a useful analysis of a violation of the Truth in Lending Act. See 15 U.S.C. Section 1601(a). The court held that the violation of that Act entitled the plaintiff to an award of reasonably attorneys’ fees and costs. The court instructed the plaintiffs’ counsel to submit a Rule 88 affidavit.