Narayan v. The Ritz-Carlton Development Company, Inc. , 135 Haw. 327 ( 2015 )

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Electronically Filed
Supreme Court
SCWC-12-0000819
03-JUN-2015
08:14 AM
IN THE SUPREME COURT OF THE STATE OF HAWAI#I
---o0o---
KRISHNA NARAYAN; SHERRIE NARAYAN; VIRENDRA NATH;
NANCY MAKOWSKI; KEITH MACDONALD AS CO-TRUSTEE FOR THE
DKM TRUST DATED OCTOBER 7, 2011; SIMON YOO; SUMIYO SAKAGUCHI;
SUSAN RENTON, AS TRUSTEE FOR THE RENTON FAMILY TRUST
DATED 12/3/09; STEPHEN XIANG PANG; FAYE WU LIU; MASSY MEHDIPOUR
AS TRUSTEE FOR MASSY MEHDIPOUR TRUST DATED JUNE 21, 2006;
G. NICHOLAS SMITH; TRISTINE SMITH; RITZ 1303 RE, LLC, a Colorado
Limited Liability Company; and BRADLEY CHAFFEE AS TRUSTEE OF THE
CHARLES V. CHAFFEE BRC STOCK TRUST DATED 12/1/99
AND THE CLIFFORD W. CHAFFEE BRC STOCK TRUST DATED 1/4/98,
Petitioners/Plaintiffs-Appellees,
vs.
THE RITZ-CARLTON DEVELOPMENT COMPANY, INC.;
THE RITZ-CARLTON MANAGEMENT COMPANY, LLC; JOHN ALBERT; EDGAR GUM,
Respondents/Defendants-Appellants,
and
MARRIOTT INTERNATIONAL INC.; MAUI LAND & PINEAPPLE CO., INC.;
EXCLUSIVE RESORTS, LLC; KAPALUA BAY, LLC;
ASSOCIATION OF APARTMENT OWNERS OF KAPALUA BAY CONDOMINIUM;
CAROLINE PETERS BELSOM; CATHY ROSS; ROBERT PARSONS;
RYAN CHURCHILL; THE RITZ-CARLTON HOTEL COMPANY, L.L.C.;
MARRIOTT VACATIONS WORDWIDE, CORPORATION; MARRIOTT OWNERSHIP
RESORTS, INC.; MARRIOTT TWO FLAGS, LP; MH KAPALUA VENTURE, LLC;
MLP KB PARTNER LLC; KAPALUA BAY HOLDINGS, LLC; ER KAPALUA
INVESTORS FUND, LLC; ER KAPALUA INVESTORS FUND HOLDINGS, LLC;
EXCLUSIVE RESORTS DEVELOPMENT COMPANY, LLC; and EXCLUSIVE RESORTS
CLUB I HOLDINGS, LLC, Respondents/Defendants.
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SCWC-12-0000819
CERTIORARI TO THE INTERMEDIATE COURT OF APPEALS
(CAAP-12-0000819; CIV. NO. 12-1-0586(3))
JUNE 3, 2015
RECKTENWALD, C.J., NAKAYAMA, McKENNA AND POLLACK, JJ.,
AND CIRCUIT JUDGE NAKASONE, IN PLACE OF ACOBA, J., RECUSED
OPINION OF THE COURT BY NAKAYAMA, J.
In this appeal we address whether the plaintiffs, a
group of individual condominium owners, can be compelled to
arbitrate claims arising from financial problems at a Maui
condominium project. We hold that because the condominium owners
did not unambiguously assent to arbitration, the purported
agreement to arbitrate is unenforceable. We also address the
doctrine of unconscionability.
I. BACKGROUND
A. Factual History
This case arose from the financial breakdown of a Maui
condominium development formerly known as the Ritz-Carlton Club &
Residences at Kapalua Bay (the project). The project consists of
84 private ownership condominium units and was developed by
Defendant Kapalua Bay, LLC (the developer), a joint venture owned
by Defendants Marriott International, Inc. (Marriott), Exclusive
Resorts, Inc., and Maui Land & Pineapple Co., Inc.
Petitioners/Plaintiffs-Appellees Krishna Narayan, et al.
(collectively the Homeowners) purchased ten of the condominiums
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units from the developer. The developer owns 56 of the
condominium units. The Homeowners, the developer, and other
third-party owners comprise the Association of Apartment Owners
of Kapalua Bay Condominium (AOAO).
Respondents/Defendants-Appellants the Ritz-Carlton
Development Company, Inc. (RCDC) and the Ritz-Carlton Management
Company, LLC (RCMC) were the original development and management
companies for the project, and were then wholly-owned
subsidiaries of Marriott. Respondents/Defendants-Appellants John
Albert (Albert) and Edgar Gum (Gum) served on the board of
directors of the AOAO while allegedly being employed by either
Marriott or Ritz-Carlton.
1. The Financial Breakdown of the Project
In April of 2012, the Homeowners learned that the
developer and its affiliated entities had defaulted on loans
encumbering the project.1 As a result, the developer could not
pay several months of maintenance and operator fees to Marriott’s
management subsidiaries, and it defaulted on its corresponding
AOAO assessments. Due to these problems, Marriott decided to
abandon the project and to pull its valuable Ritz-Carlton
branding. In the course of its departure, Marriott or one of its
1
These facts, drawn from the pleadings, are taken as true for the
limited purpose of reviewing Respondents’ motion to compel arbitration. See
Douglass v. Pflueger Hawaii, Inc., 110 Hawai#i 520, 524-25, 135 P.3d 129, 133-
34 (2006).
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subsidiaries used its authority as managing agent to withdraw
approximately $1,300,000.00 from the AOAO’s operating fund, and
threatened to withdraw the remaining $200,000.00 from the fund.
AOAO board members, many of whom were employed by Marriott, Ritz-
Carlton, and/or other interested entities, did not attempt to
block Marriott from taking these actions. Instead, the AOAO
board indicated that the multi-million dollar shortfall would
have to be covered by the Homeowners.
2. Documents Governing the Project
Prior to the sale of individual condominium units,
several documents relating to the governance of the project were
recorded in the State of Hawai#i Bureau of Conveyances pursuant
to the requirements of Hawai#i Revised Statutes (HRS) Chapter
514A. These documents included the Declaration of Condominium
Property Regime of Kapalua Bay Condominium (condominium
declaration) and the Association of Apartment Owners of Kapalua
Bay Condominium Bylaws (AOAO bylaws). Additionally, the
developer registered a Condominium Public Report (public report)
with the Hawaii Real Estate Commission. These documents were
incorporated by reference through purchase agreements that the
Homeowners executed when they purchased their condominiums.
a. The Purchase Agreements
The Homeowners entered into purchase agreements with
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the developer soon after the documents governing the project were
recorded.2 The first page of the purchase agreements state:
ACKNOWLEDGMENT OF RECEIPT, OPPORTUNITY TO REVIEW, AND
ACCEPTANCE OF PROJECT DOCUMENTS
THE FOLLOWING DOCUMENTS THAT ARE REFERRED TO IN THIS
PURCHASE AGREEMENT FORM AN ESSENTIAL PART HEREOF. PURCHASER
ACKNOWLEDGES THAT PURCHASER HAS RECEIVED COPIES OF EACH OF
THE FOLLOWING DOCUMENTS AND THAT PURCHASER HAS HAD A FULL
AND COMPLETE OPPORTUNITY TO READ, REVIEW AND EXAMINE EACH OF
THE FOLLOWING DOCUMENTS.
. . . .
2. the applicable state of Hawaii Condominium Public
Report(s)
3. the Declaration of Condominium Property Regime of
Kapalua Bay Condominium
4. the Bylaws of the Association of Apartment Owners of
Kapalua Bay Condominium
The purchase agreements also contain a clause entitled
“Purchaser’s Approval and Acceptance of Project Documentation,”
which states:
Purchaser acknowledges . . . having had a full opportunity
to read and review and hereby approves and accepts the
following documents . . .: the Condominium Public Report(s)
indicated in Section C.5, above, the Declaration, the Bylaws
. . . . It is understood and agreed that this sale is in
all respects subject to said documents.
The Homeowners do not dispute that they received the condominium
declaration, the public report, and the AOAO bylaws along with
their purchase agreements.
The arbitration clause at issue in this case appears in
the condominium declaration, which is referenced more than twenty
2
Representative purchase agreements from two of the Homeowners were
cited by the parties. These agreements appear to be identical and were signed
by these Homeowners in late May of 2006.
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times in the purchase agreements and in a variety of contexts.
For example, the purchase agreements state: “Seller . . .
reserves the right to utilize unassigned or guest parking spaces
described in the Declaration.” The purchase agreements also
state: “Purchaser agrees to purchase from Seller, in fee simple,
the following property: a. The Apartment designated in Section A
above and more fully described in the Declaration.” Thus, on
many occasions, the purchaser is put on notice that more specific
information concerning particular rights and obligations is
contained in the condominium declaration.
The purchase agreements contain two clauses related to
dispute resolution:
47. Waiver of Jury Trial. Seller and Purchaser hereby
expressly waive their respective rights to a jury trial on
any claim or cause of action that is based upon or arising
out of this Purchase Agreement. . . . Venue for any cause of
action brought by Purchaser hereunder shall be in the Second
Circuit Court, State of Hawai#i.
48. Attorneys[’] Fees. If any legal or other proceeding,
including arbitration, is brought . . . because of an
alleged dispute, breach, default or misrepresentation in
connection with any provisions of this Agreement, the
successful or prevailing party or parties shall be entitled
to recover reasonable attorneys’ fees, court costs and all
expenses even if not taxable as court costs, . . . in
addition to any other relief to which such party or parties
may be entitled.
These clauses do not mention a binding agreement to arbitrate,
nor do they direct the purchaser to the alternative dispute
resolution clause in the condominium declaration.
b. The Condominium Declaration
The arbitration clause at issue in this case appears on
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pages 34 and 35 of the 36-page condominium declaration. It
states:
XXXIII. ALTERNATIVE DISPUTE RESOLUTION.
In the event of the occurrence of any controversy or claim
arising out of, or related to, this Declaration or to any
alleged construction or design defects pertaining to the
Common Elements or to the Improvements in the Project
(“dispute”), . . . the dispute shall be resolved by
arbitration pursuant to this Article and the then-current
rules and supervision of the American Arbitration
Association.
The arbitration clause contains several other relevant
provisions. First, it states: “The arbitration shall be held in
Honolulu, Hawaii before a single arbitrator who is knowledgeable
in the subject matter at issue.” Second, it states: “The
arbitrator shall not have the power to award punitive, exemplary,
or consequential damages, or any damages excluded by, or in
excess of, any damage limitations expressed in this Declaration.”
Third, it states:
The arbitrator may order the parties to exchange copies of
nonrebuttable exhibits and copies of witness lists in
advance of the arbitration hearing. However, the arbitrator
shall have no other power to order discovery or depositions
unless and then only to the extent that all parties
otherwise agree in writing.
Fourth, it states: “Neither a party, witness, [n]or the
arbitrator may disclose the facts of the underlying dispute or
the contents or results of any negotiation, mediation, or
arbitration hereunder without prior written consent of all
parties.” Finally, it states:
No party may bring a claim or action regardless of form,
arising out of or related to this Declaration . . .
including any claim of fraud, misrepresentation, or
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fraudulent inducement, more than one year after the cause of
action accrues, unless the injured party cannot reasonably
discover the basic facts supporting the claim within one
year.
c. The Public Report and the AOAO Bylaws
The purchase agreements also incorporate the terms of
the public report and the AOAO bylaws. With respect to dispute
resolution, the public report states:
The Condominium Property Act (Chapter 514A, HRS), the
Declaration, Bylaws, and House Rules control the rights and
obligations of the apartment owners with respect to the
project and the common elements, to each other, and to their
respective apartments. The provisions of these documents
are intended to be, and in most cases are, enforceable in a
court of law.
The AOAO bylaws main reference to dispute resolution is an
attorney’s fees provision that awards fees and costs to the
prevailing party in certain types of disputes.
B. Procedural History
On June 7, 2012, the Homeowners filed suit in the
Circuit Court of the Second Circuit (circuit court) asserting
claims for breach of fiduciary duty, “access to books and
records,” and injunctive/declaratory relief.3 Respondents filed
a motion to compel arbitration on July 5, 2012, which was
summarily denied by the circuit court after a hearing.
Respondents appealed to the ICA. They argued that the
circuit court gravely erred when it denied their motion because a
valid arbitration agreement existed, this dispute fell within the
3
The Honorable Joseph E. Cardoza presided.
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scope of that agreement, and because the arbitration terms were
conscionable. In their Answering Brief, the Homeowners argued
that they had not assented to arbitration terms “buried” in a
condominium declaration, that the terms of their purchase
agreements created ambiguity regarding their assent to arbitrate,
and that even if they had agreed to arbitrate, this dispute fell
outside the scope of that agreement. The Homeowners also argued
that the arbitration clause was unconscionable because it
severely limited discovery, imposed a one-year statute of
limitations, and served to unilaterally shield Ritz-Carlton and
its partners from liability.
The Intermediate Court of Appeals (ICA) rejected all of
the Homeowners’ arguments. It held that the parties had entered
a valid agreement to arbitrate and that this dispute fell within
the scope of that agreement. The ICA also held that the
Homeowners could not establish that the arbitration clause was
procedurally unconscionable because they received reasonable
notice of the arbitration provision, signed an acknowledgment,
and had the right to cancel their purchase agreements within
thirty days of receiving the public report. The ICA did not
address the alleged substantive unconscionability of the
arbitration terms. The ICA also separately held that the
arbitration clause was not an unenforceable contract of adhesion
because the Homeowners were not “subjected to ‘oppression’ or a
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lack of all meaningful choice; individual Homeowners could elect
to buy property subject to the recorded Declaration and the
arbitration clause, or not.”
II. STANDARD OF REVIEW
“[T]his court reviews the decisions of the ICA for (1)
grave errors of law or fact or (2) obvious inconsistencies in the
decision of the ICA with that of the supreme court, federal
decisions, or its own decisions.” State v. Wheeler, 121 Hawai#i
383, 390, 219 P.3d 1170, 1177 (2009) (citing HRS § 602-59(b)
(Supp. 2012)).
“A petition to compel arbitration is reviewed de novo.”
Siopes v. Kaiser Found. Health Plan, Inc., 130 Hawai#i 437, 446,
312 P.3d 869, 878 (2013). “The standard is the same as that
which would be applicable to a motion for summary judgment, and
the trial court’s decision is reviewed ‘using the same standard
employed by the trial court and based upon the same evidentiary
materials as were before [it] in determination of the motion.’”
Brown v. KFC Nat’l Mgmt. Co., 82 Hawai#i 226, 231, 921 P.2d 146,
151 (1996) (brackets in original) (quoting Koolau Radiology, Inc.
v. Queen’s Medical Ctr., 73 Haw. 433, 439–40, 834 P.2d 1294, 1298
(1992)).
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III. DISCUSSION
The Federal Arbitration Act (FAA) governs arbitration
agreements that involve “commerce among the several states,” 9
U.S.C. §§ 1-2 (1947), and “reflects the fundamental principle
that arbitration is a matter of contract.” Rent-A-Center, West,
Inc. v. Jackson, 561 U.S. 63, 67 (2010). Accordingly, it “places
arbitration agreements on an equal footing with other contracts,
and requires courts to enforce them according to their terms.”
Id. (internal citations omitted). The parties do not dispute the
applicability of the FAA to their dispute.
“‘[W]hen presented with a motion to compel arbitration,
the court is limited to answering two questions: 1) whether an
arbitration agreement exists between the parties; and 2) if so,
whether the subject matter of the dispute is arbitrable under
such agreement.’” Douglass v. Pflueger Hawaii, Inc., 110 Hawai#i
520, 530, 135 P.3d 129, 139 (2006) (brackets omitted) (quoting
Koolau Radiology Inc., 73 Haw. at 445, 834 P.2d at 1300).
Pursuant to the FAA, we apply general state-law principles of
contract interpretation to questions of contract formation, Perry
v. Thomas, 482 U.S. 483, 492 n.9 (1987), while resolving
ambiguities as to the scope of arbitration in favor of
arbitration. See Lee v. Heftel, 81 Hawai#i 1, 4, 911 P.2d 721,
724 (1996); Moses H. Cone Mem’l Hosp. v. Mercury Const. Corp.,
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460 U.S. 1, 23 (1983). However, “the mere existence of an
arbitration agreement does not mean that the parties must submit
to an arbitrator disputes which are outside the scope of the
arbitration agreement.” Brown, 82 Hawai#i at 244, 921 P.2d at
164 (citation and internal quotation marks omitted). “What
issues, if any, are beyond the scope of a contractual agreement
to arbitrate depends on the wording of the contractual agreement
to arbitrate.” Rainbow Chevrolet, Inc. v. Asahi Jyuken (USA),
Inc., 78 Hawai#i 107, 113, 890 P.2d 694, 700 (App. 1995). An
arbitration agreement is interpreted like a contract, and “as
with any contract, the parties’ intentions control.” Heftel, 81
Hawai#i at 4, 911 P.2d at 724. “The party seeking to compel
arbitration carries the initial burden of establishing that an
arbitration agreement exists between the parties.” Siopes, 130
Hawai#i at 446, 312 P.3d at 878.
A. The Existence of an Arbitration Agreement
This court has addressed the formation of an agreement
to arbitrate on a number of occasions. See, e.g., Siopes, 130
Hawai#i 437, 312 P.3d 869; Douglass, 110 Hawai#i 520, 135 P.3d
129; Brown, 82 Hawai#i 226, 921 P.2d 146; Luke v. Gentry Realty,
Ltd., 105 Hawai#i 241, 96 P.3d 261 (2004). The following three
elements are necessary to prove the existence of an enforceable
agreement to arbitrate: “(1) it must be in writing; (2) it must
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be unambiguous as to the intent to submit disputes or
controversies to arbitration; and (3) there must be bilateral
consideration.” Douglass, 110 Hawai#i at 531, 135 P.3d at 140
(emphasis added). In this case, the arbitration clause appears
in writing and the Homeowners have not argued that it lacks
bilateral consideration. Thus, we are only concerned with the
second requirement. “With respect to the second requirement,
‘there must be a mutual assent or a meeting of the minds on all
essential elements or terms to create a binding contract.’”
Siopes, 130 Hawai#i at 447, 312 P.3d at 879 (emphasis omitted)
(quoting Douglass, 110 Hawai#i at 531, 135 P.3d at 140). “The
existence of mutual assent or intent to accept is determined by
an objective standard.” Id.
This court has identified at least two circumstances
where the requisite unambiguous intent to arbitrate may be
lacking. First, where a contract contains one or more dispute
resolution clauses that conflict, we have resolved that ambiguity
against the contract drafter and held that the parties lacked the
unambiguous intent to arbitrate. For example, in Luke, we held
that an arbitration clause was unenforceable where the ambiguity
between it and a reservation of remedies clause meant that a
reasonable buyer “would not know whether she or he maintained the
right to judicial redress or whether she or he had agreed to
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arbitrate any potential dispute.” 105 Hawai#i at 249, 96 P.3d at
269.
Second, where a party has received insufficient notice
of an arbitration clause in a document that is external to the
contract that the party signed, we have held that the party
lacked the unambiguous intent to arbitrate and that the purported
agreement was unenforceable. For example, in Siopes, this court
held that an arbitration clause was unenforceable where it was
not contained in a document that was made available to the
plaintiff at the time he executed his contract and where nothing
in the surrounding circumstances suggested that the plaintiff was
otherwise on notice of the arbitration provision. 130 Hawai#i at
452, 312 P.3d at 884. Likewise, in Douglass, we held that an
arbitration clause contained in an employee handbook was
unenforceable where the employment contract that the employee
signed did not contain the arbitration provision or notify
employee of the provision, the handbook stated that its policies
were merely guidelines, the arbitration provision was not boxed
off or otherwise set apart from the other provisions in the
handbook, and there was no evidence that the employee was ever
informed of the existence of the arbitration provision. 110
Hawai#i at 531-32, 135 P.3d at 140-41. By contrast, in Brown,
this court held that an arbitration clause was enforceable where
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it was conspicuously labeled and boxed off in the “Employee
Rights” subsection of an employment application, and where the
applicant’s signature line appeared right below the arbitration
clause. 82 Hawai#i at 159-60, 921 P.2d at 239-40.
In this case, the purported agreement to arbitrate is
unenforceable because it is ambiguous when taken together with
the terms of the purchase agreements and the public report. The
purchase agreements contain a provision that states: “Venue for
any cause of action brought by Purchaser hereunder shall be in
the Second Circuit Court, State of Hawai#i.” This conflicts with
the arbitration term stating that all claims “arising out of” the
condominium declaration “shall be decided by arbitration,” and
that the “arbitration shall be held in Honolulu, Hawaii.”
Given that the purchase agreements reference the condominium
declaration more than twenty times and that both documents
contain dispute resolution provisions that use broad language to
define their scope, a dispute may arise out of both the purchase
agreement and the declaration. It is facially ambiguous whether
those disputes would be consigned to arbitration in Honolulu
pursuant to the condominium declaration or the “Second Circuit
Court” pursuant to the purchase agreement.
The public report creates further ambiguity. It
states: “[T]he Declaration, Bylaws, and House Rules control the
rights and obligations of the apartment owners . . . . The
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provisions of these documents are intended to be, and in most
cases are, enforceable in a court of law.” A reasonable buyer
presented with these documents “would not know whether she or he
maintained the right to judicial redress or whether she or he had
agreed to arbitrate any potential dispute.” Luke, 105 Hawai#i at
249, 96 P.3d at 269. “Resolving this ambiguity in favor of the
Plaintiffs, we cannot say that the Plaintiffs agreed to submit
the claims made in this litigation to arbitration.” Id.
In sum, we hold that the arbitration provision
contained in the condominium declaration is unenforceable because
the terms of the various condominium documents are ambiguous with
respect to the Homeowners’ intent to arbitrate. Luke, 105
Hawai#i at 249, 96 P.3d at 269. The ICA gravely erred when it
concluded that the parties had formed a valid and enforceable
agreement to arbitrate.
B. Unconscionability
The FAA provides that an agreement to arbitrate is
unenforceable “upon such grounds as exist at law or in equity for
the revocation of any contract.” 9 U.S.C. § 2. Thus, like other
contracts, arbitration provisions “may be invalidated by
generally applicable contract defenses, such as fraud, duress, or
unconscionability.” Rent-A-Center, West, Inc., 130 S. Ct. at
2776 (internal quotation marks and citation omitted). “Courts
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may not, however, invalidate arbitration agreements under state
laws applicable only to arbitration provisions.” Doctor’s
Assocs., Inc. v. Casarotto, 116 S. Ct. 1652, 1656 (1996).
Although our determination regarding the existence of an
arbitration agreement is dispositive in this case, the
arbitration clause also contains unconscionable terms.
“‘Unconscionability has generally been recognized to
include an absence of meaningful choice on the part of one of the
parties together with contract terms which are unreasonably
favorable to the other party.’” Siopes, 130 Hawai#i at 458, 312
P.3d at 890 (quoting City & Cnty. of Honolulu v. Midkiff, 62 Haw.
411, 418, 616 P.2d 213, 218 (1980)). Stated otherwise, “a
determination of unconscionability requires a showing that the
contract was both procedurally and substantively unconscionable.”
Balogh v. Balogh, 134 Hawai#i 29, 41, 332 P.3d 631, 643 (2014)
(internal quotations, alterations, and citation omitted); see
also Lewis v. Lewis, 69 Haw. 497, 502, 748 P.2d 1362, 1366 (1988)
(“[T]wo basic principles are encompassed within the concept of
unconscionability, one-sidedness and unfair surprise.”).
Our caselaw defining when a contract of adhesion is
unenforceable is best understood as a subset of unconscionability
that utilizes the two-part unconscionability inquiry described
above. We have stated:
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a contract that is “adhesive” -- in the sense that it is
drafted or otherwise proffered by the stronger of the
contracting parties on a “take it or leave it” basis -- is
unenforceable if two conditions are present: (1) the
contract is the result of coercive bargaining between
parties of unequal bargaining strength; and (2) the contract
unfairly limits the obligations and liabilities of, or
otherwise unfairly advantages, the stronger party.
Brown, 82 Hawai#i at 247, 921 P.2d at 167. The first condition
corresponds to procedural unconscionability and the second
condition corresponds to substantive unconscionability.
Although both procedural and substantive
unconscionability are required in most cases, they need not be
present in the same degree. See Balogh, 134 Hawai#i at 41, 332
P.3d at 643. “Essentially a sliding scale is invoked which
disregards the regularity of the procedural process of the
contract formation . . . in proportion to the greater harshness
or unreasonableness of the substantive terms themselves.” 15
Samuel Williston, Contracts § 1763A (3d ed. 1972). “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.” Armendariz v.
Found. Health Psychcare Servs., Inc., 6 P.3d 669, 690 (Cal.
2000). Indeed, we have stated that “there may be exceptional
cases where a provision of the contract is so outrageous as to
warrant holding it unenforceable on the ground of substantive
unconscionability alone.” Balogh, 134 Hawai#i at 41, 332 P.3d at
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643 (internal quotations and citation omitted). Here, the ICA
gravely erred by placing dispositive weight on procedural
unconscionability without addressing the alleged substantive
unconscionability of the arbitration terms. In addition, the ICA
gravely erred when it concluded that the Homeowners had failed to
demonstrate procedural unconscionability.
1. Procedural Unconscionability
“The procedural element of unconscionability requires
an examination of the contract formation process and the alleged
lack of meaningful choice.” Gillman v. Chase Manhattan Bank,
N.A., 534 N.E.2d 824, 828 (N.Y. 1988). This analysis is narrowed
in the context of adhesion contracts, because the term “adhesion
contract” refers to contracts that are “drafted or otherwise
proffered by the stronger of the contracting parties on a ‘take
it or leave it’ basis.” Brown, 82 Hawai#i at 247, 921 P.2d at
167. “Consequently, the terms of the contract are imposed upon
the weaker party who has no choice but to conform.” Id.
Although adhesion contracts are not unconscionable per se, they
are defined by a lack of meaningful choice, and thus, often
satisfy the procedural element of unconscionability.
For example, in Brown, a prospective employee was
“offered the possibility of employment on a take it or leave it
form . . . that had to be filled out and signed by [the
plaintiff] if he wanted to be considered for employment with
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KFC.” 82 Hawai#i at 247, 921 P.2d at 167. Based on that fact
alone, this court held that procedural unconscionability, was
present “insofar as [the plaintiff’s] submission to the
arbitration agreement was the result of coercive bargaining
between parties of unequal bargaining strength.” Id. (quotation
marks omitted). In other words, the adhesive nature of the terms
contained in KFC’s employment application satisfied the
procedural element of unconscionability. Id.
In this case, there is a higher degree of procedural
unconscionability than was present in Brown. Not only was the
declaration drafted by a party with superior bargaining strength,
it was recorded in the bureau of conveyances prior to the
execution of the purchase agreements. The Homeowners had no
choice but to conform to the terms of the declaration as recorded
if they wanted to purchase a Ritz-Carlton condominium on Maui.
Thus, the declaration is “‘adhesive’ -- in the sense that it
[was] drafted or otherwise proffered by the stronger of the
contracting parties . . . ‘on a take this or nothing’ basis.”
Brown, 82 Hawai#i at 247, 921 P.2d at 167. Additionally, there
is an element of unfair surprise that was not present in Brown:
The arbitration clause was buried in an auxiliary document and
was ambiguous when read in conjunction with the purchase
agreements and the public report. For these reasons, the
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Homeowners satisfied the procedural prong of the test for
unconscionability.
The ICA applied a different test for procedural
unconscionability, requiring that “the party seeking to avoid
enforcement had no viable alternative source to obtain the
services contracted for.” Although a lack of viable alternatives
may provide some indicia of procedural unconscionability, it is
by no means a necessary or dispositive factor. See Potter v.
Hawaii Newspaper Agency, 89 Hawai#i 411, 424, 974 P.2d 51, 64
(1999) (stating only that “[t]he disparity of bargaining power
was made more acute by the paucity of employment opportunities
available to young people” (emphasis added)).
In addition, the ICA’s application of Ass’n of
Apartment Owners of Waikoloa Beach Villas ex rel. Bd. of Dirs. v.
Sunstone Waikoloa, LLC, 129 Hawai#i 117, 122, 295 P.3d 987, 992
(App. 2013), was erroneous. In Waikoloa Beach Villas, the ICA
held that an arbitration clause contained in a condominium
declaration was not procedurally unconscionable because, despite
the adhesive nature of the declaration, the developer’s
compliance with HRS Chapter 514A ensured that the condominium
purchasers had received reasonable notice of the condominium
declaration’s terms. Id. The ICA supported its holding with the
policy argument that a finding of procedural unconscionability
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would “frustrate the expectations of the purchasers, the
developer, and other stakeholders who relied on the Declaration
provisions.” Id. (relying on Pinnacle Museum Tower Ass’n v.
Pinnacle Mkt. Dev. (US), LLC, 282 P.3d 1217, 1232-33 and n.13
(2012)). The ICA also held that the arbitration provision was
not substantively unconscionable. Waikoloa Beach Villas, 129
Hawai#i at 122-23, 295 P.3d at 992-93.
We disagree with the ICA’s application of Waikoloa
Beach Villas to the case at bar. By concluding that the
arbitration clause was not procedurally unconscionable under
Waikoloa Beach Villas without also addressing substantive
unconscionability, the ICA suggested that a condominium developer
could impose substantively unconscionable terms on a purchaser as
long as the developer complied with the procedural requirements
of HRS Chapter 514A and provided reasonable notice of the
unconscionable terms. This implication is inconsistent with the
approach in Waikoloa Beach Villas, in which the ICA addressed
both procedural and substantive unconscionability, and the
legislature’s purpose in enacting HRS Chapter 514A, “to protect
the buying public and to create a better reception by that public
for the condominium developer’s product.” Ass’n of Owners of
Kukui Plaza v. City and Cnty. of Honolulu, 7 Haw. App. 60, 69,
742 P.2d 974, 980 (1987). By not addressing substantive
unconscionability, the ICA could not fully determine whether the
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agreement was unconscionable. Conversely, to avoid the terms of
a declaration a party must establish more than adhesion, the
party must establish that the challenged terms are substantively
unconscionable. A mere finding of procedural unconscionability
would not eviscerate the terms of an HRS Chapter 514A condominium
declaration.
2. Substantive Unconscionability
A contract term is substantively unconscionable where
it “unfairly limits the obligations and liabilities of, or
otherwise unfairly advantages, the stronger party.” Brown, 82
Hawai#i at 247, 921 P.2d at 167. Arbitration agreements are not
usually regarded as unconscionable because “the agreement ‘bears
equally’ on the contracting parties and does not limit the
obligations or liabilities of any of them.” Id. The agreement
“‘merely substitutes one forum for another.’” Leong by Leong v.
Kaiser Found. Hosps., 71 Haw. 240, 248, 788 P.2d 164, 169 (1990)
(quoting Madden v. Kaiser Found. Hosps., 552 P.2d 1178, 1186
(Cal. 1976)). However, an arbitration clause may be
unconscionable if it unfairly deprives the party resisting
arbitration an “effective substitute for a judicial forum.”
Nishimura v. Gentry Homes, Ltd., 134 Hawai#i 143, 148, 338 P.3d
524, 529 (2014). Here, the Homeowners argue that the arbitration
clause is substantively unconscionable because it “purports to:
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(1) effectively preclude all discovery; (2) eliminate rights to
punitive, exemplary, and consequential damages; (3) require that
all claims and underlying facts be kept secret, and (4) impose a
one-year statute of limitations.”
a. Discovery Limitations and Confidentiality
Limitations on discovery serve an important purpose in
arbitration because “the underlying reason many parties choose
arbitration is the relative speed, lower cost, and greater
efficiency of the process.” Kona Vill. Realty, Inc. v. Sunstone
Realty Partners, XIC, LLC, 123 Hawai#i 476, 477, 236 P.3d 456,
457 (2010) (internal citation omitted). By agreeing to
arbitrate, a party “trades the procedures and opportunity for
review of the courtroom for the simplicity, informality, and
expedition of arbitration.” Mitsubishi Motors Corp. v. Soler
Chrysler-Plymouth, Inc., 105 S. Ct. 3346, 3354 (1985). Thus,
reasonable limitations on discovery may be enforceable in
accordance with our recognition of the strong federal policy in
favor of arbitration.
At the same time, adequate discovery is necessary to
provide claimants “a fair opportunity to present their claims” in
the arbitral forum. Gilmer v. Interstate/Johnson Lane, Corp.,
111 S. Ct. 1647, 1655 (1991). Although the amount of discovery
that is adequate to sufficiently vindicate a party’s claims does
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not mean unfettered discovery, see Armendariz, 6 P.3d at 684-86
(stating that a party can agree to something less than the full
panoply of discovery permitted under the California Arbitration
Act), discovery limitations that unreasonably hinder a
plaintiff’s ability to prove a claim are unenforceable. See,
e.g., In re Poly-America, L.P., 262 S.W.3d 337, 357-58 (Tex.
2008) (collecting cases). In addition, some limitations on
discovery that might otherwise prove unenforceable have been held
enforceable because the arbitrator maintained the ability to
order further discovery upon a showing of need. See, e.g.,
Dotson v. Amgen, Inc., 181 Cal. App. 4th 975, 982-84 (2010)
(holding that limiting discovery to two depositions was not
unconscionable where additional discovery was available upon a
showing of need).
As is the case with discovery limitations, a
“[c]onfidentiality provision by itself is not substantively
unconscionable[.]” Davis v. O’Melveny & Myers, 485 F.3d 1066,
1079 (9th Cir. 2007) overruling on other grounds recognized by
Ferguson v. Corinthian Colleges, Inc., 733 F.3d 928, 933-34
(2013). However, where an arbitration clause contains severe
limitations on discovery alongside a confidentiality provision,
the plaintiff may be deprived of the ability to adequately
discover material information about his or her claim. See id. at
1078-79 (holding unconscionable a confidentiality provision in an
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employment contract because it “would handicap if not stifle an
employee’s ability to investigate and engage in discovery”); see
also Grabowski v. Robinson, 817 F. Supp. 2d 1159, 1176-77 (S.D.
Cal. 2011).
Here, the discovery limitations and confidentiality
provision unconscionably disadvantage the Homeowners. The
discovery limitations only allow the arbitrator to order the
parties to turn over “nonrebuttable exhibits and copies of
witness lists,” and precludes the arbitrator from “order[ing]
discovery or depositions unless and then only to the extent that
all parties otherwise agree in writing.” Thus, the arbitrator
does not have the ability to order additional discovery, even on
a showing of need. The confidentiality provision further
precludes the Homeowners from mentioning “the facts of the
underlying dispute without prior written consent of all parties,
unless and then only to the extent required to enforce or
challenge the negotiated agreement or the arbitration award, as
required by law, or as necessary for financial and tax reports
and audits.” If the arbitration clause were enforced as written,
the Homeowners would have virtually no ability to investigate
their claims, and thus, would be deprived of an adequate
alternative forum. These provisions are therefore
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unconscionable.4
b. Punitive Damage Limitations
The Homeowners have also challenged the arbitration
clause’s restriction on punitive and consequential damages.
“Punitive or exemplary damages are generally defined as those
damages assessed in addition to compensatory damages for the
purpose of punishing the defendant for aggravated or outrageous
misconduct and to deter the defendant and others from similar
conduct in the future.” Masaki v. Gen. Motors Corp., 71 Haw. 1,
6, 780 P.2d 566, 570 (1989) (citation omitted). “Since the
purpose of punitive damages is not compensation of the plaintiff
but rather punishment and deterrence, such damages are awarded
only when the egregious nature of the defendant’s conduct makes
such a remedy appropriate.” Id. “The conduct must be
outrageous, either because the defendant’s acts are done with an
evil motive or because they are done with reckless indifference
to the rights of others.” Restatement (Second) of Torts § 908,
cmt. b (1979).
It would create an untenable situation if parties of
superior bargaining strength could use adhesionary contracts to
insulate “aggravated or outrageous misconduct” from the monetary
remedies that are designed to deter such conduct. Masaki, 71
4
We do not decide whether the contractually shortened limitations
period is unconscionable because there has been no assertion that the
Homeowners’ claims are barred by that provision.
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Haw. at 6, 780 P.2d at 570. For this reason, many state supreme
courts that have considered the issue have held that punitive
damage limitations are unconscionable. See, e.g., Ex parte
Thicklin, 824 So. 2d 723 (Ala. 2002) overruled on other grounds by
929 So. 2d 997 (Ala. 2005) (“[I]t violates public policy for a
party to contract away its liability for punitive damages,
regardless whether the provision doing so was intended to operate
in an arbitral or a judicial forum.”); Armendariz, 6 P.3d at 680,
683 (“‘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.’”) (quoting California Civil Code § 1668
(1872)); Carll v. Terminix Int’l Co., L.P., 793 A.2d 921, 923
(Pa. Super. Ct. 2002) (holding that an arbitration agreement was
unconscionable because it precluded the arbitrator from awarding
special, incidental, consequential, and punitive damages); State
ex rel. Dunlap v. Berger, 567 S.E.2d 265 (W. Va. 2002) (holding
that an arbitration agreement which prohibited punitive damages
was unenforceable as against public policy).
Hawai#i law already disfavors limiting damages for
intentional and reckless conduct. In Laeroc Waikiki Parkside,
LLC v. K.S.K. (Oahu) Ltd. Partnership, 115 Hawai#i 201, 224, 166
P.3d 961, 984 (2007), this court held that a contract provision
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limiting tort liability would violate public policy to the extent
that it attempted to waive liability for criminal misconduct,
fraud, or willful misconduct. Further, we have acknowledged that
“[e]xculpatory contracts are not favored by the law because they
tend to allow conduct below the acceptable standard of care.”
Fujimoto v. Au, 95 Hawai#i 116, 155, 19 P.3d 699, 739 (2001)
(quoting Yauger v. Skiing Enterprises, Inc., 206 N.W.2d 60, 62
(Wis. 1996)). This court has also acknowledged that “although
parties might limit remedies, such as recovery of attorney’s fees
or punitive damages . . . a court might deem such a limitation
inapplicable where an arbitration involves statutory rights that
would require these remedies.” See Kona Vill., 123 Hawai#i at
485, 236 P.3d at 465 (Acoba, J., dissenting) (quoting Uniform
Arbitration Act § 4, cmt. 3 (2000)). Extending these principles,
and in reliance on persuasive authority from many other state
supreme courts, we endorse the view that, with respect to
adhesion contracts, a contract term that prohibits punitive
damages is substantively unconscionable.5
IV. CONCLUSION
For the foregoing reasons, we vacate the ICA’s
October 28, 2013 Judgment on Appeal, affirm the circuit court’s
5
By contrast, parties may limit consequential damages in
appropriate situations. See, e.g., HRS § 490:2-712 (2008).
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August 28, 2012 order denying Respondents’ motion to compel
arbitration, and remand to the circuit court for further
proceedings consistent with this opinion.
Terence J. O’Toole, /s/ Mark E. Recktenwald
Judith Ann Pavey, and
Andrew J. Lautenbach /s/ Paula A. Nakayama
for petitioners
/s/ Sabrina S. McKenna
Bert T. Kobayashi, Jr.,
Lex R. Smith, Joseph A. /s/ Richard W. Pollack
Stewart and Maria Y. Wang
for respondents The Ritz- /s/ Karen T. Nakasone
Carlton Development Company,
Inc., The Ritz-Carlton
Management Company, LLC,
John Albert and Edgar Gum
and respondents Marriott
International, Inc., The
Ritz-Carlton Hotel Company,
LLC, Marriott Two Flags, LP,
Marriott Ownership Resorts,
Inc., MH Kapalua Venture,
LLC, and Marriott Vacations
Worldwide Corporation
30