Most law firm partnership agreements include broad arbitration clauses which provide for the arbitration of all disputes concerning the partnership. A recent,1 partially successful challenge to a law firm’s arbitration provision, based upon the doctrine of unconscionability, is worth exploring to understand if one’s partnership agreement and practices could be susceptible to similar attack. In addition, the opinion raises the perennial question concerning whether such arbitration provisions are beneficial to all or whether they favor the firm as opposed to its individual partners.

Disputes

The rationale most law firms use for including arbitration provisions in their partnership agreements is that arbitration is confidential and faster than litigation thereby resulting in a less expensive proceeding. In addition, some law firms take advantage of the voluntary nature of arbitration and craft an arbitration procedure they believe works best for their particular culture and practice.

Despite these seemingly laudatory goals, some partners who are in a dispute with their firms contend that arbitration provisions are designed by the firms to benefit the firms at the expense of the rights of partners. Such partners have claimed that the provisions are unenforceable contracts of adhesion whose procedures benefit the firm and prejudice partners who are in dispute with their firm.

A Recent Challenge

In DeGraff v. Perkins Coie,2 the U.S. District Court for the Northern District of California considered claims by a former law firm partner that the arbitration clause of the Perkins Coie partnership agreement was unconscionable and therefore unenforceable.

Harold DeGraff, a partner of the firm, entered into both a partnership agreement and employment agreement with the firm. Thereafter, he sought to bring a class action on behalf of himself and a class of similarly situated employees claiming that the firm wrongfully required him and other employees to pay for certain business expenses. Perkins Coie, in response, claimed that DeGraff was a partner of the law firm subject to the arbitration provision of the Perkins Coie partnership agreement. The firm sought to dismiss the claim or, in the alternative, a stay pending the arbitration. DeGraff, in opposition to the motion, argued that the arbitration provision was unconscionable and therefore unenforceable.

The court’s analysis of the arguments made by DeGraff concerning why the Perkins Coie partnership agreement was unconscionable is helpful in evaluating whether a law firm partnership agreement’s arbitration provision will be found to be unconscionable or whether it will be enforceable. Because the legal standard for unconscionability is quite difficult to meet, the analysis, perhaps more practically, provides insight into whether certain arbitration provisions are perceived as fair and reasonable or are in need of modification.

Standard

Proving unconscionability among sophisticated parties such as attorneys is a difficult task. In New York, to demonstrate unconscionability, one must make “a showing that the contract was both procedurally and substantively” unconscionable when made—i.e., “some showing of 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.’”3 In DeGraff, the District Court, applying California law, added that the elements work on a “sliding scale” and stated: “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.”4 The “sliding scale” approach is also generally in accord with New York’s application of the law of unconscionability.5

Procedural Unconscionability

To demonstrate that a contract is procedurally unconscionable, one must establish that the manner in which the contract was entered into was inherently one-sided so that “it involved no choice or negotiation…but was a ‘take it or leave it’ proposition.”6

Most law firm partners are in the “take it or leave it” category when facing their partnership agreement and its arbitration clause. They are most often presented with a massive complex partnership agreement and told to sign it. There is no room for negotiation and the provisions are, frankly, set in stone. Further, unlike the case of a consumer being asked to sign an arbitration agreement in the purchase of an appliance where the alternatives and possible ability to avoid arbitration are readily available by an alternative purchase, in the case of a partnership this is not so. Lawyers who have spent their careers at a firm struggling to “make” partner and who ultimately do so, do not have the ease of saying “no” to the partnership offer because the terms of the partnership agreement include an arbitration provision.

In DeGraff, the court agreed and found that there was procedural unconscionability in the execution of the Perkins Coie partnership agreement. The court stated: “Plaintiff declares that he was told he had to sign the Partnership Agreement and that he had no opportunity to negotiate the terms. Accordingly, the court finds that Plaintiff had demonstrated the existence of procedural unconscionability.”7

Substantive Issues

To demonstrate that a contract is substantively unconscionable, it must be shown that its terms are “unreasonably favorable to the other party.”8 Accordingly, if the arbitration procedures can be shown to unreasonably favor the law firm at the expense of the partner’s rights, they can be considered to be unconscionable. As stated by the DeGraff court, “the paramount consideration in assessing conscionability is mutuality.”9

In DeGraff, the law firm partner made numerous arguments concerning unconscionablity. Potentially of most widespread importance concerned the requirement of confidentiality, the duration of the arbitration process, and the qualifications of the arbitrator.

The court ruled that the requirement that the arbitration remain confidential was unconscionable and severed that provision. It based its ruling upon the conclusion that Perkins Coie is the only party who would benefit from this provision “without receiving any negative impact in return.”10 The court based its decision upon its finding that “Perkins Coie has institutional knowledge of prior arbitrations. In contrast, individual litigants, such as Plaintiff, are deprived from obtaining information regarding any prior arbitrations.”

As most law firm partnership agreements include confidentiality provisions in their arbitration clauses, the DeGraff ruling could have wide ranging application. While it may be argued that disputes among lawyers and their firms are private matters whose public airings harm all participants and the profession in general, the fact is, as pointed out by the court in DeGraff, the result of these confidentiality provisions is that the firm, from an institutional perspective, knows what occurred in prior arbitrations and is benefitted from this knowledge which is kept secret from partners in subsequent disputes.

Knowing what arguments worked and which did not and how prior arbitrations ruled concerning disputes over the same partnership agreement is a huge advantage to the law firm. If you disagree, ask yourself how disadvantaged you would be if your adversary had access to legal research and you did not. It would not exactly be an even playing field and yet that is what can result from arbitration provisions that contain confidentiality provisions.

In considering the remaining arguments, the court found that the provision that required the arbitration to be completed in 90 days was enforceable because there was no proof that this would be insufficient time to complete what was not a complicated matter. In addition, because the clause permitted discovery, the court concluded that the provision was not unduly harsh. Firms that have arbitration clauses that limit or do not permit discovery should take heed that their provisions may be considered unconscionable. It is suggested that such a provision, like a confidentiality provision, unduly favors the firm which will likely have access to all of the relevant data without the need for discovery.

The court in DeGraff also addressed the potential unconscionability of whether the provision in the arbitration clause which provided that, if the parties did not agree as to the arbitrator, the arbitrator would be a partner in a law firm having a Seattle office with at least 100 lawyers. DeGraff argued that such a provision was unconscionable because such a lawyer/arbitrator would “necessarily be a peer of Perkins Coie.”11 The court rejected the argument, stating that such an arbitrator would “also be a peer of Plaintiff.”12

Many law firms take this type of provision one step further and, in doing so, may make themselves vulnerable to a claim of unconscionability. Those agreements, which are common, limit the pool of arbitrators to members of law firms who have had a certain number of years of management responsibility. It could be argued that, in those circumstances, such partners are not peers of the “average” partner but will have a particular management bent which will unfairly favor the firm’s perspective and which could render such provision unconscionable.

Conclusion

Partners’ disputes with their law firms are always a serious matter involving large sums of money with the potential to affect a partner’s career and the prestige of their firm. Giving up the right to litigate those rights in a court with the full set of procedural and substantive protections must be considered with this in mind. In this context, as demonstrated above, law firm partnership agreement arbitration provisions may be susceptible to claims of unconscionability. Thus, law firms may be wise to revisit such provisions to ensure their partnership agreement arbitration provisions can withstand such a claim.

Arthur J. Ciampi is the coauthor of the treatise ‘Law Firm Partnership Agreements’ and is the managing member of Ciampi LLC. Maria Ciampi, of counsel to the firm, assisted in the preparation of this article.

Endnotes:

1. DeGraff v. Perkins Coie, 2012 WL 3074982 (N.D. Cal. 2012).

2. Id.

3. Gillman v. Chase Manhattan Bank, 73 N.Y.2d 1, 10, 534 N.E.2d 824, 828 (1988) (citations omitted).

4. DeGraff, 2012 WL 3074982, at *3.

5. Simar Holding v. GSC, 87 A.D.3d 688, 690, 928 N.Y.S.2d 592, 595 (2d Dept. 2011) (“procedural and substantive unconscionability operate on a ‘sliding scale’; the more questionable the meaningfulness of choice, the less imbalance in a contract’s terms should be tolerated and vice versa”).

6. Brower v. Gateway 2000, 246 A.D.2d 246, 252, 676 N.Y.S.2d 569, 572-73 (1998).

7. DeGraff, 2012 WL 3074982, at *3.

8. Gillman, 73 N.Y.2d 1, 534 N.E.2d at 828.

9. DeGraff, 2012 WL 3074982, at *3.

10. Id.

11. Id. at *4.

12. Id.