Rare Case Highlights Pitfalls of Unconscionable Contracts

Publication Source: New York Law Journal

While it is not terribly unusual to see a defense of 'unconscionability' raised in an action for breach of contract, it is quite rare for a court to find that a contract is 'so outrageous as to warrant holding it unenforceable' because it is substantively unconscionable.

The rare case recently arose in the Commercial Part of the Supreme Court in Nassau County. In Day Op of North Nassau, Inc. v. Viola, 16 Misc.3d 1122(A), 2007 WL 2305035 (Nassau Co. Aug. 1, 2007), Justice Ira B. Warshawsky found a provision of a shareholders' agreement that would have terminated a shareholder's ownership interest without cause to be unconscionable and unenforceable. The case provides useful lessons for counsel both from a contract-drafting perspective and with respect to strategies in implementing and enforcing contracts.

Unconscionability The New York Court of Appeals has instructed that an 'unconscionable contract' is 'one which 'is so grossly unreasonable or unconscionable in light of the mores and business practices of the time and place as to be unenforcible [sic] according to its literal terms.'' Gillman v. Chase Manhattan Bank, N.A., 73 N.Y.2d 1, 10, 537 N.Y.S.2d 787, 791 (1988) (quoting Mandel v. Liebman, 303 N.Y. 88, 94, citing 1 Corbin on Contracts, §128, p. 400). Generally, to declare a contract 'unconscionable,' the court must find that the contract 'was both procedurally and substantively unconscionable when made.' Gillman, 73 N.Y.2d at 11, 537 N.Y.S.2d at 791. The 'procedural element' involves consideration of the contract formation process and whether the party alleging unconscionability was given a meaningful choice. Courts focus on 'the size and commercial setting of the transaction . . . , whether deceptive or high-pressured tactics were employed, the use of fine print in the contract, the experience and education of the party claiming unconscionability, and whether there was disparity in bargaining power.' 73 N.Y.2d at 11, 537 N.Y.S.2d at 791. On the 'substantive' side, the courts analyze whether the actual terms of the contract 'unreasonably favor' the party against whom unconscionability is urged. 73 N.Y.2d at 12, 537 N.Y.S.2d at 792.

In most instances, courts require a party to show that both the procedural and substantive aspects of the contract rise to the level of unconscionability in order to invalidate a contract in whole or in part. Id. Where a contract is negotiated at arms length between sophisticated parties, courts are not likely to invalidate any provision of the resulting contract, even if it is one-sided. See, e.g., Dallas Aerospace, Inc. v. CIS Air Corp., 353 F.3d 775 (2d Cir. 2003) (in transaction between two sophisticated corporations, court affords little sympathy to argument that contractual clause disclaiming warranties was unconscionable in its 'real-world application or effects').

Nevertheless, 'there have been exceptional cases where a provision of a contract is so outrageous as to warrant holding it unenforceable on the ground of substantive unconscionability alone.' Gillman, 73 N.Y.2d at 12, 537 N.Y.S.2d at 792. In Viola, Justice Warshawsky indeed found such an exceptional case.

'Viola'

Viola involved a dispute between a business corporation that was operating as an ambulatory surgery center and one of its shareholders. The defendant was both a shareholder and an employee of the corporation, with a five-year written employment term.

Read the full article in the attached PDF.

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Kevin Schlosser is a Shareholder at Meyer, Suozzi, English & Klein, P.C., where he is Chair of the Litigation and Alternative Dispute Resolution Department which has a full roster of available private judges from virtually all disciplines of law. Mr. Schlosser also authors the popular blog, “New York Fraud Claims,” which analyzes the latest developments concerning civil fraud claims under New York law.

Reprinted with permission by the New York Law Journal.