Narayan v. The Ritz-Carlton Development Company, Inc.

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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

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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

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