Iwen v. U.S. West Direct

No

No. 98-064

293 Mont. 512

997 P. 2d 989

IN THE SUPREME COURT OF THE STATE OF MONTANA

1999 MT 63

JOHN F. IWEN,

Plaintiff and Appellant,

v.

U.S. WEST DIRECT, A DIVISION OF U.S. WEST

MARKETING RESOURCES GROUP, INC., and

KIM HOLZER, its Agent, Servant, and Employee,

Defendants and Respondents.

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APPEAL FROM: District Court of the Eighth Judicial District,

In and for the County of Cascade,

The Honorable Kenneth R. Neill, Judge presiding.

COUNSEL OF RECORD:

For Appellant:

Timothy J. McKittrick, McKittrick Law Firm, P.C.;

Great Falls, Montana

For Respondents:

Sarah M. Power; Gough, Shanahan, Johnson & Waterman;

Helena, Montana

Submitted on Briefs: August 27, 1999

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Decided: April 1, 1999

Filed:

__________________________________________

Clerk

Justice Jim Regnier delivered the opinion of the Court.

¶1. John Iwen brought this action against U.S. West Direct in the District Court for
the Eighth Judicial District, Cascade County, to recover damages for a negligently
constructed yellow page advertisement, infliction of emotional distress, and punitive
damages. U.S. West Direct failed to answer Iwen's complaint and a default was
entered. Prior to a hearing regarding a judgment on the default, U.S. West Direct
moved to set aside the default. The District Court granted the motion and U.S. West
Direct moved to stay litigation and compel arbitration. By an order dated January
21, 1998, the District Court granted U.S. West Direct's motion. Iwen appeals from
that order. We reverse.

¶2. The issue presented on appeal is whether the District Court erred when it
concluded that the arbitration provision in U.S. West Direct's directory advertising
order is valid and enforceable and, therefore, whether Iwen is compelled to arbitrate
his dispute with U.S. West Direct.

FACTUAL BACKGROUND

¶3. John Iwen is a licensed practicing attorney in Great Falls, Montana. On June 9,
1995, Iwen called U.S. West Direct to obtain an 800 telephone number and a new
office telephone number to closely parallel the 800 number. These new telephone
numbers were to be effective July 14, 1995. Iwen sent letters on July 10, 1995, in
which he advised his clients, some attorneys, and judges of his new telephone
numbers. He also ordered new business cards and stationary printed with the new
telephone numbers.

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¶4. On July 5 or 6, 1995, Iwen met with Kim Holzer, a sales representative for U.S.
West Direct, to arrange advertisement of his law practice and new telephone
numbers in the U.S. West Direct yellow page directory. At that meeting, Iwen
discussed with Holzer the size, content, and price of the yellow page advertisement.
Holzer thereafter drafted a proof of the advertisement for Iwen to review.

¶5. In July 28, 1995, Iwen received a proof of the yellow page advertisement from
Holzer which contained his new telephone numbers. Upon review of the proof, Iwen
determined that he was not satisfied with the advertisement. On the same day, Iwen
attempted to contact Holzer but found that she was unavailable. Iwen was then
directed to a different sales representative whom he advised that he did not want the
advertisement and instructed the sales representative to use the same advertisement
he had used in the prior year's (1994-1995) U.S. West Direct yellow page directory,
but to update it by adding his new office telephone numbers. Later that day, Iwen
spoke to Holzer and gave her the same information he gave to the other sales
representative. To assure that there was no mistake, Iwen wrote a letter dated July
28, 1995, which set forth the information he had conveyed verbally to Holzer and the
other sales representative.

¶6. In early August 1995, Iwen received an unsolicited postcard dated August 4,
1995, from Kelly Frankenfeld, customer relations manager for U.S. West Direct,
which requested Iwen's opinions regarding the service provided by Holzer. Iwen
responded that Holzer's service and ideas for improving the advertisement were
worse than expected. He also complained that Holzer's follow-up was poor and that
he was rushed by Holzer.

¶7. As soon as the new U.S. West Direct yellow page directory was published and
delivered to customers, Iwen noticed that his yellow page advertisement was
incomplete because his 800 telephone number was missing. He also noticed that his
residence address and home telephone number was deleted from the white pages.
Iwen wrote a letter dated October 6, 1995, to Kelly Frankenfeld regarding these
errors but received no response.

¶8. Iwen received a bill dated October 1, 1995, from U.S. West Communications, the
billing agent for U.S. West Direct, which was to be paid by October 23, 1995. Upon
receipt of that bill, Iwen wrote a letter dated October 16, 1995, to U.S. West
Communications which advised that he was not going to pay that bill until an

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agreement was reached with U.S. West Direct regarding the negligently constructed
advertisement in the yellow pages and deletion of his white page telephone number
and residence address.

¶9. In November 1996, Iwen received another bill from U.S. West for the months of
October and November. In letters to U.S. West Communications and U.S. West
Direct dated November 10, 1995, Iwen again advised that he was not going to pay the
bill until an agreement was reached regarding his yellow page advertisement and the
white page listing.

¶10. On November 30, 1995, Iwen received a disconnect notice from U.S. West
Communications. Iwen immediately called U.S. West Communications and advised
them of the dispute he had concerning the yellow page advertisement and white page
listing. The person to whom Iwen spoke advised him that U.S. West Direct and U.S.
West Communications are two separate entities. She advised Iwen to pay the sum of
$545.11, the sum allegedly owed to U.S. West Communications. To prevent U.S. West
Communications from disconnecting the phone service to his law firm, Iwen wrote a
letter to U.S. West Communications on November 30, 1995, and enclosed a check in
the amount of $545.11. Iwen sent a copy of that letter to Frankenfeld and Holzer.
Iwen refused to pay the bill for the negligently constructed yellow page
advertisement.

¶11. On January 3, 1996, Iwen spoke to Charlene Garberson, a customer service
associate for U.S. West Direct, about the faulty yellow page advertisement and the
white page deletion. Garberson wrote a letter to Iwen on January 3, 1996, which
Iwen received several weeks later on January 24, 1996, concerning the conversation.
Garberson acknowledged that the yellow page advertisement was faulty and
apologized on behalf of U.S. West Direct. She also stated: "Unfortunately, you have
informed us that you turned this matter over to your attorney. Therefore, at this time
no adjustment will be applied and the account will bill in full."

¶12. On January 30, 1996, Iwen received another disconnect notice which stated that
his phone service was going to be shut down for nonpayment of his bill to U.S. West
Communications and U.S. West Direct. The disconnect notice advised Iwen that the
total amount was due two days later, February 1, 1996. Once again, Iwen wrote
letters to U.S. West Communications and U.S. West Direct, dated January 31, 1996,
complaining of the treatment he received and enclosed a check in the amount of

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$225.94 payable to U.S. West Communications. Iwen still refused to pay the U.S.
West Direct bill for the faulty yellow page advertisement.

¶13. On February 20, 1996, Iwen's attorney received a letter from Garberson dated
February 6, 1996, apologizing for the mistakes made and offering to settle the matter.
The very next day, Iwen received a final collection notice from U.S. West
Communications, the billing agent for U.S. West Direct. The notice demanded that
Iwen pay for the erroneously constructed U.S. West Direct yellow page
advertisement and threatened to deny Iwen credit for future advertising if he did not
pay in full. The notice further threatened to demand a deposit for full payment for
future advertising in advance, refer nonpayment information to major credit
reporting agencies, refer Iwen to an outside collection agency, and not allow Iwen to
advertise in the yellow pages at all if he did not make the payment in full.

¶14. On March 21, 1996, Iwen filed suit against U.S. West Direct for damages for
negligent construction of the yellow page advertisement, infliction of emotional
distress, and for punitive damages. On June 3, 1997, Iwen received a notice that U.S.
West Direct's billing agent, U.S. West Communications, turned him over to the
Credit Bureau of Missoula for collection of a debt in the amount of $1,779.38 for
failing to pay for the yellow page advertisement.

¶15. U.S. West Direct moved to stay litigation and compel arbitration pursuant to the
arbitration clause in the directory advertising order; the contract Iwen entered into
with U.S. West Direct for the yellow page advertisement. Iwen resisted the motion by
arguing that the arbitration provision in the directory advertising order was invalid.
By order dated January 21, 1998, the District Court ruled that the arbitration
provision is valid and granted U.S. West Direct's motion to stay litigation and compel
arbitration.

DISCUSSION

¶16. The issue presented on appeal is whether the District Court erred when it
concluded that the arbitration provision in U.S. West Direct's directory advertising
order is valid and enforceable and, therefore, whether Iwen is compelled to arbitrate
his dispute with U.S. West Direct.

¶17. A district court's order compelling arbitration is subject to de novo review. See

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Zolezzi v. Dean Wittier Reynolds, Inc. (9th Cir. 1986), 789 F.2d 1447. As we stated in
Ratchye v. Lucas, 1998 MT 87, 288 Mont. 345, 957 P.2d 1128, we review a district
court's conclusion of law regarding arbitrability to determine whether it is correct.

¶18. Without filing a motion to dismiss, U.S. West Direct has raised the issue of
whether this Court has jurisdiction to hear this appeal. We have recently addressed
the issue of the appealability of orders to arbitrate within the context of the Federal
Arbitration Act and concluded that an order compelling arbitration is final and
appealable. See Larsen v. Opie (1989), 237 Mont. 108, 110, 771 P.2d 977, 979.

¶19. The arbitration provision which is the focal point of this appeal is contained in U.
S. West Direct's directory advertising order and states, in relevant part, as follows:

11. ARBITRATION. Any controversy or claim arising out of or relating to this
Agreement, or breach thereof, other than an action by Publisher for the collection of the
amounts due under this Agreement, shall be settled by final, binding arbitration in
accordance with the Commercial Arbitration Rules of the American Arbitration
Association, which rules are incorporated herein by reference; provided, however, that any
person nominated to act as arbitrator is licensed to practice law before the courts of the
State where the arbitration is conducted. There shall be one arbitrator to any arbitration.
Judgment upon the award rendered by the arbitrator may be entered in any court having
jurisdiction thereof. Venue for any arbitration under this provision shall be at the office of
the American Arbitration Association closest to the Advertiser, or as such other location as
the parties may agree.

(Emphasis added.)

¶20. Iwen made several arguments in the District Court to support his contention
that he should not be obligated to arbitrate this dispute. On appeal, however, he
contends that the District Court erred when it enforced the arbitration provision
because the provision itself is invalid. Iwen argued in the District Court, as he does
here, that the agreement to arbitrate should not be upheld because it is a contract of
adhesion which is oppressive, unconscionable, and against public policy. U.S. West
Direct maintains that the arbitration clause was freely entered into by the parties
and the provision is not a contract of adhesion nor is it in any way oppressive,
unconscionable, or against public policy. Furthermore, U.S. West Direct contends

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that the District Court properly limited its review to the validity of the arbitration
provision and once it determined that it was a valid arbitration agreement, it ordered
the parties to arbitrate their dispute. See 9 U.S.C.A. 34 (1998).

¶21. In its ruling ordering the parties to arbitration, the District Court correctly
referred to our decision in Passage v. Prudential-Bache Securities, Inc. (1986), 223
Mont. 60, 727 P.2d 1298, where we addressed the doctrine of adhesion and its
applicability to contracts which contain arbitration clauses.

¶22. In applying these contract principles in the context of this case, the District
Court determined that the arbitration provision was one of a number of terms
located on the back of the order form and, therefore, was within the reasonable
expectations of Iwen. The court then found that the arbitration provision provides
for arbitration in conformity with the rules of the American Arbitration Association
and, therefore, was not unduly oppressive, unconscionable, or against public policy.

¶23. This Court has, on previous occasions, decided the validity of various
arbitration agreements. See Casarotto v. Lombardi (1994), 268 Mont. 369, 886 P.2d
931, vacated by Doctor's Associates, Inc. v. Casarotto (1995), 515 U.S. 1129, 115 S. Ct.
2552, 132 L. Ed. 2d 807; Chor v. Piper Jaffray & Hopwood, Inc. (1993), 261 Mont.
143, 862 P.2d 26; Mueske v. Piper Jaffray & Hopwood, Inc. (1993), 260 Mont. 207, 859
P.2d 444; Larsen v. Opie (1989), 237 Mont. 108, 771 P.2d 977; Passage v. Prudential-
Bache Securities, Inc. (1986), 223 Mont. 60, 727 P.2d 1298. Because this contract
evidences a transaction involving commerce, the application of the Federal
Arbitration Act, 9 U.S.C.A. §§ 1-16 (1998) is undisputed. Section 2 of the Act which
pertains to the validity, irrevocability, and enforcement of agreements to arbitrate
provides:

A written provision in any maritime transaction or a contract evidencing a transaction
involving commerce to settle by arbitration a controversy thereafter arising out of such
contract or transaction, or the refusal to perform the whole or any part thereof, or an
agreement in writing to submit to arbitration an existing controversy arising out of such a
contract, transaction, or refusal, shall be valid, irrevocable, and enforceable, save upon
such grounds as exist at law or in equity for the revocation of any contract.

Title 9 U.S.C.A. § 2 (1998) (emphasis added). Therefore, in our review of the legal issue

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presented, it is necessary that we refer to both federal and state law.

¶24. In Volt Information Sciences, Inc. v. Board of Trustees of Leland Stanford Junior
University (1989), 489 U.S. 468, 474, 109 S. Ct. 1248, 1253, 103 L. Ed. 2d 488, 497, the
United States Supreme Court held that one of the fundamental tenets of the Federal
Arbitration Act is that arbitration provisions should exist "upon the same footing" as
all other contractual provisions. Evaluating arbitration agreements pursuant to
federal law while evaluating all other contractual provisions pursuant to state law
would place the arbitration provision on footing different from the rest of the
contract; the arbitration provision would receive preferential treatment. See Supak
& Sons Mfg. Co. v. Pervel Indus., Inc. (4th Cir. 1979), 593 F.2d 135, 137. We endorsed
the notion of equal footing of arbitration provisions when we held that such
provisions, like all other contractual provisions, are subject to the state's laws which
govern unconscionability. See Chor, 261 Mont. at 148, 862 P.2d at 29; see also 9 U.S.
C.A. § 2 (1998).

¶25. It is also important to note that contract law is typically the domain of the states.
See Aronson v. Quick Point Pencil Co. (1979), 440 U.S. 257, 262, 99 S. Ct 1096, 1099,
59 L. Ed. 2d 296, 301. The existence of a federal common law of contract was rejected
in Erie R. Co. v. Tompkins (1938), 304 U.S. 64, 78, 58 S. Ct. 817, 822, 82 L. Ed. 1188,
1194. In fact, in Perry v. Thomas (1987), 482 U.S. 483, 492, 107 S. Ct. 2520, 2527, 96
L. Ed. 2d 426, 637, n.9, the Supreme Court indicated that state law should govern
contract formation and revocation questions. In Doctor's Associates, Inc. v. Casarotto
(1996), 517 U.S. 681, 687, 116 S. Ct. 1652, 1656, 134 L. Ed. 2d 902, 908-09, the Court
definitively stated that "the text of § 2 [of the Federal Arbitration Act] declares that
state law may be applied" to determine questions of validity.

¶26. It is therefore clear that generally applicable contract law defenses may be used
to set aside arbitration agreements. The United States Supreme Court has indicated,
however, that states may not craft special rules which apply only to arbitration
provisions for the purpose of defeating arbitration. In Casarotto, 517 U.S. at 687, 116
S. Ct. at 1656, 134 L. Ed. 2d at 909, the Supreme Court interpreted the Federal
Arbitration Act as allowing state action generally applicable to all contract and other
matters but not as fostering rejection or chilling of the federal policy in favor of
arbitration. The Court noted that such an approach does not undermine the right to
arbitrate which, by the very language of the Federal Arbitration Act, is intended to
encompass only those arbitration agreements that are not tainted by fraud, duress,

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or unconscionability. See Casarotto, 517 U.S. at 687, 116 S. Ct. at 1656, 134 L. Ed. 2d
at 909.

¶27. With this background, we now address Montana case law which has considered
the validity of arbitration clauses. As previously stated, the District Court correctly
referred to our decision in Passage in determining the validity of the arbitration
provision. In Passage, we explained the doctrine of adhesion and its applicability to
contracts which contain arbitration clauses. We stated that for such contracts to be
enforced against the weaker bargaining party, they must pass a two-prong test for
validity. We stated that test as follows:

For such a contract or clause to be void, it must fall within judicially imposed limits of
enforcement. It will not be enforced against the weaker party when it is: (1) not within the
reasonable expectations of said party, or (2) within the reasonable expectations of the
party, but, when considered in its context, is unduly oppressive, unconscionable or against
public policy.

Passage, 223 Mont. at 66, 727 P.2d at 1302.

¶28. Accordingly, our application of the Montana law of contracts must initially
begin with a determination of whether U.S. West Direct's directory advertising
order, which contains the arbitration clause at issue, is a contract of adhesion. When
determining whether a contract is one of adhesion, we focus on the nature of the
contracting process, rather than the parties' relative sizes, resources, or bargaining
power. Hence, we have held that contracts of adhesion "arise when a standardized
form of agreement, usually drafted by the party having superior bargaining power, is
presented to a party, whose choice is either to accept or reject the contract without
the opportunity to negotiate its terms." Passage, 223 Mont. at 66, 727 P.2d at 1301.
Although the doctrine of adhesion itself does not constitute a sufficient basis for
invalidating a contract, the adhesive nature of a contract, or contract provision, is
generally noted to support other contract formation defenses such as
unconscionability or public policy. See Cohen v. Wedbush, Noble, Cooke, Inc. (9th
Cir. 1988), 841 F.2d 282, 286; Passage, 223 Mont. at 66, 727 P.2d at 1301-02.

¶29. Here, Iwen was faced with a standardized form agreement which U.S. West
Direct used to market its yellow page advertising. The record clearly establishes that

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U.S. West Direct's directory advertising order is a standardized form agreement, the
terms of which Iwen was unable to negotiate and for which his only choice was to
accept or reject. As we held in Transamerica Ins. Co. v. Royle (1983), 202 Mont. 173,
181, 656 P.2d 820, 824, because this agreement is one of adhesion, we are justified in
viewing this contract from the perspective of the consumer.

¶30. Once we have determined that this contract is a contract of adhesion, we apply
the Passage test for validity. We must either determine whether the arbitration
provision is not within Iwen's reasonable expectations, or within Iwen's reasonable
expectations but, when considered in its context, is unduly oppressive,
unconscionable, or against public policy. Because, as explained below, we conclude
that the provision is unconscionable, we need not determine whether the provision
violated Iwen's reasonable expectations.

¶31. In Leibrand v. National Farmers Union Property & Casualty Co. (1995), 272
Mont. 1, 898 P.2d 1220, we referred to a Third Circuit Court of Appeals decision and
stated that:

Unconscionability in a contract is a concept introduced under the Uniform Commercial
Code and it has been applied to insurance contracts. Unconscionability requires a two-fold
determination: that the contractual terms are unreasonably favorable to the drafter and that
there is no meaningful choice on the part of the other party regarding acceptance of the
provisions.

Leibrand, 272 Mont. at 12-13, 898 P.2d at 1227 (quoting Worldwide Underwriters Ins. Co. v. Brady (3d Cir.
1992), 973 F.2d 192, 196) (citations omitted; emphasis added.) One need only look at the language of the
arbitration provision itself to determine that it is unreasonably favorable to U.S. West Direct, the drafter. The
language of the first sentence of the arbitration provision reads:

Any controversy or claim arising out of or relating to this Agreement, or breach thereof,
other than an action by Publisher for the collection of the amounts due under this
Agreement, shall be settled by final, binding arbitration in accordance with the
Commercial Arbitration Rules of the American Arbitration Association . . . .

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(Emphasis added.) Drafted as such, the weaker bargaining party has no choice but to settle
all claims arising out of the contract through final and binding arbitration, whereas the
more powerful bargaining party and drafter has the unilateral right to settle a dispute for
collection of fees pursuant to the agreement in a court of law. As a practical matter, it is
arguable that the primary reason U.S. West Direct would seek a remedy against Iwen, or
any other advertiser for that matter, is if the advertiser refused to pay his or her advertising
bill. Likewise, according to the terms of the contract, the only remedy an advertiser could
seek from U.S. West Direct is a pro rata reduction or refund of the cost of the
(1)
advertisement. With the sole remedy for either party being the cost of the advertisement,
it makes no sense for one party, U.S. West Direct, to have the freedom to seek the remedy
before a court of law, while the other party, Iwen, is forced to seek the same remedy only
through arbitration. U.S. West Direct pointedly protected itself by preserving its
constitutional right of access to the judicial system while at the same time completely
removed that right from the advertiser.

¶32. Consistent with our decision in Leibrand and others which have defined contract
unconscionability, this case presents a clear example of an arbitration provision that
lacks mutuality of obligation, is one-sided, and contains terms that are unreasonably
favorable to the drafter. Because U.S. West Direct presented this agreement on a
take-it-or-leave-it basis, it is also a contract in which there was no meaningful choice
on the part of the weaker bargaining party regarding acceptance of the provisions.
Certainly, this does not mean arbitration agreements must contain mutual promises
that give the parties identical rights and obligations, or that the parties must be
bound in the exact same manner. This simply restates the rule of law that disparities
in the rights of the contracting parties must not be so one-sided and unreasonably
favorable to the drafter, as they are in this case, that the agreement becomes
unconscionable and oppressive. See Riccardi v. Modern Silver Linen Supply Co. (N.Y.
App. Div. 1974), 45 A.D.2d 191.

¶33. U.S. West Direct cites Snap-on Tools Corp. v. Vetter (D. Mont. 1993), 838 F.
Supp. 468, for the proposition that the arbitration agreement in this case does
provide for mutual obligations. However, we agree with the federal district court that
although one party in Snap-on Tools was allowed to go to court to seek temporary
relief pending arbitration, the parities' obligations were, for the most part, mutual
because both parties were required to arbitrate. In this case, on the other hand, the
parties' obligations are completely one-sided. U.S. West Direct is allowed access to
the court system, while Iwen is not.

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¶34. Accordingly, our application of general principles that exist at law or in equity
for the revocation of any contract leads us to conclude that the arbitration provision
at issue in this case is unconscionable. Our application of Montana law regarding
unconscionability does not undermine the right to arbitrate which is, by the very
language of the Federal Arbitration Act, intended to encompass only those
arbitration agreements that are not tainted by fraud, duress, or unconscionability.

¶35. We reverse the judgment of the District Court, strike the arbitration provision
in U.S. West Direct's directory advertising order pursuant to § 30-2-302, MCA, and
remand this case to the District Court for further proceedings consistent with this
opinion.

/S/ JIM REGNIER

We Concur:

/S/ J. A. TURNAGE

/S/ KARLA M. GRAY

/S/ JAMES C. NELSON

/S/ W. WILLIAM LEAPHART

1. 19. REMEDY FOR ERROR OR OMISSION IN ADVERTISEMENT. IN THE EVENT OF ANY
ERROR IN THE ADVERTISING AS PUBLISHED, THE ADVERTISER IS ENTITLED TO A PRO-
RATA REDUCTION OR REFUND OF THE CHARGES FOR THE ADVERTISING IN THE SAME
PROPORTION THAT THE ERROR REDUCES, IF AT ALL, THE VALUE OF THE
ADVERTISEMENT AS A WHOLE. IN THE EVENT OF THE OMISSION OF ANY ITEM OF
ADVERTISING, THE ADVERTISER IS ENTITLED TO A REFUND OF THE CHARGES PAID
FOR THE ADVERTISING. ADVERTISER MUST NOTIFY PUBLISHER OF ANY ERROR OR
OMISSION WITHIN SIX MONTHS OF PUBLICATION OF THE DIRECTORY IN WHICH THE

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ERROR OR OMISSION OCCURS TO RECEIVE THE REDUCTION OR REFUND. Likewise,
paragraph 10 specifically precludes an advertiser from seeking incidental damages,
consequential damages, lost profits or any damages caused by the tortious conduct of U.S.
West Direct. It states:

10. LIMITATION OF LIABILITY. THE REMEDY SET FORTH ABOVE FOR ANY ERROR OR
OMISSION IN ADVERTISING IS ADVERTISER'S EXCLUSIVE REMEDY, AND PUBLISHER
SHALL NOT BE LIABLE FOR INCIDENTAL OR CONSEQUENTIAL DAMAGES (INCLUDING
LOST PROFITS) WHETHER IN CONTRACT, TORT OR OTHERWISE.

Paragraphs 8 and 13 of the directory advertising order provide even further protection to U.
S. West Direct by stating that U.S. West Direct is entitled to attorney fees and costs of
legal action is taken by an advertiser.

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