General Practice, Solo & Small Firm DivisionMagazine

Volume 17, Number 7
October/November 2000

Arbitration Clauses Added to Consumer Contracts:

Why They Are Not Enforceable

By A. Daniel Woska

Although currently only a ruling in California, the case of Badie v. Bank of America1 clearly and succinctly sets out legal arguments that are developing nationwide in both state and federal courts on behalf of consumers faced with the prospect of taking their disputes with monolithic corporations to arbitration rather than the courtroom. Since the Supreme Court ruling in Gilmer v. Interstate/Johnson Lane,2 the federal courts’ liberal and sometimes overabundant acceptance of arbitration based on the most scant or limited arbitration clauses has been under attack. This attack is certainly historical becuase it relates to consumers and their contracts with businesses.

The attack is twofold. First, employees are taking issue with employers who are forcing employees to agree to arbitrate any and all employment disputes as a condition of employment. Second, consumers are finding that their banks or other routine providers are changing the terms of customer agreements to include arbitration clauses that often modify substantive legal rights. Ultimately, it prevents an individual consumer from pursuing a matter to a trial by jury, replacing trial with a simplified but often more expensive arbitration before the American Arbitration Association or a similar provider.

Although this article focuses on consumers, a look at the employment law arena is instructive. The Supreme Court has recently granted certiorari in the case of Circuit City Stores v. Adams.3 The Adams case will determine whether the Court of Appeals for the Ninth Circuit erred in holding, directly contrary to all of the other U.S. courts of appeals that have addressed the issue, that the Federal Arbitration Act (FAA) does not apply to contracts of employment. This challenge will not go unnoticed by consumer advocate groups, which are certainly aware of the liberal federal policy favoring arbitration agreements that involve "interstate commerce." Various U.S. courts of appeal have upheld arbitration agreements between employers and employees as being subject to "interstate commerce" and, therefore, under the enforceability of the FAA. As a result, the FAA has been increasingly used by large corporations to force employees to arbitrate any and all disputes, including federal claims under Title VII.

Badie: Challenging the ADR Clause

In Badie, a group of plaintiffs got together to challenge the validity of an alternative dispute resolution clause that the Bank of America (the Bank) sought to add to existing account agreements between itself and its deposit account and credit card customers. The Bank accomplished this task by sending the customers an insert—or "bill stuffer"—with their monthly account statements, notifying the customers of the new terms. None of the individual plaintiffs in the case had a deposit account with the Bank, but they all had Bank credit cards. The case was originally brought on the basis of several statutory claims that are unique to California. However, one claim regarding declaratory relief related to the validity and enforceability of this change and was the source of the court’s opinion.

The Bank relied upon a "change of terms" provision that was included in all original account agreements sent years earlier. This was a fairly traditional statement that was used by banks and providers of services nationwide. It was designed to give the bank or the provider the unilateral right to modify agreements after customers enter into them. Contractually, this created an environment in which it is typically undisputed that the account agreements became contracts of adhesion. They could be unilaterally modified without consumer input, except for a consumer’s decision to take business elsewhere.

Contracts of adhesion often have a negative connotation, but in fact they simply signify, as pointed out in the Badie case, that a standardized contract imposed and drafted by the party of superior bargaining strength relegates the subscribing party only the opportunity to adhere to the contract or reject it.4 As pointed out in the Badie case, the fact that a contract is one of adhesion does not mean that it is automatically an unconscionable contract.5

No Provision for Resolving Disputes

The court in the Badie case ultimately seized on the fact that none of the customer agreements that were admitted into evidence in the case contained a provision regarding a method or form for resolving disputes. In other words, even though the contracts contained terms that allowed changes in provisions by the Bank, the change of term provision was based on the "universe of words" contained in the body of the original customer agreement. By clearly identifying what was contained in the "universe of words" in the original agreement between the parties, the Badie court was able to evaluate contract principles that would likely be applicable to any and all consumer challenges in similar situations with similar contracts in the future.

Initially, the court sought to determine whether there was originally an enforceable ADR provision in the agreement between the Bank and its customers. Once it was determined that there was none, the application of ordinary state law contract principles that govern the formation and interpretation of contracts was used to determine whether the parties in fact agreed to some form of dispute resolution, which they had not done.

Under both federal and California law, arbitration is a matter of contract between the parties.6 The liberal federal policy favoring arbitration agreements is at bottom a policy guaranteeing the enforcement of private contractual agreements,7 as is law in most states. The California Supreme Court has stated that "the policy favoring arbitration cannot displace the necessity for a voluntary agreement to arbitrate."8 Although the law favors contracts for arbitration of disputes between parties, there is no federal policy or known state policy compelling persons to accept arbitration of controversies that they have not agreed to arbitrate.9 This should always be the starting point for any challenge to an arbitration clause: Did the parties agree in writing to arbitrate anything, and if so, what?10

Bank Claims Procedure Was Followed

The first big issue that the Badie court then addressed was the argument that there is a longstanding California public policy favoring arbitration and embracing its usage. The argument by the Bank implied that the need for consumer consent with respect to ADR procedures had been eroded since the California Supreme Court decision in Madden v. Kaiser Foundation Hospitals.11 The court was thus called on to determine whether arbitration provisions could be enforced against persons who have not read them. The Badie court instead addressed an issue that cases cited by the Bank did not support, the underlying proposition that ADR can simply be imposed on Bank customers without their consent.

The Badie court quickly pointed out that the Madden court did not involve a contract of adhesion and, therefore, the California Supreme Court had not ruled that parties to contracts of adhesion simply gave up their substantive rights if the party in the position of power changed substantive rules relating to enforcement of the contract. The problem in the Badie case is that the original contracts between the Bank and its customers did not contain "any agreement" either to submit disputes to arbitration or to submit them to litigation.

The Bank argued that regardless of the nature of the modification, which in this case would be quite substantive, a new ADR provision is a valid part of the contract as long as the procedure for making the modification was followed. Then, the Bank argued that the only procedural requirement was to follow the "change of terms" provision in the agreement whereby the Bank had notified the customer of the change. The Bank argued that because it sent notice in the form of a bill stuffer, it met the sole procedural requirement of the change of term provisions and the modification was therefore automatically valid because it was made in accordance with the terms of the contract. Thus, if the consumer read the bill stuffer and disagreed, he could take his business elsewhere. The Badie court disagreed.

As the Badie court pointed out, a modification made in accordance with the terms of the contract requires at least in part a modification whose general subject matter was anticipated when the contract was entered into. The modifications in question should have been specifically identified in the original contracts as changes that might be made in the future under certain circumstances.

The Badie court pointed out that the Bank had erroneously concluded that if the imposition or increase of, for example, NSF charges was valid in one of the cases cited by the Bank, Perdue v. Crocker National Bank,12 then, a fortiori, its ADR clause is valid and enforceable because it was added to the account agreement pursuant to an expressed change of terms provision. In making this argument, the Bank failed to recognize that the Perdue signature card expressly addressed the imposition of both present and presumably different or changed future charges. Conversely, the Bank of America customer agreements contained no reference to alternative dispute resolution or litigation.

Good Faith Covenant

The Badie court pointed out that Perdue underscores the importance of the duty imposed on one party having the discretionary power to affect the rights of the other party to exercise the power to change the agreement in a manner that is consistent with the covenant of good faith and fair dealing. The Badie court refers back to the Restatement (second) of Contracts, section 205. The court’s focus on the ADR clause standing alone was misplaced. It was the Bank’s exercise of its discretionary right to change the customer agreement, not the ADR clause in and of itself, that first should have been analyzed in terms of the implied covenant. The essence of the good faith covenant is "objective reasonable conduct."13 A covenant of good faith can be breached for objectively unreasonable conduct regardless of the actor’s motive.

As the Badie court pointed out, where a party has the unilateral right to change the terms of a contract, it does not act in an objectively reasonable manner when it attempts to recapture a foregone opportunity by adding an entirely new term that has no bearing on any subject, issue, right, or obligation addressed in the original contract and that was not within the reasonable contemplation of the parties when the contract was entered into. This is particularly true where the new term deprives the other party of the right to a jury trial and the right to select a judicial forum for dispute resolution.

Interpreting Original Intent

The Badie court zeroed in on the fact that the Bank had exercised its right to make unilateral changes in the terms and provisions of the agreement without any limitation on the substantive nature of the change. Ultimately, the Badie court attempted to determine the mutual intention of the parties as it existed at the time the original account agreement was entered into and referred back to California contract interpretation provisions.

As is often the case when it comes to a contract dispute, when a dispute arises over the meaning of a contract or its language, the court must decide whether the language is reasonably susceptible to the interpretations urged by the parties. Whether the contract is reasonably susceptible to a party’s interpretation can be determined by the language of the contract itself or from extrinsic evidence of the party’s intent. If the contract is capable of more than one reasonable interpretation, it becomes ambiguous. It is then the court’s duty to determine the ultimate construction to be placed on the ambiguous language contained in the contract by applying the standard rules of interpretation to give affect to the mutual intention of the parties. Ultimately, the interpretation of a contract is solely a question of law.

In Badie, the court found that the credit agreement was reasonably susceptible to the interpretations offered by both sides and, therefore, the court was called on to determine the construction of the ambiguous language by applying the appropriate canons of construction. Because the parties never originally considered ADR, the court concluded that the nature and subject matter of the agreements strongly supported the conclusion that the customers did not intend to allow the Bank to modify their substantive rights unilaterally by adding an ADR clause.

Ultimately, the Badie court concluded that the ADR provision was not originally contemplated by the parties, and as a result, it could not later be added pursuant to the adhesion contract terms that were actually entered into between the parties. The Badie court also stated that there was no clear agreement to submit disputes to arbitration or some other form of waiver of the right to a trial by jury that is required by law. The court found no unambiguous and unequivocal waiver of a right to a trial by jury either in the language of the change of terms provision or in any other part of the original account agreement.


Consumers challenging the application of an arbitration clause to a dispute may argue that the unilateral change of an adhesion contract may be a breach of the covenant of good faith and fair dealing. Corporations would be wise to allow for changes to customer agreements to include the customers’ signed agreements to the change.


1. 67 Cal. App. 4th 779; 1998 Cal. App. LEXIS 916; 79 Cal. Rptr. 2d 273 (1998).

2. 500 U.S. 20 (1991).

3. 194 F.3d 1070 (9th Cir. 1999).

4. Neal v. State Farm Ins. Cos., 188 Cal. App. 2d 690; 10 Cal. Rptr. 781 (1961).

5. California Grocers Ass’n v. Bank of Am., 22 Cal. App. 4th 205; 27 Cal. Rptr. 2d 396 (1994).

6. First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938; 115 S.Ct. 1920; 131 L. Ed. 2d 985 (1995).

7. Mitsubishi Motors v. Soler Chrysler-Plymouth, 473 U.S. 614; 105 S.Ct. 3346; 87 L. Ed. 2d 444 (1985).

8. Victoria v. Superior Court, 40 Cal. 3d 734; 222 Cal. Rptr. 1; 710 P. 2d 833 (1985).

9. Arista Films, Inc. v. Gilford Sec., Inc., 43 Cal. App. 4th 495; 51 Cal. Rptr. 2d 35 (1996).

10. Allied-Bruce Terminix Cos., Inc. v. Dobson, 513 U.S. 265, 284-86 (1995).

11. 17 Cal. 3d 699; 552 P. 2d 1178 (1976).

12. 38 Cal. 3d 913; 216 Cal. Rptr. 345; 702 P. 2d 503 (1985).

13. Lazar v. Hertz Corp., 143 Cal. App. 3d 128; 191 Cal. Rptr. 849 (1983).


A Daniel Woska is of counsel to the firm of Woska Helms Dowd Underwood & Hasbrook, P.C., in Oklahoma City. He conducts multi-party mediations and arbitrations. He is chair of the ABA General Practice, Solo and Small Firm Division’s ADR Committee.

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