On August 30, 2002, the U.S. District Court for the Northern District of California ruled in Comb v. PayPal, Inc. that a click-wrap agreement, and its arbitration clause in particular, were unconscionable, and therefore refused to compel plaintiff consumers to arbitrate their disputes, as would otherwise have been required under that agreement.

PayPal is an online payment service that allows both businesses and individual consumers to send and receive payments over the Internet. Accounts are opened by completing an online application, which includes accepting a lengthy click-wrap agreement. Several consumers sued PayPal concerning unauthorized transfers from their accounts and PayPal’s failure to resolve those disputes on a timely basis. PayPal moved to compel arbitration of these suits, based on the arbitration clause in its click-wrap agreement.

Unconscionability, or inherent unfairness, is a defense applicable to click-wrap agreements, just as it is a defense to the enforcement of other types of contracts. For any agreement to be unenforceable on this ground, it must be unconscionable both procedurally and substantively.

The court found the click-wrap agreement in PayPal to be procedurally unconscionable because it was an adhesion contract. It was a standardized contract, drafted and imposed by a party with superior bargaining strength. The consumer plaintiffs only had the opportunity to accept or reject it; they did not have the opportunity to negotiate its terms. PayPal asserted that the agreement was not procedurally unconscionable because it did not concern essential items, such as food or clothing, and because the consumer plaintiffs had alternative sources for the services provided by PayPal. The court concluded, however, that when consumers are involved the availability of alternative sources is not sufficient to prevent it from finding procedural unconscionability under California law.

The court also found substantive unconscionability, citing four specific problems with PayPal’s click-wrap agreement:

1. Lack of Mutuality: In the event of a dispute with one of its customers, the agreement permitted PayPal to restrict the customer’s accounts, withhold funds in those accounts, undertake its own investigation of the customer’s financial records, close those accounts and take over ownership of all funds in dispute unless and until the customer is later found to be entitled to those funds. Perhaps most galling, the terms of the click-wrap agreement itself were subject to change by PayPal without prior notice, merely by posting of the revised agreement on PayPal’s website. The court found no “business realities” to justify the one-sidedness of these provisions.
   
2. Prohibition Against Consolidation of Claims: The arbitration clause in the PayPal click-wrap agreement prohibited customers from consolidating their claims with other customers. The court found that, in practice, most consumer claims involved small amounts of money, and prohibiting consolidated claims would effectively deprive them of any effective method of redress.
   
3. Costs of Arbitration: The click-wrap agreement chose arbitration under the commercial arbitration rules of the American Arbitration Association (“AAA”). The court found that the costs to each plaintiff in such an arbitration would exceed the amounts in dispute, and the court noted that those costs would have been far less under the AAA’s consumer arbitration rules. The court found that, in combining the choice of the more expensive commercial arbitration rules with the ban on consolidation of claims discussed above, PayPal appeared to be attempting to insulate itself contractually from any meaningful challenge to its practices.
   
4. Venue: The court concluded that it is unreasonable to expect individual consumers throughout the country, with average claims of only $55, to travel to one location (in this case, PayPal’s backyard) to arbitrate such small claims.

Other courts have reached similar results. In our April 9, 2001 Internet Alert, we discussed the Massachusetts case of Williams v. America Online, Inc., where the court refused to enforce a forum selection clause that would have forced individual consumers to move their lawsuits from Massachusetts to Virginia. In that case, the court found both the substantive terms of the click-wrap agreement and the methods through which that agreement was imposed to be unreasonable. In Brower v. Gateway 2000, Inc., the New York Appellate Division, First Department in 1998 determined that the arbitration clause in a shrink-wrap agreement was enforceable, but also found that conducting an arbitration of consumer claims under the rules of the International Chamber of Commerce effectively was financially prohibitive, leaving consumers without a forum to resolve disputes. That court remanded the case to a lower court, so that a more affordable arbitrator could be designated.

The PayPal court seems to go even further. It did not question the method by which the terms of that agreement were presented online, or the way in which users were asked to accept or reject those terms. For example, as was discussed in our August 20, 2001 Internet Alert, a federal judge in Specht v. Netscape Communications, Inc. found that users had not affirmatively assented to the terms of the click-wrap agreement which Netscape attempted to impose. In contrast, the PayPal court assumed that the consumer plaintiffs had assented to PayPal’s click-wrap agreement, but went on to find that agreement to be procedurally unconscionable, in part due to those plaintiffs’ inability to negotiate the terms of those agreements.

The court determined that the procedural unconscionability which it found will not, by itself, lead to rejecting a click-wrap agreement. However, the PayPal court found substantive unconscionability as well, citing such lopsided provisions as: (i) requiring consumer plaintiffs from all over the United States to come to PayPal’s backyard to resolve disputes; (ii) arbitration of consumer suits under commercial rules; (iii) no consolidation of claims; (iv) PayPal’s ability to block (and even take over) customer accounts; and (v) PayPal’s unilateral ability to amend that agreement. All the first two of these provisions are fairly standard, the other three are not typically found in most click-wrap agreements.

Going forward, e-retailers and other companies, whether relying on click-wrap or conventional individually-executed form agreements, would be well advised to consider avoiding the types of one-sided clauses noted above when dealing with consumers, who are likely to have many individual claims with small amounts in dispute. Those companies might also consider resolving disputes with consumers under consumer arbitration rules, and providing multiple venues for dispute resolution, so as to avoid significant travel costs for their consumer customers.