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Craig Comb, et al. v. PayPal, Inc.

Cases No. C-02-1227 and C-02-2777 JF (N.D. Cal., August 30, 2002)

Court holds that both PayPal's User Agreement, and the arbitration clause found therein, are unconscionable under California law.  The Court accordingly denies motions by PayPal to compel users who commenced putative class action suits arising out of PayPal's allegedly inappropriate handling of customer accounts and/or complaints to resolve their claims via arbitration.  The Court held that the User Agreement and the arbitration clause therein are unconscionable because they: (1) permit PayPal to issue binding amendments to the User Agreement at any time without notice to users; (2) obligate users to arbitrate their disputes pursuant to the commercial rules of the AAA, which is cost prohibitive in light of the average size of a PayPal transaction; (3) obligate users who reside nationwide to arbitrate in Santa Clara county, California, where PayPal is located; (4) permit PayPal to freeze and maintain possession of the funds in customer accounts until any dispute is resolved; and (5) require users to pursue their claims individually, and not via a class action.  Taken together, the Court held these provisions made the User Agreement unconscionable, and appear to represent an attempt by PayPal "to insulate itself contractually from any meaningful challenge to its alleged practices." 

PayPal aids those who buy and sell merchandise over the Internet by supplying a means by which buyers can transmit funds to sellers using credit cards or other methods of payment.  PayPal receives such funds from buyers and, in turn, transmits them to the sellers.  PayPal profits from its services by charging transaction fees, as well as collecting interest on transmitted funds while in PayPal's possession.  To utilize PayPal's services, both the buyer and seller must open PayPal accounts.  This, in turn, requires the buyer and seller to agree to be bound by the terms of PayPal's User Agreement.  The participants indicate their assent to be bound to such agreements by clicking on a box which states that they "have read and agree to the User Agreement …", the terms of which are made available via a link.  The Agreement itself is 25 pages in length.  PayPal presently services 12 million accounts.  The average size of a transaction executed using PayPal is $55.

Plaintiffs are individuals who commenced two putative class action lawsuits arising out of PayPal's allegedly poor handling of their accounts and/or complaints.  One of the plaintiff's claims arose out of PayPal's allegedly improper deduction of moneys from his bank account.  This plaintiff was not a PayPal account holder, and had not agreed to the terms of the User Agreement.  A second plaintiff claimed PayPal had deducted, without authorization, funds from her PayPal account, which PayPal then gave to third parties.  A third plaintiff alleged that his account had been improperly frozen because an unknown individual had improperly used his PayPal identity to cause individuals to make payments for goods they did not receive.  Each of the plaintiffs complained of poor customer service in connection with the handling of their complaints, and charged, in pleadings they filed, that others had experienced similar problems.

PayPal brought a motion to compel individual arbitrations of the plaintiffs' claims, pursuant to the terms of an arbitration clause contained in the then current version of its User Agreement.  This clause provided:

Any controversy or claim arising out of or relating to this Agreement or the provision of Services shall be settled by binding arbitration in accordance with the commercial arbitration rules of the American Arbitration Association.  Any such controversy or claim shall be arbitrated on an individual basis, and shall not be consolidated in any arbitration with any claim or controversy of any other party.  The arbitration shall be conducted in Santa Clara County, California, and judgment on the arbitration award may be entered in any court having jurisdiction thereof.  Either you or PayPal may seek any interim or preliminary relief from a court of competent jurisdiction in Santa Clara County, California necessary to protect the rights or property of you or PayPal, Inc. (or its agents, suppliers, and subcontractors) pending the completion of arbitration.

The Court assumed, without deciding, that the two plaintiffs who were PayPal account holders had agreed to be bound by the version of the PayPal User Agreement in effect at the time they opened their accounts.  Nonetheless, the Court, finding both the User Agreement and its arbitration clause unconscionable, denied PayPal's motion to compel arbitration.

Under California law, "unconsionability has both procedural and substantive components."  "A contract is procedurally unconscionable if it is a contract of adhesion."  "A contract of adhesion, in turn, is a 'standardized contract, which, imposed and drafted by the party of superior bargaining strength, relegates to the subscribing party only the opportunity to adhere to the contract or reject it.'"  "The substantive component is satisfied by overly harsh or one-sided results that shock the conscience.  The two elements operate on a sliding scale such that the more significant one is, the less significant the other need be."

The Court held that PayPal's User Agreement was a contract of adhesion, and hence procedurally unconscionable, because it was a form agreement drawn by PayPal, a party of superior bargaining power, and offered to its customers on a take-it-or-leave-it basis.

The Court also found that the User Agreement and its arbitration provisions were substantively unconscionable.  In reaching this conclusion, the Court pointed to a number of provisions contained in the Agreement, including provisions by which:

  1. PayPal could amend the agreement at any time without notice to users, which amendments would be binding on them;
  2. PayPal could freeze all of the funds in a customer's account pending its resolution of any dispute;
  3. The arbitration provisions mandated arbitration pursuant to the commercial rules of AAA, which was cost prohibitive, in light of evidence that such a procedure would cost $5000, while the average PayPal transaction was $55;
  4. The arbitration provision required all arbitrations to proceed in Santa Clara County, California, where PayPal was headquartered, while PayPal's customers resided throughout the United States; and
  5. The arbitration provision prohibited joinder of claims among individuals, requiring each instead to proceed individually.

Taken as a whole, these provisions rendered the User Agreement and its arbitration provisions unconscionable.  The Court accordingly denied PayPal's motion to compel arbitration.

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