Arbitration Agreement That Can Be Modified by One Side at Any Time for Any Reason Is Unenforceable — No Consideration If One Party Can Immediately Rescind, Even If It Doesn’t — Is 30 Days’ Notice Enough to Save It?

Day v. Fortune Hi-Tech Mktg., Inc., 2013 U.S. App. LEXIS 19060 (6th Cir. Sept. 12, 2013):

These two closely related cases involve Defendant Fortune Hi-Tech Marketing, Inc. ("Fortune Hi-Tech" or "FHTM"). Defendant hired Plaintiffs as independent representatives and Plaintiffs sued, alleging that FHTM was in fact running an illegal pyramid scheme. Defendant moved the district court to compel Plaintiffs to proceed to arbitration pursuant to the terms of the contract they had signed with Defendant. While the district court initially granted that motion, upon reconsideration the court reversed itself and vacated its earlier decision and ordered the cases to proceed to trial. Defendant now appeals the two orders denying its motion to compel arbitration. We AFFIRM the judgment of the district court.***

Defendant Fortune Hi-Tech Marketing, Inc. is a "multi-level marketing company that independently markets the services of various organizations."  In essence, Fortune Hi-Tech acted as a third-party marketing firm that sold services from companies to consumers. Fortune Hi-Tech hired each of the Plaintiffs as an Independent Representative ("IR"). An IR would pay an enrollment fee to Fortune Hi-Tech, and would sell the services of different companies on behalf of Fortune HiTech and receive commissions for each sale he or she made. IRs also received bonuses if they recruited others to become IRs. If an IR signed up someone else who paid the enrollment fee, then the IR could get a bonus of $100. Plaintiffs allege that it was far more lucrative to recruit new IRs than to sell services.

When an IR joined Fortune Hi-Tech, they filled in an application and agreement which included a clause which stated that the IR had read the "FHTM Polices and Procedures" and that the terms of those polices were incorporated into the agreement between the company and the IR. (R. 11, Motion to Compel, Attachment 3, Application and Agreement, Nov. 8, 2010, at ¶ 4.) Section 8.4 of the policies and procedures stated that any claim brought under the agreement would be brought in arbitration handled by the American Arbitration [Association], and included language that stated that the agreement to arbitrate would survive any termination of the agreement. Another clause in the same document stated that Fortune Hi-Tech could modify the agreement at any time. That clause made change effective upon notice, and defined notice as occurring when it was issued. Finally, section 12 of the FHTM Polices and Procedures stated that the agreement consisted of all of the documents, which FHTM retained the ability to modify at any time.***

Plaintiffs in the Day case, No. 12-6304, filed their complaint on September 2, 2010, in the United States District Court for the Eastern District of Kentucky. They alleged violations of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. §§ 1961 68, the Kentucky Consumer Protection Act, and Kentucky common law. Defendants filed a motion to compel arbitration on November 8, 2010. On December 22, 2010, Plaintiffs in the Wallace case, No. 12- 6305, filed a complaint in the United States District Court for the Southern District of California. Plaintiffs alleged violations under RICO, and California's Business and Professions Code, § 17500, et seq. Plaintiffs also sought class certification.

In January of 2011, Defendant filed a motion with respect to the Wallace Plaintiffs, asking the court to dismiss for improper venue pursuant to Federal Rule of Civil Procedure 12(b)(3), or to transfer the action pursuant to 28 U.S.C. § 1404(a). In April 2011, the case was transferred to the Eastern District of Kentucky. In November 2011, Defendant filed a motion to compel arbitration, or to stay the case pending the resolution of the Day case. Also in November 2011, Defendant filed a motion in the Day case itself, asking the court to compel arbitration.

The motion to compel arbitration in the Day case was granted in February 2012. The district court found that Plaintiffs had agreed to arbitrate their claims, and therefore it lacked jurisdiction to hear Plaintiffs' challenge to the validity of the arbitration clause. Plaintiffs moved the court to reconsider its decision. Upon reconsideration, the district court rescinded its order and opinion, and issued a new one on September 13, 2012, which denied Defendant's motion and ordered the case to proceed. The district court's reconsidered opinion was based on the Supreme Court's decision in Granite Rock Co. v. Int'l Broth. of Teamsters, 130 S. Ct. 2847 (2010), which clarified the nature of a court's jurisdiction in addressing agreements to arbitrate. On September 24, 2012, the district court issued an order in the Wallace case, which denied Defendant's motion on the same grounds and ordered the case to proceed to trial. These two appeals followed the denials of the motions to compel arbitration.***

Under the Federal Arbitration Act, 9 U.S.C. § 1 et seq., arbitration agreements are "valid, irrevocable, and enforceable, save upon grounds that exist at law or in equity for the revocation of any contract." Id. § 2; accord Floss, 211 F. 3d at 314. Plaintiffs claim that the arbitration clause of their contract with Defendant is void for lack of consideration. Because the clause could be modified at any time, within the sole discretion of Defendant, Plaintiffs claim that the provision lacked consideration and is therefore void. The district court agreed with Plaintiffs, and declined to compel arbitration. This appeal followed, and we now affirm the district court's decision.

There is a general presumption in favor of arbitration. See, e.g., Gateway Coal Co. v. United Mine Workers of Am., 414 U.S. 368, 377 (1974). Where parties have agreed to arbitrate some disputes, courts should generally construe their agreement to arbitrate broadly, and should generally resolve disputes over the scope of the arbitration clause in favor of arbitration. Granite Rock Co. v. Int'l Broth. of Teamsters, 130 S. Ct. 2847, 2857 (2010). However, if the dispute is itself over the validity of the arbitration clause, then it is a matter of ordinary judicial resolution, and no such presumption applies. Id. at 2857 58 (2010). Even if courts are meant to favor a finding that parties have agreed to submit their claims to arbitration, parties must still have a valid and enforceable agreement to resolve their claims in arbitration. Id. at 2856. Although it is a basic principle of contract law that every contract requires mutuality and consideration, Cuppy v. Gen. Accidental Fire & Life Assurance Corp., 378 S.W.2d 629, 632 (Ky. 1964), an arbitration clause does not require independent consideration; so long as the contract as a whole is adequately supported by consideration, each clause is valid unless there is some other deficiency in the contract's validity. Glazer v. Lehman Brothers, Inc., 394 F.3d 444, 452 54 (6th Cir. 2005); accord Ozormoor v. T-Mobile USA, Inc., 354 F. App'x 972, 975 (6th Cir. 2009).

The district court found that the arbitration clause was unenforceable because the contract between Plaintiffs and Defendant was not supported by adequate consideration, and we agree. Because Defendant retained the ability to modify any term of the contract, at any time, its promises were illusory. See Fowler's Bootery v. Shelby Boot Co., 117 S.W.2d 931, 932 33 (Ky. 1938). Defendant was not bound by any particular provision of the contract because at any point, including immediately after acceptance, Defendant could have changed any clause without any recourse sounding in contract law available to Plaintiffs. The only notice provision made changes effective upon their issuance, rather than after a fixed period of time. Had the contract permitted unilateral alteration upon thirty days' notice, for example, there might have been consideration, because the altering party would still have been bound to the original terms for the thirty day period. See Restatement (Second) of Contracts § 77 cmt. b, illus. 5 (1981). But in this case, in effect, Defendant promised to do certain things unless it decided not to, and that is by definition illusory. Id. § 2 cmt. e; see also id. § 77. While some states may permit enforcement of a contract that requires only notice, rather than advance notice, for alteration of its terms, Kentucky is not one of those states. See Fowler's Bootery, 117 S.W.2d at 932 33; Killebrew v. Murray, 151 S.W. 662, 664 65 (Ky. 1912) (overruled on other grounds as recognized by Johns Hopkins Hosp. v. Peabody Coal Co., 920 F. Supp. 738, 749 50 (W.D. Ky. 1996)). Accordingly, because the contract lacked consideration, the entire contract, including the arbitration clause, is void and unenforceable.

This Court's decision in Floss v. Ryan's Family Steak Houses, Inc., 211 F.3d 306 (6th Cir. 2000) is also instructive. In that case, this Court found that an arbitration clause was invalid because the promise to provide an arbitral forum, without any further detail, was "fatally indefinite." While the clause in the agreement provided details such as which arbitration organization would conduct the arbitration, and where the arbitration would take place, the fact that those could be unilaterally modified at any time rendered such promises illusory. The contract in the instant case is more detailed, but just as illusory as the one at issue in Floss, because as with the contract in Floss, it did not ultimately require Defendant to submit to any particular forum or set of rules for arbitration inasmuch as Defendant could modify the arbitration clause to suit its purposes at any time. ***

As to Defendant's argument that the fact that it did not modify the contract indicates that there was mutuality of obligation during the relevant time period, that argument confuses performance of the terms with an obligation to perform under the contract. The fact that Defendant voluntarily continued to maintain the terms of their promise is irrelevant; the question is whether it had a legally binding obligation to continue to do so. Nothing bound Defendant to continue its agreement, or even to maintain the same terms. As the district court pointed out, Defendant could have, through any one of the various notice devices it included, changed the contract immediately upon receipt of a signed copy from any one of the Plaintiffs. Without a binding obligation, a promise is illusory, and therefore not enforceable as a contract.

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