Prejudicial Conditions in Standard Contracts and the Unconscionability Doctrine: A Comparison Between the United States and Israel – Rationales and Dilemmas

Abstract

Contract law jurisprudence recognizes that people enjoy freedom of contract. That is, people are free to choose whether or not to enter into a contract and to participate in the formulation of the provisions of such a contract. Over time, particularly during the second half of the twentieth century, freedom of contract was slowly but surely whittled away, as the classic liberalism and free market ideologies that support freedom of contract were challenged and undermined. Widespread use of standard contracts is responsible for much of this trend.

In a standard contract, one party drafts the contract and offers it to many potential parties. Often, the drafting party is a supplier of goods or services, while the other is the consumer, who must either accept the contract as-is or refuse it. There is rarely an opportunity for the consumer to influence the contractual provisions in any way and, in any event, the consumer is certainly not involved in the contract formulation process as a whole. Often, not only is the consumer's freedom to participate in contract formation adversely impacted but also his freedom to decide whether or not to contract at all. This is most obvious where the goods or services are essential in nature, and the supplier has a monopoly over the market. In the modern era, most consumer contracts are standard contracts.

By the 1960s, Israel's legislature saw fit to pass a law to deal with this phenomenon. Legislatures and courts across the world developed a body of law dealing with standard contracts. Such laws are based on the assumption that freedom of contract, in its classic sense, does not exist in the case of standard contracts. As such, these laws provide for judicial oversight of the provisions of standard contracts and the right to intervene as required. Such oversight does not adversely impact upon freedom of contract to any significant extent as this freedom is, in any case, extremely limited with regard to standard contracts. Intervention in a standard contract serves to at least partially balance the inequities inherent in a relationship between the supplier offering the standard contract and the consumer to whom such a contract is presented.

Intervention in the standard contract context is far-reaching, with the justification being, as mentioned, that in any case very little freedom of contract remains in the areas that tend to be governed by such contracts. The Israeli legislature authorized the courts to intervene in a standard contract by either annulling or changing its provisions.

The test for such intervention is flexible and courts have been afforded broad discretion. Israeli courts must annul or change any injurious provision of a standard contract, defined as any provision that imposes a prejudicial condition on the customers or gives the supplier an unfair advantage, which is likely to result in injury to the customers. Beyond the aforementioned prejudicial condition, the Israeli law specifies a list of conditions that are presumed to be prejudicial. In the case that the supplier includes one of these conditions, the burden is on him to prove that the condition is not prejudicial.

In contrast to the Israeli law, which explicitly relates to standard contracts and the aforementioned prejudicial conditions, similar laws do not exist in the U.S.at the state or federal level. Nonetheless, the absence of any specific law does not imply that U.S. lawmakers were unaware of the problems that arise from standard contracts, particularly when there is an imbalance of bargaining power between the parties, such as in the case of a supplier and a consumer, an employer and an employee, or a concessionaire and a company. The doctrine applied by U.S. courts in order to intervene in standard contracts is that of unconscionability. According to this doctrine, the court can decide that a certain provision or even the entire contract will not be enforced if it is found that the contract as whole or the relevant provision suffers from unconscionability.

The unconscionability doctrine gained momentum in the U.S. during the middle of the twentieth century with the passage of the Uniform Commercial Code (“UCC”), which established in that the court can nullify a sales contract, or some part of it, if the contract or one of its clauses is unconscionable. The second restatement of U.S. contract law, which included precedent established in U.S. courts, also led to the enforcement of the doctrine of unconscionability by establishing that the court can decide not to enforce a contract of any type if it suffers from unconscionability.

Even though Israel and various states in the U.S. have annulled certain conditions in some existing contracts, there are a number of differences between the laws in the two countries. First, in contrast to the Israeli law which relates to a prejudicial condition exclusively in the context of standard contracts, U.S. law has applied the doctrine of unconscionability to all types of contracts, not just standard ones. Second, in contrast to Israeli law which listed specific conditions that are presumed to be prejudicial, U.S. contract law has left it to the courts to decide when a condition or a contract as a whole is unconscionable. Third, the various doctrines have sometimes led to divergent outcomes. In other words, certain provisions that are considered prejudicial in Israel are not considered so in the U.S. and vice versa.

This article relates primarily to a standard contract between parties where one has much greater bargaining power than the other, such as in the case of a supplier and consumer or an employer and employee. Chapter 1 will describe the various rationales for intervening in the parties’ freedom of contract by cancelling or changing prejudicial provisions. These rationales include power differentials, information differentials, insights into consumer behavior, and the fact that a standard contract is similar in nature to a law. Further, Chapter 1 will describe the U.S. doctrine of unconscionability, which enables the court to nullify a clause or an entire contract, and the possible rationales that underlie it. Chapter 2 will examine a number of dilemmas related to standard contracts while presenting existing differences between Israeli law and U.S. law and attempting to understand the rationale for these differences. The dilemmas are related to the following questions: Should an employment contract be treated differently than a consumer contract? How should arbitration and jurisdiction clauses (forum selection clauses) be viewed in a standard contract? Does a declaration by the consumer that he has read and understood the contract have any significance in the context of a standard contract? And is there any distinction between the right of the court to reduce liquidated damages in a regular contract and the right to do so in a standard contract? The presentation of normative differences between the countries can lead to a reexamination of both the issue of prejudicial provisions in standard contracts in Israel and the doctrine of unconscionability in the U.S.