Comb v. PayPal

Citation: Comb v. PayPal, Inc., 218 F.Supp.2d 1165 (N.D. Cal. 2002).

Factual Background
Defendant, PayPal, is an online service that allows private individuals and businesses to send and receive money via the Internet. Prior to opening an account with PayPal, customers are required to complete an online application for a personal, premier, or business account. As part of the application process, the potential customer must check a box indicating that “[they] have read and agree to the User Agreement and [Paypal’s] privacy policy.” Customers may choose to read the text of the agreement by clicking on a hyperlink at the bottom of the application, however the link need not be opened for the application to be processed.

PayPal encourages customers to read the User Agreement in its entirety and informs them that by accepting the terms, a binding contract is created. The clause at issue in this case, the arbitration clause, requires all controversies or claims arising out of or relating to the Agreement to be settled by binding arbitration on an individual basis. In compliance with this clause, PayPal moved to compel individual arbitration.

Plaintiffs are two PayPal subscribers and one nonsubsubscriber. The plaintiffs claim that in early 2002, PayPal restricted their accounts, withheld funds, and withdrew money without authorization from their checking and credit card accounts. Plaintiffs alleged that they attempted to follow Paypal’s investigation procedure, which requires customers to provide numerous burdensome personal documents, but have been met account restriction without notice, lengthy wait times, and invalid e-mail addresses. Plaintiffs seek injunctive relief and related remedies on behalf of a purported nationwide class.

Trial Court Proceedings
The district court denied PayPal’s motion to compel individual arbitration. The court concluded that the User Agreement and arbitration clause were procedurally and substantively unconscionable and therefore, under California law, arbitration could not be compelled. In the procedural unconscionability analysis, the court concluded that the language of PayPal’s User Agrement fell within the definition of an adhesion contract. Adhesion contracts, which are drafted and imposed by the party with superior bargaining power, provide the subscribing party opportunity to accept the contract “as is” or reject it. Despite conceding to the court that their contract fit this definition, PayPal argued that the availability of alternative choices was enough to defeat a showing of procedural unconscionability. The court rejected this assertion, concluding that finding an availability of substitute goods is not an adequate test of unconscionability.

The court's substantive unconscionability analysis focused on additional clauses within the User Agreement that had the potential to create an unfair advantage for Pay{al. The court centered on PayPal’s ability to have the final decision on actions such as: restricting and closing accounts, withholding funds, undertaking their own investigation of customer’s financial records and procuring ownership over all funds in dispute “unless and until the customer is later determined to be entitled to the funds in dispute.” The court reasoned that such unilateral conduct to provide a “margin of safety” may be appropriate when there is a legitimate commercial need. However, PayPal has not shown “business realities” that justify such one-sidedness. For these reasons, the district court declared the terms of the User Agreement are substantively unconscionable.

The court also found the arbitration agreement substantively unconscionable. Relying on the case of Szetela v. Discover Bank. the court concluded that allowing PayPal to categorically prohibit individual customers from joining or consolidating claims in arbitration had the potential for millions of customers to be overcharged small amounts without an effective method of redress.

The court also noted that requiring individual arbitration for claims arising out of the Agreement had a cost-prohibitive effect. PayPal objected to the court's classification by alleging that a customer’s only expense would be a filing fee of $125.00. However, this argument is undercut by the arbitration clause itself, which indicates the commercial arbitration rules of the American Arbitration Association are to be followed. This has the effect of raising the plaintiff’s cost of individual arbitration from $125.00 to $5,000 or more. The court reasoned that prohibitive arbitration fees and the precluding joinder of claims is simply an attempt by PayPal to insulate itself from any meaningful challenge to its alleged practices and cannot be given effect in this case.