3-1-2-9 APPALACHIAN INSURANCE CO. ET AL., PLAINTIFFS AND APPELLANTS, V. MCDONNELL DOUGLAS CORPORATION ET AL., DEFENDANTS AND APPELLANTS (Super.Ct.No. 481712)

IV Unconscionability

Appalachian contends articles 7 and 14 are not enforceable because both are unconscionable.

The doctrine of unconscionability is codified in Civil Code section 1670.5. Section 1670.5, in pertinent part, provides: "If the court as a matter of law finds the contract or any clause of the contract to have been unconscionable at the time it was made the court may . . . enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result." The doctrine of unconscionability applies to all provisions of all contracts and has both a "procedural" and a "substantive" element. (H.S. Perlin Co. v. Morse Signal Devices (1989) 209 Cal.App. 3d 1289, 1300-1301.) As we explained in A & M Produce Co. v. FMC Corp. (1982) 135 Cal.App. 3d 473:

"The procedural element focuses on two factors: 'oppression' and 'surprise.' 'Oppression' arises from an inequality of bargaining power which results in no real negotiation and 'an absence of meaningful choice.' 'Surprise' involves the extent to which the supposedly agreed-upon terms of the bargain are hidden in a prolix printed form drafted by the party seeking to enforce the disputed terms. Characteristically, the form contract is drafted by the party with the superior bargaining position.

"Of course the mere fact that a contract term is not read or understood by the nondrafting party or that the drafting party occupies a superior bargaining position will not authorize a court to refuse to enforce the contract. Although an argument can be made that contract terms not actively negotiated between the parties fall outside the 'circle of assent' which constitutes the actual agreement, commercial practicalities dictate that unbargained-for terms only be denied enforcement where they are also substantively unreasonable. One commentator has pointed out, however, that, '. . . unconscionability turns not only on a "one-sided" result, but also on an absence of "justification" for it[,]' which is only to say that substantive unconscionability must be evaluated as of the time the contract was made. The most detailed and specific commentaries observe that a contract is largely an allocation of risks between the parties, and therefore that a contractual term is substantively suspect if it reallocates the risks of the bargain in an objectively unreasonable or unexpected manner. But not all unreasonable risk reallocations are unconscionable; rather, enforceability of the clause is tied to the procedural aspects of unconscionability such that the greater the unfair surprise or inequality of bargaining power, the less unreasonable the risk reallocation which will be tolerated." (Id. at pp. 486–487, citations and fn. omitted.)

Appalachian contents the "procedural element" of unconscionability exists here because, Appalachian assets, McDonnell Douglas "had an absolute monopoly on the sale of the PAM-D, which was essential for the launch of any commercial satellite in the United States," used that monopoly power to require all customers to accept the exculpatory clause which insulated McDonnell Douglas from liability and left Western with "no 'meaningful choice' other than to accept [McDonnell Douglas's] contractual terms." The record does not support these conclusions.

It is true, that at the time Western Union sought to launch its Westar VI satellite, McDonald Douglas was the only company supplying upper stage rockets for the Space Shuttle. To that extent, McDonnell Douglas had a monopoly. But, McDonnell Douglas did not have "an absolute monopoly" on the means of launching a telecommunications satellite into a geosynchronous orbit; owners of telecommunications satellites had the option of launching their satellites into geosynchronous orbit via the Ariane rocket of the European Space Agency. An Ariane launch did not require the purchase of an upper stage rocket from McDonnell Douglas. Here, Western Union, in fact, initially contracted with Arianespace to launch the Westar VI into geosynchronous orbit. Western Union terminated that contract, not because Arianespace was not unavailable, but because Western Union decided the Space Shuttle presented a more reliable and cheaper option. Thus, contrary to Appalachian's contention, McDonnell Douglas had no monopoly vis-a-vis the means of launching satellites into geosynchronous orbits.

Appalachian contents McDonnell Douglas used oppressive negotiating practices and cites evidence of NASA's concerns about McDonnell Douglas's contracting practices.

Appalachian, in particular, cites a July 1983 letter from James Abrahamson, NASA's Association Administrator for Space Flight, responding to McDonnell Douglas's request for an increase in the ceiling price. In the letter, Abrahamson noted NASA had "received a series of major customer complaints about [McDonnell Douglas's] contractual approach" and stated "it has become increasingly clear that there are significant incompatibilities between the NASA Launch Services Agreement and the [McDonnell Douglas] contract." Abrahamson explained:

"To insure there is no misunderstanding, I would like to emphasize that customer complaints are not directed at [McDonnell Douglas's] performance, the PAM-D as a system, or [McDonnell Douglas's] dedication and commitment to customer satisfaction. Both our customers and NASA are delighted with each of those important areas of performance. We are gratified that our partnership has worked so well for the Space Transportation System and our customers to this point.

"However, our new customers are gravely concerned with your contracting approach. They complain that there is no apparent willingness, on the part of [McDonnell Douglas], to undertake responsibilities normally agreed to in the aerospace payload industry; e.g., responsibility for hardware performance, for late delivery of the hardware, for acknowledging equity to the customer in the case of termination, and for granting access to technical information . . . ."

Abrahamson disapproved McDonald Douglas's requested increase in the ceiling price at that time, but added he "would be pleased to continue the discussion within the broader content of both price and an acceptable customer contractual approach . . . ."

This letter, however, does not tell the whole story. After the letter, as a result of pressure from NASA and Western Union, McDonnell Douglas gave additional concessions to Western Union. Thus, Western Union was not the victim of allegedly oppressive contracting practices by McDonald Douglas; McDonnell Douglas responded to the complaints and yielded to the bargaining power of Western Union and NASA. Moreover, as to article 14, the record is clear this provision was neither drafted nor insisted upon by McDonnell Douglas, but was drafted by Western Union and agreed to by both parties.

As to the second factor of procedural element of unconscionability—"unfair surprise"—Appalachian does not assert any unfair surprise occurred here nor would the record support such an assertion. The record shows Western Union was well aware of article 7. It had dealt with similar provisions in earlier contracts with McDonnell Douglas and in this contract negotiated changes in the article. As to article 14, surprise cannot be claimed since Western Union itself drafted the provision.

Appalachian argues there is "substantive" unconscionability present here. Appalachian asserts the disclaimers are not "consistent with aerospace industry practice," explaining "[n]ormally, [Western Union] obtains warranties from its vendors." The evidence in the record fails to support Appalachian's assertion.

The citations are to testimony by Western Union contracting officer Anthony Cammarato addressing a different matter, i.e., Western Union's general policy when purchasing existing goods and services and, in particular, Western Union's use of printed purchase order forms containing a standard warranty for most procurements. Appalachian ignores Cammarato's later deposition testimony addressing the specific contract and warranty disclaimer here at issue. Cammarato stated it was "a standard way of doing business in the industry." Cammarato explained McDonnell Douglas did not agree to the warranty "because it's a high risk business," Western Union did not make any complaints about McDonnell Douglas's "take it or leave it" contracting attitude, and that Western Union's rationale for not seeking a warranty was "there's no such thing as a free lunch, and even if [McDonnell Douglas] would agree [to a warranty], there would be a charge."¹² Appalachian also ignores evidence showing article 14 was drafted to comply with the inter-party waiver in the Launch Services Agreement, a condition imposed by NASA, rather than McDonnell Douglas.

Appalachian asserts the disclaimers were not a "commercially reasonable allocation of risk." To support its position, Appalachian relies on language in A & M Produce Co. v. FMC Corp., supra, 135 Cal.App. 3d 473, where we stated "[f]rom a social perspective, risk of loss is most appropriately borne by the party best able to prevent its occurrence. [Citations.] Rarely would the buyer be in a better position than the manufacturer-seller to evaluate the performance characteristics of a machine." (Id. at pp. 491-492.) Appalachian asserts this case fits within the guidelines of the A & M Produce case because "[i]t is beyond dispute that [MCDONNELL DOUGLAS], MORTON THIOKOL and HITCO were in a better position than [WESTERN UNION] to prevent the exit cone failure that occurred in this case."

Appalachian's argument is overly simplistic. If unconscionability could be established merely by showing the manufacturer/seller's superior ability to detect defects, then the general rule would be that disclaimers were unconscionable and illegal. Warranty disclaimers, however, are specifically authorized by the California Uniform Commercial Code (see Cal. U. Com. Code, § 2316) and the Supreme Court has held "no public policy opposes private, voluntary transactions in which one party, for a consideration, agrees to shoulder a risk which the law would otherwise have placed upon the other party." (Tunkl v. Regents of University of California (1963) 60 Cal. 2d 92, 101.)

Further, Appalachian's reliance on our decision in A & M Produce is misplaced; Appalachian ignores the factual context of that case. A & M Produce involved the sale of a mass-produced product by "an enormous diversified corporation" to "a relatively small but experienced farming company" using a standardized preprinted form with a warranty disclaimer printed on the reverse side which was never read by the buyer. (A & M Produce Co. v. FMC Corp., supra, 135 Cal.App. 3d 473, 489-491.) In this factual context, we stated "[I]t is patently unreasonable to assume that a buyer would purchase a standardized mass-produced product from an industry seller without any enforceable performance standards." (Id. at p. 491.) We also observed:

"Especially where an inexperienced buyer is concerned [the buyer here was venturing into a new area, was unfamiliar with the equipment and turned to the seller's agent for recommendations as to what equipment was necessary], the seller's performance representations are absolutely necessary to allow the buyer to make an intelligent choice among the competitive options available. A seller's attempt, through the use of a disclaimer, to prevent the buyer from reasonably relying on such representations calls into question the commercial reasonableness of the agreement and may well be substantively unconscionable." (Id. at p. 492.)

Here, the contract was not a standardized printed form for the sale of a mass-produced product; here the contract was negotiated. It involved specialized services and new technology developed in a "high risk business." Western Union was not an inexperienced buyer who had to rely on McDonnell Douglas's representations; Western Union was a large, sophisticated corporation experienced in launching telecommunications satellites. Western Union was further given periodic progress reports, including reports of two test failures of the Star 48 motor.

In this context, of a highly specialized, risky new technology, it was not commercially unreasonable for the parties to agree Western Union would obtain insurance to protect it against the risk of loss rather than to have McDonnell Douglas warrant performance of the upper stage rocket. As a practical matter, it was a question of whether Western Union wanted to directly pay for insurance by obtaining insurance itself or indirectly pay for insurance by requiring McDonnell Douglas obtain the insurance and give a warranty.¹³ It was reasonable for Western Union to agree to obtain its own insurance directly rather than to pay an increased contract price which would include McDonnell Douglas's costs in administering the insurance for Western Union's benefit. We do not find any unconscionability existing in articles 7 and 14 of the Western Union and McDonnell Douglas contract.