Written by Attorneys Robert T. Horst and Mark H. Rosenberg

Note: This article is an interpretation of current law and is offered for informational purposes only. This material is not legal advice and should not be construed or used as a substitute for the advice of an attorney.

Last Friday, in an opinion with national ramifications, the Pennsylvania Superior Court held that an arbitration clause in a tax preparation agreement was unconscionable and therefore unenforceable. In McNulty v. H&R Block, Inc., --- A.2d ---, 2004 PA Super 45, 2004 WL 351782 (Feb. 26, 2004), the Pennsylvania Superior Court allowed a class action to proceed against H&R Block regarding fees it charged to customers for the electronic filing of tax returns. A victory for consumers, this opinion joins a quickly growing body of case law on this topic.

McNulty concerns an attack upon fees charged by the tax preparation service H&R Block for the electronic filing of tax returns. The plaintiff contended that such fees were unnecessary, as it cost Block virtually nothing to file returns electronically. In defense of a putative class action brought by the plaintiff, Block sought to invoke an arbitration provision contained within a contract for a “refund anticipation loan” obtained by the plaintiff. While Block was not a party to the loan (which was made by an independent finance company), Block was named as a beneficiary to the arbitration clause. The clause provided that “any claim, dispute or controversy... in any way relating to... the relationships of the parties” shall be subject to arbitration. McNulty, 2004 WL 351782 at *2.

The Superior Court initially held that despite the broad scope of this arbitration clause, the clause applied only to controversies regarding the refund application loan, not the electronic filing charges. Holding that Block’s broad interpretation of the contract could lead to “absurd result[s],” the Court held that the arbitration clause “does not and cannot refer to all conceivable relationships between the parties,” but is rather limited to “the relationships of the parties as it applies to the loan.” Id. at *3-*4. Accordingly, the Court affirmed the trial court’s denial of Block’s preliminary objections based upon the purported applicability of the arbitration provision.

The Court then addressed the plaintiff’s arguments regarding the unconscionability of the arbitration provision, which was not directly examined by the trial court. The Court emphasized its previous holding that “if the costs associated with arbitration of a single claim would operate to preclude a claimant from pursuing a remedy, then the enforcement of the provision would be unconscionable.” Id. at *5 (citing Lytle v. CitiFinancial Services, Inc., 810 A.2d 643, 658-59 (Pa. Super. Ct. 2002). The Court noted that while the disputed fees ranged from $34.00 to $37.00, the arbitration clause required the claimant to pay an initial $50.00 fee for the arbitration and to cover any costs in excess of $1,500.00. Observing that even the minimum $50.00 charge outweighed the potential recovery, the Court held that the case presented “a situation where the costs of arbitration, minimal though they may seem, work to preclude the individual presentation of claims.” Id. Accordingly, the Court held that “the enforcement of the arbitration provision would work to deny the allegedly injured parties access to justice and is therefore unconscionable.” Id.

While the Court emphasized that “the unconscionability of this arbitration provision is only in reference to the present factual situation,”[i] the impact of the Court’s decision is clear. By holding that the enforcement of an arbitration provision is unconscionable when the costs of arbitration exceed the potential recovery, the Court’s decision in McNulty may make the enforcement of arbitration provisions in the class action context problematic. Many class action cases concern small recoveries for each claimant, and therefore, any arbitration provision that imposes even minor costs on the claimant may be held unenforceable when invoked as a defense to a class action brought in a Pennsylvania court. In light of the McNulty decision, businesses may wish to consider drafting arbitration provisions in which all of the costs would be assumed by the business. Ultimately, bearing the cost of an individual arbitration may prove preferable to the defense of a large-scale class action case.