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Pokorny v. Quixtar

April 20, 2010


Appeal from the United States District Court for the Northern District of California Samuel Conti, District Judge, Presiding, D.C. No. 3:07-CV-00201-SC.

The opinion of the court was delivered by: Schroeder, Circuit Judge



Argued and Submitted October 6, 2009 -- San Francisco, California

Before: Mary M. Schroeder and Marsha S. Berzon, Circuit Judges, and Lyle E. Strom,*fn1 District Judge.

Defendant-Appellant Quixtar Inc. ("Quixtar"), the successor-in-interest to Amway Corporation, markets a variety of products and services that it sells to consumers through a network of individual distributors that it refers to as "Independent Business Owners" ("IBOs"). All of the IBOs signed on to agreements that included the mandatory alternative dispute resolution ("ADR") provisions that the district court held unconscionable. The other remaining Defendants-Appellants are senior IBOs: Bill and Peggy Britt are members of Britt Worldwide LLC, and owners of American Multimedia Inc. and Britt Management Inc. (collectively, the "Britt Defendants"); James and Georgia Puryear are members of World Wide Group LLC (collectively, the "Puryear Defendants"). Both the Britt Defendants and the Puryear Defendants produce and market "business support materials" and other services to junior IBOs.

Plaintiffs-Appellees are junior IBOs. Jeff Pokorny, Larry Blenn, and Kenneth Busiere (collectively, "Plaintiffs") are California residents who filed this litigation as a class action against Quixtar, the Britt Defendants, and the Puryear Defendants alleging they operate an illegal pyramid scheme in violation of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1961 et seq., and California Business and Professions Code §§ 17200 et seq. and 17500 et seq.

Relying on the mandatory ADR provisions included in its agreements with its IBOs, Quixtar, joined by the Britt and Puryear Defendants (collectively, "Defendants"), moved to dismiss Plaintiffs' suit or, in the alternative, to stay the action and compel Plaintiffs to resolve their claims through Quixtar's ADR process. The district court denied Defendants' motion, holding that the ADR provisions of Quixtar's agreements with its IBOs are unconscionable under California law. Quixtar now appeals that interlocutory ruling pursuant to 9 U.S.C. § 16(a)(1)(B), and contends (1) that the district court should not have applied California law and (2) that it erred in holding that the ADR provisions are unconscionable. We affirm the well-reasoned decision of the district court.


Quixtar is a Virginia corporation with its corporate headquarters in Michigan. It describes itself as a leader in the e-commerce business and maintains that it provides millions of Americans with the opportunity to own their own businesses as distributors of a variety of nutrition, beauty, household, and related products. These distributors, known as IBOs, earn immediate income by reselling products they purchase from Quixtar to consumers. Additionally, Quixtar awards monthly bonuses to IBOs dependent on the volume of their own product purchases, as well as on the volume of product purchases by any individuals they recruit and register as IBOs. Some senior IBOs also reap profits by producing and selling "business support materials" ("BSM") to junior IBOs. These include books, magazines, audio tapes, video tapes, meetings, and seminars designed to help IBOs manage their Quixtar businesses and recruit new IBOs.

An individual becomes a Quixtar IBO by submitting an application and entering into a registration agreement with Quixtar that must be renewed annually. The registration agreement includes an "Agreement to Arbitrate," which incorporates by reference the "Dispute Resolution Procedures" found in the Quixtar IBO Rules of Conduct. Pokorny first registered as an IBO in 1994, and both Blenn and Busiere became IBOs in 2005. IBOs who purchase BSM are also encouraged to complete the "Business Support Materials Arbitration Agreement" ("BSMAA"), which likewise incorporates by reference the Dispute Resolution Procedures in the IBO Rules of Conduct. Both Pokorny and Blenn allegedly agreed to the BSMAA. It is the three-step ADR process mandated by the IBO Rules of Conduct and incorporated by reference in the Agreement to Arbitrate and the BSMAA that is at the heart of this appeal.

In 2007, Pokorny and Blenn, later joined by Busiere, filed this lawsuit against Defendants in the United States District Court for the Northern District of California, asserting claims under RICO on behalf of a proposed nationwide class of IBOs, and claims for unfair business practices and false advertising under California law on behalf of a proposed California class of IBOs. Plaintiffs allege that Defendants operate a two-tiered pyramid scheme that has scammed junior IBOs like themselves out of millions of dollars.

First, Plaintiffs assert that Quixtar and its senior IBOs, including the Britt Defendants and the Puryear Defendants, fraudulently induce individuals to become IBOs by promising them they will be able to resell Quixtar products for a profit, when in reality the price an IBO must pay for Quixtar products is so high that any profit through resale is virtually impossible. Further, once a new recruit becomes an IBO, the recruit is instructed to purchase Quixtar products only for the new recruit's personal use and to focus on recruiting and registering new IBOs, rather than to market and resell products to retail customers.

Second, Plaintiffs contend that Quixtar and its senior IBOs fraudulently induce junior IBOs to purchase BSM by telling them the BSM are necessary to the success of an IBO business and will help them realize tremendous wealth. But the main purpose of the BSM is actually to teach junior IBOs how to recruit and register new IBOs, not to assist IBOs in conducting their own successful Quixtar business. Although this business model leads to great profits for Quixtar and its most senior IBOs, Plaintiffs allege it results in significant losses to junior IBOs.

Plaintiffs also allege that they are not required to follow the three-step ADR process outlined in the Quixtar IBO Rules of Conduct and mandated by the Agreement to Arbitrate and the BSMAA because it is unconscionable and therefore unenforceable. That process is as follows:

As the first step, the Rules of Conduct require an aggrieved IBO to attempt to resolve any dispute it has with another IBO or with Quixtar through a non-binding process of "Informal Conciliation." During Informal Conciliation, Quixtar's Business Conduct and Rules Department works with the affected parties to resolve the dispute. Quixtar equates Informal Conciliation to a "standard commercial mediation."

If Informal Conciliation does not end the dispute, the Rules of Conduct next require an aggrieved IBO to initiate the equally non-binding process of "Formal Conciliation," by requesting a hearing before the Independent Business Owners' Association International ("IBOAI") Hearing Panel. The IBOAI Hearing Panel is made up of three members of the IBOAI Board. Quixtar describes the IBOAI as "the voice of the IBO," and asserts that through its Board the IBOAI "provides an open channel of communication with [Quixtar] on all aspects of the business, taking an active role in shaping its future."

Although any IBO may join the IBOAI for a small annual fee, an IBOAI member may not participate in the election of Board members unless it has achieved the "Platinum" level of business generation that Plaintiffs maintain only the most senior IBOs can achieve. Plaintiffs were not members of the IBOAI, nor did they achieve the Platinum level.

During Formal Conciliation, the aggrieved IBO presents testimony and documentary evidence concerning its dispute to the IBOAI Hearing Panel. According to the Rules of Conduct, "[t]he Hearing Panel's primary goal is to mediate or conciliate each dispute by determining the facts and issues and recommending to [Quixtar] any possible resolutions or remedy in accordance with the Rules of Conduct." The Rules of Conduct further state that the Hearing Panel's recommendations "must be consistent with the Rules of Conduct," and that "Hearing Panel members are bound by the Rules of Conduct as adopted by [Quixtar], and may not modify, alter, amend, or ignore the current positions of the Rules of Conduct." The Hearing Panel, in turn, may request review of the dispute by the IBOAI Board, which must then issue a recommended resolution to the parties and to Quixtar. Like the Hearing Panel's recommendation, however, the Board's recommendation "must be consistent with the Rules of Conduct," and the Board "may not amend, alter, modify, or ignore the clear provisions of the Rules of Conduct."

Once Quixtar receives a recommendation from the Hearing Panel or the IBOAI Board, it reviews the complete case file and, at its discretion, may conduct its own investigation into the dispute. Quixtar then issues a final decision accepting, reversing, or modifying the recommendation. The Rules of Conduct state that only Quixtar "may impose or act upon any of the actions and/or sanctions recommended by the Hearing Panel or [IBOAI] Board."

If an aggrieved IBO is not satisfied with the result reached through the non-binding conciliation process, the Rules of Conduct require the IBO to submit the dispute to binding arbitration. This step can be taken no sooner than 90 days after the IBO first notifies the other party of its claim, and must not be taken before the Informal and Formal Conciliation processes have been completed. Further, any demand for arbitration must be made "within two years after the issue has arisen, but in no event after the date when the initiation of legal proceedings would have been barred by the applicable statute of limitations." The Rules of Conduct govern all aspects of the binding arbitration process, including how the arbitrator is selected and how costs and fees associated with the arbitration are assessed.

Because Plaintiffs did not participate in the three-stage ADR process mandated by the Rules of Conduct, Quixtar, joined by the Britt and Puryear Defendants, moved the district court to dismiss the complaint with prejudice or, in the alternative, to stay the action and compel Plaintiffs to resolve their claims through non-binding conciliation or binding arbitration. Plaintiffs opposed Defendants' motion, arguing that they never agreed to the ADR process outlined in the Rules of Conduct and that the contractual provisions purportedly requiring them to participate in it are unconscionable and therefore unenforceable. Defendants also maintained that Michigan law applies, even though Plaintiffs are all California residents, because Quixtar is headquartered in Michigan and the ADR provisions say Michigan law is to apply in arbitration.

The district court denied Defendants' motion. Applying California law, it held that both the non-binding conciliation and the binding arbitration portions of the Agreement to Arbitrate, the BSMAA, and the Rules of Conduct (collectively, the "Quixtar ADR agreements") are procedurally and substantively unconscionable. The court further determined that Quixtar's ADR process as a whole is "simply too tainted to be saved through minor adjustments" because it is "so permeated with unconscionable provisions" that severing the unconscionable provisions and enforcing the remaining ones "would have virtually no effect." It therefore ruled that the entire ADR scheme mandated by the Quixtar ADR agreements is unenforceable. Defendants timely appealed, and the district court ...

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