What is a Contract of Adhesion?
In the context of insurance policies, a contract of adhesion is a standardized contract drafted by the insurance company, which is then offered to a customer on a take it or leave it basis. As a contract of adhesion is a generalized offer that is not subject to negotiation, no opportunity exists for an insured to negotiate the individualized terms of such contract. Instead, the offer is presented as a whole, and the insurer has either accepted or rejected the offer. Furthermore , a contract of adhesion is commonly defined in dictionaries as one "where the insurer has substantially greater bargaining power – [and therefore] the policy is essentially unilaterally prepared by the insurance company, which adheres itself to boilerplate or standard form language, leaving the insured to adhere or reject." In contrast, a typical negotiated contract is written in a manner such that the terms may be modified and/or excluded.
Examples of Adhesion Contracts in Insurance
In the insurance industry, many policies are presented to insureds on a "take it or leave it" basis. That is to say, an insured is not presented with a meaningful opportunity to negotiate the terms or conditions of the policy. For example, auto insurance policies are generally standard forms adopted by state legislatures which all insurers must utilize when issuing a policy. Under an auto insurance contract of adhesion, an insured has no ability to negotiate the terms of the policy. The insured must accept the policy or obtain other insurance from other insurers which may provide similar but not identical benefits to that provided by the original policy. Insurance policies are commonly referred to in some cases as "contracts of adhesion".
Further, all homeowners insurance policies are essentially standardized across the country. Some states have prescribed specific requirements concerning the general terms and conditions of these policies. Again, generally speaking, insureds do not have any meaningful opportunity to negotiate the terms of the policy. An insured can accept the policy as presented, select basic terms and conditions, or choose to get insurance elsewhere. Homeowners policies may contain provisions to cover additional living expenses. An insured’s residence may be destroyed and he or she may temporarily need somewhere to stay. A policy will generally reimburse the insured for the out of pocket costs associated with his or her temporary accommodation. Further, the insured may be eligible for food allowances for meals not covered overnight.
The policies discussed above are not the only examples of adhesion contracts in the insurance business. However, these are the most common examples of adhesion contracts in the insurance industry. Adhesion contracts are not limited to the insurance business. Adhesion contracts are very common in the financial servicing and credit card industry. However, those issues are beyond the scope of this website.
How Policyholders are Affected by Adhesion Contracts
The United States Supreme Court has held: "citizens who rely on the provisions of a policy issued by an insurance company are entitled to have those provisions faithfully performed; and they cannot have that right if such a policy can be read as the defendant would have it interpreted." Detroit Edison Co. v. Michigan Mut. Liab. Co., 102S. Ct. 1527, 1531 (1982). The Court has also observed: "A policyholder is entitled to have its policy construed according to its terms." Id. This is precisely because courts are always concerned with the breadth of the words of policies and the terms in which agreements are made. "Contracts of adhesion" and "take-it-or-leave-it" contracts are generally defined as "standard form contracts which, ‘by their very nature[,] … are presented on a "take-it-or-leave-it" basis and in which a pressing need on the part of one party (the consuming public), and a superior bargaining position and opportunity to control in the other party (the provider of goods and services), give rise to the former’s inability to modify or refuse to assent to the contract’s terms.’" Insight Health Corp. v. First Reliance Standard Life Ins. Co., 2008 U.S. Dist. LEXIS 96604 at *11-*12 (N.D. Cal. 2008) (citing Black’s Law Dictionary 246 (8th ed 2004) (emphasis supplied)). Thus, most consumer insurance forms are created and/or approved by the insurer and mandated for use.
Advantages and Challenges
Contracts of adhesion can potentially be problematic for policyholders. These contracts tend to have a number of drawbacks. First, the contracting parties are not on equal footing, so the substantially stronger party, usually the insurer, will have most of the clout. Because the insurance company has the upper hand, it will likely be able to draft the terms that most benefit its own interests, often at the expense of the policyholder. This leads to an imbalance in the contractual obligations of the parties.
Second, many courts believe that the standard insurance policy language was the result of a mutual negotiation, when in most cases the policyholder never had an opportunity to negotiate anything. The policyholder usually only has the option of taking it or leaving it.
Third , courts do not allow changes in standard policy language without prior approval from the Department of Insurance. Therefore, even though the policyholder may seek to have particular terms deleted, such a request will most likely be denied by the Department of Insurance and consequently the insurance companies will have little incentive to negotiate.
At times, contracts of adhesion can be advantageous for the policyholder. Courts tend to read provisions in these contracts in favor of the policyholder. This does not mean, however, that the insurer has to pay the insured in every case, but it does at least offer a degree of protection that is otherwise lacking.
Challenges in Litigation with Adhesion Contracts
While courts generally will not void contracts of adhesion based solely on their adhesive nature, courts are generally more involved in disputes arising under adhesion contracts. Courts will often find provisions in adhesion contracts they deem unfair or unreasonable—unconscionable—and strike them down. For example, a court might find an arbitration or forum selection clause unconscionable and refuse to enforce it, potentially allowing a plaintiff to bring suit in court rather than arbitrate its claims.
The enforceability of an adhesion contract generally affects the standard of review that courts apply to a case, as well. Courts typically apply a "reasonableness" or a "rationally related" standard. With respect to agreements to arbitrate, most states require courts to examine the reasonableness of an arbitration clause in an adhesion contract on a case by case basis. This entails a balancing of the rights and risk-shifting that results from the agreement to determine its overall fairness, and frequently depends on the availability of alternative dispute resolution. The emphasis is on weighing the rights the plaintiff is allegedly giving up against the potential benefits dictated by the contract.
Some arbitration clauses found in insurance contracts are enforced in their entirety, often through state statutes. For example, the California rule is that a carrier has a right to compel arbitration under a term in an adhesion contract except where there is a statutory exception or the arbitration agreement is "unconscionable or otherwise unfair."
And, significantly, in cases in which there is an arbitration clause, there is a strong presumption in favor of arbitration. The standard for overcoming the enforceability presumption is high: "We will not deny enforcement of an arbitration clause in an adhesion contract unless the party seeking to avoid arbitration can show the clause is so unfair as to be unconscionable."
By contrast, it is less likely that courts will strike down entire adhesion contracts; if generally fair and reasonable, courts will enforce an adhesion contract, despite specific overreaching terms. Courts will enforce a provision so long as it is not "overreaching or so outrageous that its illegality is clearly evidenced by the contract." An adhesion contract will not necessarily be set aside "merely because it was offered on a take-it or leave-it basis." Rather, a contract of adhesion only will be invalidated when, viewed as a whole, it is obviously one-sided, highly unfair, and oppressive to the weaker party. In addition, courts will refuse to find a contract unconscionable if the contract is made between businesses of relatively equal bargaining power, or if the parties both benefit from the contract.
Similarly, courts will strive to reform provisions in a contract of adhesion if necessary to render it fair, rather than refusing to enforce an entire contract containing unfair terms. Courts usually define a contract of adhesion as one unilaterally drafted by a seller or "stronger" party which merely presents it to a "weaker" party on a take-it or leave-it basis and which the "weaker" party has no realistic bargaining opportunity.
Tips for Working with Adhesion Contracts
When navigating a contract of adhesion in the insurance context, consumers should be aware that freedom of contract does not mean freedom from having to pay for something they didn’t agree to pay for. As such, it is important for the insured to understand just how much bargaining power it really has when purchasing an insurance policy. Courts have been near unanimous in reigniting the beauty contest it can be to negotiate an insurance contract by forcing insurers to play the most difficult game of all – fair play (bad puns are fun!). So much of an adhesion contract is determined up front by the insurer, and the parties are truly unequal in their bargaining power. An insured is on its own with the policy in hand , without an attorney, to interpret it. And interpreting the adhesion contract and whether it applies to the claim is what the court is there for.
There are some basic but essential tips that can help you navigate these contracts:
The most important, proactive thing you can do as an insured is to read your policy and become informed about your coverage before a claim arises. It may not be the same as learning how to read the directions to a new electronic device you just bought, but if you purchase an insurance policy, you should be just as informed. You paid for it and you should know what your rights are.