Uber Technologies Inc. lost some of its legal clout with contract drivers in Canada’s largest province after Ontario’s highest court ruled its process for arbitrating disputes were not only unlawful but “unconscionable.”

A panel of three judges with the Court of Appeal for Ontario ruled Wednesday that Uber was improperly forcing its drivers in the province to resolve complaints about pay or other work issues through an international mediation process in the Netherlands. Drivers disputing even small complaints face a steep...