Background
Bilateral arbitration is often a preferred method of resolving disputes arising in the provision of consumer products and services, particularly in comparison to class action litigation or class arbitration. For this reason, many form contracts—such as credit card agreements, wireless telephone service contracts, and satellite television subscriptions—include an agreement to arbitrate disputes and a waiver of the right to class arbitration.
For years however, consumer advocates, the plaintiffs’ bar, and their political allies have attacked consumer arbitration agreements, and particularly those agreements containing class waivers. Such advocates prefer that even the smallest dispute be adjudicated on a mass basis and have long campaigned against the legality of arbitration agreements and class waivers. The resulting debate has focused in part on the nexus between the Federal Arbitration Act (the “FAA”) on the one hand and on state statutes and common law principles on the other.
The FAA forbids the application of state law to discriminate specifically against arbitration agreements. It does permit, however, the use of state common law principles having universal application to invalidate arbitration agreements. For example, an arbitration clause procured by fraud can be voided because contracts in general procured by fraud can be voided.
The precise scope of the FAA in this context has been subject to continuous debate for many years. State legislatures and courts historically favor a weak and narrow interpretation. But in 1984, the Supreme Court affirmed Congress’ intent that arbitration be on equal footing with litigation. States could no longer require that litigation remain an option for resolving disputes that contracting parties previously agreed to resolve through arbitration. Southland Corp. v. Keating, 465 U.S. 1 (1984). The Supreme Court has generally favored arbitration and has defended the FAA against attempts to interpret its scope narrowly. See, e.g., Allied-Bruce Terminix Co. v. Dobson, 513 U.S. 265 (1995); Perry v. Thomas, 482 U.S. 483 (1987); Southland Corp., supra.
In the context of consumer arbitration agreements and class waivers, however, consumer advocates have had increasing success in state courts and lower federal courts, setting up today’s decision.
The road to Concepcion
Consumer plaintiffs have tended to attack class waivers in arbitration agreements in several ways. They assert that a party’s contractual waiver of the right to initiate classwide redress is unconscionable and should be nullified under the common law doctrine of unconscionability. As a universal principle applicable to all contracts, they argue, the application of this principle to arbitration agreements does not offend the FAA.
They also point out that few consumers affected by an unfair provision in a standard consumer contract will bring individual claims and that the absence of a class mechanism means that most affected consumers will not see their statutory rights (e.g., consumer protection and antitrust laws) vindicated. As a consequence, they argue, class waivers undermine state consumer protection statutes, which rely on private causes of action for enforcement.
Consumer plaintiffs have successfully employed these theories to invalidate arbitration agreements and class waivers in state courts and lower federal courts. A key example is Discover Bank v. Superior Court, 113 P.3d 1100 (2005), in which the California Supreme Court held that an arbitration clause in a credit card services agreement could be negated under California’s unconscionability doctrine. Courts have been particularly concerned with the effect of arbitration agreements and class waivers on the economic feasibility of affected consumers’ pursuit of claims. Courts have stressed the economic issues for an individual plaintiff to vindicate his or her rights—i.e., the costs outweigh the benefits.
For just this reason, the Second Circuit last month invalidated an arbitration agreement in a merchant credit card acceptance agreement. In Re American Express Merchants’ Litig., 634 F.3d 187 (2d Cir. 2011). It was also the reason the Supreme Court of Kentucky in December invalidated a class arbitration waiver in a contract for broadband internet service, Schnuerle v. Insight Communications Co. L.P., 2010 Ky. LEXIS 288 (Ky. 2010), and the Supreme Court of Massachusetts in 2009 invalidated a class arbitration waiver in a case involving sales tax on computer service contracts. Feeney v. Dell, Inc., 908 N.E.2d 753 (Mass. 2009). Many other courts have held similarly in recent years. See Concepcion, 2011 U.S. LEXIS 3367 at *13 (listing California cases); see also Schnuerle, supra, at *22-*25 (listing other states’ cases). (Just weeks ago, the Supreme Court of Canada showed disfavor to consumer arbitration agreements and class action waivers. Seidel v. TELUS Communications, Inc., 2011 S.C.C. 15 (mobile phone agreement).)
To address the concerns of courts in such cases, and to preserve the ability to require bilateral arbitration in consumer agreements, companies began to draft such agreements to be much more favorable to consumers and to improve, from the consumers’ point of view, the cost-benefit analysis of pursuing a claim on an individual basis. See generally Ramona Lampley, “Is Arbitration Under Attack?: Exploring the Recent Judicial Skepticism of the Class Arbitration Waiver and Innovative Solutions to the Unsettled Legal Landscape,” 18 CORNELL J. L. & PUBL. POL’Y 477 (2009). Such agreements also sought to avoid judicial nullification on fairness grounds. It is this type of agreement that was at issue in Concepcion.
The Concepcion facts
AT&T Mobility promised new wireless telephone service subscribers a free cell phone for signing a two-year contract. California requires the payment of sales taxes on the full retail value of such free items, and AT&T Mobility passed the sales tax on to subscribers. In the Concepcions’ case, this amounted to $30.22.
The Concepcions’ service contract contained an arbitration agreement that is, by all accounts, among the most consumer-friendly ever. (The Ninth Circuit agreed. See Concepcion, supra at *32-33 (citing lower court decision.).) It requires very little effort on the part of the consumer virtually guarantees that the company would make a customer whole, often even before the commencement of arbitration. The customer does, however, agree that an arbitrator would be prohibited from conducting class arbitration proceedings.
The Concepcions objected to the $30.22 charge and, contrary to their agreement, filed a class action lawsuit alleging fraud, unjust enrichment, and violation of California’s consumer protection laws. When AT&T Mobility sought to enforce the Concepcions’ agreement and its class waiver, the District Court and Ninth Circuit Court of Appeals denied its motion to dismiss. Instead, relying on the Discover Bank rule, the lower courts held that despite the particular agreement’s unquestionable fairness to the Concepcions (see id.), its preclusion of class litigation or arbitration and thus rendered it unconscionable.
The Supreme Court’s decision
Until today, the Supreme Court had had “little occasion to examine classwide arbitration.” Id. at *24. The Supreme Court disfavored class arbitration in a 2010 decision, Stolt-Nielsen v. AnimalFeeds International Corp., 130 S.Ct. 1758 (2010). There a bilateral arbitration agreement was silent on whether one party could initiate class arbitration against the other. After one party did so over the protest of the other, the Supreme Court held that a bilateral agreement to arbitrate could not be deemed also to support class arbitration in the absence of a specific class arbitration provision. See our prior alert here.
Because Stolt-Nielsen involved an arbitration agreement between two commercial entities, it still remained unclear whether the same principle would apply in the context of consumer or employment contracts. Nor did Stolt-Nielsen address state laws forbidding arbitration agreements containing a class arbitration waiver.
Today’s decision clearly extends Stolt-Nielsen. The Court held that the Discover Bank rule and the other principles underlying the Ninth Circuit’s decision stand as obstacles to the intent of Congress, as expressed in the FAA, of favoring arbitration where parties have agreed to it as part of a contract. It also held that class waivers are not inconsistent with the intent of Congress and the FAA. In doing so, the Court noted the advantages of bilateral arbitration over class litigation and arbitration in terms of efficiency and cost. It rejected the premise that the FAA may deem class arbitration to be a fair substitute for bilateral arbitration and specifically noted the potential unfairness to defendants of class arbitration. Importantly, the court again emphasized that “[a]rbitration is a matter of contract, and the FAA requires courts to honor parties’ expectations.” Concepcion, supra at *31. The Court also addressed the concerns of consumer advocates (and the four-member dissent) as to the likelihood its holding would harm the majority of consumers who opt not to pursue small-dollar claims, stating that “States cannot require a procedure that is inconsistent with the FAA, even if it is desirable for unrelated reasons.” Id. at *32.
Looking ahead
The Supreme Court may not be finished defining the scope of the FAA. Next term, it will consider the scenario in which parties to a contract containing an arbitration agreement commence litigation and, after a period, one invokes the arbitration agreement to attempt to dismiss the litigation. Specifically, must the party opposing litigation demonstrate prejudice to defeat the motion? Stok & Associates, P.A. v. Citibank, N.A. (Sup. Ct. dkt no. 10-514).
In the meantime, many cases involving contractual class action or class arbitration waivers, such as last month’s Second Circuit decision in In Re American Express Merchants’ Litigation or Massachusetts’ decision in Feeney v. Dell must be reconsidered in light of today’s holding.
Today’s decision will not make consumer class actions disappear or guarantee the viability of all consumer arbitration clauses. Issues of fairness and cost-benefit ratios will still be present. The decision, however, definitely shifts the battle lines between consumer advocates and providers of consumer products and services to the benefit of the latter. It may be expected that issues of fairness will continue to be litigated, albeit with companies on a much better footing than before.
Lessons for companies
Today’s holding provides guidance as to how best to prepare a contract for consumer products or services in which disputes are addressed in bilateral arbitration. The decision certainly does not, however, provide carte blanche for one-sided dispute resolution agreements. Companies should consider tailoring their contracts to provide the individual customer reasonable access to a fair and inexpensive dispute resolution process like the contract addressed in Concepcion. Today’s decision helps ensure that companies that do so will minimize the risk of consumer class litigation or arbitration.
Further, while today’s holding applies specifically in a consumer services context, its principle may reasonably be expected to carry over into the context of employment agreements containing arbitration clauses with class waivers. Recent cases such as Sutherland v. Ernst & Young LLP, 2011 U.S. Dist. LEXIS 26889 (S.D.N.Y March 3, 2011) in which the court voided an arbitration agreement on the basis of its purported effect on employees’ ability to vindicate statutory rights, must also be reconsidered in light of today’s holding.