December 15, 2015
Arbitration Law Alert
This alert was co-authored by Pamela Swanson.
In a win for DIRECTV, the Supreme Court continues to give unwavering support to the preemptive power of the Federal Arbitration Act (“FAA”), again reversing a California court’s attempt to circumvent the FAA.
As we predicted, the U.S. Supreme Court today upheld, by a vote of 6 to 3, the arbitration clause and class action waiver in the consumer contracts of DIRECTV, Inc. See DIRECTV, Inc. v. Imburgia, 577 U.S. ___, No. 14-462 (Dec. 14, 2015). Interestingly, both Justices Breyer and Kagan—who had each dissented from the Court’s decision in AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011)—joined the majority. In fact, Justice Breyer authored the forceful opinion upholding DIRECTV’s contract language.
The issue in the DIRECTV case turned on a severability clause in the company’s form contracts with consumers, form contracts that required arbitration but expressly waived any right to pursue that arbitration on a class basis. The severability clause provided “that if the ‘law of your state’ makes the waiver of class arbitration unenforceable, then the entire arbitration provision ‘is unenforceable.’”
Two consumers challenged the DIRECTV contract in California state court. In response, DIRECTV sought to enforce its arbitration clause. The trial court refused DIRECTV’s request and DIRECTV appealed. The California Court of Appeal then upheld the trial court result on the principal ground that California law in effect at the time the parties had entered into their contract invalidated class action waivers as “unconscionable.” The Court of Appeal reached this result even though the United States Supreme Court had subsequently ruled that the Federal Arbitration Act (the “FAA”), 9 U.S.C. §§ 1-16, preempted the so-called Discover Bank rule on which the Court of Appeal was relying.
After the California Supreme Court refused to review this unusual decision, the United States Supreme Court granted certiorari. Writing for the majority in reversing the decision of the California Court of Appeal, Justice Breyer acknowledged that California courts are the authority on California contract law, and that the California court’s reading of the contract at issue would, notwithstanding the preference of the FAA for arbitration, be correct so long as that reading rested on a basis that would justify “revocation of any contract.” DIRECTV, No. 14-462, slip. op. at 6. Thus, the key question facing the court was whether the California Court of Appeal’s decision applying the law as it existed prior to the decision in Concepcion left arbitration agreements “on equal footing with all other contracts.” Id.
Justice Breyer disposed of the issue with six strong objections to the attempts of the California Court of Appeal to avoid Concepcion. First, Justice Breyer rejected any assertion that the relevant contract language was ambiguous. On its face, that language referred to California law, which would mean valid law, and not to California laws that were invalid, such as the rule invalidated by Concepcion. Id. at 7.
Second, Justice Breyer pointed out that California case law itself supports this interpretation of the contract language. The California Supreme Court had, for example, held in Doe v. Harris, 302 P.3d 598, 601-02 (Cal. 2013), that references to California law necessarily include the California Legislature’s power to change the law retroactively. DIRECTV, .No. 14-462, slip op. at 7-8.
Third, Justice Breyer noted that the California Court of Appeal had failed to show that it would have interpreted the phrase “law of your state” the way it did in any context other than an agreement to arbitrate. Id., slip op. at 8. To the contrary, the Court of Appeal had couched its entire interpretation of that phrase in the context of avoiding a waiver of class arbitration. It had limited the question solely to whether “law of your state” “mean[s] ‘the law of your state to the extent it is not preempted by the [FAA]’”, id., slip op. at 9, not something of more general application.
Fourth, Justice Breyer rejected the unfounded assertion of the California Court of Appeal that a state law rendering class action waivers unenforceable could retain any “independent force after it has been authoritatively invalidated by this Court.” Id. The Discover Bank rule, invalid from the start, did not actually describe California law because it was always preempted by the FAA even before the Supreme Court so ruled in Concepcion.
Finally, Justice Breyer also rejected the Court of Appeal’s tortured conclusion that the phrase “law of your state” constitutes a “specific exception” to the agreement’s “general adoption of the [Federal Arbitration Act].” Id., slip op.at 9-10. This interpretation, he explained, fails to address the question of whether the words “law of your state” can encompass laws that have authoritatively been held invalid. Justice Breyer reemphasized as well that the phrase “law of your state” is not ambiguous in this respect, because there is no case that has ever construed such a phrase as incorporating state laws invalidated by federal law. Id., slip op. at 10.
Taking these five considerations together, the majority of the Court concluded that the California Court of Appeal’s interpretation of the phrase “law of your state” simply does not place arbitration contracts “on equal footing with all other contracts.” Id. As a result, its interpretation failed to give due regard to the federal policy favoring arbitration and is pre-empted by the FAA. Id.
In addition to a short dissent by Justice Thomas (who asserts that the FAA simply does not apply to the states), Justice Ginsburg, joined by Justice Sotomayor, dissented from Justice Breyer’s opinion on grounds largely dependent on a view that a contract of adhesion by a large company such as DIRECTV should be interpreted against the company if at all possible. See DIRECTV, Inc. v. Imburgia, 577 U.S. ___, No. 14-462, Ginsburg, J., dissenting, slip op. at 1-2 (Dec. 14, 2015).
Justice Ginsburg’s dissent, however, never effectively rebuts the simpler and clearer statements on contract interpretation made by the majority. While it may be, for example, that the European Union disfavors pre-dispute arbitration clauses in some contracts, the dissent does not effectively explain why the multiple legal systems within that jurisdiction (which most prominently do not include jury trials for the kinds of claims involved in the DIRECTV case, and which are substantially different, and much more limited, on the issue of class actions) are comparable to that of the United States for purpose of this analysis.
Justice Ginsburg’s dissent is also simply wrong on some points. Among other things, it is not true that the preemptive power of the FAA extends only to state laws that “conflict with the contracting parties’ intent.” Id., slip op. at 5 (citing, e.g., Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52, 59 (1995)). If a state law purported to change the standard for review of an arbitrator’s award, for example, the FAA would preempt that, even if the parties’ agreement included the same change. See Hall Street Assocs. LLC v. Mattel, 128 S. Ct. 1396 (2008).
In short, the decision in the DIRECTV case strengthens the already-strong position expressed by the Supreme Court on the issue of pre-dispute arbitration and class action waivers. Despite disagreement with this position by other federal entities, such as the Consumer Financial Protection Board and the National Labor Relations Board, the Supreme Court shows no signs of backing down from its interpretation of the FAA. (Businesses seeking to craft arbitration clauses that straddle these positions to some extent can address the contract of adhesion concerns raised by the dissenting justices by including appropriately tailored opt-out provisions that allow counterparties a fair opportunity to negate the class waiver provisions of their contracts.)
See NP Class Action Alert, “Supreme Court agrees to decide the third case in five years involving enforcement of class-arbitration waivers in FAA-governed arbitration agreements” (March 24, 2015); NP Class Action Alert, “Will SCOTUS put the hammer down on class actions?” (September 23, 2015)
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Concepcion, 563 U.S. at 352 (expressly rejecting the rule in Discover Bank v. Super. Ct., 113 P.3d 1100, 1110 (Cal. 2005), as “an obstacle to the accomplishment and execution of the full purposes and objectives of Congress” in the FAA).
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See NP Class Action Alert, “California Supreme Court allows class action waivers — but with exception for PAGA” (June 15, 2014); NP Class Action Alert, “U.S. Supreme Court will hear landmark class action waiver case: American Express Co. v. Italian Colors Restaurant” (Nov. 19, 2012).
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