Supreme Court Limits State Law Restrictions on “Class” Arbitration Waivers
On April 27, 2011, the United States Supreme Court delivered an opinion regarding classwide arbitration that is certain to have far-reaching implications for not only class action litigation between businesses and consumers, but also for employers that use arbitration agreements with their employees. In AT&T Mobility LLC v. Concepcion, the Supreme Court was asked to decide whether the Federal Arbitration Act (“FAA”) prohibits states from conditioning the enforceability of certain arbitration agreements on the availability of classwide arbitration procedures. In a 5 to 4 vote, the Supreme Court held that a California rule of law that classified most waivers of classwide arbitration in consumer contracts as unconscionable is preempted by the FAA and is therefore unenforceable.
Facts and Procedural History
At issue in this case was a provision in AT&T Mobility LLC’s (“AT&T Mobility”) customer contracts that required all disputes to be settled by arbitration, but the provision prohibited individuals from bringing disputes as a class action. In February 2002, Vincent and Liza Concepcion (the “Concepcions”) purchased cellular telephone service from AT&T Mobility, and the service was advertised as including the provision of “free” phones. When the Concepcions were charged approximately $32 for sales tax based on the phones’ retail value, the Concepcions filed suit against AT&T Mobility in the Southern District of California. Their suit was subsequently consolidated with a putative class action alleging, among other things, that AT&T Mobility engaged in false advertising and fraud by advertising “free” phones, but later imposing a sales tax charge.
AT&T Mobility filed a motion to compel individual arbitration of the Concepcions’ claims, relying on the language in its customer contracts prohibiting class arbitration. The district court denied the motion, relying on the California Supreme Court’s decision in Discover Bank v. Superior Court. The lower court found that the class action waiver in AT&T Mobility’s customer contracts was unconscionable because AT&T Mobility had not shown that individual arbitration adequately substituted for the deterrent effects of class actions. Under Discover Bank, a class action waiver will be unconscionable if three conditions are met: (1) the waiver is in a contract of adhesion; (2) the waiver governs disputes over small amounts of money; and (3) the waiver is alleged to be part of a scheme to cheat consumers out of individually small amounts of money.
The Ninth Circuit affirmed. The Ninth Circuit also held that the Discover Bank rule was not preempted by the FAA because that rule was an application of general principles of California unconscionability law.
Supreme Court’s Ruling
The Supreme Court granted certiorari to determine whether section 2 of the FAA preempts California’s Discover Bank rule classifying most class action waivers in consumer contracts as unconscionable. Section 2 of the FAA provides that “[a] written provision in any . . . contract . . . to settle by arbitration a controversy thereafter arising out of such contract . . . shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” 9 U.S.C. § 2 (emphasis added). The Concepcions argued that the Discover Bank rule, rooted in California’s unconscionability doctrine, was a ground that “exists at law or in equity for the revocation of any contract.” They further argued that because California considers class action waivers in adhesion contracts unconscionable, arbitration agreements containing such waivers are unenforceable under the FAA. AT&T Mobility, however, argued that a restriction on class action waivers has a disproportionate impact on arbitration agreements and frustrates the purpose of the FAA.
In an opinion by Justice Scalia, the Supreme Court reversed the Ninth Circuit, explaining that the “overarching purpose of the FAA . . . is to ensure the enforcement of arbitration agreements according to their terms so as to facilitate streamlined proceedings.” The Court noted that it has long construed the provisions of the FAA to permit parties to structure their arbitration agreements as they see fit, such as by limiting the issues subject to arbitration, arbitrating according to certain rules, and limiting with whom a party will arbitrate its disputes. The rationale behind affording parties discretion in designing arbitration processes, the Court explained, is simple—it allows for efficient, streamlined procedures that are tailored to the disputes at issue. According to the majority, however, classwide arbitration does not lend itself to streamlined dispute resolution. The majority noted, for example, that classwide arbitration includes absent parties, which necessitates additional and different procedures. Class arbitration also greatly increases the risks to defendants because of the possibility of much greater losses in a class arbitration proceeding that does not have the same appeal and review procedures as court litigation, explained the majority.
The Court also rejected the argument that California’s unconscionability doctrine, as construed in Discover Bank, is a generally applicable defense to contract formation and thus is not preempted by the FAA. Although section 2 of the FAA preserves such generally available contract defenses, the Court explained that even a generally applicable rule of state law must yield to the FAA if the state rule “stands as an obstacle to the accomplishment of the FAA’s objectives” of promoting arbitration and ensuring that arbitration agreements are enforced according to their terms.
In a vote of 5 to 4, the Court ultimately determined that since the Discover Bank rule effectively forces parties into classwide arbitration proceedings—proceedings which, by their nature, are slower, more costly, and often more complex—the Discover Bank rule interferes with the FAA’s purpose and objectives. As a result, the Court held that the Discover Bank rule is preempted by the FAA. The Court reversed the judgment of the Ninth Circuit and remanded the case to the Appeals Court.
What this Case Means for Businesses
Although the full implications of this decision are yet to be seen, one thing is certain: disputes over class action waivers are not likely to end. Like California, courts in numerous states have held class action waivers unconscionable, and therefore unenforceable, relying on reasoning similar to that which was used by the California Supreme Court in Discover Bank. Such decisions are now in question, and additional litigation of the issue is inevitable.
As is sometimes the case with Supreme Court opinions, the AT&T Mobility decision raises more questions than it answers. The AT&T Mobility decision, after all, addressed only one basis for holding a class arbitration waiver unenforceable—state unconscionability law. It is unclear whether a court may refuse to enforce a class arbitration waiver on some other basis and, if so, what those additional bases may be.
Even though AT&T Mobility involved an arbitration clause contained in a consumer cellphone contract, the general principles underlying the Supreme Court’s decision may apply to any agreement to arbitrate, including employment agreements. The Court made clear that private arbitration agreements should be enforced according to their terms and that states cannot require arbitration agreements to include the availability of classwide arbitration. In light of this decision, companies and employers should review their existing arbitration agreements and determine whether modifications are needed. If a company or employer does not currently have an arbitration agreement, the company or employer should consider adopting an arbitration agreement and, more specifically, whether the agreement should include a class action waiver.
For more information on the subject of this article, contact the authors or the Larkin Hoffman attorney who customarily handles your matters. Larkin Hoffman Daly & Lindgren Ltd. has proudly served the legal and business counseling needs of clients since 1958. The firm includes over 70 attorneys serving clients’ legal needs throughout the state, the country and around the globe. As a full-service law firm, it provides counsel and legal guidance in more than 20 areas of law to clients ranging from individuals to emerging companies and Fortune 500 corporations.
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