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Arbitration Agreements & Collective Action: The Consumer, the Class, and the FAA

The Supreme Court’s Concepcion decision has brought significant clarification to a turbulent area of competing policy considerations involving agreements to arbitrate, but questions remain regarding just where the balance should be struck between favoring arbitration and protecting consumers.

When federal policy (embodied in the Federal Arbitration Act (FAA)) favoring arbitration comes into conflict with consumer-friendly state laws that condition the availability of arbitration on the parties’ acceptance of class procedures, which wins?

In AT&T Mobility LLC v. Concepcion,1 the United States Supreme Court answered that much-litigated question, holding that the FAA preempts a California common law rule that had invalidated most consumer arbitration agreements containing collective action waivers, because the rule disfavors arbitration and undermines the FAA’s “overarching purpose … to ensure the enforcement of arbitration agreements according to their terms so as to facilitate streamlined proceedings.”2

California & Concepcion

The California rule, announced by that state’s supreme court in Discover Bank v. Superior Court,3 applied California’s unconscionability doctrine and public policy against exculpatory contracts to collective action waivers in arbitration agreements:

[W]hen the waiver is found in a consumer contract of adhesion in a setting in which disputes between the contracting parties predictably involve small amounts of damages, and when it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money, then … the waiver becomes in practice the exemption of the party “from responsibility for [its] own fraud, or willful injury to the person or property of another.”  Under these circumstances, such waivers are unconscionable under California law and should not be enforced.4

The plaintiffs in Concepcion had purchased cellular service from AT&T and received what had been advertised by AT&T as a free cellular phone.  AT&T, however, collected sales tax on the value of the phone.  The Concepcions commenced a putative class action against AT&T alleging that the practice of charging sales tax for phones advertised to be free was false advertising and fraudulent.  AT&T moved to compel individual arbitration, as required by the parties’ agreement.

Applying Discover Bank, the United States District Court for the Central District of California and the 9th Circuit held that the arbitration agreement was unenforceable because AT&T had not demonstrated that individual arbitration would adequately substitute “for the deterrent effects of class actions.” That was true although the AT&T arbitration agreement promised that AT&T would pay the customer a minimum of $7,500 plus attorney fees if the customer obtained an arbitration award greater than AT&T’s last settlement offer.  The district court had thus “concluded that the Concepcions were better off under their arbitration agreement with AT&T than they would have been as participants in a class action, which ‘could take months, if not years, and which may merely yield an opportunity to submit a claim for recovery of a small percentage of a few dollars.’”5 Nevertheless, Discover Bank required invalidation of the arbitration agreement.6

The Supreme Court reversed the lower courts, holding that the Discover Bank rule “interferes with fundament attributes of arbitration.”  The rule conditions enforcement of an agreement to arbitrate on the parties’ willingness to employ class procedures in arbitration.  This, the court said, is a “fundamental” change to arbitration, which sacrifices its “principal advantage … its informality—and makes the process slower, more costly, and more likely to generate procedural morass than final judgment.”  The basic exchange in arbitration, after all, is that parties give up “procedural rigor and appellate review” in return for “lower costs, greater efficiency and speed, and the ability to choose expert adjudicators … .”7

Significant to the court’s reasoning was that class arbitration “greatly increases risks to defendants … . The absence of multilayered review makes it more likely that errors will go uncorrected.  Defendants are willing to accept the costs of these errors in arbitration since their impact is limited to the size of individual disputes.”  But that risk becomes unacceptable when multiplied over thousands of claims.

A Natural Next Step

Concepcion was the natural next step in the fast-moving development of federal arbitration law.8 In Stolt-Nielsen S.A. v. AnimalFeeds Int’l Corp.,9 the Supreme Court held that arbitrators had exceeded their authority when they imposed class procedures on parties who had not agreed to them.  In other words, when an arbitration agreement is silent as to class procedures, they may not be imposed by arbitrators. Concepcion took this rationale a step farther and held that “class arbitration, to the extent it is manufactured by Discover Bank rather than consensual, is inconsistent with the FAA.” 10

It would have been a strange development if arbitration agreements silent as to class procedures resulted in individual arbitrations but arbitration agreements explicit that no class procedures would be used were unenforceable and resulted in disputes being resolved in court rather than being arbitrated at all.11

Concepcion went a long way toward resolving the hotly disputed and previously unsettled questions of whether and when courts should enforce arbitration agreements containing collective action waivers when those agreements are made by parties that have unequal bargaining power—usually, consumer and employment contracts.  These issues raise delicate and sometimes competing policy concerns favoring the benefits of arbitration, on the one hand, and protecting consumers’ ability to maintain legitimate small dollar claims, on the other.

Arbitration allows the parties to craft by agreement the way they will resolve disputes, to select experts in the subject matter of particular industries or disputes to resolve them, and to realize the speed and reduced costs that come from giving up some of the procedures and review that accompany traditional lawsuits.  For these reasons and because arbitration relieves some of the crushing burdens on court dockets, arbitration is favored by federal and many state laws.

Consumer advocates and some courts, however, are concerned that when an arbitration agreement includes a prohibition on consolidation and class mechanisms, the agreement becomes exculpatory—insulation from small-dollar, high-volume claims rather than a real means of resolving them—because if the claims cannot be classed they cannot be economically maintained.

These competing considerations are reflected in a plethora of decisions predating Concepcion.  In Homa v. Am. Ex. Co.,12 for example, the 3rd Circuit held a class arbitration waiver in a credit card agreement unconscionable and in violation of New Jersey’s “fundamental policy” of protecting the right of consumers to class claims under New Jersey consumer protection statutes, as set forth in Muhammad v. County Bank of Rehoboth Beach, Delaware.13 And in Dale v. Comcast Corp.,14 the 11th Circuit held a class action waiver substantively unconscionable under Georgia law because the “cost of vindicating an individual subscriber’s claim, when compared to his or her potential recovery, is too great” and individual consumers are unlikely to obtain counsel without a right to attorneys’ fees if they prevail.

On the other hand, in Snowden v. CheckPoint Check Cashing,15 the 4th Circuit upheld an arbitration class action waiver, finding the waiver was not unconscionable or contrary to public policy.

The 8th Circuit Pre-Concepcion

While some jurisdictions have been skeptical of consumer and employment arbitration agreements containing class waivers, the District of Minnesota and the 8th Circuit have repeatedly enforced such agreements according to their terms, rejecting challenges under Minnesota and other state laws.

Minnesota law emphasizes the principle that drove Concepcion: Arbitration agreements ought to be enforced according to their terms.16 Just last year, in Green v. SuperShuttle Int’l, Inc.,17 Judge Ann Montgomery enforced an arbitration class waiver and said:

Plaintiffs have not shown that their substantive rights will be hindered by bringing their claims to arbitration individually nor have they provided any legal authority that Minnesota law views class action litigation as a non-waivable right.18

In Pleasants v. Am. Express Co.,19 and Cicle v. Chase Bank,20 both originating in Missouri and applying Missouri law, the 8th Circuit upheld arbitration class waivers against unconscionability challenges, finding in both cases insufficient evidence that the plaintiffs would be unable to vindicate their rights in individual arbitrations.

Interestingly, decisions of the 8th Circuit and District of Minnesota presaged the Supreme Court’s recent rulings in Concepcion and Stolt-Nielsen.  In Cicle, the 8th Circuit declined to find an arbitration agreement unconscionable because it was a contract of adhesion:

These sorts of take-it-or-leave-it agreements between businesses and consumers are used all the time in today’s business world. If they were all deemed to be unconscionable and unenforceable contracts
of adhesion, or if individual negotiation were required to make them enforceable, much of commerce would screech to a halt.21

Similarly, the Concepcion court commented: “[T]he times in which consumer contracts were anything other than adhesive are long past,”22 a comment courts have followed to reject arguments that arbitration class waivers must be invalidated based on an inequality of bargaining power.23  And 17 years before Stolt-Nielsen, Judge James Rosenbaum held that a court cannot direct an arbitrator to adjudicate a dispute as a class action where the parties’ agreement is silent as to class procedures.24

Concepcion in the Circuits

In Green v. SuperShuttle Int’l, Inc.,25 the 8th Circuit applied Concepcion to affirm Judge Montgomery’s pre-Concepcion order compelling arbitration and enforcing a class waiver in a uniform franchise agreement (“UFA”).  The court said:

Green … contends the class action waivers in the UFAs are unenforceable under Minnesota law … . Like the phone customers in Concepcion who based their challenge to the enforceability of a class action waiver provision upon California law, Green and the other drivers make a Minnesota-state-law based challenge to the enforceability of the class action waivers in the UFAs.  Our reading of Concepcion convinces us the state-law-based challenge involved here suffers from the same flaw as the state-law-based challenge in Concepcion—it is preempted by the FAA.26

Two other federal appellate courts—the 2nd and 3rd Circuits—have had the opportunity to apply Concepcion.  Both held that to the extent state law would have invalidated the subject agreements, that law was preempted by the FAA.27

In Cruz, the 2nd Circuit rejected the plaintiffs’ argument—supported by three affidavits of consumer law attorneys—that high-volume, small-dollar claims like theirs would “go undetected and unprosecuted” if the claims could not be classed. The 2nd Circuit commented:

[W]e need not reach the question of whether Concepcion leaves open the possibility that in some cases, an arbitration agreement may be invalidated on public policy grounds where it effectively prevents the claimant from vindicating her statutory cause of action. See, e.g., Mitsubishi Motors Corp. v. Soler Chrysler–Plymouth, Inc., 473 U.S. 614, 637 . . . (1985)
(“[S]o long as the prospective litigant effectively may vindicate [his or her] statutory cause of action in the arbitral forum, the statute will continue to serve both its remedial and deterrent function”) . . . . Even if the Mitsubishi vindication principle applies to state as well as federal statutory causes of action . . .

and even if it could be applied to strike down a class action waiver in the appropriate circumstance, such an argument is foreclosed here, because the Concepcion Court examined this very arbitration agreement and concluded that it did not produce such a result.28 

On the Edges

While many of the federal district courts that have applied Concepcion have likewise upheld the subject arbitration agreements and compelled individual arbitration, a few have declined to do so where other features of the agreements when combined with the waiver made it unlikely that consumers could effectively pursue their claims in individual arbitration or where particular statutory rights or remedies would be unavailable if the agreement was enforced.

In In re Checking Account Overdraft Litig.,29 for example, Judge James Lawrence King held a number of arbitration agreements unenforceable because they contained attorney-fee provisions that left bank customers with the risk that, if they were unsuccessful, they would end up paying not only their own attorneys’ fees but also the bank’s.  Most of the agreements analyzed by Judge King were one-way fee-shifting provisions in favor of the successful bank.  In other words, if the customer won, the bank would not pay the customer’s fees.  If the bank won, the customer would pay both her own fees and the bank’s.

The federal district courts in California have disagreed about Concepcion’s implications for arbitration agreements containing class waivers in employment agreements, particularly where the employee makes claims under California’s Private Attorney General Act, a statute that allows employees to act as private attorneys general to enforce California’s labor laws.30

In Plows v. Rockwell Collins, Inc.,31 the court held that Concepcion did not invalidate the California Supreme Court’s decision in Gentry v. Superior Court32 that arbitration agreements in employment contracts are unenforceable when the claims are small dollar, the risk for retaliation against class members is high, the potential plaintiffs are likely uninformed about their rights, and individual arbitration is unlikely to vindicate the plaintiffs’ rights.  The Plows court ordered discovery as to the Gentry factors.

Finally, in Chen-Oster v. Goldman, Sachs & Co.,33 a magistrate judge held that Concepcion did not save an arbitration agreement that would compel plaintiffs to arbitrate Title VII claims individually.  Because Title VII prohibits an individual from maintaining a claim that an employer has engaged in a “pattern or practice” of discrimination, a plaintiff in individual arbitration would give up the substantive right afforded by a federal statute to pursue a pattern or practice claim.  Concepcion, the court wrote, “involved the preemption of state contract law by a federal preference for arbitration embodied in … the FAA … . This case demands consideration of a separate issue:  whether the FAA’s objectives are also paramount when, as here, rights created by a competing federal statute are infringed by an agreement to arbitrate.”34

The courts that perceive limits on the reach of Concepcion often acknowledge that Concepcion may well be applied by appellate courts to uphold the arbitration agreements under consideration but conclude they are bound to follow existing precedent until that occurs.  For example, the Chen-Oster court noted:

Certainly, the Court’s opinion in Concepcion raises a question as to whether the Supreme Court, faced squarely with the issue presented here, would protect the full robustness of a federal right—particularly when that right requires proceeding on a class basis—or would mandate arbitration provided that some equivalent, individual right would be protected in that sphere.  Nonetheless, the Supreme Court has not been presented with that question, and it has indicated in the past that “statutory claims may be the subject of an arbitration agreement” only because “‘[b]y agreeing to arbitrate a statutory claim, a party does not forgo the substantive rights afforded by the statute; it only submits to their resolution in an arbitral, rather than a judicial, forum.’” … [I]t remains the law of the Second Circuit that an arbitration provision which “precludes plaintiffs from enforcing their statutory rights” is unenforceable … I remain obligated to follow it.35

Bottomline

Concepcion brought significant clarification to a turbulent area of competing policy considerations at the intersection of federal and state law.  At a minimum, Concepcion means that courts may no longer refuse to enforce arbitration agreements simply because they contain class waivers.  And, the fact that a contract is adhesive—something that carried heavy weight in many pre-Concepcion decisions—is now neutral.  But courts continue to wrestle with the reach of Concepcion—how Concepcion affects rules like that announced in Gentry, or the ability to exercise federal or other statutory rights, or when other features of an arbitration agreement (like fee-shifting provisions) combined with a class waiver make the pursuit of small-dollar claims on an individual basis unlikely.

These questions will continue to occupy the courts in coming months and may yield another opinion by a Supreme Court focused on arbitration.

Sarah Bushnell is an alumna of the Harvard Law School and a partner in the Minneapolis law firm of Kelly and Hannah, P.A. She focuses her practice on business litigation for both plaintiffs and defendants, including significant experience with arbitration, the enforcement of arbitration agreements, and post-award motion practice.

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