In 5–4 Decision, Supreme Court Vindicates Use of Class Action Waivers in Arbitration

By Jessie Kokrda Kamens and Tom P. Taylor

In a big win for corporations seeking to resolve consumer and employee disputes by way of bilateral arbitration, the U.S. Supreme Court held 5-4 that a state law requiring the availability of classwide arbitration interferes with the “fundamental attributes of arbitration” and creates a scheme inconsistent with the Federal Arbitration Act (AT&T Mobility LLC v. Concepcion, U.S., No. 09-893, 4/27/11).

One attorney who has used pre-dispute arbitration agreements in consumer contracts extensively predicted the decision will spur more companies to use class action waivers, while another leading class action expert told BNA the opinion reflects an apparent extreme distaste by the majority of the court for class actions and hints at the eventual outcome in another high-profile case this term, Wal-Mart v. Dukes.

The Supreme Court’s opinion fractured along familiar lines, with Justice Antonin Scalia writing for the majority. The opinion held that the FAA preempted a California rule, articulated in Discover Bank v. Superior Court, 36 Cal. 4th 148 (2005), which prohibits class action waivers in adhesion contracts when the damages are predictably small and the waiver exempts the party from fraud.

The critical fifth vote came from Justice Clarence Thomas, who said in a concurrence to the opinion that he “reluctantly joined” the majority. Thomas has expressed reservations about theories of obstacle preemption in cases like Wyeth v. Levine, 555 U.S. 555 (2009), but he said he could reach the same result as the majority based on a textual interpretation of the FAA. Chief Justice John G. Roberts Jr., and Justices Samuel A. Alito Jr. and Anthony M. Kennedy also joined in the majority opinion.

The majority piggy-backed on its opinion last year in Stolt-Nielsen S. A. v. AnimalFeeds Int’l Corp., 78 U.S.L.W. 4328 (U.S. 2010), where it held that a contract silent on the issue of class arbitration could not be interpreted to allow it because the “changes brought about by the shift from bilateral to class-action arbitration” are “fundamental.”

Classwide arbitration, Scalia said, includes absent parties, which necessitates additional and different procedures and involves higher stakes. “[T]he switch from bilateral to class arbitration sacrifices the principal advantage to arbitration—its informality—and makes the process slower, more costly, and more likely to generate procedural morass than final judgment.”

The fact, raised in the dissent, that most small dollar claims will be abandoned if they can not be adjudicated on a class basis, did not convince the majority. “States cannot require a procedure that is inconsistent with the FAA, even if it is undesirable for unrelated reasons.”

In dissent, Justice Stephen G. Breyer said that California’s Discover Bank rule is consistent with the FAA’s objective to place agreements to litigate and to arbitrate on the same footing. The California law, he said, applies to class action waivers in any type of contract. Justices Ruth Bader Ginsburg, Sonia Sotomayor, and Elena Kagan joined in the dissent.

Breyer suggested that the concept of federalism also supported upholding the California law. “Here, recognition of the federalist ideal, embodied in the specific language in this particular statute, should lead us to uphold California’s law, not to strike it down.”

Coffee, Other Experts Weigh In.

Professor John C. Coffee Jr., who teaches at Columbia Law School in New York and who has written extensively on class actions, told BNA April 27, “The irony here is that the majority and the minority have reversed their usual roles and their usual rhetoric. The dissent written by Breyer is saluting federalism and saying federalism requires that you defer to the state rule. That is usually the position of the conservative majority that is usually very suspicious of preemption and which generally believes that the state rule should be respected because we are a federal nation of co-equal sovereigns, federal and state.”

Coffee added, “Given that this is a majority that is normally extremely respectful of federalism and its values, animating this decision is probably the majority’s extreme distaste for class actions. I think that does not auger well for those that are predicting the eventual result in Wal-Mart [v. Dukes].”

Alan S. Kaplinsky, a partner at Ballard Spahr LLP in Philadelphia who told BNA April 27 he pioneered the use of pre-dispute arbitration provisions in consumer contracts, said that until this opinion, “there was a cloud hanging over” the use of class action waivers in arbitration agreements. Until today, courts across the country were split about whether class action bans could be enforced, Kaplinsky said. “The court has brought an end to that debate.”

Kaplinsky predicted that more companies may start using class action waivers, and that consumers will be benefited because bilateral arbitration is a better alternative for resolving disputes.

Deepak Gupta, a staff attorney at Public Citizen Litigation Group in Washington, D.C., who argued the case for the Concepcions, said in a statement that the decision was a crushing blow to American consumers and employees.

“The court’s decision today turns the [FAA]—a law that was intended to facilitate private arbitration between sophisticated companies—into a shield against corporate accountability. The decision will make it harder for people with civil rights, labor, consumer and other kinds of claims that stem from corporate wrongdoing to join together to obtain their rightful compensation,” Gupta said.

AT&T said in a statement, “This is a victory for consumers. The court recognized that arbitration often benefits consumers. And as noted in the opinion, ‘[T]he District Court 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.’ ”

Coffee said that many may be surprised by the decision. “At oral argument there was suggestion on several justices’ part that they were concerned with whether this was an overly sweeping interpretation that the appellants were seeking, but when it got to be written it came down and broke along the usual 5–4 standard fracture lines. And I would categorize it as one of the more ideological 5–4 decisions that the court has had in the last year or two.”

The Discover Bank Rule.

The class action was filed in federal court by AT&T Mobility customers Vincent and Liza Concepcion, who sought to recoup $30 in sales taxes they say they were unfairly charged for phones advertised as free. The Concepcions’ service agreement with AT&T included an arbitration provision waiving the right to proceed with dispute resolution through class arbitration.

The district court denied defendant AT&T’s motion to compel arbitration, finding that the class waiver provision of the parties’ arbitration clause was unenforceable under California law, and that California law was not preempted by the FAA.

On appeal, the Ninth Circuit affirmed that the class action waiver was unenforceable under California law.

The Ninth Circuit applied the California Supreme Court’s three-part test articulated in the Discover Bank case for determining whether a class action waiver in a consumer contract is unconscionable.

The Discover Bank test says that class action waivers act as exculpatory clauses and should not be enforceable when (1) the waiver is found in a consumer contract of adhesion; (2) in a setting in which disputes between the contracting parties predictably involve small amounts of damages; and (3) when it is alleged that the party with superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of small amounts of money.

The Ninth Circuit concluded that all three prongs applied to the arbitration agreement between AT&T and the Concepcions.

FAA’s ‘Saving Clause.’

The Ninth Circuit also held that the FAA does not preempt the Discover Bank rule.

Section 2 of the FAA provides that arbitration clauses “shall be valid, irrevocable, and enforceable save upon such grounds as exist at law or in equity for the revocation of any contract.” This saving clause permits agreements to arbitrate to be invalidated by generally applicable contract defenses, such as unconscionability, but not by defenses that apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue.

The Ninth Circuit said that the Discover Bank rule is “simply a refinement of the unconscionability analysis applicable to contracts generally in California.”

‘Disproportionate Impact.’

The majority disagreed with the Concepcions’ argument that the Discover Bank rule is a ground that “exist[s] at law or in equity for the revocation of any contract” under Section 2. The Concepcions said that the rule is an application of unconscionability doctrine and applies to contracts generally.

But Scalia said that although the Section 2 saving clause preserves generally applicable contract defenses, “nothing in it suggests an intent to preserve state-law rules that stand as an obstacle to the accomplishment of the FAA’s objectives.”

Although a doctrine such as unconscionability may appear to be generally applicable, it may be applied in a fashion that disfavors arbitration. For example, a case might find that a consumer agreement that fails to provide for judicially monitored discovery is unconscionable because it is exculpatory or because no consumer would agree to allow a corporation to hide their wrongdoing.

A rule like this, the court said, would have a “disproportionate impact” on arbitration agreements even though it applied to contracts purporting to restrict discovery in litigation.

The Concepcions suggest that “all this is just a parade of horribles, and no genuine worry” because demanding procedures incompatible with arbitration would be preempted by the FAA because they cannot sensibly be reconciled with §2, the court said.

But Scalia disagreed that the judicially monitored discovery hypothetical was a “far cry” from this case. “Requiring the availability of classwide arbitration interferes with fundamental attributes of arbitration and thus creates a scheme inconsistent with the FAA.”

Although the rule is limited to small damages cases alleging a scheme to cheat consumers, Scalia said that the damages requirement is “toothless and malleable” and the latter requirement has no limiting effect as it only requires an allegation.

Class Arbitration Inconsistent With FAA.

Scalia said that “class arbitration, to the extent it is manufactured by Discover Bank rather than consensual, is inconsistent with the FAA.” The decision in Stolt-Nielsen is instructive, the court said. In that case, the court said that the changes brought about by the shift from bilateral to class arbitration were “fundamental.”

First, class arbitration sacrifices the advantage of informality, slows down the process, and makes it more costly, the court said. Before addressing the merits of a claim, an arbitrator must decide whether the class should be certified, whether the named plaintiffs are typical, and how discovery should be conducted for the class, the court said.

Second, class arbitration requires procedural formality, the court said. If the procedures are too informal, absent class members would not be bound by the result. For a class action money judgment to bind the class members, they must be given notice, a right to opt out of the class, and an opportunity to be heard. This level of process would presumably be required for absent parties to a class arbitration, the court said.

Third, the court said that class arbitration greatly increases the risks for defendants. “Informal procedures do of course have a cost: The absence of multilayered review makes it more likely that errors will go uncorrected.”
In bilateral arbitration, this risk is limited to the amount of an individual claim, but when claims are aggregated to the thousands, “the risk of an error will often become unacceptable,” he said.

Breyer’s Dissent.

Breyer wrote in his dissent that the California law did not stand as an obstacle to executing the FAA because it applied to class action waivers in any contract, as §2 requires.

The rule is also consistent with the basic purpose behind the Act, Breyer said. The FAA’s primary objective is to secure the enforcement of agreements to arbitrate, not to guarantee procedural and cost advantages.

The majority’s finding that the Discover Bank rule stands as an obstacle to the accomplishment of the FAA’s objectives is based on its claims that the rule increases the complexity of arbitration procedures and discourages parties from entering into arbitration agreements, Breyer said. But, class arbitration is well-known in California and elsewhere, Breyer said. And, according to American Arbitration Association statistics, class arbitration takes less time than class actions in court, he said.

Breyer said that federal arbitration law generally leaves matters of contract defenses to the states. “California is free to define unconscionability as it sees fit, and its common law is of no federal concern so long as the State does not adopt a special rule that disfavors arbitration.”

Gupta argued for the Concepcions. Andrew J. Pincus, Mayer Brown, Washington, D.C., argued for AT&T Mobility.