In a profoundly significant decision with far-reaching implications, the U.S. Supreme Court on April 27, 2011, overturned an appellate court decision that held that an arbitration clause in a consumer agreement containing a class-action waiver was unconscionable, and therefore unenforceable, as a matter of law. Organizations can use this ruling to help eliminate the threat of consumer class actions by using carefully drafted contract language.
The five-to-four ruling, in the case of AT&T Mobility LLC v. Concepcion, stated that "[a]rbitration is poorly suited to the higher stakes of class litigation." The momentous opinion recognizes that arbitration is dependent on contractual consent and that arbitration clauses should be enforced as written, even when they include certain types of class-action waivers.
Concepcion offers support to organizations with customers in California and nationwide that seek to use contractual arbitration clauses with class-action waiver provisions in order to provide a fast, fair and efficient way to resolve disputes on a voluntary basis and avoid class actions. As a result, the risk of consumer class actions may be substantially reduced or possibly eliminated with the use of an appropriately drafted and implemented arbitration provision and class-action waiver.
The holding also should make it easier to defend the enforceability of arbitration agreements in other contexts. For example, Concepcion provides a strong argument to employers that pre-dispute arbitration agreements and class-action waivers (both as part of formal employment agreements or as stand-alone agreements) are enforceable, which can help eliminate the threat of high-cost wage-and-hour class actions.
While the holding of Concepcion is good news for organizations that wish to quickly and inexpensively resolve customer disputes through individual arbitrations, consumer advocates and class-action plaintiffs' attorneys have called for congressional action to move forward pending legislation that would ban mandatory arbitration agreements in most consumer and employment contracts. In addition, the new Consumer Financial Protection Bureau that was created by the Dodd-Frank Wall Street Reform and Consumer Protection Act will be studying the issue and may prohibit or limit the use arbitration clauses in consumer financial product or service agreements.
Concepcion involved a dispute brought by a California couple against AT&T Mobility ("AT&T") over a $30 charge for sales tax that was calculated on the full retail price of a cell phone, which had been advertised as a "free" phone. The AT&T contract provided for arbitration of all disputes between the parties, but required that claims be brought in the parties' "individual capacity, and not as a plaintiff or class member in any purported class or representative proceeding."
In addition to this class-action waiver, the contract's arbitration clause also contained several notable consumer-friendly provisions intended to provide customers with procedural safeguards and incentives to pursue small claims, including:
- cost-free arbitration for non-frivolous claims;
- allowing any arbitration to take place in the county where the consumer received his or her monthly bill and enabling the consumer to choose how the arbitration should proceed (i.e., in person, by telephone, or by written submission);
- the ability for consumers to opt out of arbitration and file a claim in small-claims court;
- no confidentiality required; and
- providing for the award of a success premium (minimum of $7,500 plus double attorneys' fees) for any recovery above AT&T's written settlement offer.
The couple filed a class-action lawsuit in court. Despite the requirement that sales tax be charged under state law, the Concepcions alleged that when AT&T charged them sales tax based on the full retail price for phones that were free or discounted, it violated California's unfair competition and false advertising laws (CAL. BUS. & PROF. CODE §§ 17200 et seq.; id. §§ 17500 et seq.) and Consumer Legal Remedies Act (CAL. CIV. CODE §§ 1750 et seq.). They also alleged that AT&T committed fraud and unjustly enriched itself.
Trial Court and Ninth Circuit Decisions
Both the trial court and Ninth Circuit had rejected AT&T's argument that the customers were bound by AT&T's standard contract based on the courts' belief that the arbitration clause and class-action prohibition were "unconscionable" under California law.
Despite procedural safeguards and acknowledged incentives to pursue small-dollar claims, the trial court held that AT&T had not shown that the consumer-friendly aspects of the arbitration clause were an adequate substitute for class actions in deterring AT&T from engaging in the alleged wrongdoing. Relying on the California Supreme Court's decision in Discover Bank v. Superior Court, 36 Cal. 4th 148, 113 P.3d 1100 (2005), the trial court found the arbitration provision unconscionable because it disallowed class-wide proceedings.
In the Discover Bank case, California articulated a bright line rule that class-action waivers contained in arbitration provisions found in a contract of adhesion were unenforceable when "disputes between the contracting parties predictably involve small amounts of damages, and where 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..." Discover Bank, 36 Cal. 4th at 162-163, 113 P.3d at 1110.
The Ninth Circuit agreed that the AT&T provision was unconscionable under California law and held that the Federal Arbitration Act ("FAA"), which makes arbitration agreements "valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract," did not preempt its ruling.
U.S. Supreme Court Decision and Implications
The U.S. Supreme Court reversed the lower-court decisions and found for AT&T, stating that arbitration agreements must be placed on equal footing with other contracts, and that California's Discover Bank rule was preempted by the FAA and its strong federal policy favoring informal arbitration.
The Court dismissed the argument by the Concepcions that the Discover Bank rule is a ground that "exist[s] at law or in equity for the revocation of any contract" under FAA § 2. The Court reasoned that "[r]equiring the availability of class-wide arbitration interferes with fundamental attributes of arbitration and thus creates a scheme inconsistent with the FAA." The decision makes clear that "[w]hen state law prohibits outright the arbitration of a particular type of claim, the FAA displaces the conflicting rule." Moreover, the Court stated that class arbitration, to the extent it is manufactured by the Discover Bank rule rather than consensual, interferes with fundamental attributes of arbitration.
The Concepcion decision substantially changes the landscape for organizations that interact with customers directly and that use standard-form contracts, and potentially opens the door to eliminate other class-action threats, including employee class actions.
Consumer Product and Service Contracts
Organizations should consult with their legal counsel, review their existing standard contracts, and consider whether their existing arbitration clauses and policies merit updating in light of the Concepcion decision. In addition, organizations should consider issues of fairness and perform a cost-benefit analysis when designing and implementing arbitration clauses and class-action waivers.
Here are some additional considerations:
- General Consumer Product and Service Agreements - With respect to customer agreements, organizations should immediately consider revising existing arbitration agreements or drafting new ones that are consistent with the Concepcion decision. Former customers, of course, cannot be made to sign arbitration agreements forbidding the use of class-actions claims. As a result, a former customer or any current customer who refuses to sign such an agreement will still expose the organization to risk, but eventually, the time limits on former customer claims will expire and the potential for class-action claims will be eliminated or significantly reduced.
- Regulated Consumer Product and Service Agreements - For some regulated consumer products and services, there may be additional requirements related to consumer contracts to consider when evaluating whether to use or modify an existing arbitration clause or class-action waiver. For example, there may be rules that govern providers of particular financial goods and services, including requirements that limit the use of arbitration clauses and class-action waivers, in order to satisfy licensure requirements or to have a valid customer contract. As a result, regulated entities should carefully consider all of the legal and regulatory implications to the organization before modifying consumer-facing contracts that are subject to approval by a regulator or are otherwise specifically regulated.
Moreover, at some point down the road, the Consumer Financial Protection Bureau ("CFPB") may move to limit the use of arbitration provisions and class-action waivers in contracts with respect to consumer financial products or services subject to the Consumer Financial Protection Act, which was enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. In the meantime, the CFPB is required to study the use of mandatory arbitration provisions and report to Congress.
On a related note, the U.S. Supreme Court on May 2, 2011 announced it would hear Greenwood v. CompuCredit Corporation and Synovus Bank, which could decide whether lawsuits brought under the federal Credit Repair Organizations Act, 15 U.S.C. § 1679 et seq. ("CROA"), are subject to arbitration. Greenwood, however, does not involve any challenge to the validity of the class-action waivers in the arbitration agreement, either under CROA or California law.
Impact of the Decision on Non-Product and Service Agreements
It remains to be seen how the Concepcion decision will be interpreted to apply to agreements in other contexts, although the decision provides a strong argument that appropriately crafted arbitration agreements and class-action waivers should be enforceable. For example, the use of correctly drafted arbitration agreements with class-action waivers can help to minimize the risks to employers of facing a wage-and-hour class action (or any other employment-based class actions). Employers that do require arbitration agreements and class-action waivers as a condition of employment should take this opportunity to confirm the validity of the agreements' terms. Further, employers that do not require arbitration agreements and class-action waivers should consult with their legal counsel about the pros and cons of instituting such agreements. Even job applicants can be covered, as long as an employment application contains such arbitration agreements.
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Barring a change in the law from Congress or realignment on the U.S. Supreme Court, the value of the Concepcion decision is that an organization can take steps now to limit the risk of future class-action lawsuits, particularly many consumer class actions. The decision will allow consumer product and service providers to utilize well-crafted language in their consumer agreements that facilitates swift and inexpensive resolution of disputes by requiring arbitration and simultaneously prohibiting class actions.
Jonathan L. Pompan, Of Counsel in the Washington, DC office of Venable LLP, represents providers of consumer financial products and services and others in a wide variety of areas including advertising and marketing law compliance, as well as in connection with Federal Trade Commission and state investigations and law enforcement actions.
Lawrence H. Cooke II, a Partner in the New York, NY office of Venable LLP, is a seasoned litigator who focuses on complex litigation, including product liability, class actions, securities, insurance coverage, intellectual property, and other commercial matters in federal and state courts. He has represented numerous nonprofit and for-profit consumer product and service providers.