August 16, 2011 Articles

A Blow to Class Arbitration

By Brian T. Feeney

In a 5–4 decision, the U.S. Supreme Court recently held that a state-law rule finding most class arbitration waiver provisions unconscionable stands as an obstacle to the objectives the Congress sought to meet in enacting the Federal Arbitration Act, 9 U.S.C. § 1, et seq. (FAA), and is therefore preempted by the Federal Arbitration Act (FAA). AT & T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (Apr. 27, 2011). The decision is a decided victory for businesses who sell products and services to consumers, as it provides a means by which businesses may avoid altogether defending consumer claims on a class-wide basis.

The plaintiffs, Vincent and Liza Concepcion, entered into a contract with AT&T Mobility LLC for cellular phone service. The service purchased by the Concepcions was advertised as including free phones, but AT&T charged the Concepcions sales tax based on the phones' retail value. In March 2006, the Concepcions filed suit against AT&T in the United States District Court for the Southern District of California, and the action was later consolidated with a putative class action alleging that AT&T had engaged in false advertising and fraud.

In March 2008, AT&T moved to compel arbitration under the terms of the contract, which provided for arbitration of all disputes between the parties. The contract also included a class-action waiver provision, which required that any claims be brought only in a party's individual capacity and not as a plaintiff or class member in any purported class or representative capacity.

The district court denied AT&T's motion to compel arbitration, relying on the rule articulated by the California Supreme Court in Discover Bank v. Superior Court, 113 P.3d 1100 (Cal. 2005). The Discover Bank rule renders unconscionable and thus unenforceable class-action waiver provisions in consumer contracts of adhesion where (1) the disputes between the contracting parties involve small amounts of damages, and (2) the defendant is alleged to have engaged in a scheme to cheat large numbers of customers out of individually small amounts of money. Finding these criteria satisfied, the district court declined to order the parties to arbitration.

On appeal, the United States Court of Appeals affirmed the district court's ruling, agreeing with the district court that the class-action waiver provision was unconscionable under Discover Bank. The Ninth Circuit also held that the Discover Bank rule was not preempted by the FAA, finding instead that the rule was merely a refinement of unconscionability analysis applicable to contracts in California.

FAA Preempts California's Discover Bank Rule 
Holding that the FAA preempts the Discover Bank rule, the Supreme Court reversed the Ninth Circuit's decision. The Court split along ideological lines, with Justice Scalia delivering the opinion of the Court, joined by Chief Justice Roberts and Justices Kennedy, Thomas, and Alito. Justice Thomas filed a concurring opinion. Justice Breyer filed a dissenting opinion, joined by Justices Ginsburg, Sotomayor, and Kagan.

The starting point for the Court's analysis is section 2 of the FAA, which provides that agreements to arbitrate are valid, irrevocable, and enforceable "save upon such grounds as exist at law or in equity for the revocation of any contract." The Concepcions argued before the Court that because the Discover Bank rule holds that certain arbitration provisions are unconscionable and exculpatory, it is a ground at law or equity for the revocation of their agreement to arbitrate with AT&T. The Court recognized that the Concepcions' argument presented a "complex" inquiry where a generally applicable contract defense such as duress or unconscionability is applied in a manner that precludes arbitration. The Court answered this inquiry by concluding that while section 2's savings clause preserves generally applicable contract defenses, the FAA preempts state-law rules that apply generally applicable doctrine in a manner that stands as an obstacle to the FAA's objectives.

The Court then stated that the primary purpose of the FAA is to ensure that agreements to arbitrate are enforced according to their terms, basing its conclusion on the language in sections 2, 3, and 4 of the FAA. These statutory provisions, the Court noted, declare agreements to arbitrate valid and enforceable, and they require courts to compel arbitration "in accordance with the terms of the agreement." Concluding that the Discover Bank rule interferes with arbitration and thus frustrates the FAA's objective of enforcing arbitration agreements in accordance with their terms, the Court held that the Discover Bank rule was preempted by the FAA.

Substantial Differences between Bilateral and Class Arbitration
The Court's conclusion that the Discover Bank rule is inconsistent with the FAA is based on the rule's permitting a party to demand class arbitration even where the agreement does not manifest an agreement of the parties to arbitrate a class action. The Court noted the substantial differences between bilateral and class arbitration in finding that the Discover Bank rule could not be squared with the FAA's purpose of enforcement of arbitration agreements according to their terms. These differences, the Court found, include:

  • Class arbitration sacrifices the informality of arbitration, which the Court stated was "the principal advantage of arbitration," and resulted in a slower and more costly process.
  • Class arbitration requires a certain degree of procedural formality to protect the rights of absent class members and ensure that they may fairly be bound by the results of the arbitration.
  • Class arbitration substantially increases risks to defendants, who forgo appellate rights in exchange for the informality and efficiency of arbitration. The Court concluded that risks of an uncorrectable error made by an arbitrator "become unacceptable" when the claims of large numbers of claimants are aggregated and decided in a single arbitration.

For these reasons, the Court concluded that "[a]rbitration is poorly suited to the higher stakes of class litigation" and thus state law cannot require class arbitration where the parties have not agreed to it. Finally, the Court rejected the argument that class actions are necessary to permit the prosecution of small-dollar claims that might otherwise go without redress. States cannot require a procedure at odds with the FAA, the Court concluded, "even if it is desirable for unrelated reasons."

A Concurring Opinion
Justice Thomas wrote a concurring opinion setting forth a close textual analysis of the FAA to conclude that the Discover Bank rule is not grounds for revocation of a contract under section 2's savings clause. Section 2 states that agreements to arbitrate are "valid, irrevocable, and enforceable," but the savings clause speaks only to "revocation" of a contract and not to invalidity or nonenforceability. Justice Thomas inferred from this that the FAA requires enforcement of an agreement to arbitrate as written unless the party resisting arbitration successfully asserts a defense challenging the formation of the agreement to arbitrate. Justice Thomas then concluded that the Discover Bank rule did not concern the formation of the agreement to arbitrate and thus is preempted by the FAA.

A Dissenting View
Justice Breyer authored the dissent. Justice Breyer took issue with the Court's rejection of the California Supreme Court's interpretation of the state statutes underpinning the Discover Bank decision, Cal. Civ. Code Ann. §§ 1668, 1670.5(a). Section 1668 makes unlawful any contract that exempts anyone from responsibility for a violation of the law, while section 1670.5(a) permits courts to limit the application of an unconscionable contractual clause to avoid an unconscionable result. Justice Breyer noted that the California Supreme Court's interpretation of these provisions was "authoritative" and concluded that principles of federalism required the Court to uphold, and not strike down, the Discover Bank rule. Justice Breyer also took on the argument that the Discover Bank rule is an obstacle to achieving the FAA's objectives, finding that the Discover Bank rule does not add unacceptable complexity to arbitration procedure.

AT&T Mobility is a clear victory for businesses that sell goods and services to consumers, as it provides a vehicle by which they can avoid class-action proceedings altogether, whether in arbitration or litigation. By including an arbitration clause and class-action waiver provision in their agreements with customers, businesses will most likely be able to require that any claims be brought only individually and in arbitration. AT&T Mobility is not, however, likely to be the last word on this subject. Senator Franken and others in Congress have reintroduced legislation (originally introduced in 2009) that would forbid pre-dispute arbitration agreements in consumer agreements, among other types of agreements. In addition, the AT&T Mobility decision has caused observers to wonder whether the Consumer Financial Protection Bureau may attempt to exercise rulemaking authority to regulate consumer contracts and thus modify the decision's impact either by prohibiting mandatory arbitration clauses or by imposing limitations on their use.

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