Whither McGill? The Intersection of Federal Arbitration Act Preemption and Public Injunctions

Depending on your point of view, these provisions are a mechanism for either managing risk by giving consumers an efficient forum for resolving disputes or avoiding liability by denying consumers their day in court. Despite extensive empirical evidence that consumers recover more quickly and more often in arbitration than they do in court, some courts are in the latter camp and, indeed, have been since the early days of the twentieth century.

The problem for arbitration’s detractors is that Congress responded to that anti-arbitration animus with the Federal Arbitration Act (FAA), which declares that private 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.” 9 U.S.C. § 2. Notwithstanding that clear command, however, the Supreme Court of California issued a decision in 2017—captioned McGill v. Citibank, N.A., 393 P.3d 85 (2017)—that invalidated any arbitration provision that purports to bar an arbitrator from adjudicating a claim for so-called “public injunctive relief.”

Now, two years later, the Ninth Circuit has agreed with the California Supreme Court, holding unenforceable any arbitration provision that seeks to waive the ability to seek injunctive relief for the benefit of the (wholly uninjured) public at large, and concluding that this rule is not preempted by the FAA. This article analyzes McGill and subsequent Ninth Circuit decisions and provides an overview of the considerations for companies that deploy such agreements while the appellate processes continue to unfurl.

Background

The McGill Decision

In McGill, the California Supreme Court held that an arbitration clause that prohibits an individual from seeking “public injunctive relief” in both an arbitral and a judicial forum is unenforceable under California law. The court did so based on a California statutory directive that “a law established for a public reason cannot be contravened by a private agreement.” Cal. Civ. Code § 3513. (So-called “public” injunctive relief is relief that has the “primary purpose and effect of prohibiting unlawful acts that threaten future injury to the general public,” as opposed to relief that has the “primary purpose or effect of redressing or preventing injury to an individual plaintiff—or to a group of individuals similarly situated to the plaintiff.” McGill, 393 P.3d at 90 (internal quotation marks and citation omitted).) The McGill court also held that its ruling was a generally applicable contract defense and, thus, not preempted by the FAA.

The McGill rule thus invalidated all such public injunctive relief waivers for contracts governed by California law. And because many arbitration clauses contain a severability provision stating that those waivers are an essential part of the arbitration agreement, the practical effect of McGill in many cases will be the invalidation of the arbitration clause.

The Aftermath: Three Federal Courts in California Follow McGill

Shortly after McGill was decided, three different judges in the Northern District of California applied its holding to invalidate the arbitration provisions in three different consumer contracts. In McArdle v. AT&T Mobility LLC, No. 09-1117, 2017 WL 4354998 (N.D. Cal. Oct. 2, 2017), Judge Claudia Wilken held that McGill invalidated the arbitration provision in a wireless telephone contract. A few weeks later, Judge William Alsup issued Blair v. Rent-A-Center, Inc., No. 17-2335, 2017 WL 4805577 (N.D. Cal. Oct. 25, 2017), in which the court largely rejected an attempt to enforce the arbitration provision in a rent-to-own agreement. Finally, a few months after Blair, Judge Vince Chhabria applied McGill to invalidate an arbitration provision in a cable services agreement. See Tillage v. Comcast Corp., No. 16-5969, 2018 WL 4846548 (N.D. Cal. Feb. 15, 2018). All three courts further found that the McGill rule was not preempted by the FAA.

The defendants in these cases each appealed to the Ninth Circuit Court of Appeals.

The Ninth Circuit Upholds the McGill Rule

On June 28, 2019, the Ninth Circuit issued opinions in each case, though only Blair was published. See Blair v. Rent-A-Ctr., Inc., 928 F.3d 819 (9th Cir. 2019). The primary issue in Blair was whether the FAA preempts the McGill rule. The court held that it does not.

The Blair court explained (correctly) that a state law rule can be preempted by the FAA in two ways: (1) if it is not a generally applicable contract defense (and thus does not fall within the FAA’s saving clause); or (2) if it “interferes with fundamental attributes of arbitration.” Blair, 928 F.3d at 825 (internal quotation marks and citation omitted).

The court then concluded (we think incorrectly) that neither standard was met. First, the court held that a rule barring waivers of public injunctive relief is a generally applicable contract defense that derives from established public policy and applies equally to arbitration agreements and non-arbitration agreements alike. Blair, 928 F.3d at 827 (“[T]he McGill rule expresses no preference as to whether public injunction claims are litigated or arbitrated. . . .”).

Second, and more significantly, the court held that the McGill rule did not interfere with fundamental attributes of arbitration. Relying on circuit precedent holding that the FAA did not preempt a state law rule barring waivers of certain types of private attorney general actions, the court concluded that the McGill rule likewise did not deprive parties of the benefits of arbitration. It reasoned that the arbitration of public injunctions “does not require formalities,” “need not comply with state-law class procedures,” and does not implicate due process concerns (as compared with, say, a rule requiring class-wide arbitration). Blair, 928 F.3d at 828.

The court continued: “Crucially, arbitration of a public injunction does not interfere with the bilateral nature of a typical consumer arbitration.” Id. at 829. That is because a plaintiff requesting a public injunction “files the lawsuit ‘on his or her own behalf’ and retains sole control over the suit,” even if such claims “are brought for the benefit of the general public.” Id. (quoting McGill, 393 P.3d at 92). The court acknowledged that arbitration of a public injunction “will in some cases be more complex,” but the court reasoned that a “state-law rule that preserves the right to pursue a substantively complex claim in arbitration without mandating procedural complexity does not frustrate the FAA’s objectives.” Blair, 928 F.3d at 829.

Upon finding no FAA preemption, the Blair court affirmed the district court’s order denying in part the defendants’ motion to compel arbitration.

In the unpublished McArdle and Tillage dispositions, the Ninth Circuit likewise affirmed the district court decisions. Notably, however, one argument addressed only in Tillage remains undisturbed by Blair. The arbitration agreement at issue in Tillage contained an opt-out provision, and Comcast argued that this removed the agreement from the purview of the McGill rule because it did not preclude the consumer from bringing a claim for public injunctive relief in “any forum”—a consumer could simply opt out of arbitration and bring such a claim in court. The Ninth Circuit disagreed, reasoning that McGill “applies to any consensual waiver of public injunctive relief, irrespective of how the parties choose to waive that relief.” Tillage v. Comcast Corp., 772 F. App’x 569, 569 (9th Cir. 2019) (citation omitted). But because Tillage is unpublished, courts within the Ninth Circuit are not bound to follow it in future cases.

On August 9, 2019, the defendants in McArdle and Tillage filed petitions for rehearing en banc; Rent-A-Center has notified the court that it is exploring settlement with Mr. Blair and thus has obtained a stay of the time for it to file its own rehearing en banc petition.

Analysis: Was the Ninth Circuit Right?

To those who regularly practice in the field of consumer class actions, the Ninth Circuit’s opinion in Blair feels unsatisfying at best. At least since the Supreme Court’s 2011 decision in Concepcion, it has been clear that even a “generally applicable” state law contract defense (such as unconscionability) will be preempted if it (1) “interferes with fundamental attributes of arbitration” or (2) is “applied in a fashion that disfavors arbitration.” AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 341, 344, 348–50 (2011).

The McGill rule faces seemingly insurmountable problems on both prongs. First, it interferes with fundamental attributes of arbitration, including FAA arbitration’s “traditionally individualized” structure, as well as the lower costs, simplified procedures, and reasonably ascertainable scope of potential liability that flow from that traditional, one-claim-at-a-time structure. See Epic Sys. Corp. v. Lewis, 138 S. Ct. 1612, 1622–23 (2018).

Specifically, it dramatically expands the scope of potential liability that would result from injecting a request for public injunctive relief into what has been almost exclusively a forum for the resolution of a single claimant’s allegations since the enactment of the FAA in 1925. Id. In a traditional bilateral arbitration, each party knows from the outset what its worst-case-scenario liability is likely to be—e.g., for consumer contracts, liability is unlikely to exceed the total amount that the seller received from any particular customer. That predictability allows decision makers to make an informed judgment regarding whether the benefits of arbitration (reduced costs, faster dispute resolution, etc.) outweigh its costs (heightened risk of an incorrect merits ruling, limited opportunity for judicial review, etc.).

That calculus is fundamentally different in a world where any claimant could also demand public injunctive relief. In that scenario, the company’s potential liability includes not just the monetary claims of a single consumer but also the cost of altering its practices toward, or providing specific relief to, all 39.5 million California residents. In such a contest, the streamlined procedures, expedited resolution, and narrowly circumscribed appellate review that were affirmatively beneficial (or, at worst, an acceptable trade-off) in the context of a single, small-dollar claim are now existential threats that must be avoided at all costs. In other words, injecting public injunction claims into an otherwise bilateral arbitration would, as a practical matter, deny to prospective users of arbitration virtually all of the benefits that it is intended to provide by making it too financially risky to attempt to obtain those benefits.

Second, even if it could be argued that the McGill rule does not frustrate the fundamental attributes of arbitration, it is clear that it discourages and disfavors arbitration. Concepcion, 563 U.S. at 341. As Concepcion itself explains, when a state law rule alters the fundamental characteristics of arbitration such that parties are discouraged from providing for arbitration in their contracts and selecting it as a means of dispute resolution, the rule in question impermissibly disfavors arbitration and is preempted. See id. at 347 (“[F]aced with inevitable class arbitration, companies would have less incentive to continue resolving potentially duplicative claims on an individual basis.”).

The McGill rule cannot survive that standard. If a company knows that it will face either (1) a ceaseless stream of “bilateral” claims for public injunctive relief in a streamlined arbitration that lacks any merits-based judicial review or (2) a litigated class or representative action in which it would benefit from all the requisites of due process—formal evidentiary rules, merits-based appellate review, and res judicata effect for any judgment—it is not hard to see which route most would pick. A law that forces such a Hobson’s choice is a prototypical case of “disfavor[ing] arbitration” in the manner forbidden by the FAA. It is difficult to believe that such a result is consistent with the pro-arbitration vision of the FAA’s framers. See Concepcion, 563 U.S. at 351 (“find[ing] it hard to believe . . . that Congress would have intended to allow state courts to force” companies to choose whether to “bet the company with no effective means of review”).

What’s Next?

Both AT&T and Comcast have petitioned for panel and en banc rehearing. As of this writing, neither petition has been resolved. If their requests are denied, either or both could seek review at the Supreme Court. Although such prognostication is always fraught, such petitions would have a better chance than most of receiving the four votes necessary to grant review. Among other reasons, the Supreme Court has been quite active on the issue of FAA preemption in recent years and has trained a significant amount of that focus on the Ninth Circuit. An overly formalistic decision that fails to honor the full and natural scope of the Court’s recent jurisprudence in this area might well draw the Court’s attention westward once again.

In the meantime, however, companies that operate in California must decide how, if at all, to amend their arbitration clauses in light of McGill and Blair. The considerations such companies face are many, including whether to retain public injunctive relief waivers at all and, if so, whether to modify them to permit such claims to proceed in court while the rest of the parties’ dispute proceeds in arbitration. Companies will also need to decide whether to stay their present course at least until the McArdle and Comcast appeals are fully resolved or make changes immediately now that the Ninth Circuit has ruled. Regardless of how each individual company chooses to address these questions, there is no denying the fact that McGill and Blair threaten to impose a significant additional litigation burden on consumer-facing companies in California.

Nor are companies that operate wholly outside of California immune. To be sure, McGill itself is limited to rights arising under California law. But opponents of arbitration may seek to argue that anti-waiver statutes in other states invalidate arbitration agreements à la McGill. Perhaps of even greater concern, the Ninth Circuit’s formalistic preemption analysis and miserly view of the benefits afforded by arbitration signals that litigants, legislatures, and courts that are hostile to arbitration may have an easier time imposing their anti-arbitration view going forward. Companies that rely on arbitration clauses must remain vigilant against such efforts.

Conclusion

Whether McGill and Blair are here to stay remains an open question. In the meantime, consumer-facing companies in California (and elsewhere) face difficult questions on how best to manage their risk of class and representative actions going forward, and both sides of the class action bar will have many new issues to grapple with as they and the courts continue to sharpen our collective understanding of the scope of FAA preemption.

Michael P. Daly is a partner with the law firm of Drinker Biddle & Reath LLP in Philadelphia, Pennsylvania. Mark D. Taticchi is an associate who practices at Drinker Biddle’s Philadelphia office. Matthew J. Adler is an associate at Drinker Biddle’s office in San Francisco, California.

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