Originally published in The Banking Law Journal
In this article, the author reviews a U.S. Supreme Court decision enforcing a class action waiver provision under California law and another recent decision by the U.S. Court of Appeals for the Second Circuit that refused to enforce a class action waiver provision.
In an effort to avoid class action litigation, many financial institutions (and other businesses) include a waiver of class action claims in their contracts, limiting dispute resolution to arbitration of claims on an individual rather than class action or collective basis. This is consistent with Section 2 of the Federal Arbitration Act ("FAA"), which provides that an arbitration agreement "shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract."
Although the waiver of class action claims may be freely negotiated, the allegedly injured party still may seek to evade that waiver by asserting a contract defense to its enforcement, such as that the waiver is unconscionable or procured by fraud or duress. When a consumer plaintiff challenges a waiver provision, courts evaluate the waiver on a case-by-case basis, focusing on the specific claims asserted and whether relief can be achieved in an economically feasible way through arbitration of individual claims. However, based on a recent U.S. Supreme Court decision enforcing a class action waiver provision under California law, liberal application of the policy favoring arbitration will cause certain waiver provisions to survive a challenge based on unconscionability.
This article reviews that Supreme Court decision and another recent decision by the U.S. Court of Appeals for the Second Circuit that refused to enforce a class action waiver provision. Both decisions demonstrate the tension between the savings clause in the FAA ("save upon such grounds as exist at law or in equity for the revocation of any contract") and the Federal policy favoring enforcement of arbitration agreements.
The Supreme Court's Ruling
The U.S. Supreme Court recently issued a decision that strengthens the position of companies seeking to enforce class action waivers. In AT&T Mobility LLC v. Concepcion,1 the Supreme Court reversed — in a 5-4 decision written by Justice Scalia that engendered a strong dissent by Justice Breyer — a decision by the U.S. Court of Appeals for the Ninth Circuit that invalidated a class action waiver provision in a consumer contract. The Supreme Court defined the issue as "whether the FAA prohibits States from conditioning the enforceability of certain arbitration agreements on the availability of classwide arbitration procedures." The Court found that California law improperly required invalidation of class action waiver provisions in arbitration clauses contained in consumer contracts, which conflicted with the FAA's policy of encouraging arbitration in accordance with the terms of parties' contracts.
AT&T Mobility LLC ("AT&T") provided free mobile phones to its customers but charged sales tax for the "free" phones. Vincent Concepcion sued AT&T in federal court in a proposed class action, alleging that AT&T had engaged in false advertising and fraud by charging sales tax for a phone it advertised as free. Concepcion claimed as damages the sales tax he paid, which amounted to $30.22. Under Concepion's contract with AT&T, any dispute was to be arbitrated solely in an "individual capacity, and not as a plaintiff or class member in any purported class or representative proceeding." AT&T's motion to compel arbitration was denied on the ground that the class action waiver clause was unconscionable under California law, which invalidated class action waivers in cases where consumers' damages claims were small and businesses with superior bargaining power allegedly had sought "to deliberately cheat large numbers of consumers out of individually small sums of money," thus effectively insulating the businesses from responsibility for their conduct. That decision was affirmed on appeal by the Ninth Circuit.
The Supreme Court held that the FAA pre-empted California law because that law effectively prohibited enforcement of an arbitration clause that expressly prohibited class actions. "When state law prohibits outright the arbitration of a particular type of claim, the analysis is straightforward: The conflicting rule is displaced by the FAA."
The Court recognized the savings clause in Section 2 of the FAA that preserves generally accepted contract defenses, "but nothing in it suggests an intent to preserve state-law rules that stand as an obstacle to the accomplishment of the FAA's objectives." According to the Court, the "overreaching purpose of the FAA, evident in the text of §§ 2, 3 and 4, is to ensure the enforcement of arbitration agreements according to their terms so as to facilitate streamlined proceedings." The Court found that the California law invalidating class action waivers and permitting class actions to proceed in court "interferes with arbitration. Although the rule does not require classwide arbitration, it allows any party to a consumer contract to demand it ex post."
There are "fundamental" differences between bilateral arbitration and classwide arbitration, and California's approach "sacrifice[d] the principal advantage of arbitration — its informality — and makes the process slower, more costly, and more likely to generate a procedural morass than final judgment." Class arbitration also "requires procedural formality" and "greatly increases risks to defendants." In short, the 5-4 majority viewed class arbitration as "poorly suited to the higher stakes of class litigation."
Importantly, the Court discussed in detail AT&T's arbitration procedure, which afforded several protections to the consumer:
In the event the parties proceed to arbitration, the agreement specifies that AT&T must pay all costs for nonfrivolous claims; that arbitration must take place in the county in which the customer is billed; that, for claims of $10,000 or less, the customer may choose whether the arbitration proceeds in person, by telephone, or based only on submissions; that either party may bring a claim in small claims court in lieu of arbitration; and that the arbitrator may award any form of individual relief, in cluding injunctions and presumably punitive damages. The agreement, moreover, denies AT&T any ability to seek reimbursement of its attorneys' fees, and, in the event that a customer receives an arbitration award greater than AT&T's last written settlement offer, requires AT&T to pay a $7,500 minimum recovery and twice the amount of the claimant's attorneys' fees.
The availability of those protections plainly influenced the Court's decision that bilateral arbitration provided an appropriate remedy for Concepcion.
The AT&T decision followed a decision by the U.S. Supreme Court last year holding that "a party may not be compelled under the FAA to submit to class arbitration unless there is a contractual basis for concluding that the party agreed to do so."2 In that case the arbitration clause was silent on whether class claims could be included in an arbitration proceeding. "[P] arties are 'generally free to structure their arbitration agreements as they see fit.'" Courts and arbitrators must "give effect to...contractual limitations" and "give effect to the intent of the parties." Because the contract was "silent" on class arbitration, there was nothing to indicate that Defendant affirmatively agreed to class arbitration. As a result, the arbitration panel erred in concluding that class arbitration was appropriate. The "differences between bilateral and class action arbitration are too great for arbitrators to presume, consistent with their limited powers under the FAA, that the parties' mere silence on the issue of class-action arbitration constitutes consent to resolve their disputes in class proceedings."3
Thus, by either leaving arbitration clauses silent as to class action claims or making it clear that the company does not agree prospectively to class action arbitration, a company, when faced with a potential class action, should be able to either consent to class arbitration or insist that the class action proceed in a court.
The Second Circuit's Decision
Shortly before the Supreme Court issued its AT&T decision, the U.S. Court of Appeals for the Second Circuit invalidated a class action waiver in an arbitration clause in a contract between American Express and certain of its merchants because litigation of the plaintiff-merchants' antitrust claims on an individual (as opposed to class action) basis would be prohibitively expensive.4 The district court had granted American Express' motion to compel arbitration pursuant to the FAA, leaving it to the arbitrator to decide if the waiver was enforceable. In reversing that decision, the Second Circuit first observed that the issue of enforceability of the waiver is for a court to determine, not an arbitrator. The Second Circuit then recognized the "firm principle of antitrust law that an agreement which in practice acts as a waiver of future liability under the federal antitrust statutes is void as a matter of public policy." According to the Second Circuit, "[o]ther Circuits also have observed that a plaintiff could challenge a class action waiver clause on the grounds that it would be a cost prohibitive method of enforcing a statutory right, provided that a plaintiff set forth sufficient proof to support such a finding." "[W]hen a party seeks to invalidate an arbitration agreement on the ground that arbitration would be prohibitively expensive, [that] party bears the burden of showing the likelihood of incurring such costs."
The Second Circuit evaluated the "fiscal impracticality of pursuing individual claims" by comparing the cost to litigate against the potential recovery associated with an individual claim. To meet their burden of proving fiscal impracticality, plaintiffs submitted to the district court a detailed affidavit from an economist (Gary L. French, Ph.D.) in a financial consulting firm retained by the plaintiffs. The economist's affidavit stated that the purpose of his affidavit was "to provide an expert opinion concerning the likely costs and complexity of an expert economic study concerning the liability and damages relating to this action, and to compare this with the potential recovery of damages by an American Express Card merchant with annual sales volume of $10 million or less, such as most if not all of the named plaintiffs in this litigation, and to provide my opinion as to whether it would be economically rational for such a merchant to pursue a recovery of damages given the likely out-of-pocket costs of the arbitration or litigation proceeding." The expert concluded that it would not be rational to pursue the antitrust claim on an individual basis because the cost of the antitrust study would exceed the maximum potential recovery. The antitrust study was estimated to cost in excess of $300,000, while the largest potential individual recovery would be significantly less than $50,000. American Express "brought no serious challenge to the plaintiffs' demonstration that their claims cannot reasonably be pursued as individual actions, whether in federal court or in arbitration."
According to the circuit court, the expert affidavit "demonstrates that the only economically feasible means for enforcing [plaintiffs'] statutory rights is via a class action." Although the antitrust laws include fee-shifting for a prevailing plaintiff and the recovery of litigation expenses, the circuit court rejected that remedy as insufficient to protect the statutory rights of plaintiffs.
The "Clayton Act's fee-shifting provisions [are] inadequate to alleviate our concerns given the low expert witness reimbursement rate. Even with respect to reasonable attorney's fees, which are shifted under Section 4 of the Clayton Act, the plaintiffs must include the risk of losing, and thereby not recovering any fees, in their evaluation of their suit's potential costs." The Second Circuit therefore invalidated the waiver because it "flatly ensures that no small merchant may challenge American Express' tying arrangements under the federal antitrust laws." The circuit court remanded the case to the district court to "'allow Amex the opportunity to withdraw its motion to compel arbitration,'" which it apparently did.
The Court emphasized, though, that it did not hold that class action waivers "are per se unenforceable in the context of antitrust actions. Rather, we hold that each case which presents a question of enforceability of a class action waiver in an arbitration agreement must be considered on its own merits, governed with a healthy regard for the fact that the FAA 'is a congressional declaration of a liberal federal policy favoring arbitration agreements.'"
Conclusion
The Supreme Court's AT&T decision and the Second Circuit's American Express decision can be harmonized. Both recognize the strong federal policy favoring arbitration, with the Second Circuit expressly stating that it did not hold that class action waivers "are per se unenforceable in the context of antitrust actions." And both the Supreme Court and the Second Circuit evaluated the litigation procedures, associated costs, and potential recoveries for the specific claims before them. Given the nature of the antitrust claims being pursued, the Second Circuit found it unconscionable from a cost perspective to pursue those claims on an individual basis. In contrast, the Supreme Court identified the litigation procedures implemented by AT&T under its arbitration procedures that made litigation of individual claims reasonable, prompt and cost-efficient. Finally, the AT&T litigation involved straightforward state-law claims whereas the American Express litigation involved complicated federal antitrust claims with their own associated policy rationales.
Class action waivers can be an effective way to limit financial exposure in litigation. The AT&T decision makes such waivers more likely to be enforced, but companies need to be aware that those clauses may still be successfully challenged in court as shown by the American Express decision.
Footnotes
1 Docket No. 09-893 (April 27, 2011).
2 Stolt-Nielsen SA v. AnimalFeeds International Corp., 130 S. Ct. 1758, 1775 (2010).
3 Id. at p.23.
4 In re: American Express Merchants' Litigation, Docket No. 06-1871 (2d Cir. March 8, 2011.
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