Supreme Court to Decide Rule on Class Waivers in Arbitration Clauses

James Morphy is a partner at Sullivan & Cromwell LLP specializing in mergers & acquisitions and corporate governance. This post is based on a Sullivan & Cromwell client memorandum, and relates to an appeal in the case of AT&T Mobility LLC v. Concepcion; the decision of the Ninth Circuit from which the appeal arose, Laster v. AT&T Mobility LLC, is available here.

The U.S. Supreme Court recently granted certiorari in a case that is likely to resolve important outstanding questions regarding attempts to limit arbitration clauses so that they do not permit class action arbitrations. The case, AT&T Mobility LLC v. Concepcion, No. 09-893, presents the question whether the Federal Arbitration Act preempts state laws holding such class action waivers unconscionable if they are contained in consumer contracts. This case follows closely on the Court’s holding last month in Stolt-Nielsen S.A. v. AnimalFeeds Int’l Corp., No. 08-1198 (Apr. 27, 2010), that contracts that are silent on class arbitration must be read to bar that procedure.

Class Arbitration Waivers and Unconscionability Law

The case on appeal is Laster v. AT&T Mobility LLC, 584 F.3d 849 (9th Cir. 2009), which struck down a class waiver in an arbitration clause as unconscionable under California law. The Ninth Circuit held that the Federal Arbitration Act, 9 U.S.C. § 1 et seq. (“FAA”), does not preempt California law in this respect. 584 F.3d at 852.

In Laster, plaintiffs signed wireless service contracts that advertised a “free” cellular phone for new customers, but the customers were charged sales tax on the retail value of the phone. Id. Plaintiffs filed a class action alleging that AT&T’s advertised offer was fraudulent. AT&T demanded that the plaintiffs arbitrate on an individual basis, citing the wireless service contract’s arbitration clause, which forbade arbitrators from “order[ing] consolidation or class arbitration.” Laster v. T-Mobile USA, Inc., No. 05cv1167 DMS (AJB), 2008 WL 5216255, *2 (S.D. Cal. Aug. 11, 2008). The district court denied defendants’ motion to compel arbitration, ruling that the class waiver was unconscionable. Id. at *14.

The Ninth Circuit affirmed under Shroyer v. New Cingular Wireless Services, Inc., 498 F.3d 976 (9th Cir. 2007), and Discover Bank v. Sup. Ct., 35 Cal.4th 148 (2005), which together state that, under California law, a class waiver in a consumer contract is unconscionable where (1) the contract is an adhesion contract, i.e., a contract whose terms were imposed unilaterally by a party with superior bargaining power and without the opportunity to negotiate; (2) the parties’ dispute is likely to involve small amounts of damages; and (3) it is alleged “that the party with superior bargaining power has carried out a scheme deliberately to cheat large numbers of consumers out of individually small sums of money.” Laster, 584 F.3d at 854. The Court of Appeals agreed with the district court that the claim against AT&T fit all three criteria and that the arbitration clause was therefore unconscionable. Id.

In response to AT&T’s argument that the FAA preempted state unconscionability law, the Court of Appeals noted that 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.” 9 U.S.C. § 2 (emphasis added). Because unconscionability is an existing state-law ground for revoking contracts generally, the court held that § 2 could not be read to preempt such grounds. Laster, 584 F.3d at 857.

Implications

The question of whether class action waivers are unconscionable in at least some settings is a recurrent one, with the lower courts reaching divergent results. A number of circuit courts have struck down class action waivers in arbitration clauses as unconscionable under state law. For example, the Second Circuit last year struck a class waiver in an antitrust case on the ground that the waiver effectively immunized the defendant from liability because it was not economically feasible for plaintiffs to bring antitrust claims individually. In re American Express Merchants’ Litig., 554 F.3d 300 (2d Cir. 2009). The Supreme Court remanded that case for reconsideration in light of its decision three weeks ago in Stolt-Nielsen. Am. Express Co. v. Italian Colors Restaurant, – S.Ct. -, 2010 WL 1740528 (May 3, 2010). See also Homa v. American Express Co., 558 F.3d 225, 233 (3d Cir. 2009) (finding class arbitration waiver unconscionable under New Jersey law—under a rationale similar to that in American Express and Laster — and noting that the FAA does not preempt New Jersey unconscionability law); Skirchak v. Dynamics Research Corp., 508 F.3d 49, 59-60 (1st Cir. 2007) (striking down class waiver in employment contract as unconscionable because notice of waiver was hidden in obscure email sent before holiday weekend).

Other lower courts have reached a contrary conclusion, either as a matter of state unconscionability law, e.g., Cicle v. Chase Bank USA, 583 F.3d 549, 555-57 (8th Cir. 2009) (finding class waiver in arbitration clause was not unconscionable under Missouri law); Iberia Credit Bureau, Inc. v. Cingular Wireless LLC, 379 F.3d 159, 174-75 (5th Cir. 2004) (finding arbitration clause was not unconscionable under Louisiana law merely because it forbade class arbitration), or federal law, e.g., Pyburn v. Bill Heard Chevrolet, 63 S.W.3d 351, 365 (Tenn. Ct. App. 2001) (“[The] Supremacy Clause . . . preclude[s] [a court] from invalidating an arbitration agreement otherwise enforceable under the FAA simply because a plaintiff cannot maintain a class action.”).

It is unclear whether AT&T Mobility will provide a vehicle for addressing whether federal law upholds class action waivers in a broad category of cases, because the AT&T contract at issue had an unusual feature designed to tilt the procedure in favor of consumers: it provided that AT&T would pay $7,500 to the customer if the phone company’s last written settlement offer before selection of an arbitrator was less than the arbitrator’s award to the customer. 584 F.3d at 855-56. The Ninth Circuit held, in effect, that this “leveling” provision did not cure the problem. If the Supreme Court reverses, it may do so on narrow grounds.

In Stolt Nielsen S.A. v. AnimalFeeds Int’l Corp., No. 08-1198 (Apr. 27, 2010), the Supreme Court held that class arbitrations are impermissible unless the parties affirmatively agree to them. See slip op. at 21-23. The Supreme Court’s rationale—that class arbitration is a fundamentally different and more onerous procedure than bilateral arbitration, id. — may suggest that the Court will view clauses that explicitly prohibit class arbitration with some sympathy.

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