13 May 2014
Three years after the U.S. Supreme Court rejected a key challenge to mandatory arbitration agreements in AT&T Mobility v. Concepcion, the legal rules favoring enforcement of arbitration provisions are fairly settled. Now, with their options dwindling in the courts, arbitration's opponents are shifting their efforts to the policy arena.
Concepcion and the Supreme Court's subsequent decision in American Express v. Italian Colors Restaurant make clear that arbitration agreements cannot be invalidated just because they provide for dispute resolution on an individual rather than a class basis. Lower courts, as a result, routinely reject such challenges to arbitration contracts.
But these rulings do not mean that "anything goes." Most significantly, if arbitration agreements specify procedures that are fundamentally unfair, and therefore violate state contract law principles of unconscionability, courts can and do refuse to enforce them.
That is what the U.S. Court of Appeals for the Ninth Circuit did in Chavarria v. Ralphs Grocery, holding that an arbitration provision was unenforceable because the company "gets to pick the pool of potential arbitrators every time an employee brings a claim." Similar decisions invalidate arbitration clauses that subject consumers or employees to unfair arbitration fees, require unduly burdensome travel for arbitration proceedings, or force the losing party to pay the winner's legal bills.
Critical to the validity of these rulings is that the unconscionability principle applied to the arbitration agreement is the same one that governs all other types of contracts under the relevant state's law. That is because, as the Supreme Court reiterated in Concepcion, the Federal Arbitration Act preempts state law that is "applied in a fashion that disfavors arbitration."
Indeed, the Ninth Circuit in Mortensen v. Bresnan Communications refused to follow a Montana Supreme Court decision invalidating an arbitration contract on unconscionability grounds because it determined that the Montana court had applied a legal rule that, although framed in general unconscionability terms, in practical effect discriminated against arbitration agreements.
Over the past three years, most courts have gotten this message. But the jury is still out on the California state courts. In particular, the California Supreme Court, in its decision last fall in Sonic-Calabasas A v. Moreno, suggested in dicta that California courts should apply a unique arbitration-specific unconscionability standard that is different, and more likely to invalidate contract provisions, than the unconscionability test that applies generally to other contracts under California law. But that sort of discrimination against arbitration agreements is squarely prohibited by the FAA. A California decision invalidating an arbitration agreement based on an arbitration-focused unconscionability rule would therefore be a good candidate for reversal by the U.S. Supreme Court.
Arbitration's opponents, largely stymied in the courts, have been shifting their attention to Capitol Hill.
Legislation to amend the FAA so as to eliminate the statutory basis for Concepcion and Italian Colors is now the subject of significant lobbying activity. The Consumer Financial Protection Bureau, meanwhile, is being urged to exercise its authority to ban arbitration agreements in the contracts subject to the agency's jurisdiction.
I welcome this debate. The reality of our judicial system is very different from the theory: It is an extremely expensive, slow way to resolve disputes that benefits lawyers who file lawsuits and those who defend them, but not necessarily their clients. Arbitration offers a cheaper, quicker option to resolve disputes that are too small to attract a lawyer and too individualized for a class action. In practice, the judicial system is effectively closed to this entire category of claims. Arbitration therefore produces a new opportunity for access to justice, and for accountability, that its opponents typically ignore.
Perhaps recognizing this, opponents of arbitration have sought to shift the focus of the policy debate toward a supposed need to preserve class actions, which are not available in arbitration. But there too, reality diverges significantly from theory. In studying a neutrally selected sample of class actions, we found that few class actions deliver benefits to class members. Two-thirds of the cases that had been resolved were either dismissed or otherwise provided no relief for class members. For the one-third that settled on a class basis, the actual benefits to class members were unclear, because settlement distribution results are almost never made public. The few available distribution rates were, for the most part, extremely small.
This bleak outlook was confirmed in a recent settlement challenge brought by Ted Frank, whose Center for Class Action Fairness works to shine a spotlight on abusive class actions. In a declaration filed with the court, a class action settlement administrator addressed settlements in which notice is provided through the media, and not through direct mail—which is to say many, many of the class action settlements in the consumer context. It stated that "the claims rate in these cases ranged between 0.002 percent and 09.378 percent, with a median rate of 0.023 percent." In other words, fewer than three-hundredths of 1 percent of the class members filed a claim in half of the settled cases.
Many lawyers who prosecute and defend class actions recognize this reality. Still, the argument goes, class actions deter wrongdoing. Again, theory and reality collide. How can class actions provide deterrence when virtually every case that gets to the class certification stage is settled? The burden of those settlements falls on wrongdoers and the innocent alike—which means that company executives look at class actions as a cost of doing business, not a badge of wrongdoing. Any general counsel will acknowledge that deterrence comes from the threat of government enforcement, not the threat of private class actions.
Three years after Concepcion, the landscape of arbitration has been transformed. Arbitration challenges lawyers to do something that does not come naturally in a profession trained to cling to precedent: recognize and accept change. Rather than fighting arbitration, give it a chance.
Reprinted with permission from the May 13 edition of The Am Law Litigation Daily © 2014 ALM Properties, Inc. All rights reserved. Further duplication without permission is prohibited.