Arbitration Clauses in Class Action Waivers

Why many legal observers believe that a recent Supreme Court decision could signal the death knell to consumer class actions.

Arbitration clauses can be an effective means of controlling the risks and costs of litigation. This is particularly true for businesses serving a large customer base. Such businesses may face the specter of a class action prompted by a single disgruntled customer. The costs and exposure associated with class actions may lead companies to settle otherwise defensible claims rather than place their companies at risk. Fortunately the U.S. Supreme Court has staunchly supported the use of arbitration clauses, including those that waive class action claims. In 2011, the Court held that the Federal Arbitration Act (“FAA”) preempted a California law that would have invalidated, as unconscionable, an arbitration clause containing a class action waiver. AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (2011). The arbitration clause in Concepcion was a fairly typical boilerplate clause utilized in consumer mobile phone contracts. The victory of the FAA over state laws antagonistic to such clauses in consumer contracts did not, however, end the battle. Concepcion was decided by a narrow 5-4 margin, and many consumer advocates quickly moved forward to try to punch holes in the scope and effect of the decision.

One such attack appeared to be successful. The Second Circuit Court of Appeals noticed that an arbitration clause containing a class action waiver in American Express’s standard merchant agreement could not be enforced against federal antitrust law claims. In re Am. Express Merchants’ Litig., 667 F.3d 204 (2d Cir. 2012). The Second Circuit noted that the costs of proving the antitrust claims significantly exceeded the individual merchant’s potential recovery, making the costs of the action prohibitive. It therefore reasoned that, between competing federal laws, the FAA must yield to the Sherman and Clayton Acts because it precluded the “effective vindication” of those antitrust laws.

In June of this year, the Supreme Court reversed the Second Circuit’s decision. See Am. Express Co. v. Italian Colors Rest., 133 S. Ct. 2304 (2013). The Court found that arbitration agreements will generally be enforced as applied to federal claims absent “contrary congressional command.” Finding no such command in the FAA or antitrust laws, the Court held that the arbitration clause was enforceable.

The Court also addressed the lower court’s application of the “effective vindication” doctrine. While recognizing the existence of the doctrine, the Court found that it was limited to prevent “prospective waiver of a party’s right to pursue statutory remedies.” The Court stated that it would “certainly cover” attempts to waive statutory rights, and “would perhaps cover” filing and administrative fees that were so high as to “make access to the forum impracticable.” However, the Court distinguished the circumstance under review because “the fact that it was not worth the expense involved in proving a statutory remedy” did not “constitute the elimination of the right to pursue that remedy.”

Although the American Express decision arose out of an antitrust dispute, it is likely to have a substantially broader impact. Both the Second and  Ninth Circuits have recently applied the Concepcion and American Express decisions to enforce arbitration clauses containing class action waivers to class actions asserting labor and employment law violations. See Sutherland v. Ernst & Young LLP, 12-304- CV, 2013 WL 4033844 (2d Cir. Aug. 9, 2013); Richards v. Ernst & Young, LLP, 11-17530, 2013 WL 4437601 (9th Cir. Aug. 21, 2013).

The Ninth Circuit has also relied upon Concepcion to allow arbitration in a recent decision involving class claims asserting violations of unfair competition and consumer protection laws. See Ferguson v. Corinthian Colleges, Inc., 733 F.3d 928 (9th Cir. 2013). The Ferguson panel reversed the lower court’s denial of a motion to compel arbitration, and held the FAA preempted California’s “Broughton-Cruz Rule,” which dictates that injunctive relief sought for the public’s benefit cannot be subjected to mandatory arbitration.

Nevertheless, arbitration clauses are still subject to attack. 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.” Lower courts have relied on this language to find certain arbitration clauses unenforceable under general contract principles.

The Fifth Circuit has recently affirmed the invalidation of an arbitration clause on the grounds that the clause was illusory, and thereby allowed a class action to proceed in court. The company seeking to compel arbitration had reserved the right to amend the contract, including the arbitration clause, at any time. The court found this provision included retroactive modification to the contract, since there was no express limitation on the company’s right to modify. As such, the Fifth Circuit concluded that the arbitration clause was only enforceable by one side and, therefore, was illusory. The court held that Concepcion does not govern illusory contracts. Carey v. 24 Hour Fitness, USA, Inc., 669 F.3d 202 (5th Cir. 2012).

The Ninth Circuit also recently upheld a lower court’s decision to deny arbitration where an arbitration clause contained in an employment application was procedurally and substantively unconscionable under California law. See Chavarria v. Ralphs Grocery Co., 733 F.3d 916 (9th Cir. 2013). The Chavarria court specifically held that the Concepcion decision “cannot be read to immunize all arbitration agreements from invalidation no matter how unconscionable they may be, so long as they invoke the shield of arbitration.” The Ninth Circuit further noted that American Express does not bar a court from considering the costs that may be imposed by virtue of the arbitration agreement at issue.

The law will surely continue to develop in this area as various interests attempt to solidify or weaken the enforceability of arbitration clauses. In the meantime, arbitration clauses in contracts should always be considered as an alternative to judicial proceedings, particularly for companies at risk from class action claims. While the courts now generally support the enforcement of such provisions, they must be properly drafted, and overreaching and oppressive terms should be avoided.

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