U.S. Supreme Court Allows Arbitration Clauses In Form Contracts That Preclude Class-Wide Relief

In a big victory for businesses seeking to resolve consumer and employee disputes by individualized arbitration, the U.S. Supreme Court has held that, as a matter of overriding federal law, such provisions in standard form contracts are enforceable even though they preclude arbitrating such disputes on a class-wide basis. AT&T Mobility LLC v. Concepcion, No. 09-893, 2011 WL 1561956 (April 27, 2011). The practical effect of the ruling by the closely-divided Court is to pave the way for businesses, through carefully-drafted arbitration clauses in their standard-form contracts, to immunize themselves against class-wide consumer and employee claims in any form.

Factual Background

The plaintiffs in AT&T were a married couple who entered into a standard-form cellular phone sale and servicing agreement with AT&T that provided, among other things, that disputes between them and the company could only be resolved in single-claim arbitration and not on a class-wide basis. Subsequently, the plaintiffs filed a class-action lawsuit against the company in California, claiming that AT&T's practice of advertising its giveaway of mobile phones as "free", when in fact it charged sales tax on the value of the phones, was fraudulent.

AT&T moved to compel the plaintiffs' individual claims to arbitration. The district court denied the motion, holding that the arbitration clause was unenforceable under California law. In so ruling, the court relied on a California Supreme Court case, Discover Bank v. Superior Court, that said class action waivers in arbitration clauses are unenforceable when (1) the waiver is found in a consumer contract of adhesion; (2) the disputes between the contracting parties predictably involve small amounts of damages; and (3) the plaintiff alleges that the party with superior bargaining power carried out a scheme to deliberately cheat large numbers of consumers out of small amounts of money. The Ninth Circuit upheld the district court's decision.

The Supreme Court's Opinion

In a 5-4 decision, the Supreme Court reversed, finding the arbitration clause valid and enforceable despite its class action waiver. It began by noting that, under federal law, arbitration is favored and agreements to arbitrate must be enforced except to the extent of generally-applicable contract defenses like fraud or duress. Specifically, the Court found that federal law favoring the enforcement of arbitration clauses preempted any conclusion, as in Discover Bank, that such a clause was unenforceable unless it permitted class-wide arbitration. The Court reasoned that "requiring the availability of classwide arbitration interferes with the fundamental attributes of arbitration" and highlighted the following three reasons - (1) the main advantage of arbitration is its informality and swift resolution, which is sacrificed when class arbitration is imposed; (2) AAA's rules mimic the Federal Rules of Civil Procedure for class litigation, requiring procedural formality inconsistent with arbitration and "odd[ly]" leaving important due process determinations effecting absent class-members to an arbitrator; and (3) class arbitration does not provide the same type of procedural protections as formal litigation, such as appellate review, and exposes defendants to high-stakes risks not present in single-claim arbitration.

What are the Implications?

The Supreme Court's decision protects the right of businesses, in a properly-drafted standard-form contract, to require the arbitration of disputes on an individualized basis, even where the other party to the contract might otherwise have a right to bring his or her claims on behalf of a class. Because such clauses can be written to mandate the arbitration of virtually all disputes between the company and the individual, the practical effect of such a clause will be to eliminate many types of class claims from being brought at all, not just in the arbitral forum.

A few caveats to the Court's holding should be noted.

First, the arbitration clause at issue in AT&T Mobility, like most consumer contracts today, was a contract of adhesion. Under the general law of contract, such standard-form contracts are subjected to special scrutiny for unconscionability in their terms. The Court explained that, while federal law may preempt state laws that invalidate class action waivers per se, states can still take steps in regard to such waivers to address the concerns that attend standard-form contract provisions generally. The Court gave the example that states may require that class-action waivers be highlighted. Accordingly, businesses planning to provide for single-claim arbitration in their form contracts should carefully evaluate how to ensure that the provision complies more broadly with the rules governing adhesion contracts, including among other things highlighting the waiver provision in some manner.

Second, it should be noted that, except for the class arbitration waiver, AT&T's arbitration provision was extremely consumer friendly. The provision required, among other things, that AT&T pay all arbitration costs for non-frivolous claims, that the arbitration take place in the county in which the customer is billed, and that in the event a customer receives an arbitration award greater than AT&T's last written settlement offer, AT&T must pay a $7,500 minimum recovery and twice the amount of claimant's attorney's fees. The Supreme Court commented on the favorability of these terms and, although the terms may not have figured in the technical legal reasoning that validated the waiver provision, they undoubtedly created a more favorable context for reaching that result. It is safe to say that the fewer such favorable terms an arbitration clause has, the greater the risk that it will be challenged as unconscionable and unenforceable in whole or perhaps even just as to its class waiver provision.

Third, the Court's decision may not have a short term impact where a selected arbitration forum has established its own class-action procedural rules. An example is customers of brokerage firms who are FINRA members and have designated FINRA as the arbitration forum in their customer agreements. The FINRA Code prohibits class arbitration claims and prohibits member firms from enforcing arbitration agreements against a customer who is a member of a class action unless or until class certification is denied, the class is decertified, the customer is excluded from the class or opts out, or elects not to participate. In the wake of this opinion, there may be a movement among member firms to convince FINRA to amend the Code to allow brokerage firms to prohibit class claims by customers. Some brokerage firms may rewrite their arbitration clauses to select a different arbitration forum and prohibit class claims.