In a decision with important implications for all companies that use arbitration clauses in form contracts, the United States Supreme Court held yesterday, in a 5-4 decision written by Justice Scalia, that California’s unconscionability doctrine cannot be used to invalidate a class action waiver provision in AT&T’s standard form consumer contract. See AT&T Mobility LLC v. Concepcion. The Court held that the Federal Arbitration Act (FAA) preempts California’s unconscionability doctrine, as applied to prohibit class action waivers in arbitration, because class arbitration is so fundamentally different from bi-lateral arbitration that to force it on parties who agreed to bi-lateral arbitration only would violate the FAA’s purpose of ensuring enforcement of arbitration contracts as written. Concepcion represents an important change in the law, as state law unconscionability doctrine had been used in California and elsewhere to prohibit or limit the use of class action waivers in arbitration clauses, forcing companies to face the risk of class arbitration or forego arbitration altogether. That risk is substantially reduced or possibly eliminated by the Concepcion decision.
Concepcion involved a dispute over an arbitration provision found in a cell phone contract. The provision in question provided for arbitration of all disputes, but did not permit class-wide arbitration. The arbitration provision also contained consumer-friendly provisions that (a) required AT&T to provide a settlement offer within 30 days of receipt of a Notice of Dispute filed by a consumer; (b) required AT&T to pay all costs for non-frivolous claims pursued in arbitration; (c) provided consumers with the ability to opt out of arbitration and file a claim in small-claims court; (d) required any arbitration to take place in the county where the consumer received its monthly bill and enabled the consumer to choose how the arbitration should proceed (i.e., in person, by telephone, or by written submissions); and (e) provided for the award of a success premium (minimum of $7,500 plus double attorneys’ fees) for any recovery above AT&T’s original settlement offer.
Despite the consumer-friendly aspects of the arbitration provision, the Concepcions pursued a class action in court and claimed that AT&T engaged in false advertising and fraud by charging sales tax on “fee” phones. The Concepcions sought to avoid the arbitration clause in their cell phone contract under California’s unconscionability doctrine set forth in Discover Bank v. Superior Court, 36 Cal. 4th 148, 113 P.3d 1100 (2005). In Discover Bank, the California Supreme Court held that class action waiver provisions found in a contract of adhesion are unenforceable when “disputes between the contracting parties predictably involve small amounts of damages, and where it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money ... .” Both the trial and the Ninth Circuit agreed with the Concepcions that the Discover Bank rule is a generally applicable contract defense under Section 2 of the FAA that may be used to invalidate a class action waiver.
The Supreme Court did not answer the specific question of whether unconscionability is a generally applicable contract defense, but instead focused on the inconsistency between the Discover Bank rule and the purpose of the FAA. The Court held that “[n]othing in [Section 2 of the FAA] suggests an intent to preserve state-law rules that stand as an obstacle to the accomplishment of the FAA’s objectives.” Class arbitration, the Court reasoned, is inconsistent with the FAA because it “sacrifices the principal advantage of arbitration – its informality” and “greatly increases risks to defendants.” Arbitration, the Court concluded, “is poorly suited to the higher stakes of class litigation.”
Writing separately, Justice Thomas “reluctantly join[ed] the Court’s opinion.” He would have held that the only generally applicable contract defenses that should be allowed under the FAA are those that go to formation of the arbitration agreement, such as fraud or duress, and not defenses based on public policy, such as unconscionability.
Writing in dissent, Justice Breyer, joined by Justices Ginsburg, Sotomayor, and Kagan, would have held that unconscionability as applied to class action waivers is a generally applicable contract defense under Section 2 of the FAA because it applies regardless of whether the class action waiver is asserted in court or in arbitration. The dissent also took issue with the majority’s view that class arbitration is inconsistent with the purpose of the FAA.
Concepcion is a big win for companies that use arbitration clauses to resolve disputes with consumers or employees. Although it involved California law, it appears to be broad enough to cover unconscionability challenges to class action waiver provisions under the law of other states as well. It is the logical outgrowth of last term’s decision in Stolt-Nielsen S.A. v. AnimalFeeds Int’l Corp., 130 S. Ct. 1758 (2010). Stolt-Nielsen held that “a party may not be compelled under the FAA [Federal Arbitration Act] to submit to class arbitration unless there is a contractual basis for concluding that the party agreed to do so.”
The trend in the law is clear – the Court, or at least a five-justice majority, recognizes that arbitration is a creature of contractual consent and that arbitration clauses should be enforced as written, including class action waivers. As a result, we expect that more and more companies will use arbitration clauses with class action waiver provisions in order to provide a fast, fair and efficient way to resolve disputes and avoid class actions.
Stephen G. Harvey and Angelo A. Stio III