Supremes: Class Actions and Arbitration Do Not Mix

In a recent issue we reported on the oral argument in the Supreme Court of the AT&T Mobility case, involving the right to bring class actions in arbitration. AT&T Mobility imposed on all of their cell phone customers a standard form contract containing a requirement that all disputes be submitted to arbitration, and prohibiting class actions. The lower courts had held that the “no class action” provision was unenforceable because prosecution of individual claims would be financially impracticable, and enforcement of the no class action provision would therefore choke off any possibility that the consumer could get relief. Individual claims in this particular case, for example, would be in the area of $30 per plaintiff. No one would bring an individual claim for such a small amount.

We concluded at the time of the oral argument that the Court seemed to be siding with the plaintiffs, because it was reluctant to second-guess California state law. Boy, were we wrong. The Court has now ruled, 5-4, that the Federal Arbitration Act (“FAA”) trumps state law of unconscionability, and that the “no class action” provision is enforceable. In our opinion, that decision is a travesty and will go a long way towards extinguishing consumer and other class action rights.

The alleged wrongdoing was simple enough: plaintiffs (the Concepcions) had purchased AT&T cell phone service, which AT&T advertised would include ”free phones.” The phones, however, were not free – the Concepcions were charged $30.22 in sales tax based upon the phones’ retail value. The plaintiffs commenced a class action in federal court alleging that AT&T was guilty of fraud and false advertising. AT&T moved to compel arbitration.

The FAA was designed to encourage enforcement of contractual arbitration provisions, but it has a “savings clause” that bars arbitration if grounds exist for revocation of the contract, such as fraud, duress, or “unconscionability.” California law will not enforce unconscionable (grossly unfair, one-sided) contracts or contract provisions, including provisions that choke off all effective forms of redress, such as “no class action” provisions. The lower courts and the Ninth Circuit found the no class action provisions unconscionable under California law.

The Supreme Court concluded that the FAA overrides California law because requiring that class actions be available in arbitrations would frustrate the purposes of the FAA:

The overarching purpose of the FAA . . . is to ensure the enforcement of arbitration agreements according to their terms so as to facilitate streamlined proceedings. Requiring the availability of classwide arbitration interferes with fundamental attributes of arbitration and thus creates a scheme inconsistent with the FAA.

These “fundamental attributes of arbitration,” according to the Supreme Court, are “informality,” which means speedy and cheap. Class actions, on the other hand, require “procedural formality,” such as the application of cumbersome rules for class certification, which are neither speedy nor cheap because they have to comply with due process for class members.

Most revealing, however, is the majority’s reliance on “increasing the risk to defendants”: “when damages allegedly owed to tens of thousands of potential claimants are aggregated and decided at once, the risk of an error will often become unacceptable,” because it is more difficult to appeal.

None of these “fundamental aspects” of arbitration identified by the majority, while true in many cases, are enshrined anywhere in the Arbitration Act. To hold that any deviation from “cheap, speedy, informal” procedures is fundamentally inconsistent with the entire scheme of the Act is a figment of the majority’s imagination. The majority apparently viewed arbitration procedure primarily as a way to make it easy for corporations to get rid of pesky consumer complaints, without fear of a substantial judgment that would be difficult to overturn. We would note, however, that there have recently been huge arbitration awards in cases that were not class actions.

To bolster its position, the majority noted that “the times in which consumer contracts were anything other than adhesive are long past.” It cites no authority for this position, which is belied by the facts of the case. No consumer would voluntarily agree to surrender all right to redress for any wrongdoing by the company; yet that is exactly what a “no class action” provision amounted to here.

The reality is that class-wide arbitration is necessary to prosecute small claims that might otherwise fall by the wayside because they cannot be cost effectively pursued on an individual basis. While weighing the pros and cons of the case, the majority never shows the slightest concern that, in its pursuit of the ideal cheap and speedy process, it is actually making any process for consumers impossible.

In a virtually identical case, the Second Circuit, in In re American Express, recently found a mandatory arbitration and class action waiver unenforceable “because enforcement of the clause would effectively preclude any action seeking to vindicate the statutory rights asserted by Plaintiffs.” The focus of the Second Circuit’s analysis was on the fiscal impracticability of pursuing small individual claims. Indeed, in American Express the defendant conceded that individual claims cannot be cost-effectively pursued where litigation expenses far exceed the recovery for one claimant. That is a point Justice Breyer echoed in his dissent in AT&T Mobility, when he noted that class actions for small claims would go unremedied as no “rational lawyer would have signed on to represent the Concepcions in litigation for the possibility of fees stemming from a $30.22 claim.”

The dissent in AT&T Mobility and the majority in American Express recognized that enforcing the arbitration and no class action waivers would essentially grant corporations de facto immunity from liability for their own misconduct. The class action mechanism was designed specifically “to overcome the problem that small recoveries do not provide the incentive for any individual to bring a solo action ..”

The Supreme Court may soon face these arguments again. How it will address the conflict of its Concepcion decision with antitrust law and Fed. R. Civ. P. 23 will be interesting. It will also be interesting to see if it addresses the economic reality that individually arbitrating disputes can be cost prohibitive, thereby making the class action device the only economically feasible means for enforcing statutory rights. Depriving claimants of their federal statutory rights and preventing the use of the class device under Fed. R. Civ. P. 23 cannot be what Congress intended concerning claims too small to prosecute on an individual basis. But for now, that is the contrived conclusion reached by the US Supreme Court.