U.S. Supreme Court Refuses to Enforce Agreement to Permit Class-Wide Arbitration

January 29, 2016

The Supreme Court in WashingtonArbitration has been widely touted as an efficient, cost effective way to resolve disputes. However, compelling consumers to arbitrate claims individually can effectively insulate the contracting party with superior bargaining power against liability.

As I have examined elsewhere, arbitration clauses in many standardized contracts effectively shield the contract drafter from liability unless the arbitrator has the authority to address disputes on a class-wide basis. A variety of factors—including the modest size of the potential individual recovery, the lack of understanding among consumers of their rights, and potential retaliation—often are practical obstacles to vindication of rights unless the arbitrator’s findings are applicable to others affected by the challenged business practice.

In recent years, the United States Supreme Court has been highly protective of the efforts of large corporations to force waivers of the right to arbitrate disputes on a class-wide basis on their customers, their vendors, and their employees. In Stolt-Nielsen S.A. v. AnimalFeeds Int’l Corp., 130 S.Ct. 1758, the Court interpreted the Federal Arbitration Act (FAA) to deprive arbitrators of discretion to order class arbitration when an arbitration agreement is silent on the question of class. A year later, in AT & T Mobility LLC v. Concepcion, 131 S.Ct. 1740, the Court interpreted the Federal Arbitration Act to preempt state courts from refusing to enforce class arbitration waivers that the state court determines to be unconscionable.

Compulsion v. Consent

Last month, the Court continued this trend in DirectTV, Inc. v. Imburgia, __ U.S. __, 136 S.Ct. 463 (Dec. 14, 2015). DirectTV  is a significant expansion of Concepcion, which held only that the State cannot compel a party to engage in class arbitration when the controlling agreement unconditionally prohibits class arbitration. DirectTV holds that a State court’s use of contractual interpretation principles to enforce an agreement to allow class wide arbitration violates the Federal Arbitration Act,” 9 U.S.C. § 2.

Factual Background

DirectTV’s service agreement with its customers contains a mandatory binding arbitration provision. Although the agreement expressly prohibits class arbitration, the agreement further provides that if the “law of your state” makes the waiver of class arbitration unenforceable, then the entire arbitration provision “is unenforceable.”

In 2007, when plaintiffs, DirectTV customers, entered into their service agreements, California law unambiguously prohibited class action and class arbitration waivers in consumer contracts. DirectTV fully understood the California Supreme Court’s decision in Discover Bank v. Superior Court, 36 Cal.4th 148, 162-163, 30 Cal.Rptr.3d 76, 113 P.3d 1100 (2005), holding that class arbitration waivers in adhesive consumer contracts are “unconscionable under California law and should not be enforced,” was the controlling “law of the state.” Ambiguity about whether the Discover Bank rule was the prevailing law in California did not arise until 2011—nearly three years after plaintiffs filed suit—when the United States Supreme Court held that the Federal Arbitration Act preempted the Discover Bank rule in AT & T Mobility LLC v. Concepcion, 563 U.S. 333, 131 S.Ct. 1740, 179 L.Ed.2d 742 (2011).

When plaintiffs sued DirectTV for allegedly charging early termination fees in violation of California law, DirectTV, knowing that the Discover Bank rule would render its class action waiver unenforceable, initially did not invoke the service agreement’s arbitration clause. DirectTV did so only after the Supreme Court issued its opinion in Concepcion. In essence, DirectTV argued that the Concepcion decision changed the parties’ understanding of the phrase “law of your state” when they entered into the service agreement and when plaintiffs filed suit, converting what was an unconscionable and hence enforceable arbitration agreement under California law into a fully enforceable agreement under California law as nullified by federal preemption.

The Tug-a-War between the California Courts and the Supreme Court

Applying the universally accepted principle that ambiguities in a contract should be resolved against the drafter, both the trial court and the California Court of Appeal rejected DirectTV’s argument. After the California Supreme Court denied discretionary review, the United States Supreme Court granted DirectTV’s petition for a writ of certiorari, and in a 6-3 decision reversed the California appellate court.

The Supreme Court, in an opinion authored by Justice Breyer, who dissented in Concepcion, focused not on the validity of the appellate court’s contractual analysis, but on whether the appellate court’s interpretation of California contract law could be reconciled with the Federal Arbitration Act. The Supreme Court concluded that the appellate court’s analysis failed to put arbitration contracts “on equal footing with all other contracts” in violation of the Federal Arbitration Act. Specifically, the Court noted that in other contexts California courts had consistently interpreted contractual references to California law to incorporate the California Legislature’s power to change the law retroactively, meaning that outside the arbitration context the phrase “law of your state” would ordinarily mean valid contract law and not law that has been invalidated by a higher court. The Court therefore determined that the California appellate court’s analysis “appears to reflect the subject matter at issue here (arbitration), rather than a general principle that would apply to contracts using similar language but involving state statutes invalidated by other federal law.”

Implications

Justice Ginsburg’s dissent described the practical consequences of the Court’s decision. In particular, she decried the majority’s reading of the FAA to “deprive consumers of effective relief against powerful economic entities that write no-class-action arbitration clauses into their form contracts” and “disarm consumers, leaving them without effective access to justice.”

Titles by John DiMugno