Should consumers be bound by waivers in arbitration agreements of the right to bring class actions, and where do the courts stand on the enforceability of class action waivers? As with so much in the law, it depends upon whom you ask.
Alan S. Kaplinsky and Mark J. Levin, partners with Ballard Spahr Andrews & Ingersoll, LLP in Philadelphia, asserted last year in the ABA publication, The Business Lawyer, that class action waivers are desirable. They state in Consumer Arbitration: If the FAA ‘Ain't Broke,’ Don't Fix It, 63 Bus. Law. 907 (May 2008), “Many courts and commentators consider class action waivers an important part of a properly functioning consumer arbitration system on the ground that such waivers substantially lower litigation costs and pass on those savings to consumers, in whole or in part, in the form of lower prices for goods and services….Most of the litigation continues to reflect an apparent consensus that the rights of consumers are well-protected by the FAA, by the careful drafting of arbitration agreements, by the widely used national arbitration administrators, and by the oversight of federal and state courts.”
Randall D. Quarles, a partner with Waller Lansden Dortch & Davis LLP in Birmingham, Alabama, says in The Alabama Lawyer that, “Arbitration clauses in agreements between businesses and their customers often include a waiver of the customer's right to assert claims on behalf of a class. Whether such a waiver can be enforced, though, remains an open question. Recent federal and state court decisions provide three answers: yes, no and maybe.” Courts Disagree: Is Arbitration a "Class" Act?, 68 Ala. Law. 476 (Nov. 2007). While he successfully defended a bank’s class action waiver in federal court in 2006, he notes that “the enforceability of an arbitration agreement's class-action ban is by no means assured. Nevertheless, many courts are reluctant to buck the strong federal policy favoring arbitration agreements unless barring a class action would leave a consumer without any practical way to pursue a small claim. The possibility of an award of attorney's fees to a successful plaintiff may make a class-action ban more palatable. An option for a small-claims court lawsuit as an alternative to arbitration also may help persuade a court that a class-action wavier is not unconscionable.”
Even if a court finds that a consumer transaction plaintiff is barred from proceeding with a class action in a judicial forum, the court may determine that the class action should proceed in the arbitration forum, which is not the result that a business seeks when it inserts a class action waiver in its arbitration agreement. One year ago in the Boston Bar Journal, James E. McGuire, a mediator, and Bette J. Roth, a mediator who also writes and teaches mediation and ADR, propounded the following question and answer in Class Action Arbitrations: A First Circuit Update, 52 B.B.J. 17 (March/April 2008). “Are prohibitions of class actions in arbitration agreements enforceable? The answer is clear: it depends.” They point out that in three recent rulings dealing with class action waivers in arbitration agreements, the United States Court of Appeals for the First Circuit did the following: (1) severed the class action waiver and permitted the class action to proceed in arbitration; (2) ruled that the arbitrator was to determine under state law if the class action waiver was enforceable; and (3) struck the class action waiver and permitted the class action to proceed in arbitration. McGuire and Roth point out that although there were class action waivers in all three agreements, “the result in two of them was precisely classwide arbitration, and in the third case, empowerment of the arbitrator to make the class action decision.” While a class action in arbitration may be more desirable for a business than a class action before a jury in a judicial forum, an arbitration victory for class action plaintiffs, especially in an arbitration proceeding that cannot be appealed, may still be devastating to the business.
Into this morass last month stepped the United States Court of Appeals for the Ninth Circuit. In Chalk v. T-Mobile USA, 06-35909 (Ninth Cir. March 27, 2009), the Ninth Circuit found that a class action waiver in a consumer transaction arbitration clause was unconscionable and thus unenforceable.
The plaintiffs purchased from T-Mobile a wireless LAN PC card to connect a laptop to the Internet, and they also signed a one-year service agreement with T-Mobile. The service agreement stated that it “Requires Mandatory Arbitration of Disputes….Requires Mandatory Waiver of the Right to Jury Trial and Waiver of Any Ability to Participate in a Class Action.” Although the PC card initially worked in the laptop, the plaintiffs eventually were unable to connect to the Internet using the PC card. They then filed a class action in the United States District Court for the District of Oregon that alleged violations of both federal and Oregon state law. Defendants filed a motion to dismiss the class action and to compel arbitration. The district court rejected the plaintiffs’ argument that the arbitration was unconscionable and dismissed the action. Chalk v. T-Mobile USA, Inc., 2006 U.S. Dist. LEXIS 67948 (D. Or. 2006). The district court found that although an attorney fee provision in the arbitration agreement was unconscionable, that provision was severable and thus plaintiffs were required to proceed to arbitration.
The Ninth Circuit reversed, holding that under Oregon law, specifically the decision in Vasquez-Lopez v. Beneficial Oregon, Inc., 152 P.3d 940 (Or. Ct. App. 2007), which was issued after the district court ruling, the class action waiver was unconscionable. While the waiver was not procedurally unconscionable under Oregon law, it was substantively unconscionable. The arbitration agreement was adhesive and reflected an underlying inequality in the ability of the parties to bargain. The Ninth Circuit found that the class action waivers were unreasonably favorable to companies such as T-Mobile because (1) such waivers were inherently one-sided in consumer transactions, and (2) such waivers frequently prevented consumers from vindicating their rights. Under Vasquez-Lopez, a class action waiver in a contract where individual damages were likely to be small was substantively unconscionable under Oregon law.
The Ninth Circuit noted that the class action waiver in question was unilateral, pointing out that, “It can hardly be imagined that T-Mobile or its suppliers would ever want or need to bring a class action against T-Mobile’s customers.” In addition, the waiver created a disincentive to litigate because the maximum amount of damages that the plaintiffs suffered was only $ 693.63, and many claims of other potential class plaintiffs would be even less. Thus, the Ninth Circuit predicted, “Given the small size of the individual claims covered by the arbitration agreement, the class action waiver here, like the waiver in Vasquez-Lopez, is likely to prevent T-Mobile’s customers from vindicating their rights because the time and expense of prosecuting such claims makes it impracticable to embark on litigation in which the optimum result might be more than consumed by the cost.”
Finally, the Ninth Circuit was required to determine if the class action waiver should be severed from the entire contract as permitted by Oregon law. The waiver was not severed, though, because the contract contained a provision that prohibited the severance of the class action waiver. Thus, the Ninth Circuit held that “in accordance with its severability clause, the arbitration agreement as a whole is unenforceable.”
Clearly, legal counsel who draft consumer contracts for companies dealing with consumer products and services must be thoroughly familiar with arbitration law in all states in which their clients conduct business with consumers. While Kaplinsky and Levin assert that class action waivers are enforceable in many states, the Ninth Circuit pointed out that the T-Mobile waiver would likely be unenforceable in Washington and California as well as in Oregon. (A similar result was reached last year by the Supreme Court of North Carolina in Tillman v. Commer. Credit Loans, Inc., 362 N.C. 93 (N.C. 2008)). Furthermore, by including a clause that prohibited severance of the waiver, T-Mobile subjected itself to a potential class action in a judicial forum. But, as McGuire and Roth note, in the First Circuit, if the waiver can be severed, then the company may have to defend a class action in an arbitration setting. Thus, legal counsel must determine which alternative might be more desirable within a particular jurisdiction. Or legal counsel may want to attempt to draft a provision that will make the waiver more palatable to a court, such as the right to initiate a small claims action that Quarles successfully relied upon in Alabama.