Bankin’ Bits

Supreme Court Provides a Victory for Arbitration Clauses—At Least For Now

In a victory for arbitration clauses, the U.S. Supreme Court has decided that the Federal Arbitration Act preempts a rule applied by California courts which frequently found arbitration agreements unconscionable.  However, this victory may be short lived for financial institutions that will be subject to the new Consumer Financial Protection Bureau (“CFPB”).  Under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the CFPB is required to study arbitration clauses and has been authorized to impose conditions or limitations by regulation on the use of arbitration clauses with consumers.  In addition, the Dodd-Frank Act has added additional arbitration limitations in certain instances. 

Summary of Supreme Court Case:

Building on last year’s decision in Stolt-Nielsen S.A. v. AnimalFeeds International Corp. rejecting class arbitration when the arbitration agreement is silent on the issue, the United States Supreme Court now has upheld the enforceability of class action waivers in arbitration agreements. See AT&T Mobility LLC v. Concepcion.

The court struck down California’s so called Discover Bank rule forbidding class action waivers in contracts providing for arbitration. The 5-4 majority held that the Federal Arbitration Act (FAA), 9 U.S.C. § 1 et seq., preempts state law that has a disproportionate impact on arbitration agreements, even if the state law applies generally to all contracts.

Writing for the majority, Justice Scalia opined that the overarching purpose of the FAA is to ensure enforcement of arbitration agreements according to their terms so as to facilitate streamlined proceedings. The California rule could not stand, he explained, because mandatory class-wide arbitration interferes with the fundamental attributes of arbitration and creates a scheme inconsistent with the FAA.

Emphasizing the contractual nature of arbitration, the majority held that application of class procedures in arbitration must be based on the parties’ consent. It referenced three main reasons for this decision.

First, it explained, the switch from bilateral to class arbitration sacrifices the principal advantages of arbitration–informality and speed–and makes arbitration slower, more costly and more likely to produce a procedural mess than a final judgment. The majority cited a report by the American Arbitration Association, which found that it took 6 months for the average bilateral consumer arbitration to reach a disposition on the merits while it took more than 18 months for class arbitrations merely to be settled, withdrawn or dismissed without reaching adjudication on the merits.

Second, class arbitration requires procedural formality to protect absent class members. The majority considered it unlikely that Congress meant to leave these important procedural requirements to an arbitrator.

Third, the majority observed that class arbitration greatly increases risks to the defendant because the absence of multilayered review makes it more likely that errors will go uncorrected. Defendants may be willing to accept the costs of those errors in bilateral arbitration since their impact is limited to the size of individual disputes. But when damages allegedly owed to tens of thousands of potential claims are aggregated and decided at once, the risk of error becomes unacceptable.

Writing for the minority, Justice Breyer took issue with each of the majority’s points, arguing that there is no basis for the notion that individual, rather than class, arbitration is a fundamental attribute of arbitration and that the AAA has found class arbitration not only to be fair, balanced and efficient but also faster than the average class action in court.

Implying hypocrisy among the majority, Justice Breyer also contended that federalist principles should lead the court to uphold California’s law rather than strike it down. But the crux of the dissent appears to rest in Justice Breyer’s rhetorical question: “What rational lawyer would have signed on to represent the Concepcions in litigation for the possibility of fees stemming from a $30.22 claim?”

The facts of the case, however, presented little reason for the majority to worry about that question. The terms of the agreement at issue had the following consumer-friendly provisions:

• Customers could initiate a dispute with AT&T by completing a one-page form available on AT&T’s website;
• If AT&T did not resolve the dispute to the customer’s satisfaction within 30 days, the customer could invoke arbitration by filing a Demand for Arbitration (also available on AT&T’s website);
• AT&T agreed to pay all costs for non-frivolous claims;
• The arbitration would take place in the county in which the customer was billed;
• For claims of $10,000 or less, the customer could choose whether the arbitration would proceed in person, by telephone, or based only on submissions;
• Either party could bring a claim in small claims court in lieu of arbitration;
• AT&T could not seek reimbursement of its attorney’s fees; and
• If the customer received an arbitration award greater than AT&T’s last written settlement offer, AT&T would have to pay a $7,500 minimum recovery and twice the amount of the customer’s attorney’s fees.

AT&T obviously wrote these provisions to avoid a finding that the agreement was unconscionable or exculpatory. And it succeeded. As the majority explained, the District Court found not only that these terms provided sufficient incentive for customers to prosecute meritorious claims that were not immediately settled but also that customers were better off under this agreement than they would be as participants in a class action, which would take months or years and might yield only the opportunity to submit a claim for recovery of a small percentage of a few dollars.

Likewise, the majority pointed out that the Ninth Circuit had “admitted” that customers who filed claims were essentially guaranteed under this structure to be made whole. Because the arbitration agreement could not be deemed unconscionable except for California’s rule against class arbitration waivers, the court held the rule preempted as posing an obstacle to the federal policy favoring arbitration.

With this decision, banks can predictably enforce class arbitration waivers in their agreements with their customers and take advantage of the benefits of arbitration. They must take care, however, to fashion those agreements so they are not unconscionable or otherwise violate those “grounds as exist at law or in equity for the revocation of any contract.”

The complete majority and dissenting opinions of the U.S. Supreme Court in the AT&T Mobility LLC v. Concepcion case are available here.

Looming Implications of Dodd-Frank Act:

The application of the Supreme Court’s preemption may be short lived for banks however, as the federal government may ultimately impose limitations on arbitration clauses under the authority provided to the CFPB in the Dodd-Frank Act. The Dodd-Frank Act requires the CFPB to conduct a study of and report to Congress regarding the use of arbitration clauses in connection with the offering or providing of consumer financial products and services.  The CFPB, by regulation, may prohibit or impose conditions or limitations on the use of arbitration clauses, if the CFPB finds that such prohibitions and impositions are in the public interest and for the protection of consumers.  Any such limitations on agreements entered into with consumers will follow the CFPB’s study, CFPB rule-making and a 180-day waiting period after the effective date of the regulation (such waiting period is set forth in the Dodd-Frank Act).

Of note, the Dodd-Frank Act includes several other arbitration limitations.  In particular,

• The Dodd-Frank Act has modified the Truth-in-Lending Act to add a provision that no residential mortgage loan and no extension of credit under an open end consumer credit plan secured by the principal dwelling of a consumer may include terms which require arbitration or any other nonjudicial procedure as the method for resolving any controversy or settling any claims arising out of the transaction. 
• The Dodd-Frank Act has added provisions to protect whistleblowers for covered employees (any individual performing tasks related to the offering or provision of a consumer financial product or service) and those subject to the Securities Exchange Act of 1934 and the Commodity Exchange Act.  No predispute arbitration agreement is valid or enforceable, if the agreement requires arbitration of a dispute arising under these new provisions. 
• The Dodd-Frank Act has provided the SEC the authority under the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 to prohibit or impose conditions or limitations on the use of, agreements that require customers or clients of any broker, dealer, municipal securities dealer, or investment adviser to arbitrate any future dispute between them arising under the Federal securities laws, the rules and regulations thereunder, or the rules of a self-regulatory organization if it finds that such prohibition, imposition of conditions, or limitations are in the public interest and for the protection of investors.

May 19, 2011 at 1:39 pm Scott Smalley Leave a comment