Avoid Class Action Suits by Using Arbitration Agreements

On April 27, 2011, the U.S. Supreme Court issued a ruling in AT&T Mobility LLC v. Vincent Concepcion that barred a consumer class action and overturned prior California law that prohibited class action waivers in arbitration agreements. In doing so, the Court created a mechanism by which savvy businesses can avoid class actions in a number of different contexts, which may, in turn, dramatically impact the way companies resolve disputes with their customers, employees and contractors.

Underlying Facts and Procedure

In 2002, in response to a promotional advertisement, the plaintiffs in the case, Vincent and Liza Concepcion, entered into a cell phone contract with AT&T (Cingular Wireless at the time) that entitled them to two “free” phones. After the Concepcions signed the company’s mobile service agreement, they discovered that although AT&T’s advertisement promised that they would receive the phones for free, they were charged $30.22 as tax on the phones’ retail value.

In March 2006, the Concepcions sued AT&T in the United States District Court in the Southern District of California, alleging that it engaged in false advertising and fraud. The District Court later consolidated the case into a class action lawsuit.

AT&T challenged the lawsuit, arguing that its standard mobile service contract, signed by the Concepcions and all other customers, precluded a class action because of two key provisions in the agreement: a mandatory arbitration clause and a class action waiver that required consumers to bring claims only in their individual capacity. AT&T asked the court to send the matter to arbitration in each plaintiff’s individual capacity as was required by the contracts.

The plaintiffs opposed AT&T’s request, arguing that a well-established decision by the California Supreme Court–Discover Bank v. Superior Court, 36 Cal.4th 148 (2005)–had already determined that class action waivers in consumer contracts were unreasonable, or “unconscionable,” and therefore unenforceable. The District Court agreed with the Concepcions and denied AT&T’s request to compel arbitration, and the Ninth Circuit Court of Appeals affirmed that decision. Critical to the decisions of both the District Court and the Ninth Circuit Court of Appeals was the determination that the Federal Arbitration Act (“FAA”), the purpose of which is to ensure the enforcement of arbitration agreements according to their terms, did not override, or “preempt,” the California Supreme Court’s decision in Discover Bank .

The Supreme Court Ruling

In a remarkably broad 5-4 ruling, divided along ideological lines, the Supreme Court reversed the Ninth Circuit, holding that the Discover Bank rule is inconsistent with the FAA and is therefore preempted.

Writing for the majority, Justice Antonin Scalia stated that the purpose of the FAA was twofold: to ensure the enforcement of private agreements to arbitrate and to make dispute resolution more efficient. By essentially allowing the parties to re-write arbitration agreements after the fact, Scalia explained, the rule in Discover Bank “stands as an obstacle to the accomplishment and execution” of Congress’s purpose and objective in enacting the FAA.

Specifically, the Court found that allowing class arbitration under the Discover Bank rule is inconsistent with the FAA for three reasons: 1) when compared with two-party arbitration, class arbitration makes the process slow, expensive and procedurally difficult; 2) class arbitration requires a formality that was not envisioned by Congress when the FAA was passed; and 3) class arbitration greatly increases the risk to defendants because a single mistake by the arbitrator, multiplied by thousands of class members, could result in a “devastating loss.” As a result, according to the Court, the rule in Discover Bank is likely to dissuade companies from using arbitration as a means of resolving disputes, thereby undermining the FAA.

Implications

The implications of the ruling in AT&T Mobility are significant. Indeed, the ruling comes only a year after the Supreme Court’s decision in Stolt-Neilsen S.A. v. Animalfeeds International, Corp., 130 S. Ct. 1758 (2010), in which the Court held that if parties to an arbitration agreement did not intend to allow class claims, arbitrators have no power to impose class-wide arbitrations under agreements that are merely “silent” on the issue. Both decisions further the Court’s clear directive that the FAA, and its liberal policy favoring arbitration, should be given full effect.

Given the ubiquity of arbitration clauses in everything from cell phone plans to franchise agreements to employment contracts, the potential ramifications of the Court’s decision in AT&T Mobility are sweeping.

Impact on Franchisors & Distributors

Many franchisors with arbitration provisions in their franchise agreements have felt insulated from the threat of class-action suits since last year’s Stolt-Nielsen decision. However, some lingering doubt remained, since some California courts had allowed franchisee attempts to either avoid arbitration or force a class certification since Discover Bank was decided, citing that case as authority. The AT&T Mobility decision puts an end to this argument.

Franchisors or distributors that draft consumer contracts for use by others in their distribution chain should also pay close attention to this decision. By incorporating arbitration clauses into those consumer agreements, they can eliminate the threat of class actions, provided that the terms for the individual arbitration are not unfair. The majority opinion noted that AT&T’s arbitration policy prevented AT&T from seeking its own attorney’s fees if it prevailed in arbitration, but provided for payment of twice the plaintiff’s attorney’s fees if AT&T lost. In addition AT&T’s policy agreed to pay an additional $7,500 to any plaintiff who obtained a better arbitration award than AT&T’s last settlement offer. While the opinion does not require a consumer arbitration clause to match these terms, the FAA would not require the enforcement of an obviously unfair arbitration provision.

Impact on Employers

The Supreme Court’s ruling is also certain to have far-reaching consequences for employers that use arbitration agreements with their employees. In particular, it could dramatically change wage and hour litigation, which often relies on class actions as a vehicle to redress relatively small individual losses. Without being able to consolidate these claims into a large class action, it will likely become increasingly difficult for individual employees to secure legal representation. Indeed, if an employer’s arbitration agreement is drafted correctly, because of the ruling in AT&T Mobility, it can potentially eliminate the risks to employers of facing a wage and hour class action (or any other employment-based class actions).

There is, however, one important caveat regarding employment arbitration agreements. Unlike most commercial arbitration agreements, under California law there are numerous technical requirements and restrictions that must be followed in order to have an enforceable employment arbitration agreement. While class action waivers can now safely be incorporated as part of employment arbitration agreements, employers must not lose sight of those additional requirements and restrictions.

What Should Businesses Do

Regardless of the context, businesses with existing arbitration agreements should carefully examine them to determine whether they should be modified to obtain the benefits of AT&T Mobility. Businesses that do not currently use arbitration agreements should, at a minimum, seriously consider adopting them. In so doing, businesses should not only take into consideration the significant benefits of arbitration, but also its notable drawbacks, which can include the expense of paying arbitrators, the risk of an arbitrator’s departure from the law, and the risk of an adverse decision that cannot be appealed.