JURIST Guest Columnist Robert Marcelis, University of California, Davis School of Law Class of 2013, discusses the US Supreme Court’s effort to make lower courts enforce arbitration agreements…

The Consumer Attorneys of California, a group whose members represent individuals with personal injury claims, call arbitration agreements “viruses” — “hard to spot, but spreading fast.” Numerous businesses include arbitration agreements in their contracts — from cell phone and automobile purchases and bank accounts to employment and attorney agreements. Generally, parties enter into these agreements before a dispute arises. When disputes do arise, plaintiff claims are often so small that attorneys will only take their cases if they can aggregate small claims into a class action, thereby rendering their legal services compensable. Defendants, on the other hand, prefer each dispute be resolved on a case-by-case basis. As Sun Tzu observed about the art of war: “If double his strength, divide him.” Not surprisingly, arbitration agreements, because they are usually tendered by defendants to plaintiffs as adhesion contracts, require plaintiffs to forego class action lawsuits decided by judges and juries and submit their individual grievances before a neutral, third-party arbitrator. When the arbitrator renders a decision, it is binding on all parties and is subject, if at all, to limited appellate review.

Arbitration has its modern roots in the labor movement and the process has been touted as providing advantages over litigation for defendants. Arbitration limits the discovery and pretrial motion process, which means less time and money spent by attorneys. Plaintiffs’ attorneys generally recover lower fees in arbitration. In full-blown litigation, attorneys might be entitled to fees under federal statutes or state laws. While this is a point of much contention, many plaintiffs’ attorneys and scholars have argued that defendants would rather take their chances with arbitrators. There is a perception, they argue, that arbitrators return lower damage awards compared to their counterparts in litigation — juries — who might be more sympathetic to injured plaintiffs. For these reasons, defendants generally prefer to enforce arbitration agreements, while plaintiffs and their attorneys prefer to invalidate arbitration agreements. While plaintiffs in years past could use state laws to invalidate arbitration agreements, the US Supreme Court recently restricted the viability of these challenges.

Three years ago the Supreme Court decided AT&T v. Concepcion, which is described as the watershed case in the Court’s repudiation of state laws that work to invalidate arbitration agreements. Some commentators describe the case as a death knell for class action lawsuits and class arbitration. In Concepcion, the Court directed lower courts to enforce arbitration agreements with class action waivers based on its authority to interpret the Federal Arbitration Act (FAA). The FAA was adopted by Congress in 1925 in an environment of judicial hostility to the enforcement of arbitration agreements. While the FAA preempts state law, Section 2 — “the savings clause” — allows plaintiffs to challenge arbitration agreements based on common law contract defenses such as duress, fraud, contract formation and unconscionability. Parties may also repudiate the FAA if they decide to do so explicitly in their arbitration agreements. Many states, including California, have enacted their own arbitration acts and rules which govern these particular arbitration agreements. However, parties benefit (or do not benefit, depending on their perspective) from the following cases as long as their agreement falls within the scope of the FAA.

In Concepcion, AT&T challenged California’s common law rule developed by the California Supreme Court in Discover Bank v. Superior Court. In Concepcion, Vincent and Liza Concepcion purchased phone service from AT&T, which included phones advertised as free. Predictably, they signed an arbitration agreement in which they agreed to arbitrate individually and not to file a class action. The Concepcions were charged sales tax on their phones. They filed suit alleging that AT&T had “engaged in false advertising and fraud by charging sales tax on phones it advertised as free.” In response, AT&T moved to compel arbitration pursuant to its agreement. The Concepcions opposed the motion arguing that the agreement was unconscionable based on the Discover Bank rule.

The common law rule established in Discover Bank had allowed California lower courts to invalidate arbitration agreements with class waivers in consumer contracts of adhesion: (1) if the claims were relatively small, and (2) when it was alleged that the corporate defendant deliberately engaged in a scheme to cheat consumers out of small sums of money. To the dismay of state defendants, California courts regularly applied this rule to invalidate arbitration agreements. The US District Court for the Southern District of California and the US Court of Appeals for the Ninth Circuit agreed with the Concepcions and invalidated the agreement. The Ninth Circuit referred to the Discover Bank rule as a “refinement of the unconscionability analysis applicable to contracts generally in California.” According to Section 2 of the FAA, plaintiffs may use common law defenses such as unconscionability to challenge arbitration agreements governed by the FAA. This remains unchanged today and, therefore, would seem to control the case in favor of the Concepcions.

However, the US Supreme Court took a closer look at California’s Discover Bank rule. The Court first noted that the policy goals of the FAA are twofold: “enforcement of private agreements and encouragement of efficient and speedy dispute resolution.” California’s Discover Bank rule allowed plaintiffs to demand class arbitration ex post facto. This switch, the Court reasoned, from “bilateral to class arbitration” sacrificed the advantages of arbitration by making “the process slower, more costly and more likely to generate procedural morass than final judgment.” Because class arbitration “interfered with fundamental attributes of arbitration and thus create[d] a scheme inconsistent with the FAA,” the Court held that the FAA preempted California’s Discover Bank rule. As arbitration agreements with class action waivers become ubiquitous in the business world, courts will be forced to enforce these agreements — which will require plaintiff’s attorneys to arbitrate each claim on a case-by-case basis.

Shortly before Concepcion, the Court faced another class arbitration question in Stolt-Nielsen v. Animalfeeds. In Stolt-Nielsen, two sophisticated commercial entities entered into an agreement with an arbitration clause, but the clause was entirely silent on whether class arbitration was permitted. The parties agreed to delegate authority to a panel of arbitrators to decide the issue. The arbitrators interpreted the clause to allow class arbitration. The Supreme Court was critical of the decision and chided the arbitration panel for imposing “its own policy choice.” The Court explained that arbitrators cannot find implicit agreements to allow class arbitration, because of the fundamental differences between bilateral arbitration and class arbitration. Bilateral arbitration provides all the benefits of “private dispute resolution: lower costs, greater efficiency and speed,” while class arbitration diminishes these benefits because it involves “disputes between hundreds or perhaps thousands of parties.” Accordingly, the Supreme Court reversed and remanded the case. These two cases — major obstacles for plaintiffs and their attorneys — stand for the proposition that defendants will arbitrate on a case-by-case basis, unless they consent to class arbitration.

Outside of the class action context, the Court recently restricted challenges to arbitration agreements based on state common law. Last year in Marmet Health Care Center v. Brown, the Court repudiated West Virginia’s categorical bar invalidating arbitration agreements that involve personal injury or wrongful death in nursing homes. In Marmet, three family members of patients that required care in nursing homes signed pre-dispute arbitration agreements on behalf of the patients. After these patients died, the three family members filed wrongful death suits against the nursing home in state court alleging negligence. The cases were consolidated. The Supreme Court of Appeals of West Virginia held that “as a matter of public policy under West Virginia law, an arbitration clause in a nursing home admission agreement adopted prior to an occurrence of negligence that results in a person injury or wrongful death, shall not be enforced to compel arbitration.” The Supreme Court vacated and remanded the case, citing the legal framework from Concepcion: “[W]hen state law prohibits outright the arbitration of a particular type of claim, the analysis is straightforward: [t]he conflicting rule is displaced by the FAA.” The Supreme Court went on to state that the FAA does not include any exceptions for personal injury or wrongful death and that West Virginia’s common law categorical bar was inconsistent with the FAA’s strong policy of enforcing arbitration agreements — a victory for defendants.

The Supreme Court also resolved the question of whether state legislatures can enact statutes to invalidate arbitration agreements. Last year the Court granted certiorari, vacated and remanded the California Supreme Court’s decision in Sonic-Calabasas v. Moreno in light of Concepcion. In Sonic-Calabasas, an employer signed an arbitration agreement as a condition of employment. Under the California Labor Code, employees with claims for unpaid wages are entitled to an administrative hearing with the California Division of Labor Standards pursuant to Section 98 et seq. After the employee left his position, he filed a claim with the labor commissioner for unpaid vacation pay. In response, the defendant moved to compel arbitration pursuant to its agreement with the employee. The California Supreme Court held as a matter of public policy that arbitration agreements “cannot be made to serve as a vehicle for the waiver of [state] statutory rights.” The Supreme Court remanded the case to the California Supreme Court for reconsideration.

The remand of Sonic-Calabasas the decision in Marmet sent a strong message to the states and plaintiff’s attorneys — only Congress may create exceptions to the FAA.

The last bastions for plaintiffs are common law contract defenses including unconscionability — a defense plaintiffs use fairly regularly to invalidate arbitration agreements. But who decides this important issue: the judge or the arbitrator? The law treats the arbitration agreement and the rest of the contract as separate agreements. Courts generally determine whether an arbitration agreement and its terms are unconscionable and, if so, it is unenforceable. The doctrine of unconscionability allows courts to invalidate adhesive arbitration agreements with unfair terms. For example, a defendant cannot require plaintiffs to arbitrate in another state, to shoulder exorbitant upfront arbitration fees or pay all arbitration costs if the plaintiff loses arbitration. On the other hand, once a court determines an arbitration agreement is enforceable, it compels arbitration and the arbitrator decides all other issues under the contract. For example, an arbitrator would determine whether a non-compete agreement was lawful or whether an employment contract stipulated at-will employment or for-cause employment.

Even if the doctrine of unconscionability leaves the door slightly ajar for plaintiffs to challenge agreements, the Supreme Court appears to have foreclosed the possibility in Rent-A-Center v. Jackson. In Rent-A-Center, the Court held that defendants may delegate authority to an arbitrator to determine whether an arbitration agreement is unconscionable. In other words: can courts determine whether the terms of arbitration agreement are unconscionable when defendants assign that responsibility to an arbitrator? The answer is “no” — the arbitrator will decide. In essence, the Court treats delegation clauses and the rest of an arbitration agreement as entirely separate agreements. In these cases, plaintiffs must challenge the delegation clause itself. That means courts may only decide whether the delegation clause itself is unconscionable, even if the terms of the arbitration agreement containing the delegation clause are blatantly unconscionable.

As a practical matter, plaintiffs’ attorneys should be careful to identify delegation clauses in arbitration agreements. Once identified, plaintiffs must draft their pleadings carefully and direct any challenge to the delegation clause. If they challenge the terms of the arbitration agreement — the fateful misstep taken by the employee’s attorney in Rent-A-Center — courts will ignore the challenge and enforce the agreement. Unfortunately, the Court did not provide a standard to guide lower courts when a delegation clause is substantively unconscionable. But the Court did leave the window open for plaintiffs to challenge delegation clauses based on the bias of an arbitrator, prohibitive arbitration fees or lack of discovery.

After Rent-A-Center, it is advisable [PDF] that defendants include delegation clauses in their arbitration agreements to limit jurisdiction of courts. “In the end, Rent-A-Center may be most important for what it says about the US judicial view of arbitration itself. It is simply getting harder and harder for litigants to argue their way out of [] arbitration agreement[s].”

Robert Marcelis studied Government at California State University, Sacramento. Johnny Colon and Leah White, University of California, Davis School of Law, Class of 2013; David Horton, Acting Professor of Law, University of California, Davis School of Law; and Fred Hiestand, General Counsel for the Civil Justice Association of California each provided thoughtful feedback for this article.

Suggested citation: Robert Marcelis, US Supreme Court Tells Lower Courts to Enforce Arbitration Agreements, JURIST – Dateline, Feb. 16, 2013, http://jurist.org/dateline/2013/02/robert-marcelis-arbitration-agreement.php