The U.S. Supreme Court heard arguments Tuesday in a dispute that could have far-reaching implications for the future of consumer fraud class actions. While one possible outcome threatens, in the words of one of the litigants, to become the "death knell for consumer arbitration in California," another could have a similar impact on consumer class actions nationwide.
At issue is a class action waiver in AT&T Mobility LLC's consumer arbitration agreement. Both the U.S. District Court for the Southern District of California and the U.S. Court of Appeals for the 9th Circuit held the provision unconscionable under California law. AT&T argued to the Court that the lower court decisions are at odds with the Federal Arbitration Act and, if allowed to stand, would undermine the FAA's sweeping protections of contractual arbitration clauses. A reversal, by contrast, may lead to even more widespread use of class action waivers in consumer contracts, resulting in substantially fewer consumer class actions.
The Dispute
The case, AT&T Mobility v. Concepcion, was originally filed in 2006 as a putative class action by a couple alleging that AT&T had violated California's consumer protection laws by advertising wireless phones as "free" without disclosing a $30.22 fee that appeared on their bill. When AT&T moved to compel individual arbitration pursuant to the contract's arbitration clause, which prohibited class-wide arbitration, the federal district court denied the motion. Laster v. T-Mobile USA, Inc., 2008 WL 5216255 (S.D. Cal. 2008). The court followed the California Supreme Court's decision in Discover Bank v. Superior Court of Los Angeles, 113 P.3d 1100 (Cal. 2005), which held that some class action bans are unconscionable.
As articulated in Discover Bank, California law requires that courts evaluate contracts for both "procedural" and "substantive" unconscionability. Procedural unconscionability, "generally takes the form of a contract of adhesion, which, imposed and drafted by the party of superior bargaining strength, relegates the subscribing party only the opportunity to adhere to the contract or reject it." Discover Bank, 133 P.3d at 1108. Substantive unconscionability "may take various forms" but includes clauses that "operate effectively as exculpatory clauses" to prevent recovery even where one party has violated the other's rights. Id. The district court here found AT&T's class action ban substantively as well as procedurally unconscionable, concluding that it effectively operates as an exculpatory clause by denying recovery to consumers who are unaware that their rights are being violated, and who thus depend on the class action notification process to obtain relief. The 9th Circuit affirmed.
Ironically, both the district court and the Ninth Circuit found that the AT&T arbitration clause creates incentives to consumers to pursue even the "small dollar" claims likely to arise out of a wireless contract. The AT&T clause provides the consumer with cost-free arbitration and a minimum award of $7,500, plus double attorney's fees, if the arbitrator's award exceeds AT&T's final settlement offer before arbitration. The district court found that the clause "sufficiently incentivizes consumers" to pursue small claims and prompts AT&T to make generous settlement offers "even for claims of questionable merit." Laster, 2008 WL 5216255, at *11. Moreover, the 9th Circuit acknowledged that the provision "does essentially guarantee that the company will make any aggrieved customer whole who files a claim." Laster v. AT&T Mobility LLC, 584 F.3d 849 (9th Cir. 2009). Another federal district court, in a subsequent case, described AT&T's arbitration clause as containing "perhaps the most fair and consumer-friendly provisions this Court has ever seen." Makarowski v. AT&T Mobility, LLC, 2009 WL 1765661 (C.D. Cal. June 18, 2009).
However, the 9th Circuit also held that the $7,500 minimum award does not negate the unconscionability of the class action waiver, because the premium payment is available only if AT&T does not make a settlement offer to the aggrieved customer in a sum at least equal to the eventual arbitration award. Thus, if a customer files for arbitration of a small dollar claim against AT&T, AT&T can simply pay the value of the claim before the selection of an arbitrator to avoid paying $7,500. Thus, the 9th Circuit concluded, "the maximum gain to a customer for the hassle of arbitrating a $30.22 dispute is still just $30.22." 584 F.3d at 856.
The Argument
AT&T argued to the Supreme Court that the 9th Circuit's decision is inconsistent with the FAA, which provides that contractual arbitration provisions are enforceable except "upon such grounds as may exist at law or in equity for the revocation of any contract." 9 U.S.C. § 2. AT&T contends that California's unconscionability doctrine, as articulated in Discover Bank, discriminates against arbitration clauses and therefore does not constitute grounds for "revocation of any contract," only for revocation of dispute resolution agreements. AT&T argued that the Discover Bank test deviates from California's traditional unconscionability principles by (i) requiring only that a reasonable consumer prefer class-wide litigation, rather than requiring that the class action ban "shock the conscience"; (ii) considering the effect of the arbitration clause on third-parties (i.e., hypothetical members of a putative class) rather than focusing only on fairness to the actual plaintiffs, who chose to file a claim and therefore can be made whole under the contract; and (iii) determining unconscionability in view of the allegations made in a particular lawsuit, rather than as of the time the contract is made.
This argument met with aggressive questioning from a majority of the justices, many of whom expressed hesitation to interfere with a California court's application of its own unconscionability doctrine. Justice Scalia asked whether the Court should "tell the State of California what it has to consider unconscionable." Justice Ginsburg noted that California's courts had never stated that arbitration clauses face a "special" unconscionability standard, and suggested that Discover Bank could be read in harmony with California's other unconscionability cases. Justices Kagan and Breyer noted that Discover Bank relied on precedent outside the arbitration arena and, as Justice Kagan concluded, "thereby made clear that its rule . . . applied both in the arbitration sphere and in the litigation sphere."
Not all of the difficult questions, however, were directed at AT&T. Chief Justice Roberts repeatedly challenged the plaintiffs' counsel to reconcile Discover Bank with California's application of its unconscionability doctrine outside the arbitration context, calling the Discover Bank test "a different mode of analysis than I'm familiar with under basic contract law." Justice Alito noted that the plaintiffs, as opposed to third-parties, would fare no better in a class arbitration than under the contract as enforced. Moreover, several justices appeared to struggle during both parties' arguments with how to determine whether a state's contract law discriminates against arbitration, including whether the intent or the effect of the law should be determinative.
Potential Impact
The Court's ruling is expected early in 2011. While it is unlikely that the Court, even if it overturns the 9th Circuit's decision, would rule so broadly as to hold that the FAA prohibits states from ever invalidating class action waivers, even a narrow ruling in AT&T's favor could be expected to lead to more confident and widespread use by businesses of such waivers in consumer agreements. Conversely, if the Ninth Circuit's decision is upheld, companies nationwide may be reluctant to rely on class action waivers. The plaintiffs' brief, in an effort to deflate the perception that "California had struck out on its own in its approach to the enforceability of class-action bans," asserted that "courts applying the general contract law of at least twenty States have held that provisions purporting to bar consumers or employees from pursuing classwide relief in any forum may be unenforceable." Thus, the Supreme Court's decision — regardless of the outcome — is likely to have implications on consumer class actions both in and outside California.
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