United States: Shouldn't You Be Using Arbitration Agreements To Reduce The Costs Of Litigation And The Risk Of Class Action Claims?

Businesses across the country regularly bemoan the time and expense of litigation. Even when businesses are successful in defending non-meritorious consumer claims alleging unfair or deceptive practices, false advertising, technical violations of statutory rules, and so on, they nonetheless essentially suffer defeat because of the time and resources they expend to fend off such claims. There is a relatively proven way to ameliorate this situation that is often quicker and less expensive for everyone involved—and yet many companies do not understand or utilize pre-dispute arbitration provisions when they easily could do so.

Arbitration is a procedure in which a dispute is submitted, by agreement of the parties involved, to one or more neutral arbitrators who will make a binding decision on the dispute. In choosing arbitration, the parties opt for this alternative dispute resolution process, thus avoiding the delays, technical procedures, and expense that often accompany use of the court system. For businesses, arbitration clauses also provides an effective tool to avoid or minimize cost and risk from class actions or other multi-party lawsuits, as well as sometimes the irreparable publicity that accompanies a lawsuit even if it is meritless.

In this article, we explain how arbitration works, what type of arbitration agreements are generally enforceable, what features that have or can cause problems, and how such provisions can reduce the risk of class actions.

How does arbitration work?

Agreement to arbitrate. Businesses often will include a pre-dispute arbitration clause ("arbitration clause") in their existing consumer contracts.1 Arbitration clauses typically provide that either party to the agreement can file claims against the other in arbitration and obtain a binding decision from the arbitrator. They also may provide that if one side sues the other in court, the party that has been sued in court can invoke the arbitration clause to require that the matter proceed in arbitration instead of court. An arbitration clause also may contain a provision prohibiting the consumer from bringing claims as a group (a "class action waiver").

The arbitration process. Arbitrations are subject to their own simplified procedures. Although arbitration requires paying for the arbitrator's time and certain administrative/filing fees, the costs are usually much lower than a court case. In general, motions and discovery are restricted in arbitration, in contrast with the burdensome and costly discovery obligations and motions practice associated with court litigation. In arbitration, the parties have an opportunity to select their arbitrator(s), who may specialize or have experience in the relevant subject matter. Arbitrations are generally resolved faster, with very little appeal rights and limited bases to vacate awards. Arbitrations are confidential, whereas most court files are public. As Congress has stated, "[t[he advantages of arbitration are many: it is usually cheaper and faster than litigation, it can have simple procedural and evidentiary rules; it normally minimizes hostility and is less disruptive . . . [and] is often more flexible."2

How are arbitration agreements enforced?

The Federal Arbitration Act ("FAA"), which applies "in any maritime transaction or a contract evidencing a transaction involving commerce."3 creates a strong national policy in favor of honoring arbitration clauses, requiring courts to compel arbitration in accordance with the terms of an arbitration agreement, upon the motion of either party to the agreement, provided that there is no issue regarding its creation.4 Consistent with this mandate, there is solid court precedent generally upholding the validity of arbitration agreements, with the Supreme Court issuing major cases in recent years upholding arbitration clauses in the face of many different kinds of state laws designed to curtail the arbitration procedure5 and, in most situations, enforcing class action waivers.6

Nevertheless, not all arbitration clauses and class waiver provisions will be enforceable. To begin with, subject to variations in state laws, arbitration clauses can be voided based on the same contract principles and defenses applicable to contracts generally. That inquiry will often focus on whether the arbitration clause is "unconscionable," that is, whether it is so oppressive or one-sided that it cannot be enforced. There are issues that both relate to how the contract was formed (so-called procedural unconscionability) as well as the fairness of actual terms of the contract (so-called substantive unconscionability).

Further, although the Supreme Court has generally confirmed the enforceability of class waivers in arbitration agreements, just like some arbitration clauses may not be enforced based on contractual principles, there are a few circumstances in which class action waivers will not be enforced. For example, in one case, where a service provider included an arbitration clause with a class action waiver in a warranty brochure in a box containing the purchased product (a cellphone) and nothing in the box called the consumer's attention to the existence of the arbitration clause, the court refused to enforce the arbitration clause and class action waiver.7 Likewise, in April of this year, in a case distinguishing the United States Supreme Court's Concepcion decision, the California Supreme Court invalidated a general class waiver because it sought to prohibit the consumer from pursuing claims for public injunctive relief in any forum under California's Unfair Competition and False Advertising laws and Consumer Legal Remedies Act, which provide statutory rights to seek public injunctive relief.8 The lower appellate court had gone the other way, holding that a California rule which categorically prohibits arbitration of these kinds of injunctive relief claims falls squarely within the line of authority establishing that the FAA preempts any state law that amounts to a categorical ban on arbitration.9 But in a unanimous opinion, the California Supreme Court disagreed, concluding that the arbitration provision was unenforceable to the extent it purported to waive the statutory right to seek public injunctive relief under these consumer protection laws, which the high court stressed are aimed at prohibiting unlawful acts that threaten future injury to the general public.10 That issue is a likely candidate for review by the U.S. Supreme Court.

Where do arbitration agreements and class action waivers go off the rails and what features make them more defensible?

Companies should have their agreements with arbitration clauses reviewed periodically to make sure they are up to date, account for differences in state law and the most recent guidance provided by the courts, and are tailored for the types of disputes and circumstances they are intended to cover. Generally speaking, here are some of the more common issues that arise regarding the general enforceability of a class action waiver and/or arbitration clause:

  • Arbitration clauses and class action waiver provisions should be clear and prominent. The arbitration clause, as well as any class action waiver provision, should be brought to the attention of the consumer at the time of entering the consumer agreement (using capital letters, bolding, headers, etc. to draw the consumer's attention as compared to the rest of the agreement). This includes but is not limited to language alerting the consumer to the fact that in agreeing to arbitrate, the consumer is waiving any right to a jury trial. Likewise, make any class action waiver clear and conspicuous and, if desired, indicate that the parties do not want there to be any class or multi-party proceeding in the arbitration. While not required, arbitration clauses and class action waivers are generally more likely to be upheld if the consumer (i) acknowledges (e., with a separate signature or initials by each such provision) having read and understood them; and/or (ii) is given the opportunity to opt out from such provisions.
  • Arbitration should be accessible and affordable to the consumer. High administrative fees may make arbitration agreements unenforceable, if the result is that the costs to the consumer would be prohibitively expensive. Companies may wish to consider agreeing to cover all or most of the arbitration costs. Providing consumers with an unreasonably short period of time or unreasonably burdensome method in which to file or advance a grievance also could be deemed unconscionable.
  • The terms should not be overly one-sided against the consumer. Examples could include providing the company with an unfair advantage in the process of selecting the arbitrator(s), or providing that the company has the unrestricted discretion to retroactively amend or alter the terms of the arbitration agreement.
  • A class action waiver/arbitration clause may face higher risks of challenge if it seeks to deny the consumer benefits or rights conferred by statute. Examples include providing for a shorter statute of limitations than would be allowed under the applicable law, limiting available statutory damages (or, in California, the right to seek certain kinds of injunctive relief such as those at issue in McGill), or providing that the consumer would not be entitled to attorney's fees or costs in cases involving fee-shifting statutes.
  • Consider including a provision that if any portion of the arbitration provision is deemed invalid or unenforceable, the remaining arbitration provisions shall nevertheless remain in force.

Apart from the foregoing types of issues that could endanger the enforceability of an arbitration clause/class action waiver, there are many other considerations bearing on the efficiency and effectiveness of the agreement to arbitrate. These include, but are not limited to, the following:

  • Care should be taken with the language describing the scope of disputes to be arbitrated. Give thought to whether you intend to arbitrate all disputes that may touch on or collaterally relate to the contract, or whether you may need express language specifically identifying and narrowly describing the scope of disputes to be arbitrated.
  • Consider whether the agreement to arbitrate is intended to be broad enough to encompass claims involving nonsignatories, such as claims involving other companies that are not a party to the consumer agreement but that may have a role in the consumer's transaction and, accordingly, potentially could face litigation risk along with you. In that case, special care should be taken in drafting the arbitration clause, with reference to applicable state contract law principles.
  • Clearly designate who is to resolve any issues regarding the availability of class claims and/or arbitrability. If an issue arises concerning arbitrability (e., whether the parties have agreed to arbitrate) and the agreement does not expressly provide for how that issue is to be decided, courts have generally held that the issue should be resolved by a court, not arbitrator. However, the courts are split on whether the decision of the availability of class arbitration is for a court or an arbitrator. While it is not a "silver bullet," a best practice is to clearly and unmistakably indicate in the agreement who should resolve any questions about arbitrability or the availability of class arbitration under that agreement, as well as the arbitration provider and rules that will apply.
  • Other issues. Depending on the specific circumstances, consideration could also be given to addressing the such procedural issues as: the number of arbitrators; whether pre-arbitration mediation or negotiation is required; special allowances or limitations on discovery; hearing venue and choice of law; and the right to appeal (keeping in mind that because the FAA provides for very limited review, you would have to take special measures if you want to provide for such review, such as, for example, structuring the arbitration agreement under the law of your state, rather than the FAA).

The proposed CFPB rule on arbitration is unlikely to be enacted quickly enough to change the current environment favoring arbitration.

In 2016, the Consumer Financial Protection Bureau ("CFPB") proposed a rule11 ("Proposed Arbitration Rule") that would prohibit certain companies who provide consumer financial products and services12 from using arbitration clauses to bar consumers from filing or participating in class actions. The Proposed Arbitration Rule also would require such companies to submit information to the CFPB concerning arbitrations conducted under agreements.

This proposal arose under a provision of the Dodd-Frank Act in which Congress instructed the CFPB to study the use of pre-dispute arbitration provisions in connection with consumer financial products or services, and authorized the CFPB to prohibit or impose conditions or limitations on their use if doing so was in the public interest and for the protection of consumers. In 2015, the CFPB completed its study and published a 728-page report.13 The report's premise is that most consumers are not aware of or do not understand arbitration clauses, such that these agreements are "forced" on consumers, and that they do not offer significant benefit over traditional litigation. The CFPB took comments on the Proposed Arbitration Rule and the comment period ended on August 22, 2016. While many consumer groups supported the Bureau's proposal, the Chamber of Commerce and several other groups issued scathing criticisms of the procedures utilized in the Bureau's study and its conclusions.14 A final rule would require compliance within 211 days of final publication.

If enacted, the CFPB's Proposed Arbitration Rule likely would curtail the use and benefits of arbitration clauses and class action waivers by business that would be subject to its restrictions,15 and it is likely that the number of class action lawsuits filed each year would increase. But even before the recent PHH court decision questioned the constitutionality of the CFPB, the President's inability to remove the CFPB's director except "for cause," and whether the agency should be subject to the same agency review as other executive agencies,16 it is likely that any effort to publish and finalize the Proposed Arbitration Rule would have faced immediate and serious legal challenges. It seems highly unlikely that the CFPB would seek to finalize its arbitration rule with the questions posed by the PHH panel decision hanging over the CFPB and the full court review of that decision pending. Given that the PHH case is only going to be argued in the end of May, that a ruling is likely to take at least several months (if not much more), that a final rule would not require compliance until 211 days of its final publication, and that Director Cordray's term ends in July 2018, it is doubtful that the Proposed Arbitration Rule will ever take effect in its current form.

Our Takeaway

A properly drafted arbitration clause with a class action waiver should be enforceable and can be a good and useful line of defense against expensive and costly litigation, especially class action lawsuits. If consumers have valid claims, they can and should be successfully prosecuted through arbitration, which will be more efficient than through the courts. On the other hand, if such claims are not meritorious and are bundled together simply to exert leverage and to try to force settlements based on the mere anticipated costs of defense, then arbitration agreements can be of great assistance in avoiding "blackmail" settlements. It is a good time to review your consumer agreements and make sure you have what you need in place.

Footnotes

[1] There are some limitations on the ability to do this. For example, in 2013, as called for in the Dodd-Frank Act, the Truth in Lending Act was amended to ban mandatory arbitration provisions in any agreement for a closed-end loan secured by a dwelling or an open-end loan secured by the consumer's principal dwelling.

[2] H.R. Rep. No. 97-542, at 13 (1982) (Report by the Committee on the Judiciary regarding a bill to authorize certain appropriations to the Patent and Trademark Office).

[3] 9 U.S.C. § 2 (1982).

[4] See 9 U.S.C. §§ 2, 4; see also AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 344 (2011).

[5] The scope of the FAA's applicability and its preemptive effect—while not unlimited—is quite broad. As noted, the FAA generally applies to all written agreements to arbitrate disputes evidencing a transaction involving interstate commerce. Moreover, the U.S. Supreme Court has repeatedly held that the FAA was intended to foreclose state legislative attempts to undercut the enforceability of arbitration agreements, pre-empting state statutes and rules that categorically conflict with that policy. See Concepcion, 563 U.S. at 341 ("[w]hen state law prohibits outright the arbitration of a particular type of claim, the analysis is straightforward: The conflicting rule is displaced by the FAA."); see also, e.g., Marmet Health Care Ctr., Inc. v. Brown, 565 U.S. 530, 533 (2012)(FAA preempted state prohibition against pre-dispute agreements to arbitrate personal-injury or wrongful-death claims against nursing homes because this was a categorical rule prohibiting arbitration of a particular type of claim); Preston v. Ferrer, 552 U.S. 346, 356 (2008) (FAA pre-empted state law granting state commissioner exclusive jurisdiction to decide issue the parties agreed to arbitrate); Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52, 56 (1995) (FAA pre-empted a state law requiring judicial resolution of claims involving punitive damages); Perry v. Thomas, 482 U.S. 483, 491 (1987) (FAA pre-empted state-law requirement that litigants be provided a judicial forum for wage disputes); Southland Corp. v. Keating, 465 U.S. 1, 10 (1984)( FAA pre-empted state financial investment statute's prohibition of arbitration of claims brought under that statute). Further, while "[s]tates may regulate contracts, including arbitration clauses under general contract law principles[,]" states may not single out arbitration clauses for special treatment. Allied-Bruce Terminix Cos., Inc. v. Dobson, 513 U.S. 265, 281 (1995)(states may not "decide that a contract is fair enough to enforce all its basic terms . . . but not fair enough to enforce its arbitration clause.").

[6] In 2011, in Concepcion, the Supreme Court upheld the validity of an arbitration agreement with a class action waiver, instead requiring the claims to be resolved through arbitration. 563 U.S. at 346-47. In that case, the FAA preempted a California rule that class action arbitration waiver in consumer contracts were substantively unconscionable. Concepcion, 563 U.S. at 356. In 2015, in DIRECTV, Inc. v. Imburgia, U.S., 136 S.Ct. 463, 466-67, 471 (2015), the U.S. Supreme Court affirmed this reasoning, holding that the FAA preempted California law, making the class action waiver in the arbitration agreement enforceable.

[7] Norica v. Samsung Telecommunications America, LLC, 845 F.3d 1279 (9th Cir. 2017). The Norica facts, however, should be contrasted with shrink-wrapped license and other similar cases noted in that decision (see id. at 1287), where courts have generally enforced notices on the package providing that the consumer agreed to certain terms by opening the package.

[8] McGill v. Citibank, N.A., 2 Cal. 5th 945 (Apr. 6, 2017).

[9] See McGill v. Citibank, N.A., 232 Cal. App. 4th 753, 764 (Cal. App. 4th Dist. Dec. 18, 2014).

[10] The California Supreme Court reasoned that although Concepcion does hold that the FAA requires courts to place arbitration agreements on equal footing with other contracts and to enforce them according to their terms, the U.S. Supreme Court qualified that statement with a "saving clause," which "permits arbitration agreements to be declared unenforceable 'upon such grounds as exist at law or in equity for the revocation of any contract.'" McGill, 2 Cal. 5th at 964. The California Supreme Court reasoned that this leaves room to invalidate an arbitration clause under the contractual defense that a law established for a public reason cannot be contravened by a private agreement—in that case, a contractual provision attempting to waive the statutory right to seek public injunctive relief. Id. at 965-66.

[11] Arbitration Agreements, 12 C.F.R. § 1040 (2016) (proposed rule with request for public comment).

[12] The proposed rule covers a variety of consumer financial products and services that the Bureau believes are in or tied to the core consumer financial product markets, including extending or regularly participating in decisions regarding consumer credit; engaging primarily in the business of providing referrals or selecting creditors for consumers to obtain such credit, and the acquiring, purchasing, selling, or servicing of such credit; extending or brokering of automobile leases; consumer debt collection and management; providing consumers with consumer credit information under the Fair Credit Reporting Act; providing accounts under the Truth in Savings Act and accounts and remittance transfers subject to the Electronic Fund Transfer Act; transmitting or exchanging funds, certain other payment processing services, and check cashing, check collection, or check guaranty services. See http://files.consumerfinance.gov/f/documents/CFPB_Arbitration_Agreements_Notice_of_Proposed_Rulemaking.pdf, at 4-5.

[13] See http://files.consumerfinance.gov/f/201503_cfpb_arbitration-study-report-to-congress-2015.pdf.

[14] See https://www.uschamber.com/issue-brief/the-cfpb-s-flawed-arbitration-study; see also https://www.uschamber.com/above-the-fold/cfpb-s-arbitration-rule-the-numbers.

[15] As part of its study, the CFPB reviewed 562 putative class action cases (namely, class actions filed from 2010 through 2012 in federal courts and selected state courts concerning six different consumer financial products), estimating its report that companies moved to stay or dismiss class disputes on the basis of arbitration clauses over 16% of those cases. http://files.consumerfinance.gov/f/201503_cfpb_arbitration-study-report-to-congress-2015.pdf, at 253 (Page 8 of section 6).

[16] PHH Corp. v. Consumer Fin. Prot. Bureau, 839 F.3d 1 (D.C. Cir. 2016), vacated, rehearing, en banc, granted by PHH Corp. v. Consumer Fin. Prot. Bureau, 2017 U.S. App. LEXIS 2733 (D.C. Cir. Feb. 16, 2017).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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