United States: Class Action Arbitration: The Green Tree Decision and Other Recent Developments

Originally posted October, 2003

Article by Los Angeles partner Miles Ruthberg, Washington, D.C. partner Peter Winik, Orange County partner Mark Finkelstein and associate Laura Hayward.

The ubiquitous nature of arbitration clauses has led to a surge in the number of class action arbitrations. Several recent decisions in federal and state courts - including the United States Supreme Court’s decision in Green Tree Financial Corp. v. Bazzle¹ - have shed some light on this topic, although many issues remain unresolved. Parties should be cognizant of these unresolved issues when defending class actions filed in court and when drafting and reviewing arbitration clauses. This article discusses these recent developments surrounding class-wide arbitration.

The U.S. Supreme Court Ruled That Arbitrators, not Courts, Must Determine Whether an Arbitration Clause Prohibited Class-Wide Arbitration

In Green Tree, the United States Supreme Court recently held that the issue of whether a contract prohibited class-wide arbitration was a question for the arbitrator, not the court, to decide.

The Green Tree decision stemmed from two South Carolina state court cases involving contracts between a commercial lender (Green Tree) and its customers. In both cases, plaintiffs sought class certification from the trial courts and defendant Green Tree moved to compel arbitration and stay the court proceedings. The trial court certified a class and compelled arbitration in one case. After an interlocutory appeal found the arbitration agreement enforceable, the arbitrator certified a class in the other case. Both cases then proceeded in arbitration, and the classes in both were awarded damages and attorneys’ fees. The trial courts affirmed both awards, and Green Tree appealed both cases, claiming that class arbitration was legally impermissible under the contracts. The South Carolina Supreme Court consolidated the proceedings and found that, because the contracts were silent with respect to class arbitration, they authorized class arbitration under South Carolina law.

A fractured Supreme Court reversed and remanded, holding that the arbitrator, not the court, must decide whether the arbitration clause prohibited class-wide arbitration.

The arbitration clause at issue was unremarkable, providing that: "All disputes, claims, or controversies arising from or relating to this contract or the relationships which result from this contract . . . shall be resolved by binding arbitration by one arbitrator selected by us with consent of you. This arbitration contract is made pursuant to a transaction in interstate commerce, and shall be governed by the Federal Arbitration Act ["FAA"] at 9 U.S.C. section 1. . . ."²

Defendant Green Tree argued that the contract prohibited class certification because it provided that disputes "shall be resolved . . . by one arbitrator selected by us [Green Tree] with consent of you [Green Tree’s customer]."³ Four Justices of the Court—Justices Breyer, Scalia, Souter and Ginsburg—agreed that, because class arbitration would have the effect of preventing Green Tree from independently selecting an arbitrator to arbitrate its disputes with the unnamed class members, class arbitration could potentially be prohibited by the contract. They believed that the issue of whether "selected by [Green Tree]" means "selected by [Green Tree] to arbitrate this dispute and no other (even identical) dispute with another customer" was an issue of contract interpretation for the arbitrator to decide. The plurality reasoned that, while a court typically determines certain issues—including whether the arbitration clause is valid or whether the arbitration clause applies to a certain type of controversy—the arbitrator must determine whether the contract prohibited class arbitration, since this goes to the kind of arbitration proceeding to which the parties agreed. Justice Stevens concurred in the judgment for the express reason of forming a majority in favor of that result, although his preference would have been to affirm the decision of the Supreme Court of South Carolina, because he believed "the decision to conduct a class-action arbitration was correct as a matter of law" even though "[a]rguably the interpretation of the parties’ agreement should have been made in the first instance by the arbitrator, rather than the court." Justices Rehnquist, O’Connor and Kennedy dissented, finding that the court, not the arbitrator, should decide the interpretation of the arbitration clause and that the arbitration clause unambiguously prohibited class-wide arbitration. They would have ruled that, because "the imposition of class-wide arbitration contravenes" the parties’ arbitration clause, "the holding of the Supreme Court of South Carolina contravenes the terms of the contract and is therefore pre-empted by the FAA."⁴

Thus, the one issue that Green Tree resolved is that, at least under the arbitration clause at issue there, the arbitrator must decide whether the clause prohibited class-wide arbitration. As discussed below, jurisdictions are split on several other issues, including (1) whether an arbitration clause that is silent prohibits class-wide arbitration, (2) whether (once the threshold issue of whether the contract precludes class arbitration is resolved) the arbitrator or court should determine whether a class should be certified and (3) whether a state unconscionability defense is pre-empted by the FAA. Since the Green Tree decision, no court has had the occasion to consider its application to arbitration agreements exclusively governed by state law.⁵

Green Tree considered whether an arbitration clause prohibited class-wide arbitration in South Carolina, a state that interprets silent contracts as permitting class arbitration. Jurisdictions are split, however, on whether a silent arbitration clause in fact permits class-wide arbitration. The only federal circuits that have addressed the issue have held that, unless an arbitration clause specifically permits class-wide arbitration, it is prohibited.⁶ The rationale given by the Seventh Circuit in Champ is that the FAA "requires that district courts enforce arbitration agreements ‘in accordance with the terms of the agreement,’"⁷ and compelling class arbitration where that is not specifically provided for is not in accordance with the agreement. Indeed, "[f]or a federal court to read [a class arbitration] term into the parties’ agreement would ‘disrupt[] the negotiated risk/benefit allocation and direct[] [the parties] to proceed with a different sort of arbitration.’"⁸ It should be noted, however, that at least one federal court has held that consolidation of arbitrations may be ordered where the arbitration agreement is silent on consolidation, which could lead it to a similar conclusion with respect to class-wide arbitrations.⁹

Notwithstanding the position of many federal courts, courts in several states, including South Carolina,¹⁰ Pennsylvania,¹¹ and California,¹² have ruled that, unless an arbitration clause specifically prohibits class-wide arbitration, it is permitted. In California, the Court of Appeal declined to follow Champ, concluding that the FAA does not pre-empt California’s decisional authority that permits class-wide arbitration when the arbitration clause is silent on that issue.¹³ Other state courts, including courts in Alabama, ¹⁴ Washington¹⁵ and Minnesota,¹⁶ reached the same result as Champ.

Because of the differences among federal and state laws and decisions, parties are wise to pay close attention to choice of law, forum selection and class arbitration clauses in those contracts that provide for arbitration of disputes.¹⁷

Assuming that class-wide arbitration is permitted (or not prohibited) by an arbitration clause, courts are again split on whether the court or the arbitrator should determine whether a class should be certified. Some courts hold that the court must make this determination while other courts hold that the arbitrator must make this determination. It also appears that parties can agree, by contract, whether the court or arbitrator will make this determination.

Under California decisional law, prior to Green Tree, the court, rather than an arbitrator, determined whether a class would be certified, at least in the absence of contractual language to the contrary. In Sanders v. Kinko’s Inc., ¹⁸ the Court of Appeal concluded that the FAA does not pre-empt state procedural law relating to arbitration agreements, and thus the trial court was not required immediately to order arbitration. Instead, it was entitled to stay the arbitration pending resolution of class issues, including the possibility of class-wide arbitration of the litigation. ¹⁹ To the extent Sanders stands for the proposition that courts also should determine whether an arbitration clause prohibits class-wide arbitration, the Supreme Court in Green Tree seemingly overruled it. But Green Tree is less clear on the issue of whether the court or the arbitrator must decide the class certification issue once the arbitrator has made the threshold determination that class arbitration is not prohibited.

The Fifth Circuit’s post-Green Tree decision in Pedcor Management Co. Welfare Benefit Plan v. Nations Personnel of Texas, Inc.,²⁰ could be read to hold, based at least partially on Green Tree, that class certification should be determined by the arbitrator.²¹ But this interpretation both of Pedcor and Green Tree is subject to debate, and no doubt will be litigated in other courts.

In any event, one court in the Eastern District of Pennsylvania, in Brennan v. Ace Ina Holdings,²² recognized that parties can decide, by contract, whether the court or arbitrator should determine issues of certification. The arbitration clause at issue provided that "the arbitrator will have all the powers a judge would have in dealing with any question or dispute that may arise before, during, and after the arbitration hearing."²³ The court reasoned that, under the explicit terms of the arbitration agreement, if the issue could be submitted to a district judge then it could be submitted to the arbitrator.²⁴

In light of Green Tree, parties wishing to oppose class-wide arbitration in states that previously had required the court to determine whether to certify a class now likely will engage in a multi-prong attack on class-wide arbitration—first, by arguing to the arbitrator that the contract prohibits class-wide arbitration; second, by arguing to the arbitrator or court that a class should not be certified based on the facts of the case.²⁵

As set forth above, parties may attempt to contract around class-wide arbitrations. Some courts have held, however, that such contractual provisions potentially can be invalidated because arbitration clauses are subject to general contract defenses, including unconscionability.²⁶ On the other hand, at least one court in California has held that the FAA pre-empts such unconscionability defenses, thus making the class waiver enforceable.²⁷ The California appellate courts are now split on the issue of whether an unconscionability defense applies to class action waivers in arbitration clauses that are governed by the FAA.

In Szetela v. Discover Bank,²⁸ a credit card holder filed a class action against the credit card issuer, Discover Bank. Discover moved to compel arbitration based on the cardholder agreement, which precluded class-wide arbitration and stated that the FAA governed the agreement. The California Court of Appeal found the portion of the arbitration clause that prevented class or representative actions to be unconscionable, holding that Discover created for itself virtual immunity from class actions despite their potential merit, without suffering any detriment to its own rights.

But another California Court of Appeal reached a contrary conclusion when reviewing the same waiver clause in a subsequent petition for extraordinary writ relief. In Discover Bank, the Court of Appeal held that, where there is a valid arbitration agreement governed by the FAA, California’s unconscionability laws are pre-empted and invalid. "While a state may prohibit the contractual waiver of statutory consumer remedies, including the right to seek relief in a class action, such protections fall by the wayside when the waiver is contained in a validly formed arbitration agreement governed by the FAA."²⁹ The Court disagreed with the Szetela decision— finding that the Szetela Court failed to discuss federal pre-emption—and reasoned that its decision is consistent with the U.S. Supreme Court’s Casarotto decision (see note 26) because, in that case, the Supreme Court held that "the FAA has pre-empted a state’s ability to refuse to enforce an arbitration agreement on the basis of state substantive law."³⁰ Discover Bank currently has been granted review by the California Supreme Court, so this split in California soon may be resolved.

The U.S. Supreme Court has clarified that, at least where an arbitration clause is ambiguous and the FAA applies, the arbitrator, not the court, must decide whether class-wide arbitration is prohibited. State and federal courts, however, are divided on many other issues surrounding class-wide arbitration, including whether class-wide arbitration is prohibited if the arbitration clause is silent on the issue, whether the court or arbitrator determines whether a class should be certified and whether class arbitration waivers can be deemed unconscionable in light of the potential pre-emption of the FAA.

1 123 S.Ct. 2402 (June 23, 2003).

2 Id. at 2405.

3 Id.

4 Id. at 2409, 2411. Justice Thomas did not reach the issue of the meaning of the arbitration clause, finding that the FAA does not apply to proceedings in state courts.

5 See Pedcor Management Co. Welfare Benefit Plan v. Nations Personnel of Texas, Inc., No. 02-20878, 2003 U.S. App. Lexis 16633, at *17, n.30 (5th Cir. August 13, 2003) (expressing "no opinion on whether arbitration agreements governed exclusively by state arbitration law would be controlled by the Court’s holding in Green Tree").

6 See Champ v. Siegel Trading Co., Inc., 55 F.3d 269, 274-77 (7th Cir. 1995); Iowa Grain Co. v. Brown, 171 F.3d 504, 510 (7th Cir. 1999); Dominium Austin Partners, LLC v. Lindquist, 248 F.3d 720, 728-29 (8th Cir. 2001). The Third Circuit indicated a willingness to follow Champ in Johnson v. West Suburban Bank, 225 F.3d 366, 377, n.4 (3d Cir. 2000). In addition, the Champ decision has been followed by several district courts. E.g., Herrington v. Union Planters Bank, N.A., 113 F. Supp. 2d 1026, 1033-34 (S.D. Miss. 2000); Gray v. Conseco, Inc., No. SACV 00-0322 DOC(EEx), 2001 U.S. Dist. Lexis 21696, at *7-*8 (C.D. Cal. September 17, 2001). Several other circuit and district courts have ruled that arbitrations may not be consolidated unless expressly permitted by the arbitration clause. E.g., Gov’t of United Kingdom v. Boeing Co., 998 F.2d 68, 73-74 (2d Cir. 1993); Weyerhauser Co. v. Western Seas Shipping Co., 743 F.2d 635, 637 (9th Cir. 1984).

7 Champ, 55 F.3d at 274, quoting 9 U.S.C. § 4.

8 Id. at 275, quoting New England Energy, Inc. v. Keystone Shipping Co., 855 F.2d 1, 10 (1st Cir. 1998) (Selya, J., dissenting). The Champ Court reasoned that "absent an express provision in the parties’ arbitration agreement providing for class arbitration, Rule 81(a)(3) does not provide a district court with the authority to reform the parties’ agreement and order the arbitration panel to hear these claims on a class basis pursuant to Rule 23." Id. at 276-77. The Court noted that several other courts reached the same conclusion when asked to use Rule 81(a)(3) to order consolidation under Rule 42(a). Id. at 274-75.

9 Keystone Shipping, 855 F.2d at 5-6 (relying on Massachusetts law and not deciding "whether a federal court also has the power, under Fed. R. Civ. P. 42(a), to order consolidation in the absence of a state law providing for it"); see also Compania Espanola de Petroleos, S.A. v. Nereus Shipping, S.A., 527 F.2d 966, 975 (2d Cir. 1975), cert. denied, 426 U.S. 936 (1976), which came to a similar conclusion, but was severely limited by Gov’t of United Kingdom, 998 F.2d at 71. In addition, in an opinion authored by Judge Posner, the Seventh Circuit (the same circuit that decided Champ) ordered consolidation based on an arbitration provision that "neither clearly permits not clearly forbids consolidation," holding that "the court may resort to the usual methods of contract interpretation" to determine if it is "more likely than not" that the parties intended consolidation. Conn. Gen. Life Ins. Co. v. Sun Life Assurance Co. of Canada, 210 F.3d 771, 774-76 (7th Cir. 2000).

10 Bazzle v. Green Tree Fin. Corp., 569 S.E. 2d 349 (S.C. 2002), vacated by Green Tree, 123 S.Ct. at 424.

11 Dickler v. Shearson Lehman Hutton, Inc., 596 A.2d 860, 865-67 (Pa. Super. Ct. 1991).

12 Blue Cross of California v. Superior Court, 78 Cal. Rptr. 2d 779, 788-94 (Ct. App. 2d Dist. 1998).

13 Id.

14 Med Ctr. Cars, Inc. v. Smith, 727 So. 2d 9, 20 (Ala. 1998).

15 Stein v. Geonerco, Inc., 17 P.3d 1266, 1270-71 (Wash. Ct. App. 2001).

16 Dominium Austin Partners, LLC v. Lindquist, No. C5-00-2010, 2001 Minn. App. Lexis 943 at *26-*29 (Minn. Ct. App. 2001).

17 The FAA governs contractual arbitration in written contracts "involving interstate commerce." 9 U.S.C. §§ 1, 2. While parties are free to contract around the FAA, they probably must do so explicitly and not through a generic choice-of-law provision. Volt Info. Sciences, Inc. v. Board of Trustees of the Leland Stanford Junior Univ., 489 U.S. 468, 479 (1989) (parties may "specify by contract the rules under which that arbitration will be conducted"); see also Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52, 64 (1995) ("the choice-of-law provision covers the rights and duties of the parties, while the arbitration clause covers arbitration; neither sentence intrudes upon the other"). The FAA, however, does not independently create federal jurisdiction. Southland Corp. v. Keating, 465 U.S. 1, 15, n.9 (1984). Thus, either diversity or federal question jurisdiction must exist in order to proceed in federal court, even where the FAA controls. And in state court, the FAA’s procedural provisions may not apply. See Volt Info. Sciences, 489 U.S. at 477, n.6 ("[w]hile we have held that the FAA’s ‘substantive’ provisions—§§ 1 and 2—are applicable in state as well as federal court, [citation], we have never held that §§ 3 and 4, which by their terms appear to apply only to proceedings in federal court [citation] are nonetheless applicable in state court [citations]"). Certain states, including California, thus have held that "the procedural provisions of the [FAA] are not binding on state courts . . . provided applicable state procedures do not defeat the rights granted by Congress." Rosenthal v. Great Western Fin. Securities Corp., 58 Cal. Rptr. 2d 875, 883 (1996) (emphasis in original, citation omitted).

18 121 Cal. Rptr. 2d 766 (Ct. App. 4th Dist. 2002).

19 Id. at 769-72. See also, In re O’Quinn, No. 12-02-00352-CV, 2003 Tex. App. Lexis 5339, at *12 (Tex. App. June 25, 2003) (in AAA arbitration, the trial court abused its discretion in allowing an arbitrator to determine class certification, where the AAA rules had no procedure for certifying a class). But see Pedcor, 2003 U.S. App. Lexis 16633, at *19 ("in light of Green Tree, the AAA has stated that it will administer demands for class arbitration in particular circumstances, and is developing rules to accommodate these types of cases").

20 2003 U.S. App. Lexis 16633.

21 Compare Id. at *18-*20 with *8, *21.

22 No. 00-2730, 2002 U.S. Dist. LEXIS 15039 (E.D. Penn. Aug. 1, 2002).

23 Id. at *8-*9.

24 Id. at *9; see also Sanders, 121 Cal. Rptr. 2d at 772 (implying that parties could agree to have procedural issues governed by the FAA, but finding that the parties’ agreement in the case before it did not "clearly reflect an intent to apply both [the FAA’s] substantive and procedural aspects").

25 Green Tree did not reach the issue of whether the court should make an initial determination of whether an arbitration clause unambiguously prohibits class-wide arbitration, thus obviating the necessity of submitting the issue to the arbitrator. See Pedcor, 2003 U.S. App. Lexis 16633, at *9-*11. Accordingly, parties opposing class-wide arbitration also could attempt to seek an initial ruling from the court that the arbitration clause clearly prohibits class-wide arbitration before asking the arbitrators to rule that the clause in fact prohibits class-wide arbitration.

26 See, e.g., State ex rel. Dunlap v. Berger, 567 S.E. 2d 265, 278-80 (W. Va. 2002), cert. denied Friedman’s Inc. v. West Virginia ex rel. Dunlap, 123 S.Ct. 695 (2002) (holding that a claim of unconscionability is available under the FAA and that the prohibition on class action relief is unconscionable); Luna v. Household Finance Corp. III, 236 F. Supp. 2d 1166, 1178-79 (W.D. Wash. 2002) (concluding that the prohibition on class actions in an arbitration agreement weighed heavily in favor of a substantive unconscionability finding and that the "totality of the circumstances" established a fundamental unfairness, which made the prohibition unconscionable and unenforceable under Washington law). These cases cited, among other authorities, Doctor’s Associates, Inc. v. Casarotto, a case in which the U.S. Supreme Court ruled that a Montana statute that required that notice of arbitration clauses be typed in underlined capital letters on the first page of a contract was pre-empted by the FAA, the Supreme Court holding that while "generally applicable contract defenses, such as fraud, duress, or unconscionability, may be applied to invalidate arbitration agreements without contravening § 2 [of the FAA]. . . . Courts may not, however, invalidate arbitration agreements under state laws applicable only to arbitration provisions." 517 U.S. 681, 686-88 (1996) (emphasis in original, citations omitted).

27 Discover Bank v. Superior Court, 129 Cal. Rptr. 2d 393 (Ct. App. 2d Dist. 2003), review granted 132 Cal. Rptr. 2d 526 (2003).

28 118 Cal. Rptr. 2d 862 (Ct. App. 4th Dist. 2002).

29 129 Cal. Rptr. 2d at 408.

30 Id. at 405-06.

*********************

Latham & Watkins operates as a limited liability partnership worldwide with an affiliate in the United Kingdom and Italy, where the practice is conducted through an affiliated multinational partnership. © Copyright 2003 Latham & Watkins. All Rights Reserved.

Latham & Watkins is an international law firm of more than 1,500 attorneys in 21 offices worldwide, including Boston, Brussels, Chicago, Frankfurt, Hamburg, Hong Kong, London, Los Angeles, Milan, Moscow, New Jersey, New York, Northern Virginia, Orange County, Paris, San Diego, San Francisco, Silicon Valley, Singapore, Tokyo, and Washington, D.C.