Abby Cohen Smutny (Partner) and Lee A. Steven (Counsel), Leah Witters (Associate), White & Case LLP
The US Supreme Court has found that California’s Discover Bank Rule (DBR), which was applied to prohibit the enforcement of an arbitration agreement with a class action waiver, frustrates the purposes and objectives of the Federal Arbitration Act (FAA).
In AT&T Mobility v Concepcion, 563 U.S. No. 09-893 (2011), the Supreme Court addressed the question of whether the FAA prohibits states from conditioning the enforceability of certain arbitration agreements on the availability of classwide arbitration procedures (see previous Legal update, Supreme Court holds that Federal Arbitration Act preempts California rule on unconscionability (www.practicallaw.com/4-505-9795)).
Concepcion entered a cellular telephone contract with AT&T. The contract included an arbitration clause governing all disputes and required parties to bring claims in their individual capacity, and not as a plaintiff or class member in any purported class or representative proceeding.
Concepcion then filed a complaint in the District Court for the Southern District of California, which was consolidated with a putative class action. AT&T moved to compel arbitration under the contract and Concepcion opposed, arguing that the arbitration agreement was unconscionable under California's DBR because it did not allow classwide procedures. The District Court found that the arbitration clause was unconscionable and denied the motion. The Ninth Circuit Court of Appeals affirmed, finding that the arbitration agreement was unconscionable and the FAA did not pre-empt the DBR.
The Supreme Court reversed, finding that the FAA did pre-empt the DBR. California's DBR prohibits the enforcement of class action waivers in arbitration agreements if there is a contract of adhesion involving predictably small amounts of money and a deliberate plan by the party with more bargaining power to cheat consumers out of small amounts of money. Section two of the FAA allows states to apply their "generally applicable contract defences" to find arbitration agreements unenforceable so long as the defences do not apply only to arbitration agreements.
In its decision, the Supreme Court rejected Concepcion's argument that the DBR applied to all dispute resolution contracts because California also prohibits class litigation waivers. It explained that this case involved allegations that a generally applicable doctrine was applied to disfavour arbitration.
The purpose of the FAA, as articulated by the Supreme Court, is to "ensure the enforcement of arbitration agreements according to their terms so as to facilitate streamlined proceedings." The DBR, which prohibits waivers of classwide arbitration and, therefore, permits parties to demand it, interferes with this purpose in three ways:
First, classwide arbitration eliminates the main benefit of arbitration, that is, informality, making it "slower, more costly, and more likely to generate procedural morass than final judgment."
Second, classwide arbitration requires "procedural formality" and it is unlikely that Congress, when enacting the FAA, intended an arbitrator to interpret and apply such procedural requirements.
Third, classwide arbitration "increases risks to defendants" because there are not multiple opportunities for review as in classwide litigation, so it is less likely that errors will be corrected.
The Supreme Court concluded that although arbitration is a matter of contract and the FAA requires enforcing the parties' contract, parties cannot agree to arbitration that is "not as envisioned by the FAA" and state law cannot require enforcement of such contracts. Since the DBR created an obstacle to achieving the purpose of the FAA, it was pre-empted.
After this decision, it is not clear how courts can rely on state unconscionability doctrines to refuse to enforce class arbitration waivers. This could affect future use of arbitration agreements with class arbitration waivers.