Recent Appellate Decisions Reshape the Landscape of Arbitration Law
Kelly Margolis Dagger
Kelly Margolis Dagger
Stephen D. Feldman
By Stephen Feldman & Kelly Margolis Dagger
For in-house counsel who drafts and enforce arbitration agreements, trying to keep up with the fast-moving landscape of arbitration law is a significant challenge. Over the last several years, the United States Supreme Court has issued three major decisions that affect the enforceability of arbitration agreements. State and federal appellate courts have then applied those decisions in varying ways. This article examines the key rulings and concepts in these seminal Supreme Court decisions.
II. The FAA and Key Defenses to Enforceability of Arbitration Agreements
When it passed the Federal Arbitration (“FAA”), Congress declared a “liberal federal policy favoring arbitration agreements.” Consistent with that policy, section 2 of the FAA provides that written agreements to arbitrate disputes in contracts involving transactions in interstate commerce “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” In other words, when the FAA applies to an arbitration agreement, the agreement will be enforced unless a generally applicable contract defense precludes enforcement. For example, an arbitration agreement induced by fraud or duress is unenforceable.
The Supreme Court’s recent decisions on arbitration have focused on two often-overlapping defenses to enforceability asserted by the party seeking to avoid arbitration—typically the plaintiff—in response to a motion to compel arbitration.
The first defense is that arbitration is prohibitively expensive. The plaintiff who invokes this defense argues that the cost of arbitration—including filing fees and administrative costs, arbitrator’s fees, witness fees, attorney fees, and any other costs—exceeds the amount that could be recovered in the arbitration.
The second defense concerns class action waivers. Increasingly, arbitration agreements explicitly provide that the parties waive any right to pursue potential class action claims, meaning that a potential plaintiff may assert only individual claims in arbitration. Class action (or class arbitration) waivers prevent plaintiffs from sharing costs, such as attorney and witness fees, with other similarly situated plaintiffs.
To avoid the effect of such waivers, plaintiffs have invoked various state-law doctrines to argue that the waivers are invalid and render the arbitration agreement itself unenforceable. For example, many plaintiffs have argued that arbitration agreements containing such provisions are unconscionable because they effectively preclude litigation of low-value claims; i.e., no rational plaintiff would bring a claim in arbitration when the cost of pursuing the claim individually would exceed any potential recovery.
Recently, the Supreme Court may have foreclosed this argument. In particular, and as discussed more fully below, the Court has held that when state law would invalidate an arbitration agreement because the agreement contains a class action waiver, that state law is likely preempted by the FAA—even if the result is that no rational plaintiff would bring an individual claim in arbitration. According to the Court, this result, though harsh, is mandated by the policies underlying the FAA.
A. The Effective-Vindication Defense
A starting point to understanding the Supreme Court’s recent arbitration decisions is the 1985 decision in Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc. In that case, the Supreme Court considered whether a party could avoid arbitration of a federal statutory claim because the parties’ arbitration agreement did not specifically mention that type of claim. The Supreme Court held that arbitration was required. The key question, the Court noted, was whether the party could effectively vindicate its federal statutory cause of action in arbitration. If the answer is yes, then the party could not avoid arbitration merely by asserting a federal statutory claim.
In 2000, in Green Tree Financial Corp.-Alabama v. Randolph, the Supreme Court revisited these concepts and more expressly acknowledged an effective-vindication defense. That defense has potency, the Supreme Court explained, when “the existence of large arbitration costs could preclude a litigant . . . from effectively vindicating her federal statutory rights in the arbitral forum.” The Supreme Court tasked the party asserting the defense—that is, the party seeking to avoid arbitration—with showing that the costs the party will incur in arbitration will exceed any likely recovery.
Read together, the Mitsubishi Motors and Green Tree decisions appeared to permit a party alleging a federal statutory claim to use an effective-vindication defense to avoid arbitration. In Green Tree, in particular, the Supreme Court explained that an effective-vindication defense could reconcile competing for congressional policies: (1) the FAA’s policy in favor of arbitration, and (2) policies in other federal statutes that favor judicial resolution of certain claims.
Following Green Tree, many state appellate courts imported the Supreme Court’s effective-vindication analysis when evaluating the enforceability of arbitration agreements under state law. These courts applied this analysis even when the plaintiff did not assert federal statutory claims. Other courts tied the effective-vindication analysis to state law unconscionability standards, ruling that if a party could not effectively vindicate a state statutory claim in arbitration, the arbitration agreement was substantively unconscionable and, therefore, invalid.
B. Challenging Class Arbitration Waivers
One way a plaintiff can cost-effectively pursue relief via arbitration is by arbitrating the claim on a class basis. According to defendants, however, the complexities inherent in class proceedings are fundamentally at odds with the core benefits of arbitration. In light of this tension, state courts applying the effective-vindication test were frequently called upon to adjudicate the availability of class proceedings in arbitration.
The Supreme Court addressed these arguments in Stolt-Nielsen S.A. v. AnimalFeeds International Corp. In Stolt-Nielsen, the parties entered into an arbitration agreement that did not address the permissibility of class arbitration. The Supreme Court held that the plaintiff could not pursue classwide relief in arbitration because the parties had not agreed to it. The Supreme Court reasoned that, because of the degree to which class proceedings alter the arbitration process, it could not be assumed the parties consented to class arbitration simply because they agreed to arbitrate their disputes.
One year later, in AT&T Mobility LLC v. Concepcion, the Supreme Court again examined the circumstances in which a party can assert, or be barred from asserting, class claims in arbitration proceedings. Concepcion concerned a California state-law rule that effectively barred class action waivers in consumer contracts calling for arbitration. Under this rule, first announced by the California Supreme Court in Discover Bank v. Superior Court, a class arbitration waiver was unconscionable—and therefore invalid—if the waiver was part of a “consumer contract of adhesion in a setting in which disputes between the contracting parties predictably involve a small number of damages.” In other words, if a consumer adhesion contract contained an arbitration agreement that included a class action waiver, and the arbitration clause was likely to cover low-value claims, the California rule invalidated that agreement.
AT&T argued that the so-called “Discover Bank rule” was preempted by the FAA. The Supreme Court agreed. A rule that requires classwide arbitration to be available, the Supreme Court said, “interferes with fundamental attributes of arbitration.” That interference cannot be reconciled with the FAA’s liberal policy in favor of arbitration and thus “creates a scheme inconsistent with the FAA.”
Notably, the Supreme Court in Concepcion had no sympathy for plaintiffs with small damages claims for whom a class action was the only cost-effective method for seeking redress of those claims. In the words of the Concepcion Court, even if “class proceedings are necessary to prosecute small-dollar claims that might otherwise slip through the legal system[,] . . . States cannot require a procedure that is inconsistent with the FAA.”
III. The Fate of Class Arbitration Waivers in the Appellate Courts
Following Concepcion, state and federal appellate courts have struggled to determine exactly how to apply the Supreme Court’s mandate. These post-Concepcion decisions can be divided into three categories: those that interpret the opinion narrowly, those that interpret it expansively, and those that strike a middle ground between the two extremes.
A. Narrow Interpretations of Concepcion
One group of appellate courts applying Concepcion has interpreted the FAA’s preemptive scope narrowly. Under these decisions, the FAA preempts only state-law rules that mirror the Discover Bank rule—i.e., those that, in large part, automatically invalidate class arbitration waivers.
For these courts, the FAA’s preemptive effect turns on the nature of the state-law rule used to evaluate the validity of a class action waiver. If that state-law rule is more flexible than the Discover Bank rule, then the FAA does not preempt that rule. And if the state-law rule is not preempted, that rule—such as unconscionability—can be used as a framework to demonstrate that an arbitration agreement with a class action waiver is invalid. In that circumstance, a plaintiff may avoid arbitration by showing that he or she cannot effectively vindicate his or her rights, even for state-law claims, because of the cost of individual arbitration.
B. Expansive Interpretations of Concepcion
Another group of appellate courts has taken the polar opposite approach. These courts have concluded that, under Concepcion, the FAA preempts any consideration of class arbitration waivers by any state-law rule used to evaluate the enforceability of an arbitration agreement.
In view of these courts’ broad interpretation of Concepcion, plaintiffs in these jurisdictions are hard-pressed to argue that an arbitration agreement is invalid because a class action waiver renders arbitration cost-prohibitive. One of these courts, however, has suggested that an effective-vindication claim based on the high cost of arbitration might remain viable if the plaintiff can establish that arbitration fees themselves are prohibitively high, or that the location of the arbitration is exceptionally remote.
C. Decisions Adopting a Middle Ground
The third group of appellate courts falls within the two extremes. These courts hold that the FAA preempts even flexible state-law rules, like unconscionability, that invalidate arbitration agreements with class action waivers. However, they do not wholly foreclose a party from pointing to the effects of a class action waiver as a consideration in analyzing an effective-vindication defense. Such an approach is viable in the light of the fact that Concepcion did not specifically address, much less invalidate, the effective-vindication defense enunciated in Mitsubishi Motors and Green Tree.
For example, in Cottonwood Financial, Ltd. v. Estes, the Court of Appeals of Wisconsin upheld an arbitration agreement containing a class arbitration waiver. According to the Cottonwood Court, Concepcion means only that “the FAA preempts any state law that classifies an arbitration agreement as unconscionable . . . simply because the agreement prohibits an individual from proceeding as a member of a class.” The court did not address whether, after Concepcion, courts were still permitted to take into account the effects of a class action waiver on a case-by-case basis.
Likewise, the Court of Appeals of Ohio enforced an arbitration agreement with a class action waiver but did not address whether such a waiver could ever cut against enforcement of an arbitration agreement. The West Virginia Supreme Court has also left this question open.
IV. “Effective Vindication” in the Context of Class action waivers
These decisions set the stage for the Supreme Court’s June 2013 decision in American Express Co. v. Italian Colors Restaurant (“AmEx III”). In AmEx III, a restaurant argued that its arbitration agreement with American Express was invalid because it included a class action waiver. More specifically, the restaurant said that the costs of proving its claims in individual, rather than class, arbitration would be too high to allow the restaurant to vindicate its rights under the Sherman Act. On three separate occasions, the Second Circuit agreed, holding that the plaintiffs had made a sufficient showing of prohibitive costs to avoid arbitration. In the court’s view, because Concepcion did not alter Green Tree, the effective-vindication defense remained viable.
The Supreme Court disagreed. The effective-vindication defense, the Court explained, prevents a party from prospectively waiving its “right to pursue” statutory remedies. The right to pursue a statutory remedy, however, does not guarantee a cost-effective pursuit. In the Court’s words, “the fact that it is not worth the expense involved in proving a statutory remedy does not constitute the elimination of the right to pursue that remedy.” The AmEx III decision thus prevents a party from avoiding arbitration based on the financial impracticality of pursuing a complex small-dollar claim in individual arbitration.
Although precluding assertion of an effective-vindication defense based solely on the existence of a class arbitration waiver, the Amex III decision did leave some room for asserting such a defense. The effective-vindication exception, the Supreme Court explained, would apply to an arbitration agreement that forbids the assertion of certain statutory rights. Large filing and administrative fees, too, could justify an effective-vindication defense.
Justice Kagan wrote a stinging dissent. She called the decision “a betrayal of our precedents.” Pointing to Mitsubishi Motors and Green Tree, the dissent argued that the effective-vindication rule serves “to prevent arbitration clauses from choking off a plaintiff’s ability to enforce congressionally-created rights.” Moreover, the dissent explained, the federal policy favoring arbitration is a policy that favors the method of dispute resolution, not the killing off of valid claims. Consistent with this policy, the effective-vindication rule ensures that arbitration is a real, viable method of dispute resolution. Without the effective-vindication rule, “companies have every incentive to draft their agreements to extract backdoor waivers of statutory rights, making arbitration unavailable or pointless.”
V. Enforcing Class Arbitration Waivers After AmEx III
The AmEx III decision leaves open several important questions for parties seeking to enforce arbitration agreements containing class action waivers.
For example, courts have continued to recognize that the FAA, like any federal statute, maybe “overridden by a ‘contrary congressional command.’” Litigants have argued—so far, with little success—that such a contrary congressional command exists when a federal statute includes a collective action provision. However, the Eleventh Circuit’s analysis in Walthour v. Chipio Windshield Repair, LLC, suggests the effective-vindication analysis may have continuing relevance in determining whether a federal statute contains a contrary congressional command sufficient to invalidate an arbitration agreement containing a class action waiver. In Walthour, the plaintiffs and their employers signed arbitration agreements with class action waivers. The plaintiffs brought a putative collective action against their employers alleging violations of the Fair Labor Standards Act (“FLSA”). When the defendants moved to compel arbitration, the plaintiffs argued they could not be required to arbitrate their FLSA claims individually because the FLSA specifically permits collective actions, and the collective action provision thus constituted a “contrary congressional command.” Although the Eleventh Circuit disagreed, it did so only after analyzing whether Congress viewed collectively actions as essential to the effective vindication of an FLSA claim.
Nor is it clear how the Court’s reasoning in AmEx III will affect state law unconscionability doctrine. The state appellate courts that have adopted some version of the effective-vindication defense—and that have imported that analysis into state law rules of substantive unconscionability—may choose to limit the effect of AmEx III by characterizing it as a decision of federal common law concerning only the arbitrability of federal statutory causes of actions.
To the same end, state courts that have interpreted Concepcion to allow consideration of the effects of class action waivers as part of a case-by-case unconscionability analysis might simply continue to apply that analysis, effectively limiting AmEx III’s definition of “effective vindication” to federal statutory rights. Whether that approach will succeed, however, is open to a serious question: The Tenth Circuit, at least, has made clear that state courts cannot use that approach to avoid the FAA.
Some state courts that have continued to consider the effects of class action waivers after Concepcion might reverse course in light of AmEx III. For example, prior to AmEx III, the Supreme Judicial Court of Massachusetts had interpreted Concepcion to permit an arbitration agreement with a class action waiver to be invalidated on unconscionability grounds if the plaintiff demonstrated that individual arbitration would be cost-prohibitive. More recently, however, the same court recognized that AmEx III abrogated that interpretation of Concepcion; thus, cost-prohibitiveness, even when analyzed in terms of unconscionability, is not a defense to an individual arbitration agreement.
Courts that have held that the FAA’s preemptive effect is limited to state-law rules of automatic invalidation, like California’s Discover Bank rule, may quickly find themselves in the minority. Indeed, the California Supreme Court itself recently held that Concepcion “invalidated our decision in Discover Bank” and stated that the fact that a “rule against class waiver[s] is stated more narrowly than Discover Bank’s rule does not save it from FAA preemption under Concepcion.”
Courts that have not yet addressed the import of Concepcion will now have the benefit of the Supreme Court’s emphatic reaffirmance of Concepcion in AmEx III. Considering the two decisions together, state appellate courts may be more likely to interpret the preemptive impact of the FAA broadly. For example, prior to Concepcion and AmEx III, the North Carolina Supreme Court had adopted the cost-prohibitiveness principle of Green Tree as part of its state-law unconscionability analysis for class action waivers. Recently, however, an intermediate appellate court in North Carolina squarely rejected that analysis, holding that after Concepcion and AmEx III, whether individual arbitration is cost-prohibitive is no longer relevant to unconscionability under state law.
One particular area of interest for state appellate courts might be the statement in AmEx III that the effective-vindication defense could invalidate “an arbitration agreement forbidding the assertion of certain statutory rights.” This statement provides a pulse—even if a weak one—to effective-vindication analyses that have bled into state-law unconscionability doctrines. Conceivably, an arbitration agreement that purports to prohibit the assertion of remedial statutory rights, such as the recovery of attorney fees or double or treble damages, could still be invalidated on effective-vindication grounds.
A Word for Drafters
It is difficult to predict how arbitration law will continue to evolve after AmEx III. Nonetheless, it is clear that attorneys charged with drafting arbitration clauses should avoid any provision that could be perceived as a prospective waiver of statutory rights. Another party might enthusiastically agree to give up a particular statutory right in exchange for a better bargain in other respects; however attractive that waiver might seem, it could be costly if it results in invalidating an arbitration agreement.
Drafters should also keep in mind that AmEx III did not end all cost-based challenges to arbitration agreements. For example, the Supreme Court suggested that an arbitration agreement that requires the claimant to pay “filing and administrative fees attached to arbitration that are so high as to make access to the forum impracticable” might be considered an impermissible waiver of the right to pursue a statutory claim. The Court did not elaborate on how lower courts should evaluate whether arbitration fees render the forum impracticable. The Ninth Circuit has weighed in on this question, holding that an arbitration agreement with a cost-sharing provision that required a claimant to pay significant arbitration costs upfront—an amount the court determined would “likely dwarf the amount of [the plaintiff’s] claims”—was unconscionable under California law. Rejecting a challenge made on the same grounds, a New Jersey federal court held that the plaintiffs’ ability to pursue their statutory remedies through arbitration “would not be hindered” where the evidence established that the defendant had a policy and practice of paying for arbitral costs when its customers sought individual arbitration.
As these authorities suggest, to avoid cost-based challenges, drafters might consider including a fee-shifting provision that forgives the individual claimant’s filing fees and related administrative costs. While agreeing to pay such expenses might appear to encourage the filing of claims, that risk might be outweighed by a greater benefit: stopping a plaintiff from pursuing a cost-prohibitiveness defense. In the long run, arbitration filing fees might be a small price to pay to avoid time-consuming and costly litigation over the enforceability of the arbitration agreement.
*This article was republished in the Winter 2015 issue of FDCC Quarterly.
- Federal Arbitration Act, 9 U.S.C. §§ 1—16 (2014).
- Moses H. Cone Mem’l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24 (1983).
- 9 U.S.C. § 2 (2014).
- Doctor’s Assocs., Inc. v. Casarotto, 517 U.S. 681, 687 (1996).
- 473 U.S. 614 (1985).
- See id. at 624—25.
- Id. at 637.
- Id. at 636—37.
- 531 U.S. 79 (2000).
- Id. at 90.
- Id. at 91.
- See id. at 90.
- See, e.g., Tillman v. Commercial Credit Loans, Inc., 655 S.E.2d 362, 366 (N.C. 2008); Fiser v. Dell Computer Corp., 188 P.3d 1215, 1220—21 (N.M. 2008).
- See, e.g., Schnuerle v. Insight Commc’ns Co., 376 S.W.3d 561, 573 (Ky. 2012); State ex rel. Richmond Am. Homes of W.Va., Inc. v. Sanders, 717 S.E.2d 909, 921 (W.Va. 2011); Tillman, 655 S.E.2d at 373; Vasquez-Lopez v. Beneficial Or., Inc., 152 P.3d 940, 952 (Or. Ct. App. 2007).
- 559 U.S. 662 (2010).
- Id. at 684.
- Id. at 686—87.
- 131 S. Ct. 1740 (2011).
- 30 Cal. Rptr. 3d 76, 87 (2005)
- Concepcion, 131 S. Ct. at 1746 (quoting Discover Bank, 30 Cal. Rptr. 3d at 87).
- Id. at 1748.
- See Kelker v. Geneva-Roth Ventures, Inc., 303 P.3d 777, 780—82 (Mont. 2013); Brewer v. Mo. Title Loans, 364 S.W.3d 486, 491 (Mo. 2012).
- See Brewer, 364 S.W.3d at 491 (interpreting Concepcion as allowing “case-by-case approach” to class action waivers).
- See id. at 493—96.
- See McKenzie Check Advance of Fla., LLC v. Betts, 112 So. 3d 1176, 1187 (Fla. 2013); Coneff v. AT&T Corp., 673 F.3d 1155 (9th Cir. 2012); Cruz v. Cingular Wireless, LLC, 648 F.3d 1205, 1212 (11th Cir. 2011); Schnuerle v. Insight Commc’ns Co., 376 S.W.3d 561, 572 (Ky. 2012).
- See, e.g., McKenzie, 112 So. 3d at 1187.
- Schnuerle, 376 S.W.3d at 573.
- See, e.g., Muriithi v. Shuttle Express, Inc., 712 F.3d 173, 180—81 (4th Cir. 2013).
- 810 N.W.2d 852 (Wis. Ct. App. 2012).
- Id. at 858.
- Wallace v. Ganley Auto Grp., No. 95081, 2011 WL 2434093, at *6—7 (Ohio Ct. App. June 16, 2011).
- State ex rel. Richmond Am. Homes of W.Va., Inc. v. Sanders, 717 S.E.2d 909, 920 (W.Va. 2011).
- 133 S. Ct. 2304 (2013).
- Id. at 2308.
- Id. at 2310 (quoting Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 637) (emphasis in original).
- Id. (emphasis in original).
- Id. at 2311.
- Id. at 2313 (Kagan, J., dissenting).
- Id. at 2315.
- Walthour v. Chipio Windshield Repair, LLC, 745 F.3d 1326, 1330 (11th Cir. 2014) (quoting Shearson/Am. Express, Inc. v. McMahon, 482 U.S. 220, 226 (1987)); see Amex III, 133 S. Ct. at 2309.
- Walthour, 745 F.3d at 1330.
- See id. at 1335.
- Id. at 1328.
- Id. at 1329.
- Id. at 1330.
- Id. at 1334—35 (holding that legislative history did not show congressional intent for collective action to be essential to effective vindication of FLSA claims).
- THI of N.M. at Hobbs Ctr., LLC v. Patton, 741 F.3d 1162, 1170 (10th Cir. 2014) (“[W]e cannot agree with the statement . . . that because the state court’s invalidation of the ban on class relief rests on the doctrine of unconscionability, a doctrine that exists for the revocation of any contract, the FAA does not preempt [the state court’s] holding.” (Internal quotation marks omitted)).
- Feeney v. Dell Inc., 989 N.E.2d 439, 462 (Mass. 2013).
- Machado v. System4 LLC, 993 N.E.2d 332, 332 (Mass. 2013); see also Lewis v. Advance Am., Cash Advance Ctrs. of Ill., Inc., No. 13—cv—942—JPG-SCW, 2014 WL 47125, at *3 (S.D. Ill. Jan. 6, 2014) (holding FAA preempted application of state-law unconscionability doctrine to invalidate arbitration agreement based on cost-prohibitiveness).
- Iskanian v. CLS Transp. Los Angeles, LLC, 173 Cal. Rptr. 3d 289, 295, 296 (2014).
- Tillman v. Commercial Credit Loans, Inc., 655 S.E.2d 362, 366 (N.C. 2008).
- Torrence v. Nationwide Budget Fin., 753 S.E.2d 802, 811 (N.C. Ct. App. 2014).
- Am. Express Co. v. Italian Colors Rest., 133 S. Ct. 2304, 2310 (2013).
- Id. at 2310-11.
- Chavarria v. Ralphs Grocery Co., 733 F.3d 916, 925-27 (9th Cir. 2013). According to the court’s estimate, plaintiff would have been required to pay $3,500 to $7,000 per day for the arbitrator’s fee alone. Id. at 925.
- In re Sprint Premium Data Plan Mktg. & Sales Practices Litig., No. 11-2308 (SDW) (MCA), 2014 WL 685297, at *4 (D.N.J. Jan. 15, 2014) (emphasis added).