Arbitration Clauses Under Attack, Again

David W. Bertoni:

On November 7, 2014, I wrote about the implications for direct marketers of the FTC’s case against AT&T for unfair and misleading trade practices.  (To bring you up to speed, since that time, the federal court rejected AT&T’s motion to dismiss claims based upon so-called “data throttling” on the grounds of its common carrier status.  That decision has been appealed to the United States Court of Appeals for the Ninth Circuit.  At stake is a $100 million FTC penalty.)

One of the subjects that came up in my blog entry about AT&T’s battle with the FTC was the enforceability of arbitration clauses between businesses and consumers.  As I explained, the United States Supreme Court “held that the Federal Arbitration Act trumped the longstanding California legal principle that such anti-class action provisions were unfair to consumers. And so, the Concepcion decision forced customers to pursue claims against AT&T piecemeal, cases too small to attract class action plaintiffs lawyers hungry for big pay-offs.”

The impact of the Concepcion decision was immediate.  More and more companies began including arbitration provisions in their agreements with consumers, including web site terms and conditions, that sought to limit class actions (both in court and in the context of class-based arbitrations).   The reasons for doing so were obvious.  One of the biggest worries facing direct marketers is the specter of bankrupting class action litigation over sales and marketing practices in a highly litigious and aggressive environment.  It is a world where even innocent mistakes that result in no measurable harm to consumers can devastate a company in one fell swoop.

Of course, the Supreme Court of California couldn’t let it rest there, and a recent decision amounts to a potential opening for a new assault on arbitration clauses (including those with class action waivers) that has potentially sweeping implications.  Specifically, if those clauses are found to be one-sided and oppressive, for example, they may well be stricken in their entirety, forcing cases into the court system, including on a class action basis.  The test is whether the provisions are “unreasonably favorable to the more powerful party.”

Concepcion Arbitration Decision Reaches The Supreme Court of California

In Sanchez v. Valencia Holding Company, LLC, the plaintiff entered into an automobile sales contract that included a complex, two-tiered arbitration clause.  In the first instance, claims would be resolved by a single arbitrator.  A party dissatisfied with that result, however, could appeal to a panel of arbitrators, provided that the appealing party had to pay up front all of the costs of such appeal.  The clause preserved the parties’ rights to go to small claims court if they wished, but expressly waived the right both to class action litigation or class action-based arbitration.

Sanchez ignored the arbitration clause and filed a class action lawsuit in California state court, which triggered Valencia moving to compel arbitration.  The trial court–acting before the Supreme Court had issued its Concepcion decision–denied the motion, finding that the arbitration clause’s class action waiver was unconscionable.  The California Court of Appeal upheld the decision, and Valencia sought review by the Supreme Court of California.

The California Supreme Court’s August 3, 2015 Decision In Sanchez

The Supreme Court of California concluded in Sanchez that, despite the holding in Concepcion, unconscionability “remained a valid defense to a petition to compel arbitration.”  In so doing, it seized on language in Concepcion that traditional contract defenses are permitted in response to efforts to enforce arbitration agreements provided they apply in the same way to contracts both involving and not involving arbitration.  Such defenses, the California’s highest court found, “must not facially discriminate against arbitration and must be enforced evenhandedly.”  Moreover, even if nondiscriminatory on their face, such defenses must not–as actually applied–interfere with the “fundamental attributes” of arbitration, including, among other things, reduced costs and the ability to choose experts to decide specific controversies.

In other words, the California Supreme Court opened the door to reformulated approach to the doctrine of unconscionability that would be highly fact dependent and did not render class action waivers in consumer contracts automatically unenforceable.  For example, it explained that, as it had found in a prior case, that “a $50,000 threshold for an arbitration appeal that decidedly favored defendants in employment contract disputes” was unconscionable, and that this was consistent with Concepcion because it reflected the weighing of factors that would apply neutrally to all agreements.  It did not, the court reasoned, interfere with the “fundamental attributes” of arbitration.

Although Sanchez Lost, Other Plaintiffs May Win

Although the California Supreme Court in Sanchez ultimately reversed the Court of Appeal and found the arbitration agreement in that case was enforceable, its analysis provides substantial fodder for plaintiffs seeking to challenge arbitration clauses as unconscionable, under theories of both “procedural” (how was the clause presented to the consumer) and “substantive” unconscionability (are its terms unduly oppressive).

For example, if an arbitration clause provides rights to one side, but not the other–for example, allowing a medical group, “but not the patient to reject the first arbitration award and submit the dispute to a second arbitration panel”–it could be struck down as unconscionable despite the ruling in Concepcion.  The question asked by the Supreme Court of California was whether the provision “obviously favors the drafting party.”

The Supreme Court of California also opened the door to a case by case analysis of whether provisions shifting appeal costs to the claimant were unconscionable, allowing it to weigh the peculiar facts of each case, including the nature of the dispute.  It found that it would be more difficult to sustain a high “pay to appeal” cost in an employment dispute than in a contract to purchase an automobile, thus seeking to underscore that its approach to unconscionability did not target arbitration clauses for special and different treatment.

Lessons Learned

The Sanchez decision offers a powerful reminder that arbitration clauses remain in the cross-hairs, and so must be carefully crafted and scrutinized to ensure that they are fair.  As a rule of thumb, direct marketers should make sure that whatever process is included in an arbitration clause, that it be even-handed and not reflect overreaching on the part of the party with the greater bargaining power, i.e., the author of the agreement.