Friday, April 29, 2011

FYI: US Sup Ct Says FAA Preempts State Law Rule Allowing Invalidation of Class Action Waivers

As widely reported in the news, the Supreme Court of the United States
recently held that the Federal Arbitration Act (FAA) preempted a state
court rule that class action waivers in consumer arbitration agreements
may be invalidated as unconscionable.

A copy of the opinion is available at

Respondents-consumers ("Respondents") entered into a contract for cell
phones and service with AT& T. That contract provided for arbitration of
all disputes between the parties, and disallowed class arbitration. After
a dispute arose between the parties, Respondents filed a complaint in
federal court in California. AT&T moved to compel arbitration.
Respondents opposed the motion on the grounds that the arbitration
agreement was unconscionable.

The district court denied AT&T's motion, and the Ninth Circuit affirmed,
finding the provision denying class arbitration unconscionable under state
law. Both courts based their decision on the rule laid out in Discover
Bank v. Superior Court, 36 Cal. 4th 148, 113 P. 3d 1100 (2005) (the
"Discover Bank rule"). The Ninth Circuit further held that the Discover
Bank rule was not preempted by the FAA. The Supreme Court granted

As you may recall, the FAA provides that agreements to arbitrate are
"valid, irrevocable, and enforceable, save upon such grounds as exist at
law or in equity for the revocation of any contract." See 9 U.S.C. §2.
The Discover Bank rule provides that class waivers in consumer arbitration
agreements are unconscionable where the agreement is in an adhesion
clause, the amount of damages are likely to be small, and the party with
inferior bargaining power alleges a deliberate scheme to defraud. The
Court's decision turned on whether the Discover Bank rule was preempted by
the FAA's provision that agreements to arbitrate are generally valid, or
consistent with the FAA's provision that such agreements may be invalided
upon legal or equitable grounds to revoke contracts.

In holding that the Discover Bank rule was preempted by the FAA, the
United States Supreme Court began by examining the FAA, noting that it
reflects a "liberal policy favoring arbitration" and was intended to allow
for "efficient, streamlined procedures" to resolve disputes. The Court
then laid out several flaws with class-wide arbitration, describing it as
slower, costlier and more complicated than bilateral arbitration. The
Court also raised a concern that if the Discover Bank rule were allowed to
stand, then agreements to arbitrate might be invalidated on grounds that
would effectively eliminate arbitration clauses from contracts (for
example, on the grounds that such an agreement did not allow for
judicially monitored discovery).
Further, the Court noted that the informal procedures of arbitration are
"poorly suited to the higher stakes of class litigation." In particular,
the Court expressed doubt that defendants in arbitration matters would
consent to class-wide arbitration, due to the risk of error, lack of
judicial review, and the size of potential losses. Although the Court
noted that defendants are often willing to accept those risks in bilateral
arbitrations with smaller stakes, the Court stated that "[w]e find it hard
to believe that defendants would bet the company with no effective means
of review."

Because "[r]equiring the availability of classwide arbitration interferes
with fundamental attributes of arbitration and thus creates a scheme
inconsistent with the FAA," the Court held that the Discover Bank rule is
preempted by the FAA.

Ralph T. Wutscher
McGinnis Tessitore Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874

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