The U.S. Court of Appeals for the Ninth Circuit recently held that: (1) the Federal Arbitration Act preempted a California rule against arbitrating claims for public injunctive relief; and (2) the state common law contract defense of unconscionability was not available to invalidate an arbitration clause, where a loan agreement clearly and conspicuously set forth the arbitration clause and provided ample opportunity to opt-out of arbitration.
A copy of the opinion is available at:
Plaintiffs ("Plaintiff Borrowers") brought a putative class action in California state court against a bank ("Defendant Bank") that extended student loans to the Plaintiff Borrowers. The complaint alleged that the Defendant Bank violated California's Unfair Competition Law, Cal. Bus. & Prof. Code § 17200, et seq. ("UCL"), with respect to student loans the Plaintiff Borrowers obtained in order to fund their training to become helicopter pilots.
The Plaintiff Borrowers alleged that, after they had enrolled in aviation school in California and incurred substantial debt, the school became insolvent, filed for bankruptcy protection, and ceased operations. The Plaintiff Borrowers claimed that, as a result of the demise of the aviation school, they were left unable to complete their training and lost all the money they had borrowed from the Defendant Bank. The Plaintiff Borrowers alleged among other things that the aviation school had engaged in misleading marketing tactics to attract students, and that the Defendant Bank improperly continued to extend student loans despite its alleged knowledge of the aviation school's precarious financial condition. The Plaintiff Borrowers sought an injunction enjoining the Defendant Bank from enforcing the loan agreements and from engaging in false and deceptive practices with respect to certain consumer credit agreements.
The student loan agreements provided that federal and Ohio law would govern the agreements. The loan agreements also contained an arbitration clause that waived class-actions and allowed either party to elect binding arbitration of disputes. In addition, the loan agreements included an opt-out provision, allowing Plaintiff Borrowers the opportunity to opt-out of the arbitration clause within a specified period after signing the agreement. The Plaintiff Borrowers signed the agreements without opting-out of the arbitration clause.
The Defendant Bank removed the case to federal district court, and moved to compel arbitration pursuant to the arbitration clause. The district court denied the motion to compel. In so doing, the district court declined to apply Ohio law in accordance with the choice-of-law provision. Ruling that Ohio law was contrary to California's "fundamental policy" prohibiting arbitration of claims for public injunctive relief, the district court applied California law and thus held that the arbitration clause was unenforceable.
The Defendant Bank appealed the denial of its motion to compel arbitration. During the pendency of the interlocutory appeal, the Defendant Bank also moved to dismiss the Plaintiff Borrowers' complaint, arguing that the National Bank Act and federal regulations preempted the Plaintiff Borrowers' California UCL claims. Retaining jurisdiction over the case, the district court dismissed the complaint on federal preemption grounds, and entered judgment against the Plaintiff Borrowers. The Plaintiff Borrowers appealed.
The Ninth Circuit reversed the denial of the motion to compel arbitration, vacated the judgment of dismissal, and remanded.
As you may recall, the Federal Arbitration Act ("FAA") provides that arbitration agreements are "valid, irrevocable, and enforceable" unless the agreements can be invalidated "upon such grounds as exist at law or equity for the revocation of any contract," such as fraud, duress, or unconscionability. See 9 U.S.C. § 2.
Finding it unnecessary to address whether California or Ohio law applied to this case, the Ninth Circuit focused on the FAA's preemption of state law. In its analysis of the FAA, the Ninth Circuit noted that the Supreme Court identified two situations in which the FAA preempts state law: (1) where state law prohibits the arbitration of a particular type of claim; and (2) where a generally applicable doctrine under state law, such as unconscionability, is applied in a manner that creates an obstacle to the FAA's objective of enforcing arbitration agreements according to their terms. See AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740, 1747 (2011) ("Concepcion").
The Ninth Circuit analyzed whether decisions of the California Supreme Court and Ninth Circuit should be followed in light of the Supreme Court's Concepcion decision. See Broughton V. Cigna Healthplans of California, 988 P.2d 67 (Cal. 1999), Cruz v. Pacificare Health Systems, Inc., 6 P.3d 1157 (Cal 2003), and Davis v. O'Melveny & Myers, 485 F.3d 1066, 1082 (9th Cir. 2007)(holding that California law prohibits arbitration of claims for injunctive relief on behalf of the general public, including claims under the UCL).
In reviewing various court decisions that addressed whether the so-called "Broughton-Cruz" rule remained viable after Concepcion, the Court concluded that it did not. The Ninth Circuit reasoned that, because the Broughton-Cruz rule prohibited the arbitration of a "particular type of claim" – here, claims for public injunctive relief -- the rule could not survive Concepcion. Accordingly, the Court held that the FAA preempted California's prohibition against the arbitration of claims for public injunctive relief.
In so ruling, the Ninth Circuit noted that, post-Concepcion, the public policy arguments advanced by the Plaintiff Borrowers no longer justified invalidating an otherwise enforceable arbitration agreement, and that the FAA deprived state legislatures of the ability to require judicial resolution of claims that parties contractually agreed to resolve through arbitration. The Court noted, however, that federal statutory claims were not subject to arbitration under the FAA if Congress intended to keep such claims out of arbitration. See Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 627 (1985)(absent countervailing federal policy, the FAA requires enforcement of private arbitration agreements).
Mindful that its holding could adversely affect the enforcement of certain state laws such as the UCL, and thereby thwart the legislative purposes of state law, the Court nevertheless noted that the preemption analysis in Concepcion required the result in this case.
Turning to the issue of unconscionability as a state-law contract defense to the arbitration clause, the Ninth Circuit noted that this common law defense survived Concepcion. Applying California law, the Court pointed out that the promissory notes clearly and conspicuously set forth the arbitration agreement, plainly stated that the Plaintiff Borrowers would waive certain rights unless they opted-out of the arbitration agreement, and contained a clear warning to Plaintiff Borrowers to read the loan contract carefully before signing it. Accordingly, the Ninth Circuit ruled that the Plaintiff Borrowers lacked an unconscionability defense to enforcement of the arbitration clause.
Finally, because the Court's ruling on the enforceability of the arbitration agreement rendered moot Plaintiff Borrowers' appeal of the district court's dismissal of the complaint, the court declined to address whether the National Bank Act and federal regulations preempted the UCL.
Ralph T. Wutscher
McGinnis Tessitore Wutscher LLP
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