The enforceability of class waivers in arbitration agreements

In light of the U.S. Supreme Court's ruling in Lamps Plus v. Varela, 139 S. Ct. 1407 (2019), a hot topic in the business and legal communities is the overall enforceability of class action waivers in arbitration agreements. Trial judges, lawyers and litigants encounter this issue in drafting, arguing, interpreting and ruling on the effectiveness of the myriad of arbitration clauses containing class action waivers. This article seeks to inform the reader of how courts view arbitration clauses generally in light of the purposes of the Federal Arbitration Act and specifically as to class action waivers. It will also show that attempts by courts, legislative bodies, and contracting parties to avoid application of the FAA or thwart its purpose or application will not generally survive judicial scrutiny.

Federal Law and Policy Favors Arbitral Dispute Resolution

In drafting or reviewing arbitration clauses effectively, it is important to understand some basic principles as to how arbitration agreements are viewed by the courts. The principle statute dealing with arbitration is the FAA. The FAA provides that a "written provision in ... a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction ... shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract." Marmet Health Care Ctr., Inc. v. Brown, 565 U.S. 530, 532 (2012). The FAA "'reflects an emphatic federal policy in favor of arbitral dispute resolution.'" KPMG LLP v. Cocchi, 565 U.S. 18, 21, quoting Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 631. Under the FAA courts must "enforce arbitration agreements according to their terms." Epic Sys. Corp. v. Lewis, 138 S. Ct. 1612, 1619 (2017). It is now unquestionably clear that courts must do so "rigorously." American Express Co. v. Italian Colors Restaurant, 570 U. S. 228, 233 (2013). The FAA applies in state as well as federal courts. Southland Corp. v. Keating, 465 U.S. 1, 14-15 (1984).

Arbitration is a Matter of Consent

According to the Supreme Court, the foundational principle that underscores all of its arbitration decisions is that "[a]rbitration is strictly 'a matter of consent.'" Granite Rock Co. v. Teamsters, 561 U. S. 287, 299, quoting Volt Info. Sciences, Inc. v. Board of Trustees of Leland Stanford Jr. University, 489 U.S. 468, 479 (1989); see also Lamps Plus, 139 S. Ct. 1407. By consenting to arbitration, the parties give arbitrators the power to hear and resolve their disputes. Stolt-Nielsen S. A. v. AnimalFeeds Int'l Corp., 559 U.S. 662, 682 (2010). The parties also have tremendous power in shaping the process. They may designate "with whom they will arbitrate, the issues subject to arbitration, the rules by which they will arbitrate, and the arbitrators who will resolve their disputes." Id. at 683-84. In reviewing arbitration agreements, the fundamental task of the courts is to "to give effect to the intent of the parties." Id. at 684. Normally, a court may rely on state law contract principles to give effect to such intent, including things such as whether the parties agreed to arbitrate a particular matter. First Options of Chicago, Inc. v. Kaplan, 514 U. S. 938, 944 (1995). However, where state law principles "stand[] as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress" as articulated by the FAA and interpreted by the courts, they are preempted. AT&T Mobility LLC v.Concepcion, 563 U.S. 333, 352 (2011).

For example, although unconscionability is a generally a defense to enforcement of an arbitration agreement under the FAA, "[t]he general applicability of the rule" could not "save it from preemption under the FAA with respect to arbitration agreements" where it "had been interpreted by [a] state court to bar class action waivers in consumer contracts" both in the litigation and arbitration contexts "because it had the consequence of allowing any party to a consumer arbitration agreement to demand class proceedings 'without the parties' consent.'" Lamps Plus, 139 S. Ct. at 1418, quoting Epic Sys., 138 S. Ct. 1612 (describing the Supreme Court's action in Concepcion, 563 U.S. at 348).

Courts Will Not Compel Class Arbitration Where the Parties Have Not Clearly Consented to Such Arbitration as Contemplated by the FAA

The foregoing arbitration principles are indispensable in determining whether courts will enforce various arbitration clauses or grant or deny petitions or motions to compel arbitration of certain disputes. One of the major issues now presented in the cases is whether courts will order class arbitration in light of the parties' particular agreement and various state and federal laws and decisions dealing with the subject. For example, employers who have entered into arbitration agreements often seek to avoid class arbitration, which as will be later discussed, significantly alters the nature of a traditional arbitration. Lamps Plus, 139 S. Ct. 1407. Likewise, there are many cases where a plaintiff will file a lawsuit on behalf of himself or herself individually, as well as claims on behalf of a specified class. Sandquist v. Lebo Automotive, Inc., 1 Cal. 5th 233 (2016). Applying the basic arbitration principles set forth above, the courts will start with a review of the arbitration clause or clauses in dispute. If the arbitration agreement provides for class arbitration, the courts will generally enforce it. This results from the fact that courts will enforce class arbitration if "there is a contractual basis for concluding that the [parties] agreed" to it. Stolt-Nielsen, 559 U.S. at 684. This relates back to the fundamental principle that arbitration is a matter of consent.

Nevertheless, the Supreme Court has noted that class arbitration fundamentally changes the traditional nature of arbitration. Id. at 685-86. These differences between class action arbitration and individual arbitration strongly affects the court's view of class action waivers. In traditional individual arbitration, the parties avoid the usual procedural formality, rigor and heightened stress of a trial in the courts and, with few exceptions, give up the right to appellate review of the arbitrator's decision. Id. at 685. In exchange, their matter is heard in a proceeding in which there are "lower costs, greater efficiency and speed, and the ability to choose expert adjudicators to resolve specialized disputes." Id. In the Supreme Court's view, class arbitration is slower, more formal, "more costly, and more likely to generate procedural morass than final judgment." Concepcion, 563 U.S. at 348. With class arbitration, "the virtues Congress originally saw in arbitration, its speed and simplicity and inexpensiveness, [are] shorn away and arbitration [winds up] looking like the litigation it was meant to displace." Epic Sys., 138 S. Ct. at 1623. "Because of these 'crucial differences' between individual and class arbitration" courts will not infer mutual consent to class arbitration. Lamps Plus, 139 S. Ct. at 1411. Such consent must be manifested by a contractual agreement to arbitrate class claims. Id. Silence on the matter of class arbitration in an arbitration agreement has been declared a legally insufficient basis to conclude the parties consented to class arbitration. Stolt-Nielsen, 559 U.S. at 687.

The question then arises as to "whether the FAA similarly bars an order requiring class arbitration when an agreement is not silent, but rather 'ambiguous' about the availability of such arbitration." Lamps Plus, 139 S. Ct. at 1412. For the same reasons set forth by the court with respect to silence on the issue of class arbitration, the court has held that ambiguity cannot form the necessary contractual basis for compelling class arbitration. Id. at 1416. Ambiguity arises when some clauses support one interpretation of an issue and other clauses support a different interpretation of the same issue but both interpretations are reasonable under the circumstances. Id. at 1414-15. The court has held that the FAA "requires more than ambiguity to ensure that the parties actually agreed to arbitrate on a classwide basis." Id. at 1415. Moreover, a state law doctrine, known as contra preferendum, which provides that ambiguities are resolved against the drafter, cannot be used to compel class arbitration where the agreement is ambiguous on that issue because class arbitration which is "'manufactured by [state law] rather than consen[t], is inconsistent with the FAA.'" Id. at 1412 quoting Concepcion, 563 U.S. at 348.

Thus, the preferred method for dealing with class arbitration is to do so expressly within the arbitration agreement. If the parties wish to exclude class arbitration from the scope of arbitral issues, they would be well served to expressly manifest their intent within the arbitration agreement. This applies with equal or greater strength if the parties wish to include class arbitration within the scope of the arbitral issues as the courts will not infer that intent from silence or ambiguity. This analysis highlights the importance of reviewing the arbitration clause in its entirety, searching for possible ambiguities, and clearly and unambiguously setting forth the parties' intent. Lamps Plus, 139 S. Ct. at 1418.

State Laws and Court Decisions that Limit Parties' Ability to Waive Class Action Proceedings in Arbitration Are Generally Preempted by Application of the FAA

Parties often enter into agreements that waive their right to class proceedings. The question arises as to whether a "refusal to enforce such a waiver on grounds of public policy or unconscionability is preempted by the FAA." Iskanian v. CLS Transportation Los Angeles, LLC, 59 Cal. 4th 348, 360 (2014). In other words, can such waivers be appropriately written into arbitration agreements or will state law or court decisions prevent the enforcement of class action waivers? The evolving case law suggests that state laws prohibiting the enforcement of class action waivers on the grounds that they violate public policy or unconscionability are preempted by the FAA. Id. at 360.

Discover Bank Rule Invalidated by Concepcion

Beginning in 2005, by virtue of the California Supreme Court's decision in Discover Bank v. Superior Court, 36 Cal. 4th 148 (2005), California had what was known as the Discover Bank rule. That rule "restricted consumer class action waivers in arbitration agreements." Iskanian, 59 Cal. 4th at 361. The court in Discover Bank stopped short of holding that all class action waivers are unconscionable and therefore unenforceable. However, the Discover Bank court did enunciate the rule that "when the waiver is found in a consumer contract of adhesion in a setting in which disputes between the contracting parties predictably involve small amounts of damages, and when it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money, then, at least to the extent the obligation at issue is governed by California law, the waiver becomes in practice the exemption of the party 'from responsibility for [its] own fraud, or willful injury to the person or property of another'" in violation of California law. In this scenario, the court said that "such waivers are unconscionable under California law and should not be enforced."

The Discover Bank rule was found to be inconsistent with the FAA and invalidated in by the U.S. Supreme Court in Concepcion. In Concepcion, the Supreme Court considered the effect of Section 2 of the FAA on the state court ruling holding the class waiver unenforceable. Section 2 of the FAA provides that arbitration agreements "may be declared unenforceable ... 'upon such grounds as exist at law or in equity for the revocation of any contract.'" That section has been often referred to as a "savings clause."

In Concepcion, the court stated that although the savings clause found within Section 2 of the

FAA, "preserves generally applicable contract defenses, nothing in it suggests an intent to

preserve state-law rules that stand as an obstacle to the accomplishment of the FAA's objectives." The court found that the Discover Bank rule wrongfully "interferes with arbitration." Although the rule was limited to adhesion contracts, the court found that that limitation was not particularly helpful in saving the rule because virtually all consumer contracts are contracts of adhesion. The court found that the rule "'stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress'" and therefore was preempted.

In 2014, in light of Concepcion, the California Supreme Court in Iskanian overruled its own 2007 decision in Gentry v Superior Court, 42 Cal. 4th 443(2007). In Gentry, like Discover Bank, the court had held that some class action waivers were unenforceable. Gentry dealt with class action waivers in arbitration contracts in employment cases. The Gentry court held that where a plaintiff employee was alleging that an employer had "systematically denied proper overtime pay to a class of employees" and the employee sought class arbitration notwithstanding an arbitration agreement prohibiting class arbitration, a trial court must consider several factors to determine whether the class action waiver would be enforceable. If a court concluded based upon factors such as "the modest size of the potential individual recovery, the potential for retaliation against members of the class, the fact that absent members of the class may be ill informed about their rights, and other real world obstacles to the vindication of class members' rights to overtime pay through individual arbitration" "that a class arbitration [was] likely to be a significantly more effective practical means of vindicating the rights of the affected employees than individual litigation or arbitration, and [concluded] that the disallowance of the class action [would] likely lead to a less comprehensive enforcement of overtime laws for the employees alleged to be affected by the employer's violations, it [would be required to] invalidate the class arbitration waiver to ensure that these employees [could] 'vindicate [their] unwaivable rights in an arbitration forum.'"

In Iskanian, the court ruled that Gentry ran "afoul" of the principle in Concepcion that the FAA "prevent[s] states from mandating or promoting procedures incompatible with arbitration." The court thus held that the FAA preempted the Gentry rule. The court noted that "the fact that Gentry's rule against class waiver is stated more narrowly than Discover Bank's rule does not save it from FAA preemption under Concepcion." The court pointed out that the Supreme Court held in Concepcion that even when a state law prohibiting consumer class waivers is limited to "'class proceedings [that] are necessary to prosecute small-dollar claims that might otherwise slip through the legal system,'" "it would still be preempted because states cannot require a procedure that interferes with fundamental attributes of arbitration 'even if it is desirable for unrelated reasons.'"

Additionally, the court noted that "Concepcion held that because class proceedings interfere with fundamental attributes of arbitration, a class waiver is not invalid even if an individual proceeding would be an ineffective means to prosecute certain claims." The Iskanian court concluded that by virtue of Concepcion, it had become apparent that the FAA preempts the Gentry rule. This is largely due to the fact that "the FAA ... prevent[s] states from mandating or promoting procedures incompatible with arbitration." Therefore, class action waivers which are viewed as interfering with the full purposes of the FAA are likely to be held preempted.

Conclusion

When it comes to the enforceability of class arbitration waivers, the courts will focus on the question of consent. If the parties have clearly manifested their intention to permit or exclude class proceedings in their arbitration agreement, the courts will enforce such agreements rigorously. Neither silence nor ambiguity regarding class proceedings in the agreement provide a sufficient basis to conclude the parties have consented to class arbitration. The reader is cautioned that courts have not looked favorably upon legislative attempts to void class waivers as such legislation is often viewed as interfering with the full purposes of the FAA which allows the parties to define, in their agreement, the things to which they consent.

Courts, legislative bodies, or contracting parties must understand the purposes of the FAA and should avoid taking actions that thwart or frustrate those purposes or risk the possibility the actions they take may be voided or otherwise determined to be unenforceable and unable to survive judicial scrutiny.