Federal Arbitration Act Preempts California Law of Contractual Unconscionability: Supreme Court

This posting was written by William Zale, Editor of CCH Advertising Law Guide.

In a dispute over a consumer contract with an arbitration clause that included a class action waiver, the Federal Arbitration Act preempted a California rule of law that barred the waiver as unconscionable, the U.S. Supreme Court held today in a 5-4 decision.

The court reversed and remanded a decision of the U.S. Court of Appeals in San Francisco (CCH Advertising Law Guide ¶64,059) declining to compel individual arbitration of a consumer’s claim for $30.22 in a dispute over a wireless telephone service provider's practice of charging sales tax on cell phones advertised as “free.” The appeals court had held that the class action waiver in the wireless service agreement was unconscionable under the law of California.

In Discover Bank v. Superior Court, the California Supreme Court held that the doctrine of unconscionability barred the enforcement of class action waivers in arbitration clauses when the contracting party with superior bargaining power is alleged to have deliberately cheated large numbers of consumers out of individually small sums of money.

Federal Arbitration Act

Section 2 of the Federal Arbitration Act provides that a written contractual provision to arbitrate a controversy arising out of the contract is enforceable “save upon such grounds as exist at law or in equity for the revocation of any contract.”

While acknowledging that unconscionability is a generally applicable doctrine of contract law, Justice Scalia, writing for the majority, concluded that Section 2 of the Federal Arbitration Act preempted California’s Discover Bank rule.

Individual v. Class Arbitration

A switch from individual to class arbitration would make the process slower, more costly, less informal, and greatly increase the risks to defendants, according to the Court. When damages allegedly owed to tens of thousands of potential claimants are aggregated and decided at once, the risk of an error will often become unacceptable, the Court announced.

The arbitration agreement provided that the wireless provider would pay claimants a minimum of $7,500, and twice their attorney’s fees, if they obtained an arbitration award greater than the provider’s last settlement offer, the Court added.

Dissent

Justice Breyer, in a dissent joined by Justices Ginsburg, Sotomayor, and Kagan, questioned whether a rational lawyer would have signed on to represent a client for the possibility of fees stemming from a $30.22 claim. The Federal Arbitration Act’s basic objective was to assure that courts treat arbitration agreements like all other contracts. Recognition of the federalist ideal, embodied in specific language in the statute, should lead the Court to uphold California’s law, not to strike it down, according to the dissent.

The April 27 decision in AT&T Mobility LLC v. Concepcion will be reported in CCH Advertising Law Guide.

Non-Signatory Not Obligated to Arbitrate Claims Against Manufacturer, Distributor

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

The doctrine of direct benefits estoppel did not obligate an oil drilling company to arbitrate its claims against a manufacturer and a distributor of mooring ropes because the drilling company did not “embrace” the Purchase Order Agreements between the manufacturer and distributor that contained a mandatory arbitration clause, according to the U.S. Court of Appeals in New Orleans.

A federal district court’s dismissal of the drilling company’s suit—based on the application of the doctrine of direct benefits estoppel—was reversed, and the case was remanded for further proceedings.

To fulfill the drilling company’s order for mooring ropes, the distributor entered into Purchase Order Agreements with the manufacturer that incorporated a mandatory arbitration provision. The drilling company was not shown to have been furnished a copy of those agreements, and its orders for the mooring ropes did not contain an arbitration clause, the court noted.

After the mooring ropes allegedly failed—damaging the drilling company’s rigs—the company brought suit against the manafucturer and distributor for breach of warranty, fraud, and other claims.

The district court held that the drilling company was required to arbitrate its claims because they were premised on the manufacturer’s failure to perform according to the Purchase Order Agreements.

“Embracing” Contract

Direct benefits estoppel involved non-signatories who, during the life of a contract, “embraced” the contract, despite their non-signatory status, and then attempted to repudiate the arbitration clause in the contract during litigation, the appellate court observed.

A non-signatory could embrace a contract containing an arbitration clause either by:

(1) knowingly seeking and obtaining direct benefits from the contract or

(2) seeking to enforce the terms of the contract or asserting claims that must be determined by reference to the contract.

The first of those two possibilities was not satisfied because there was no evidence that the drilling company had any knowledge of the Purchase Order Agreements at the time that it purchased and received the ropes. Thus, the drilling company did not have the knowledge required to support the “knowingly exploited” theory of direct benefits estoppel.

Since the drilling company did not seek to enforce a specific term of the Purchase Order Agreements, the second theory of direct benefits estoppel could apply only if the drilling company’s claims could be determined solely by reference to the Purchase Order Agreements.

Non-Contractual Claims

As a plaintiff, the drilling company was not required to base its claims on the Purchase Order Agreements and could, disclaim any reliance upon them, the court held. The drilling company argued that all of its claims were based either on pre-purchase misrepresentations or on obligations imposed by law. Thus, the second theory of direct benefits estoppel did not apply.

The September 15 decision in Noble Drilling Services, Inc. v. Certex USA, Inc. will appear in the CCH Business Franchise Guide.

Chrysler Required to Reinstate Dealership Terminated in Network Reduction

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

A balancing of the economic interests of a motor vehicle franchisor (Chrysler), a terminated dealer (Fury), and the public led to the conclusion that the Lake Elmo, Minnesota dealership should be reinstated to the Chrysler motor vehicle dealer network and have its franchise agreements renewed, as prescribed by Section 747 of the Consolidated Appropriations Act of 2010, an arbitrator has determined.

The dealer had been terminated in connection with Chrysler’s reorganization in bankruptcy and sought reinstatement through the binding arbitration procedures outlined in the statute (CCH Business Franchise Guide ¶14,281) that was signed into law on December 16, 2009.

The Act required an arbitrator’s determination as to whether a dealer should be added back to a franchisor’s dealer network to result from a balancing of the economic interests of the dealer, the franchisor, and the public at large.

According to the arbitrator, the factors to be considered in such balancing included:

(1) Chrysler’s overall business plan;

(2) Fury’s profitability during 2006, 2007, 2008, and 2009;

(3) Fury’s current economic viability;

(4) Fury’s satisfaction of the performance objectives of its franchise agreement;

(5) the demographic and geographical characteristics of the dealer’s market territory;

(6) Fury’s performance in relation to the criteria used by Chrysler to terminate it; and

(7) the length of Fury’s experience.

Reinstating Fury would not result in any meaningful harm to the economic interests of Chrysler, the arbitrator decided. Based on all of Chrysler’s dealership performance criteria, Fury scored within the top 29% to 47% of all dealers in the local and national markets during the two years prior to its termination.

The public interest would not be materially affected by a decision to restore Fury to Chrysler’s network, the arbitrator reasoned. There was no material public interest associated with the convenience of having, or the inconvenience of not having, the Fury dealership in Lake Elmo, Minnesota.

There were economic harms to Fury from not being reinstated, but they were not overwhelming. Fury would not fail to survive if Chrysler did not reinstate it; however, it certainly would be more vulnerable. Moreover, Fury would suffer the stigma of being only a used car dealer with no new car franchise.

While those harms were not overwhelming, they were also not trivial and were greater than any meaningful harms to Chrysler, which were largely non-existent, the arbitrator concluded.

A detailed summary of the arbitrator’s determination (Fury Dodge, LLC v. Chrysler Group, LLC, American Arbitration Association, Case No. 65-532 000047 10, June 25, 2010) appears at CCH Business Franchise Guide ¶14,406.

Further information regarding CCH Business Franchise Guide appears here on the CCH Online Store.

Arbitration Firm Agrees to Settle False Advertising Case

This posting was written by William Zale, Editor of CCH Advertising Law Guide.


The National Arbitration Forum—the country’s largest administrator of credit card and consumer collections arbitrations—has agreed to get out of the business of arbitrating credit card and other consumer collection disputes, in order to settle a false advertising, consumer fraud, and deceptive trade practices action filed by Minnesota Attorney General Lori Swanson.

The Forum allegedly misrepresented its independence and hid from consumers and the public its extensive ties to the collection industry. The Forum is named as the arbitrator of consumer disputes in tens of millions of credit card agreements.

According to Attorney General Swanson’s complaint, the Forum allegedly told consumers and the public that it is independent and neutral, operates like an impartial court system, and is not affiliated with and does not take sides between the parties. The Forum allegedly worked behind the scenes, however, to convince credit card companies and other creditors to insert arbitration provisions in their customer agreements and then appoint the Forum to decide the disputes.

The complaint also alleged that the Forum has financial ties to the collection industry. The company allegedly arbitrated 214,000 consumer arbitration claims in 2006, nearly 60 percent of which were filed by laws firms with which the Forum is linked through ties to a New York hedge fund.

“The National Arbitration Forum remains committed to consumer arbitration as the best and most affordable option for consumers to resolve disputes quickly and efficiently. However, the FORUM lacks the necessary resources to defend against increasing challenges to arbitration on all fronts, including from state attorneys general and the class action trial bar,” said Mike Kelly, CEO of Forthright, which provides administrative services for the Forum.

Pending Federal Legislation

Legislative proposals pending in both houses of Congress threaten to eliminate pre-dispute arbitration, according to the Forum’s press release announcing the settlement. The Arbitration Fairness Act of 2009 (S. 931/H.R. 1020) would invalidate every pre-dispute contractual arbitration agreement that is part of a consumer, financial or franchise dispute. The Fairness in Nursing Home Arbitration Act (S. 512/H.R. 1237) would eliminate pre-dispute mandatory arbitration in all nursing home contracts. Legislation before the House to create a new Consumer Financial Protection Agency (H.R. 3126) would provide regulatory authority to restrict or eliminate consumer arbitrations.

In announcing the settlement on July 20, Attorney General Swanson said that she had accepted an invitation from Congressman Dennis Kucinich, Chairman of the Congressional Committee on Oversight and Government Reform, to testify before the Committee. She said she would ask Congress to prohibit the use of mandatory pre-dispute arbitration clauses in consumer contracts.

“The playing field is tilted against the ordinary consumer when credit card companies bury unfair terms like forced arbitration clauses in fine print contacts. Congress should change that,” said Swanson.