Mortgage Banking & Consumer Financial Products Alert

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1 Mortgage Banking & Consumer Financial Products Alert May 11, 2011 Authors: R. Bruce Allensworth Andrew C. Glass Robert W. Sparkes, III K&L Gates includes lawyers practicing out of 37 offices located in North America, Europe, Asia and the Middle East, and represents numerous GLOBAL 500, FORTUNE 100, and FTSE 100 corporations, in addition to growth and middle market companies, entrepreneurs, capital market participants and public sector entities. For more information, visit "Waive of Change:" Class Arbitration in the Aftermath of the Supreme Court's Decision in AT&T Mobility v. Concepcion The United States Supreme Court s most recent decision regarding class arbitration, AT&T Mobility LLC v. Concepcion, 1 represents a significant shift in the legal landscape. The decision validates the enforceability of class action waiver provisions contained in arbitration agreements and clarifies and strengthens the preemptive scope of the Federal Arbitration Act ( FAA ). In particular, the Supreme Court ruled that the FAA preempts state jurisprudence that is applied in a fashion that disfavors arbitration or otherwise interferes with or stands as an obstacle to the pro-arbitration objectives of the FAA. 2 The decision is thus an important victory for businesses that seek to limit their exposure to class action lawsuits through the use of agreements to individually arbitrate disputes, including businesses in the consumer wireless, telecommunications, credit, finance, sales, and products (including the pre-paid card) industries. Silent No Longer; the Court Validates Express Class Action Waivers In a 2010 opinion, Stolt-Nielsen S.A. v. Animal Feeds International Corp., the Supreme Court held that a party may not be compelled under the FAA to submit to class arbitration unless there is a contractual basis for concluding that the party agreed to do so. 3 Where Stolt-Nielsen dealt with arbitration agreements that were silent as to the availability of class arbitration, Concepcion addressed the validity of express class action waivers in arbitration agreements. Specifically, the Court considered whether the FAA prohibits States from conditioning the enforceability of certain arbitration agreements on the availability of classwide arbitration procedures. 4 In a five-four decision, the Court answered in the affirmative, ruling that the FAA preempts state law that stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress. 5 As discussed below, the Court s decision expands the preemptive scope of the FAA and as a result, may preclude most challenges to class action waiver clauses brought pursuant to state-law unconscionability principles.

2 Plaintiffs Claims The Concepcion plaintiffs wireless services agreement with defendant AT&T Mobility LLC ( AT&T ) contained a provision that required arbitration of all disputes between the parties and expressly precluded either party from prosecuting claims on a class-wide basis. 6 When the plaintiffs filed class claims against AT&T in the California federal court, challenging a sales tax charge of $30.22, AT&T moved to compel bilateral arbitration. 7 The District Court denied AT&T s motion to compel arbitration, and the Ninth Circuit affirmed, finding that the class action waiver was unconscionable under California s so-called Discover Bank Rule. 8 The Ninth Circuit reasoned that the Discover Bank Rule was not preempted by the FAA because it was merely a refinement of the unconscionability analysis applicable to contracts generally in California. 9 This outcome was consistent with the majority of federal and state courts that had previously addressed the enforceability of class action waivers in similar contexts. 10 The FAA and Prior Lower Court Treatment of Class Action Waivers The FAA governs the validity and enforceability of arbitration agreements. 11 The act contains a savings clause that provides that an agreement to arbitrate shall be valid, irrevocable and enforceable save upon such grounds as exist at law or in equity for the revocation of any contract. 12 The Supreme Court has interpreted the FAA to expressly preempt any contradictory state law that specifically targets arbitration agreements. 13 The Court, however, has held that, under the savings clause of Section 2 of the FAA (quoted above), agreements to arbitrate or provisions therein may be unenforceable pursuant to state statutes or common law rules that apply equally to all types of contracts. 14 Thus, the Court had held that generally applicable contract defenses such as fraud, duress, or unconscionability, may be applied to invalidate arbitration agreements without contravening [the FAA]. 15 Applying these principles, many federal and state courts that have addressed the enforceability of class action waivers have found that such waivers are not per se unenforceable, but that the waivers may be unenforceable if they are found to be unconscionable under state law. Where class action waivers are contained in consumer-based contracts, courts have typically found such waivers to be unenforceable under state unconscionability law (or a related vindication of statutory rights analysis under the federal substantive law of arbitrability). 16 Courts have reasoned that waivers effectively preclude plaintiffs from pursuing substantive claims because of the remote likelihood that they would bring such claims, normally seeking small damages, on an individual basis. 17 The California Supreme Court s decision in Discover Bank v. Superior Court 18 was an oft-cited example of this unconscionability jurisprudence. That decision provided: [W]hen [a class action] 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 the waiver becomes in practice the exemption of the party from responsibility of [its] own fraud, or willful injury to the person or property of another. Under these circumstances, such waivers are unconscionable under California law and should not be enforced. 19 The Supreme Court s Strengthening of FAA Preemption In Concepcion, the Supreme Court considered the issue of whether California s Discover Bank Rule predicated on California law of unconscionability was preempted by the FAA. 20 The Supreme Court found that the FAA does preempt the Discover Bank Rule, and therefore, that the rule cannot preclude enforcement of a class action waiver. 21 The Court explained that the rule was not only inconsistent with the purposes and objectives of the FAA, but also an obstacle to the accomplishment and execution of those purposes and objectives. 22 May 11,

3 Significantly, the Court ruled that the purposes and objectives of the FAA may be thwarted not only by laws that expressly prohibit arbitration of certain claims, but also by generally applicable contract defenses like unconscionability that are applied in a fashion that disfavors arbitration. 23 This is true, the Court reasoned, even if the generally applicable rule of law at issue technically applies to all contracts but in effect has a disproportionate impact on arbitration agreements in particular. 24 A rule that invalidates an express class action waiver, and effectively requires the parties to undergo classwide arbitration, necessarily interferes with fundamental attributes of arbitration because such a rule is inconsistent with the plain language of the parties arbitration agreement. 25 Moreover, the Court found that compelling a party to defend class claims in arbitration undermines the fundamental and principal advantages of arbitration that is, streamlined procedures geared towards quick, efficient, and less costly resolution of disputes. 26 Put simply, class arbitration that is manufactured by application of state law is not arbitration as envisioned by the FAA, lacks its benefits, and therefore may not be required by state law. 27 The Potential Impact of the Supreme Court s Decision The Supreme Court s decision in Concepcion will likely have a far-reaching impact on the enforceability of class action waivers contained in consumer contracts. The decision will extend more broadly than the particular facts presented in Concepcion. First, the Court s own description of the issue presented is expansive, namely whether the FAA prohibits States from conditioning the enforceability of certain arbitration agreements on the availability of classwide arbitration procedures. 28 Viewing the issue through such a broad lens suggests that the Court would likely find no meaningful distinction between the application of California law and another state s unconscionability law. That is so because most, if not all, courts unconscionability analyses turn, at least in part, on the unavailability of class procedures and whether that unavailability effectively precludes a party from vindicating his or her substantive rights. Second, and most importantly, the wide-ranging impact of the Concepcion decision is supported by the Court s significant expansion of the preemptive scope of the FAA. Indeed, the Court found that state contract law of general applicability including unconscionability principles may be preempted by the FAA where such rules interfere with or are applied in a fashion that disfavors arbitration. 29 Accordingly, the writing is on the wall that the Supreme Court will likely not permit state unconscionability law to preclude enforcement of arbitration agreements or the class action waivers contained therein. Conclusion In Concepcion, the Supreme Court clearly signals that courts should enforce arbitration agreements and class action waivers contained therein and that the FAA preempts state jurisprudence that tends to frustrate the pro-arbitration objectives underlying the FAA. The Court s decision significantly limits the manner in which plaintiffs may avoid class action waivers and, thus, is a decisive victory for business entities particularly entities in the consumer wireless, telecommunications, credit, and similar industries that seek to limit their exposure to class action lawsuits through bilateral arbitration agreements. May 11,

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For more information, visit K&L Gates comprises multiple affiliated entities: a limited liability partnership with the full name K&L Gates LLP qualified in Delaware and maintaining offices throughout the United States, in Berlin and Frankfurt, Germany, in Beijing (K&L Gates LLP Beijing Representative Office), in Brussels, in Dubai, U.A.E., in Shanghai (K&L Gates LLP Shanghai Representative Office), in Tokyo, and in Singapore; a limited liability partnership (also named K&L Gates LLP) incorporated in England and maintaining offices in London and Paris; a Taiwan general partnership (K&L Gates) maintaining an office in Taipei; a Hong Kong general partnership (K&L Gates, Solicitors) maintaining an office in Hong Kong; a Polish limited partnership (K&L Gates Jamka sp.k.) maintaining an office in Warsaw; and a Delaware limited liability company (K&L Gates Holdings, LLC) maintaining an office in Moscow. K&L Gates maintains appropriate registrations in the jurisdictions in which its offices are located. A list of the partners or members in each entity is available for inspection at any K&L Gates office. This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer K&L Gates LLP. All Rights Reserved. 1 No , --- U.S. ---, 2011 WL (U.S. Apr. 27, 2011). 2 3 Id. at *6, 9, 13. Stolt-Nielsen S.A. v. AnimalFeeds International Corp., 559 U.S. ---, 130 S. Ct. 1758, (2010) (emphasis in original). For a more detailed discussion of the United States Supreme Court s decision in Stolt- Nielsen, see K&L Gates Client Alert entitled Class Arbitration Waivers: Silence Reigns in Stolt-Nielsen, But the Courts Have More to Say, by Bruce Allensworth, Andrew Glass, Robert Sparkes, and Roger Smerage (June 15, 2010), available at Concepcion, 2011 WL , at *3. Id. at *13 (quoting Hines v. Davidowitz, 312 U.S. 52, 67 (1941) (internal quotations omitted)) See id. at *3. See id. Id. The Discover Bank Rule has its genesis in the California Supreme Court s decision in Discover Bank v. Superior Court, 36 Cal. 4th 148, 113 P.3d 1100 (2005). 9 Concepcion, 2011 WL , at *4 (quoting Laster v. AT&T Mobility LLC, 586 F.3d 849, 857 (9th Cir. 2009)). 10 Notably, the arbitration agreement at issue in Concepcion contained a number of consumer-friendly provisions, including that: (1) AT&T would pay all costs for arbitration of nonfrivolous claims; (2) either party could bring a claim in small claims court in lieu of arbitration; (3) the arbitrator could award any form of individual relief; (4) AT&T would be precluded from seeking reimbursement of its attorneys fees; and (5) AT&T would be required to pay a minimum recovery of $7,500 and twice the amount of the claimant s attorneys fees if the claimant obtained an arbitration award greater than AT&T s last written settlement offer. See id. at *3. The Court s decision in Concepcion does little more than identify the existence of these provisions. See id See 9 U.S.C. 1, et seq. (2006). Id. 2. See Preston v. Ferrer, 552 U.S. 346, 353 (2008); Doctor s Assocs., Inc. v. Casarotto, 517 U.S. 681, 687 (1996) See Doctor s Assocs., Inc., 517 U.S. at 687. Id. See, e.g., Fensterstock v. Education Fin. Partners, 611 F.3d 124, (2d Cir. 2010) (finding unenforceable class action waiver contained in student loan promissory note); Homa v. American Express Co., 558 F.3d 225, (3d Cir. 2009) (finding class action waiver in arbitration provision contained in consumer credit card agreement unconscionable under New Jersey law); Lowden v. T-Mobile USA, Inc., 512 F.3d 1213, (9th Cir. 2008) (finding class action waiver in cellular phone service agreement unconscionable and unenforceable under Washington law); Dale v. Comcast Corp., 498 F.3d 1216, (11th Cir. 2007) (finding class action waiver in cable television subscriber agreements unconscionable under Georgia law); Kristian v. Comcast Corp., 446 F.3d 25, 60-61, 63 (1st Cir. 2006) (finding class action waiver in cable television service agreement unenforceable under the federal substantive law of arbitrability s vindication of statutory rights analysis). But see Cicle v. Chase Bank USA, 583 F.3d 549, 556 (8th Cir. 2009) (finding class action waiver in credit card agreement enforceable under Missouri and Delaware law); Pleasants v. American Express Co., 541 F.3d 853, (8th Cir. 2008) (finding class action waiver in credit card agreement enforceable under Missouri law); Jenkins v. First Am. Cash Advance, 400 F.3d 868, (11th Cir. 2005) (finding class action waiver contained consumer loan agreement to be enforceable under Georgia law); Lloyd v. MBNA Am. Bank, N.A., 27 Fed. Appx. 82, 85 (3d Cir. 2002) (finding class action waiver in consumer credit card agreement enforceable under Delaware law); Snowden v. Checkpoint Check Cashing, 290 F.3d 631, (4th Cir. 2002) (finding class action waiver in consumer lending agreement enforceable) See Note 16, supra. 36 Cal. 4th 148, 113 P.3d 1100 (2005). Concepcion, 2011 WL at *5 (quoting Discover Bank, 36 Cal. 4th at 162, 113 P.3d at 1110). For May 11,

5 cases applying the Discover Bank Rule as a basis for finding class action waivers unconscionable under California law, see Omstead v. Dell, Inc., 594 F.3d 1081, (9th Cir. 2010) (finding unenforceable class action waiver in consumer sales contract); Chalk v. T-Mobile USA, Inc., 560 F.3d 1087, 1095 (9th Cir. 2009) ( a class action waiver in a consumer contract involving small damages is substantively unconscionable ); Shroyer v. New Cingular Wireless Servs., Inc., 498 F.3d 976, (9th Cir. 2007) (finding class action waiver in cellular phone service agreement unconscionable under California law). Courts in other jurisdictions have also relied upon Discover Bank as persuasive authority to assess the enforceability of class action waivers under other states laws. See, e.g., Fensterstock, 611 F.3d at ; Homa, 558 F.3d at ; Kristian, 446 F.3d at 60-61, See Concepcion, 2011 WL at *5-6. See id. at *8, 13. Id. at *13 (internal quotation omitted). Id. at *6-7. See id. at *7 ( [a]lthough 2 [of the FAA s] saving clause 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 ). 25 See id. at *8-10. Moreover, to the extent that a state rule of law would invalidate the entire arbitration agreement and thus permit the plaintiff to bring class claims in state or federal court, the rule would likely be found to violate the FAA s liberal policy favoring the enforcement of agreements to arbitrate See id. at *12. Id. Id. at *3. See id. at *6-7. May 11,