In AT&T Mobility v. Concepcion, No. 09-893, the U.S. Supreme Court validated consumer contracts with arbitration clauses containing class action waivers. This decision may cause companies that do not have arbitration provisions in their consumer contracts to add them in order to limit or avoid class actions.

In a 5-4 ruling, Justice Antonin Scalia’s majority opinion held that the Federal Arbitration Act (“FAA”) preempted the California rule articulated in Discover Bank v. Superior Court, 36 Cal. 4th 148, 113 P.3d 1100 (2005), which stated that class action waivers in consumer contracts are largely unconscionable. Specifically, the Court found the Discover Bank rule “stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress.” In the course of reaching its decision, the Court made clear its strong disfavor of class action arbitration.

Procedural History

Vincent and Liza Concepcion entered into a cell phone contract with AT&T Mobility LLC (“AT&T”) in answer to an advertisement for a free phone. While the Concepcions were not charged for the phones, they were charged sales tax of $30.02 based on the phones’ retail value. They sued in the Southern District of California, alleging that AT&T engaged in false advertising and fraud. The case was then consolidated into a putative class action lawsuit.

The cell phone contract required that arbitration be pursued on an individual basis and not as a plaintiff or class member in a class. AT&T moved to compel arbitration under the contract. The Concepcions opposed, arguing that the contract was unconscionable because it prohibited class action relief. AT&T’s arbitration agreement was otherwise unusually consumer friendly.

The district court denied AT&T’s motion to compel arbitration, agreeing that the arbitration provision prohibiting class action relief was unconscionable under Discover Bank. The Ninth Circuit affirmed on the same reasoning and additionally held that the FAA did not preempt the Discover Bank rule because it was simply “a refinement of the unconscionability analysis [in California]” and did not conflict with the FAA’s goals.

The Supreme Court's Decision Permits Contractual Waiver of Classwide Arbitration

The Supreme Court reversed and remanded. The majority opinion concluded that Section 2 of the FAA preempted the Discover Bank rule and held that commercial arbitration clauses may limit a plaintiff’s ability to seek classwide relief. Instrumental to this holding was the Court’s finding that Section 2 of the FAA preempted the California rule articulated in Discover Bank.

According to the Court, the two goals of the FAA are the “enforcement of private agreements and encouragement of efficient and speedy dispute resolution.” To that end, the Court found that Section 2 of the FAA required courts to interpret arbitration agreements according to their terms—just like any other contract. Specifically, Section 2 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.” In other words, under FAA Section 2, arbitration agreements can be invalidated by any defense that applies to contracts generally, including fraud, duress, and unconscionability. However, these provisions cannot be avoided by defenses that apply only to arbitration or agreements to arbitrate.

California courts had applied the Discover Bank rule equally to class action litigation waivers in contracts without arbitration agreements and to class arbitration waivers in contracts with such agreements. Thus, the rule seemed to fall within the scope of the FAA’s exception that permitted courts to refuse to enforce arbitration agreements on grounds that exist “for the revocation of any contract.” 9 U. S. C. § 2 (emphasis added).

Nonetheless, the Court found that the Discover Bank rule, which prohibited consumer classwide arbitration waiver provisions in adhesion contracts, improperly interfered with arbitration. The Court explained that judicial application of the rule created an inherent conflict between the state rule and the federal rule: “Requiring the availability of classwide arbitration interferes with fundamental attributes of arbitration and thus creates a scheme inconsistent with the FAA.”

In reaching this decision, the Court built upon its 2010 decision in Stolt-Nielsen S.A. v. AnimalFeeds International Corp., (read related Perkins Coie Update) finding class arbitration unavailable where the contract was silent on the issue. Citing Stolt-Nielsen, the Court emphasized that classwide arbitration diminishes the major benefits to bilateral arbitration and is “poorly suited to the higher stakes of class litigation”:

• Where bilateral arbitration employs “efficient, streamlined procedures tailored to the type of dispute,” class arbitration results in procedural difficulties involving class certification and discovery issues;
• Where bilateral arbitration is inexpensive and quick, class arbitration is more costly and slows down the dispute resolution process;
• Where bilateral arbitration is informal, class arbitration requires procedural formalities to protect absent class members; and
• Where bilateral arbitration is relatively low risk, class arbitration “greatly increases risks to defendants,” as monetary risks are multiplied by the number of petitioners involved in the class and coupled with the inability to appeal or overturn an arbitrator’s decision.

Bottom line: “The switch from bilateral to class arbitration sacrifices the principal advantage of arbitration—its informality—and makes the process slower, more costly and more likely to general procedural morass than final judgment.”

Concurring Opinion

Justice Clarence Thomas “reluctantly” joined the majority opinion, agreeing that the FAA preempts Discover Bank but under a different rationale. In concurring, Thomas contends that the FAA and Discover Bank address separate contract issues—the FAA provides grounds to revoke contracts based on problems at contract formation, while the state case deals with enforcing contracts in light of prevailing public policy concerns.

In interpreting FAA Section 2 as applying to contract formation, Justice Thomas points to Section 4, which requires arbitration according to a contract’s terms only “upon being satisfied that the making of the agreement for arbitration . . . is not in issue.” Thus, he concludes, the FAA requires that arbitration clauses be enforced “unless a party successfully challenges the formation of the arbitration agreement, such as by proving fraud or duress.” Challenges to arbitration agreements based on public policy are not “challenges to the formation” of the contract. Because the rule in Discovery Bank invalidates arbitration agreements based on public policy, i.e., grounds entirely unrelated to the making of the contract, the FAA controls and preempts the state case.

Dissenting Opinion

Justice Stephen Breyer, writing for the three other dissenting justices, took issue with the majority positions that the FAA has twin purposes and that the Discover Bank rule is inconsistent with the primary purpose of the FAA. According to the dissent, the principal objective of the FAA is to secure the enforcement of agreements to arbitrate. Because the Discover Bank rule applies equally to class action waivers in any type of contract, regardless of whether the contract in question contains an arbitration agreement, it does not interfere with the enforcement of arbitration agreements. Additionally, the dissent disagreed with the majority's contention that class arbitration diminished any benefits inherent in arbitration itself, comparing class arbitrations to class action litigations, and argued that class proceedings provided an incentive for small dollar claimants to pursue their claims and a mechanism to prevent companies from “deliberately cheating large numbers of consumers out of individually small sums of money.” Justice Breyer also suggested that federalism principles supported upholding the California rule because federal arbitration usually leaves matters such as contract defenses to the states.

Conclusions and Recommendations

• The decision likely spells the end of class action arbitration, as contracts with arbitration provisions prohibiting classwide relief will be enforced according to their terms.
• Companies seeking to avoid consumer class actions are likely to turn increasingly to arbitration, with a provision barring classwide relief as a means to avoid any class action relief. In effect, the Court has placed class action waivers that are part of arbitration agreements on a higher footing than class action waivers that are not. As a result, companies that calculated the pros and cons of arbitration and rejected arbitration may want to reevaluate their calculus and choose to require arbitration in their consumer agreements.
• ATT Mobility LLC did not entirely block courts from rejecting arbitration provisions as unconscionable. Consumer arbitration agreements must still provide a fair, balanced and inexpensive dispute resolution process.
• Although this was a consumer case, it could significantly impact the development and enforcement of pre-dispute arbitration programs in the employment context.

© 2011 Perkins Coie LLP