August 2012

1. Significant Developments in Arbitration Under Federal and State Law Presented by: Terry F. Moritz - Goldberg Kohn Ltd., Chicago, Illinois Hiro N. Aragaki – Loyola Law School, Los Angeles, California Eric Tuchmann – American Arbitration Association August 2012

2. AT&T Mobility In AT&T Mobility, the Supreme Court decided that a California judicially crafted rule that served to invalidate an arbitration class-action waiver as unconscionable is in conflict with the Federal Arbitration Act and therefore ineffective. How did the Court get to this position? Is this case mainly about whether class actions generally are appropriate in an arbitration setting?

3. U.S. Chamber of Commerce as Amicus A class-action waiver is a key component of many Chamber members’ arbitration agreements. Decisions like the opinion below, which invalidated a class-action waiver in an arbitration agreement, frustrate the parties’ intent, undermine their existing agreements, and erode the benefits offered by arbitration as an alternative to litigation.

4. The Counterpoint by Amici States of IL, MD, MN, MT, NM, TN, and VT, and the District of Columbia “States have long declined to enforce contracts that are unconscionable or offensive to public policy. These and other state law contract defenses are an important means of protecting consumers against predatory or unfair treatment. In urging FAA preemption of a state-law determination that an adhesive class-action waiver is unconscionable, petitioner asks federal courts to second-guess decades of state contract law, without any administrable standard to guide them.”

5. Brief History of Class Actions in Arbitration Before the Court. In Green Tree Financial Corp. v. Bazzle, 539 U.S. 444 (2003) the Court remanded a matter, ultimately to be returned to an arbitrator to determine whether an arbitration agreement that was silent on class arbitration would permit them.

6. Essential Facts. The parties entered into a contract, governed by South Carolina law, which contained a broad arbitration clause. It was alleged that Green Tree, a lender, failed to provide to the borrowers a legally required form informing them of their rights to counsel and insurance agents. Two sets of borrowers brought separate actions in South Carolina State Court and both sets of respondents compelled arbitration by the same arbitrator. The arbitrator allowed the matters to proceed as class actions. The arbitrator found for the class in both proceedings and awarded significant damages. The South Carolina Supreme Court withdrew both cases from the Court of Appeals after Green Tree appealed the arbitrator's rulings. "[W]e ... hold that class-wide arbitration may be ordered when the arbitration agreement is silent if it would serve efficiency and equity, and would not result in prejudice. If we enforced a mandatory, adhesive arbitration clause, but prohibited class actions in arbitration where the agreement is silent, the drafting party could effectively prevent class actions against it without having to say it was doing so in the agreement.“ In essence, the South Carolina Supreme Court determined the scope of the arbitration agreement. Id., at 266, 569 S.E.2d, at 360.

7. The issue before the U. S. Supreme Court was whether the South Carolina Supreme Court's action was consistent with the FAA. A plurality of the Court said no, vacating and remanding the case for an arbitrator to decide the question of contract interpretation.

8. Green Tree was read to espouse a rule that whether an arbitration agreement -- silent as to the issue of class arbitration -- allows for class arbitration is a matter of contractual interpretation for the arbitrator and not a court. The court did not validate class arbitration.

9. The next major decision: Stolt-Nielsen SA v. AnimalFeeds International Corp., 130 S.Ct. 1758 (2010). Stolt-Nielsen SA, an international shipping company, along with other shippers, found itself facing a class action arbitration demand by a customer, AnimalFeeds International.

10. AAA Class Certification Rules The parties agreed that the arbitrators would follow and be bound by Rules 3 through 7 of the American Arbitration Association's Supplementary Rules for Class Arbitrations. Rule 3 provides that the arbitrator decides whether the arbitration clause allows for class arbitration in a particular instance. The arbitration panel looked at the relevant arbitration clauses and determined that they were silent as to the issue of class arbitration.

11. Competing Contentions AnimalFeeds and its co-plaintiffs argued that the class arbitration could -- and should -- proceed, citing Rule 3 and public policy, in addition to claiming the contracts would otherwise be unconscionable. Stolt-Nielsen argued that the silence meant the parties did not intend to allow for class arbitration, citing cases and arbitration decisions and purporting to distinguish decisions cited by AnimalFeeds.

12. Clause ConstructionAward The arbitration panel issued a Clause Construction Award, concluding that the agreements and the arbitration clauses allowed for class arbitration. It based the award on 21 other class arbitration awards in similar circumstances, though not in international maritime contracts.

13. The case made several trips to the Second Circuit Court of Appeals which ultimately let the matter go forward as a class action arbitration. 548 F.3d 85 (2d Cir. 2008). The Supreme Court reversed the 2nd Circuit and held that a party could not be bound to a class action arbitration if it had not agreed to such a procedure.

14. The Arbitration Panel’s Decision The Supreme Court noted that the Arbitration Panel concluded: "The parties' arbitration clause should be construed to allow class arbitration because (a) the clause is silent on the issue of class treatment and, without express prohibition, class arbitration is permitted under Bazzle; (b) the clause should be construed to permit class arbitration as a matter of public policy; and (c) the clause would be unconscionable and unenforceable if it forbade class arbitration."

15. The Supreme Court analyzed the panel's decision as follows: Because the parties agreed their agreement was "silent" in the sense that they had not reached any agreement on the issue of class arbitration, the arbitrators' proper task was to identify the rule of law that governs in that situation. Had they engaged in that undertaking, they presumably would have looked either to the FAA itself or to one of the two bodies of law that the parties claimed were governing, i.e., either federal maritime law or New York law. But the panel did not consider whether the FAA provides the rule of decision in such a situation; nor did the panel attempt to determine what rule would govern under either maritime or New York law in the case of a "silent" contract. Instead, the panel based its decision on post-Bazzle arbitral decisions that "construed a wide variety of clauses in a wide variety of settings as allowing for class arbitration." The panel did not mention whether any of these decisions were based on a rule derived from the FAA or on maritime or New York law.

16. One of the core decisions. Ultimately, the Court concluded: (T)he differences between bilateral and class-action arbitration are too great for arbitrators to presume, consistent with their limited powers under the FAA, that the parties' mere silence on the issue of class-action arbitration constitutes consent to resolve their disputes in class proceedings.

17. No Inferred Intent The Court went on to find that such a result could not be inferred "solely from the fact of the parties' agreement to arbitrate" because class-action arbitration "changes the nature of arbitration" in various ways: (1) the arbitrator is charged with resolving not just a single dispute, "but instead resolves many disputes between hundreds or thousands of parties"(2) the "presumption of privacy and confidentiality" is lost; (3) the arbitrator's award "adjudicates the rights of absent parties"; and (4) the commercial stakes are particularly significant, as in class-action litigation.

18. Rent-A-Center West v. Jackson, 130 S.Ct. 2772, June 21, 2010 Rent-A-Center West v. Jackson involves the allocation of authority between arbitrators and courts to decide whether an arbitration agreement is unconscionable in a situation where the arbitration clause expressly allocated to the arbitrator any challenge that the arbitration agreement itself was unconscionable.

19. A Rule of Construction – The Interpretive Rule In Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79, 83, 123 S.Ct. 588, 154 L.Ed.2d 491 (2002), the Court established an "interpretive rule," based on an assumption about the parties' expectations. In "circumstance[s] where contracting parties would likely have expected a court to have decided the gateway matter," we assume that is what they agreed to. Thus, "[u]nless the parties clearly and unmistakably provide otherwise, the question of whether the parties agreed to arbitrate is to be decided by the court, not the arbitrator." AT&T Technologies, Inc. v. Communications Workers, 475 U.S. 643, 649, 106 S.Ct. 1415, 89 L.Ed.2d 648 (1986). fn 1

20. Section 2 (of the FAA) operates on the specific "written provision" to "settle by arbitration a controversy" that the party seeks to enforce. Accordingly, unless Jackson challenged the delegation provision specifically, we must treat it as valid under § 2, (of the FAA) and must enforce it under §§ 3 and 4, (of the FAA) leaving any challenge to the validity of the Agreement as a whole for the arbitrator.

21. The 5-4 decision holds that when a contract contains an arbitration clause, then it is up to the arbitrator to decide whether the agreement is enforceable or not. The only time a court considers the validity of the arbitration agreement is when a party challenges the validity of the agreement to delegate the validity question to the arbitrator.

22. Where Does This Leave Us: Some Basic Rules • Under the Federal Arbitration Act (“FAA”), courts must enforce arbitration contracts according to their terms. • Agreements to arbitrate are a matter of consent, not coercion, and parties are generally free to structure their arbitration agreements as they see fit. • Doubts about the scope of arbitrable issues or the meaning of arbitration clauses should be resolved in favor of arbitration.

23. Some Basic Rules D. Congress enacted the FAA to overcome judicial hostility toward arbitration and Congress utilized the full extent of its Commerce Clause power in enacting the FAA. • An arbitration agreement under the FAA is “valid, irrevocable, and enforceable, save upon such grounds as exist law or in equity for the revocation of any contract. • The §2 savings clause “embodies the national policy favoring arbitration and places arbitration agreements on equal footing with all other contracts.

24. In AT&T Mobility LLC v. Vincent & Lisa Concepcion, Supreme Court Docket #09-893, the Supreme Court granted Certiorari to consider. "Whether the Federal Arbitration Act preempts states from conditioning the enforcement of an arbitration agreement on the availability of particular procedures -- here, class-wide arbitration -- when those procedures are not necessary to ensure that the parties to the arbitration agreement are able to vindicate their claims.“ The courts below found that the Concepcions were "essentially guaranteed" to obtain full relief under ATTM's arbitration provision. They thus invalidated that provision not because it precluded the Concepcions from vindicating their own claims, but because it precluded them from serving as the agents for the vindication of claims of third parties.

25. AT&T Mobility focused on two essential facts. The courts below found that the Concepcions were "essentially guaranteed" to obtain full relief under ATTM's arbitration provision. The lower courts invalidated that provision not because it precluded the Concepcions from vindicating their own claims, but because it precluded them from serving as the agents for the vindication of claims of third parties.

26. The Discover Bank Rule The rule deems unconscionable under California law class-action or class-arbitration waivers where: (a) "the waiver is found in a consumer contract of adhesion in a setting in which the disputes between the contracting parties predictably involve small amounts of damages"; and (b) "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. . . ." Discover Bank v. Superior Court, 36 Cal. 4th 148, 162-63 (2005) (citing Cal. Civ. Code § 1668).

27. The Discover Bank Rule The Discover Bank rule is grounded in a California-law principle – embodied in Cal. Civ. Code § 1668 – that "contracts which have for their object, directly or indirectly, to exempt anyone from responsibility for his own fraud. . . are against the policy of the law." See Cal. Civ. Code § 1668. If a company is allegedly engaging in fraudulent acts designed to cheat numerous consumers out of small amounts of money, a class action or class arbitration waiver may, if enforced, effectively act as and exculpatory provision that insulates the company from the consequences of its small scale, but widespread fraud, because the individual, allegedly defrauded consumers have little incentive to pursue separate actions or arbitrations to recoup trivial amounts of damages.

28. AT&T Mobility – Consumer Class Action Confronts Arbitration The Court focused on §2 of the FAA, acknowledging that this provision, “permits arbitration agreements to be declared ‘unenforceable’ upon such grounds as exist at law or in equity for the revocation of any contract” but that arbitration agreements can only be invalidated by generally applicable contract defenses, such as fraud, duress, or unconscionability – not by defenses that apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue.

29. AT&T Mobility – Consumer Class Action Confronts Arbitration Ruling that §2 of the FAA preempts California’s Discover Bank rule – a rule that declared the classification of class arbitration waivers in consumer contracts unconscionable – the Court noted that: Class-wide arbitration includes absent parties, necessitating additional and different procedures and involving higher stakes. Confidentiality becomes more difficult. And while it is theoretically possible to select an arbitrator with some expertise relevant to the class-certification question, arbitrators are not generally knowledgeable in the often dominant procedural aspects of certification, such as the protection of absent parties. The conclusion follows that class arbitration, to the extent it is manufactured by Discover Bank rather than consensual, is inconsistent with the FAA.

30. AT&T Mobility – Consumer Class Action Confronts Arbitration The Court concluded that “[a]rbitration is poorly suited to the higher stakes of class litigation,” and, thus, struck down the Discover Bank Rule as hostile to the use of individual arbitration to resolve consumer disputes.

31. Following AT&T Mobility There Are Several More Refined Rules. The FAA supplants state laws that discriminate against arbitration. • States cannot require a dispute to be resolved in a judicial forum where the parties have agreed to arbitration. • The FAA preempts state law that undermines a primary objective of an arbitration agreement, such as “achieving streamlined proceedings and expeditious results.” • Under the FAA, pre-dispute arbitration agreements are valid even if the governing state law provides that such arbitration agreements are unenforceable.

32. How Lower Courts Have Viewed AT&T Mobility Some courts skirt the holding of AT&T Mobility by finding a particular arbitration agreement to be unenforceable for reasons aside from the inclusion of a class arbitration waiver. Kanbar- v. O’Melveny for example, “arbitration agreements are still subject to unconscionability analysis... [and] the doctrine of unconscionability can override the terms of an arbitration agreement and the parties’ expectations in connection therewith.” The Kanbar court held that the arbitration agreement was both procedurally and substantively unconscionable based on its “take it or leave it” condition of employment, its strict notice requirements and overly burdensome confidentiality provisions.

33. How Lower Courts Have Viewed AT&T Mobility The court in NAACP of Camden County East v. Foulke Management Corp. held that the arbitration agreement was unenforceable due to lack of mutual assent and because of confusing and inconsistent provisions. Likewise, in Sanchez v. Valencia Holding Co., LLC, a California Court of Appeal for the Second District declared an arbitration agreement to be procedurally and substantively unconscionable based on the cumulative effect of various provisions.

34. Some Lower Courts Expanded the AT&T Mobility Holding In Litman v. Cello Partnership, the Third Circuit refused to follow the New Jersey Supreme Court’s holding in Muhammed v. County Bank of Rehoboth Beach, Delaware, which prohibited class waivers in consumer contracts of adhesion that involved disputed involving small amounts of damages. In overturning Muhammed and enforcing the particular arbitration agreement at issue, the Third Circuit noted: We understand the holding of Concepcion to be both broad and clear: a state law that seeks to impose class arbitration despite a contractual agreement for individualized arbitration is inconsistent with, and therefore preempted by, the FAA, irrespective of whether class arbitration ‘is desirable for unrelated reasons.’

35. Some Lower Courts Expanded the AT&T Mobility Holding The Eleventh Circuit applied a strict interpretation of AT&T Mobility to the Florida Deceptive and Unfair Trade Practices and held that “[i]nsofar as Florida law would invalidate [arbitration] agreements as contrary to public policy, such a state law would ‘stand as an obstacle to the accomplishment and execution’ of the FAA.”

36. The Vindication of Rights Doctrine – Does It Apply When Federal Policy Considerations Are At Issue? In Kaltwasser v. AT&T Mobility, LLC, the plaintiff argued that Concepcion did not disturb the vindication of rights doctrine (i.e., the common law doctrine that applies a cost-benefit analysis to class arbitration) under federal common law. Instead, plaintiff argued that Concepcion left room for a court to conduct an “individualized case-by-case” analysis of whether binding plaintiff to individual arbitration would prevent a vindication of rights, in which case the arbitration agreement should be unenforceable.

37. The Competing Federal CasesAmerican Express Merchants Litigation Feb. 1, 2012 The class action waiver in the Card Acceptance Agreement cannot be enforced in this case because to do so would grant Amex de facto immunity from antitrust liability by removing the plaintiffs’ only reasonably feasible means of recovery. As already set forth, Section 2 of the [Federal Arbitration Act], 9 U.S.C. §2, 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.” Given that we believe that a valid ground exists for the revocation of the class action waiver, it cannot be enforced under the FAA.

38. American Express Merchants Litigation The Court relied on a detailed testimony from an economist by a supported affidavit which stated that “[i]n my experience, even a relatively small economic antitrust study will cost at least several hundred thousand dollars, while a larger study can easily exceed $1 million... after reviewing the complaint and doing some preliminary research in this case, it is my opinion that... the cost for this case will fall in the middle of the range.

39. American Express Merchants Litigation The Court found that based on the affidavit that the only economically feasible means for enforcing plaintiffs statutory rights is via a class action,” and remanded the case to the district court.

40. American Express Merchants Litigation Stolt-Nielsen and Concepcion do not require that all class-action waivers be deemed per se enforceable. That leaves open the question presented on this appeal; whether a mandatory class action waiver clause is enforceable even if the plaintiffs are able to demonstrate that the practical effect of enforcement would be to preclude their ability to bring federal antitrust claims. While we cannot rely on Concepcion or Stolt-Nielsen to answer the question before us, we continue to find useful guidance in other Supreme Court decisions addressing the issue of vindicating federal statutory rights via arbitration.

41. American Express Merchants Litigation Supreme Court precedent recognizes that the class action device is the only economically rational alternative when a large group of individuals or entities has suffered an alleged wrong, but the damages due to any single individual or entity are too small to justify bringing an individual action. A critical fact in this litigation is that petitioner’s individual stake in the damages award he seeks is only $70. No competent attorney would undertake this complex antitrust action to recover so inconsequential an amount. Economic reality dictates that petitioner’s suit proceed as a class action or not at all. Eisenv. Carlisle & Jacquelin 917.2S156 161 (1974)

42. American Express Merchants Litigation Arbitration is also recognized as an effective vehicle for vindicating statutory rights, but only “so long as the Prospective litigant may effectively vindicate its statutory cause of action in the arbitral forum. “Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 632 (1985) (emphasis added). Indeed, in dicta the Mitsubishi Court noted that should clauses in a contract operate “as a prospective waiver of a party’s right to pursue statutory remedies for antitrust violations, we would have little hesitation in condemning the agreement as against public policy.”

43. American Express Merchants Litigation Neither Stolt-Nielsen no Concepcion overrules Mitsubishi, and neither makes mention of Green Tree. We continue to find Green Tree “controlling here to the extent that it holds that when ‘a party seeks to invalidate an arbitration agreement on the ground that arbitration would be prohibitively expensive, that party bears the burden of showing the likelihood of incurring such costs.’” Amex II, 634 F.ed at 197 (quoting Green Tree, 531 U.S. at 92). Other Circuits permit plaintiffs to challenge class action waivers on the grounds that prosecuting such claims on an individual basis would be a cost prohibitive method of enforcing a statutory right. See e.g. In re Carton Yarn Antitrust Litig., 505 F.3d 274, 285 (4th Cir. 2007) (“[I]f a party could demonstrate that the prohibition on class actions likely would make arbitration prohibitively expensive, such a showing could invalidate an agreement.”) (citation omitted; Livingston v. Assoc. Fin. Inc., 339 F.3d 553, 557 (7th Cir. 2003).

44. American Express Merchants Litigation As detailed above, we are persuaded by the record before us that if plaintiffs cannot pursue their allegations of antitrust law violations as a class, it is financially impossible for the plaintiffs to seek to vindicate their federal statutory rights. Since the plaintiffs cannot pursue these claims as class arbitration, either they can pursue them as judicial class action or not at all. If they are not permitted to proceed in a judicial class action, then they will have been effectively deprived of the protection of the federal antitrust law. The defendant will thus have immunized itself against all such antitrust liability by the expedient of including in its contracts of adhesion an arbitration clause that does not permit class arbitration, irrespective of whether or not the provision explicitly prohibits class arbitration.

45. American Express Merchants Litigation Therefore, in light of the fact that the arbitration provision at issue here does not allow for class arbitration, under Stolt-Nielsen and by its terms, if the provision were enforced it would strip the plaintiff of rights accorded them by statute. We conclude that this arbitration clause is unenforceable. We remand to the district court with the instruction to deny the defendant’s motion to compel arbitration.

46. Reed v. Florida Metropolitan University Incorporated, 5th Circuit Arbitration Provisions Both student and the University irrevocably agree that any dispute between them shall be submitted to Arbitration. Neither the student nor the University shall file or maintain any lawsuit in any court against the other, and agree that any suit filed in violation of this Agreement shall be dismissed by the court in favor of an arbitration conducted pursuant to this Agreement.

47. The District Court Properly Referred the Class Arbitration Issue to the Arbitrator. The School contends that the district court erred when it allowed the arbitrator to determine whether the parties’ arbitration agreement allowed for class arbitration, instead of deciding the issue itself. We disagree. The Supreme Court has not definitively decided this issue. In Green Tree Financial Corp. v, Bazzle, 539 U.S. 444, 123 S.Ct. 2402, 156 L.Ed.2d 414 (2003), four Justices concluded that the class arbitration issue did not constitute a “gateway” or arbitrability matter that is generally decided by a court, but was instead a procedural matter for the arbitrator. Id. at 452. In Stolt-Nielsen, the Court confirmed that Green Tree “did not yield a majority decision” on this issue. 130 S.Ct. at 1772. The Stolt-Nielsen Court declined to revisit the question because the parties in that case had agreed to submit the question to the arbitrator rather than the court. Id. At the least at the Supreme Court level, therefore, the question remains open.

48. The District Court Erred in Confirming the Arbitration Award. After a hearing, the arbitrator issued an award in which he determined that the parties’ arbitration provision allowed for class arbitration. The district court granted Reed’s motion to confirm the award and denied the School’s cross-motion to vacate the award. The School contends that the arbitration award is inconsistent with Stolt-Nielsen, and that the arbitrator exceeded his authority by ordering the parties into class arbitration without a sufficient contractual basis.

49. The Basis For The Award. The arbitrator began by acknowledging that the class arbitration issue presented a “close case,” and was primarily governed by Stolt-Nielsen. After determining that the FAA and Texas law applied, he then focused on two provisions of the parties’ arbitration agreement: (1) the “any dispute” provision, which provides, “[t]he student agrees that any dispute arising from my enrollment at Everest University, no matter how described, pleaded or styled, shall be resolved by binding arbitration under the Federal Arbitration Act conducted by the American Arbitration Association under its Commercial rules;” and (2) the “any remedy” provision, which provides, “[a]ny remedy available from a court under the law shall be available in the arbitration.” The arbitrator concluded that, “[w]hen these two provision[s] are read in the context of the entire Agreement, the [School] implicitly agreed to class arbitration,” and there was a sufficient “’contractual basis’ for class arbitration.”

50. First, the arbitrator improperly relied upon the “any dispute” clause of the arbitration agreement. On its face, the “any dispute” clause merely reflects an agreement between the parties to arbitrate their disputes. Stolt-Nielsen makes clear, however, that an “implicit agreement to authorize class-arbitration is not a term that the arbitrator may infer solely from the fact of the parties’ agreement to arbitrate.” 130 S.Ct. at 1775 (emphasis added). This clause is therefore not a valid contractual basis upon which to conclude that the parties agreed to submit to class arbitration.