Part II
Introduction
Part I of this two-part post (here) briefly discussed the background of AT&T Mobility LLC v. Concepcion, No. 09-893, a case pending before the United States Supreme Court that will be argued on November 9, 2010. We now delve into the details of the preemption questions before the Court and take a guess at the outcome.
Federal Arbitration Act Preemption
The Federal Arbitration Act does not preempt all state law applicable to arbitration agreements, but it expressly preempts state law that conflicts with Section 2, and impliedly preempts all state law that “stands as an obstacle to the accomplishment and execution of the full purposes of Congress” embodied in the Federal Arbitration Act. See Shroyer v. New Cingular Wireless Serv., Inc., 498 F.3d 976, 988 (9th Cir. 2007) (citations and quotation omitted).
Does Section 2 of the Federal Arbitration Act Expressly Preempt the Discover Bank Rule?
Section 2 of the Federal Arbitration Act declares that arbitration agreements within its scope “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” 9 U.S.C. § 2. Section 2 establishes substantive federal law that expressly preempts all conflicting state law, except for state law that permits “the revocation of any contract” or governs the formation, interpretation, or construction of contracts generally.
The exception to federal preemption is exceedingly narrow, for it saves from preemption only state laws that apply equally across the board to all contracts. The United States Supreme Court summarized it well when it said:
States may regulate contracts, including arbitration clauses, under general contract law principles and they may invalidate an arbitration clause ‘upon such grounds as exist at law or in equity for the revocation of any contract. What States may not do is decide that a contract is fair enough to enforce all its basic terms (price, service, credit), but not fair enough to enforce its arbitration clause. The Act makes any such state policy unlawful, for that kind of policy would place arbitration clauses on an unequal footing, directly contrary to the Act’s language and Congress’s intent.
Allied-Bruce Terminix Cos. v. Dobson, 513 U.S. 265, 281 (1995) (citations and quotations omitted; emphasis in original).
By preempting state laws that do not apply to all other contracts, it makes arbitration agreements as enforceable of all other contracts, and prevents states from discriminating against them or otherwise making them less enforceable than all other contracts.
The Supreme Court has said that state law grounds for the revocation of “any contract” include “generally applicable contract defenses, such as fraud, duress, or unconscionability,” and that these defenses “may be applied to invalidate arbitration agreements without contravening § 2.” Doctor’s Associates, Inc. v. Casarotto, 517 U.S. 681, 687 (1996). The United States Court of Appeals for the Ninth Circuit and the California Supreme Court say that the Discover Bank rule is a state law ground for the invalidation of any contract (or at least for invalidating a class action waiver made part of the contract) for two reasons.
First, the Discover Bank rule is part of California’s unconscionability law, and unconscionability is a defense to the enforcement of “any contract.” California permits any contract to be voided on unconscionability grounds if, at the time it was made, it was both procedurally and substantively unconscionable. Procedural unconscionability can be established by showing that a party with superior bargaining power offered the agreement on a take-it-or-leave it basis or the bargaining process was otherwise unfair. Substantive unconscionability is established if the agreement “shock[s] the conscience,” or is one that a person would have to be “under delusion” to enter. Odell v. Moss, 130 Cal. 352, 358 (1900); Belton v. Comcast Cable Holdings, LLC, 151 Cal.App.4th 1224, 1245 (1st Dist. 2007); California Grocers Ass’n v. Bank of Am., 22 Cal.App. 4th 205, 215 (1st Dist. 1994). California applies a “sliding scale” rule – if the degree of procedural unconscionability is relatively low, then a greater showing of substantive unconscionability is required, and vice-versa.
The Discover Bank rule says that, as a matter of law, an agreement to waive class arbitration or litigation is procedurally unconscionable if it is contained in a contract of adhesion and is substantively unconscionable if it is: (a) “in a setting in which disputes between the contracting parties predictably involve small amounts of damages;” and (b) “it is alleged that the party with 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 Ct., 36 Cal.4th 148, 162-63 (2005).
Second, the Discover Bank rule is an application of Cal. Civ. Code § 1668, which declares certain exculpatory contracts to be “against the policy of the law:”
All contracts which have for their object, directly or indirectly, to exempt anyone from responsibility for his own fraud, or willful injury to the person or property of another, or violation of law, whether willful or negligent, are against the policy of the law.
Cal. Civ. Code § 1668.
A key premise of the Discover Bank rule is that class waivers are exculpatory contract provisions because consumers that have been the victims of alleged small-dollar but widespread fraud will, for economic reasons, allegedly be deterred from pursuing their small-dollar claims in individual, bilateral arbitrations or litigations. According to California law an agreement that deprives consumers of class procedures exculpates the corporate wrongdoer from full responsibility for its fraud, or at least is intended to do so.
Because California law bars enforcement of all unconscionable contracts, and all exculpatory contracts falling within Section 1668 of its Civil Code, and because the Discover Bank rule applies to class action waivers in contracts that do not contain arbitration agreements, the California Supreme Court and the Ninth Circuit hold that it does not discriminate against arbitration agreements in violation of Section 2.
While this conclusion admittedly has a superficial ring of reason to it, it cannot withstand scrutiny. The Discover Bank rule may be based on or derived from general unconscionability-law principles and Cal. Civ. Code Section 1668, but it is not a general rule that applies to all contracts.
To be sure, the rule targets not only certain arbitration agreements, but also a very small class of other contracts that do not contain arbitration agreements, but which purport to require a party to waive the right to bring a class action in court. That alone, however, cannot save the rule from preemption, for the rule is no less discriminatory of arbitration agreements simply because it also happens to apply to another small subset of – but not all other – contracts. Far from a general ground for the revocation of “any contract,” it is a special rule that applies principally to arbitration agreements. Section 2 expressly preempts all state laws that discriminate against arbitration agreements, and the Discover Bank rule does exactly that.
That doesn’t mean California law on unconscionability or exculpatory contracts can’t be invoked to void an arbitration agreement in whole or in part. But it does mean that California must apply to arbitration agreements the same standards for assessing unconscionability or Section 1668 enforceability that it applies to all other contracts.
California could therefore apply its general rule against unconscionable contracts to an arbitration agreement. That rule allows courts to void only those adhesive contracts that “shock the conscience” or would be accepted only by the delusional. The ultra-consumer-friendly arbitration agreement in AT&T could never meet this rigorous test, the Ninth Circuit never suggested that it could, and, to our knowledge, the Concepcions do not contend that it could.
California could also probably apply its general rule against exculpatory contracts to an arbitration agreement without violating Section 2. One might legitimately argue that an arbitration agreement would violate Section 1668’s general rule if, for example, the agreement required arbitration of fraud claims, but forbade the arbitrators from awarding full monetary relief for fraud. But nothing in the AT&T Mobility arbitration agreement purports to impair the Concepcions’ rights – or those of any other party that has the same or a similar agreement with AT&T Mobility – to obtain in bilateral arbitration the same monetary relief from fraud that it might obtain in class arbitration or litigation.
There is yet another reason why California’s Discover Bank rule is not a rule of general contract law: it is not a rule that is intended to govern the validity or enforceability of any particular contract viewed in isolation, but a dispute resolution or consumer protection policy that seeks to guarantee class procedures are available to consumers in circumstances where many consumer parties have entered into independent, substantially similar adhesive contracts with a common corporate party and one or more consumers allege small dollar but widespread fraud. Even assuming there is an empirical basis for the Discover Bank rule, and that it otherwise reflects a reasonable exercise of judicial power to declare public policy, the policy it is designed to advance has nothing to do with the enforceability of contracts generally, everything to do with the enforceability of consumer dispute resolution contracts particularly, and most to do with regulating consumer arbitration agreements specifically.
Does the Federal Arbitration Act Impliedly Preempt the Discover Bank Rule?
Even if state law is not expressly preempted by the Federal Arbitration Act, it may be impliedly preempted if it conflicts with the purpose of the Act, or the strong federal policy in favor of arbitration that it seeks to advance. State laws or policies that undermine “the goals and policies of the FAA” are preempted by the Act. Volt Info. Sciences, Inc. v. Board of Trustees of Leland Stanford Univ., 489 U.S. 468, 477-78 (1990).
The Ninth Circuit held that the Discover Bank rule did not conflict with policies and purposes of the Federal Arbitration Act for essentially the same reasons it held that Section 2 did not expressly preempt the rule. Those reasons do not save the rule from implied preemption anymore than they save it from express preemption, but there is more.
The Ninth Circuit decided AT&T Mobility before the Supreme Court decided Stolt-Nielsen, S.A. v. AnimalFeeds, Inc., 130 S. Ct. 1758 (2010), which spelled out in no uncertain terms what Federal-Arbitration-Act policy was as respects class arbitration. In Stolt-Nielsen the Court reaffirmed that “the central or ‘primary’ purpose of the FAA is to ensure that ‘private agreements to arbitrate are enforced according to their terms” and according to “the contractual rights and expectations of the parties.” 130 S. Ct. at 1773 (citations and quotations omitted). To that end, said the Court, the Act “imposes certain rules of fundamental importance, including the basic precept that ‘arbitration is a matter of consent, not coercion.’” 130 S. Ct. at 1773 (citations omitted). These rules authorize the parties to:
- generally “structure their arbitration agreements as they see fit[;]”
- “agree to limit the issues they choose to arbitrate[;]”
- “agree on the rules under which any arbitration will proceed[;]”
- “choose who will resolve specific disputes[;]” and
- “specify with whom they choose to arbitrate.”
130 S. Ct. at 1773-74 (citations and quotations omitted; emphasis in original).
The Court admonished “courts and arbitrators to give effect to these contractual limitations” and reminded them not to “lose sight of the purpose of the exercise: to give effect to the intent of the parties.” 130 S. Ct. at 1774-75 (citations omitted).
From these Federal Arbitration Act “fundamental rules of importance” Stolt-Nielsen derived a new rule that effectively puts the kibosh on judicial attempts to nullify class waivers: “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.” 130 S. Ct. at 1775 (emphasis in original). The Discover Bank rule squarely conflicts with this and other Federal Arbitration Act “rules of fundamental importance,” because it either (a) imposes class arbitration on parties that not only did not agree to it, but expressly forbade it; or (b) requires parties to submit their dispute to class-action litigation, all in derogation of their arbitration agreement.
Stolt-Nielsen has set Discover Bank on a collision course not only with the Federal Arbitration Act, but with itself. Discover Bank assumes that, if consistent with state law on severability a class waiver can be severed from an arbitration agreement that is otherwise silent on class relief, then an arbitrator could impose class arbitration. That’s part of the justification for Discover Bank; it is allegedly not an anti-arbitration rule because it permits class arbitration.
Stolt-Nielsen has negated this key premise of Discover Bank by rejecting the argument that class arbitration is a mere matter of arbitral procedure and holding that courts or arbitrators cannot impose class arbitration without the parties’ affirmative consent. It teaches us that if the parties’ agreement is silent on class relief, then the parties have not agreed to class arbitration, and thus cannot be compelled to participate in it, even if state law would deem the parties to have consented to class arbitration.
If the Supreme Court were to hold that the Federal Arbitration Act does not preempt Discover Bank, then it would transform Discover Bank into a rule that not only barred class waivers, but also a certain class of ordinary arbitration agreements that are simply silent on class procedures, something that the Discover Bank rule does not purport to do. And the result could not be squared with the Federal Arbitration Act.
Stolt-Nielsen renders class waivers irrelevant in most cases. If the waiver can be severed consistent with state law on severability applicable to any contract, then what is left is usually an arbitration agreement that is silent on class arbitration. But under the Federal Arbitration Act, such an arbitration agreement provides no basis for a court or arbitrator to compel class arbitration, and a court faced with such an agreement has no choice but to compel bilateral arbitration.
That demonstrates that the Federal Arbitration Act impliedly preempts the Discover Bank rule, because it does not allow the rule to accomplish its intended result, which was to require class arbitration in cases where the parties expressly provide for bilateral arbitration only. In the recent, post-Stolt-Nielsen, Fensterstock v. Education Finance Partners, ___ F.3d ___ (2d Cir. July 12, 2010), case (blogged here), the United States Court of Appeals for the Second Circuit attempted to avoid this foregone conclusion by completely ignoring the Federal Arbitration Act “rules of fundamental importance,” and holding that, under Discover Bank, the entire arbitration agreement was void because merely severing the class waiver would not permit class arbitration. In attempting to implement the purposes of the Discover Bank rule it was forced to effectively expand the scope of the rule into one that voids not only class arbitration waivers, but also arbitration agreements that do not affirmatively authorize class relief.
Ironically, the conclusion the Second Circuit reached in Fensterstock negates the key premise on which it was based. The reason the Second Circuit saw fit to apply the Discover Bank rule in the first place was that it was purportedly a state law rule that applied to all contracts generally because it applied equally to arbitration agreements and contracts that waived class litigation. But the expanded Discover Bank rule cannot survive express preemption even on that questionable basis.
The expanded Discover Bank rule discriminates against adhesive arbitration agreements that are silent on class arbitration by voiding them, but enforcing all other contracts that are silent on class litigation. The Discover Bank rule does not condition enforcement of non-arbitration agreements on the parties agreeing to submit to class action litigation proceedings. Class litigation is provided for by applicable state procedural law or the Federal Rules of Civil Procedure; nobody has to consent to it. But the Discover Bank rule as applied by the Second Circuit conditions enforcement of adhesive arbitration agreements on the parties affirmatively consenting to class arbitration in cases where the consumer alleges small-dollar but widespread fraud.
That inescapable conclusion causes the Second Circuit’s express and implied preemption analysis to collapse like a house of cards. The Second Circuit’s expanded Discover Bank rule treats arbitration agreements that are silent on class arbitration differently than all other contracts that are silent on class litigation, and there is no basis – however thin – for contending otherwise.
It also bulldozes the Ninth Circuit’s express and implied preemption analysis in AT&T Mobility. For Stolt-Nielsen renders irrelevant the Discover Bank rule unless it is construed to apply in a way that puts arbitration agreements on a wholly different footing than all other contracts.
What is the Likely Outcome in AT&T Mobility?
Predicting the outcomes of cases pending before the Supreme Court is, at best, educated guesswork. But we do not think that the Supreme Court can affirm the Ninth Circuit unless it is prepared to make significant exceptions to its prior jurisprudence interpreting the Federal Arbitration Act, or fashion a whole new set of rules and policies that apply to adhesive arbitration agreements.
It seems highly unlikely that a majority of the Court will be willing to take such a bold step, particularly in light of the recently decided Stolt-Nielsen case. Congress could, of course, do so, and under the Dodd-Frank Act (blogged here), the Bureau of Consumer Financial Protection and the Securities and Exchange Commission may have the power to do so as respects arbitration agreements contained in the financial service, broker-dealer, and investment-advisory contracts that the Dodd-Frank Act authorizes them to regulate.
Our best guess is that the Court will stay the course it has set over the last few decades in the many Federal Arbitration Act cases it has decided, and let Congress change the law if it sees fit.
Stay tuned for further coverage of the perplexing and exceedingly important AT&T Mobility case. . . .
Tags: Allied-Bruce Terminix Cos. v. Dobson, AT&T Mobility LLC v. Concepcion, Bureau of Consumer Financial Protection, Cal. Civ. Code § 1668, California Supreme Court, Class Actions, Class Waivers, Discover Bank Rule, Discover Bank v. Superior Court, Doctor’s Associates Inc. v. Casarotto, Dodd-Frank Act, Exculpatory Contracts, Express Preemption, Federal Arbitration Act, Federal Arbitration Act Preemption, Feeney v. Dell Inc., Implied Preemption, Inc. v. Board of Trustees of Leland Stanford Univ., Laster v. AT&T Mobility LLC, Section 2, Securities and Exchange Commission, Shroyer v. New Cingular Wireless Serv. Inc., Stolt-Nielsen S.A. v. AnimalFeeds Inc, Unconscionability, United States Court of Appeals for the Ninth Circuit, United States Supreme Court, Volt Info. Sciences
