By Professor Peter Friedman
In my recent two-part guest post published in Disputing about recent state court decisions striking down mandatory arbitration clauses and class action waivers in consumer, online transactions, I concluded that those courts were “acting in legitimate ways [by requiring contract] disputes to be resolved in ways that provide relief for and deterrence of wrongdoing.” (Part I here; Part II here) In particular, I applauded the New Mexico Supreme Court and the Supreme Judicial Court of the Commonwealth of Massachusetts for making explicit the purely public policy grounds for invalidating mandatory arbitration clauses and class action waivers in consumer transactions. See Feeney v. Dell Inc., ___ Mass. ___ (July 2, 2009); Fiser v. Dell Computer Corp., ___ P.3d ___ (N.M. June 27, 2009). The courts concluded that the provisions deprived consumers of any meaningful remedies for the defendants’ alleged breaches of contract and that those provisions were therefore in conflict with strong state policies in favor of consumer protection.
It is worth examining more closely, however, my reasons for believing the courts in these cases were acting in judicially legitimate ways. It might be suggested, for example, that, if a court could strike these particular provisions down on public policy it had articulated without explicit statutory support, there would be nothing to stop courts from striking down any arbitration provisions on judicially formulated public policy grounds.
These fears are unfounded; the decisions in Feeney and Fiser fall well within the scope of the traditional power of state courts to interpret and develop contract law. Moreover, these decisions were based on public policy applicable to any contract and therefore were exercises of power expressly reserved to state courts by Congress in the Federal Arbitration Act (the “FAA”).
No one could plausibly argue that a state court lacks the power to invalidate an arbitration agreement that was obtained under duress, one that was unsupported by consideration, one that violated the statute of frauds, or one that lacked agreement on all material terms. These grounds for striking down agreements have always been recognized as reasons to override freedom of contract. Invalidating agreements for contravening judicially announced public policy that has not been pre-empted by federal law is just as legitimate an exercise of state judicial power as invalidating contracts under these and similar conventional contract doctrines.
The Restatement (Second) of Contracts makes this point explicit, stating that courts can invalidate agreements based solely on judicially recognized public policy:
A promise or other term of an agreement is unenforceable on grounds of public policy if legislation provides that it is unenforceable or the interest in its enforcement is clearly outweighed in the circumstances by a public policy against the enforcement of such term. (emphasis added)
Restatement (Second) of Contracts, § 178.
It is important in this respect to recognize that Restatements are drafted as articulations of existing law, not as recommendations of what the authors believe the law should be. As the American Law Institute explains:
Restatements are addressed to courts and others applying existing law. They aim at clear formulations of common law and its statutory elements or variations and reflect the law as it presently stands or might plausibly be stated by a court. Restatement black-letter formulations assume the stance of describing the law as it is. (emphasis added)
Williston’s commentary corroborates the Restatement’s view that courts act legitimately when invalidating contracts contrary to public policy:
Common law, as distinguished from statutory development, forbids the actual performance of certain acts opposed to social welfare and proscribes various types of executory agreements. Illegal bargains have been classified both by the common law and in statutory enactments as those opposed to positive law, those which are contrary to morality and those which offend public policy. (footnote omitted; emphasis added).
5 Williston on Contracts § 12:1 (4th ed.). Thus, “many acts which are themselves neither criminal nor tortious may not be made the subject of a contract . . . .” Id.
Nonetheless — particularly given political rhetoric that criticizes judicial decisions based on public policy as illegitimate acts of “judicial activism” — courts frequently will avoid discussions of public policy and instead fashion their decisions to fit within expanded and even strained interpretations of conventional legal doctrine.
No doubt sound legal and political strategies drive the preference to articulate decisions in conventional doctrinal terms rather than in judicial formulations of public policy – why risk seeming appearing to tread on the domain of the legislature if you can reach your desired result by applying, for example, a new interpretation of the venerable doctrine of consideration?
Such strategy seems a compelling explanation for the opinion in Harris v. Blockbuster, Inc. (N.D. Tex. April 15, 2009). As I discussed in Part II of my Disputing guest post (here), the court in Harris held that a consumer contract containing a mandatory arbitration and class action waiver was unenforceable as an “illusory” contract because the defendant could have (though it had not) amended the agreement unilaterally and without notice. The court’s reasoning seems to stretch near to breaking the conception of illusory obligations. Since the contract in Harris had not been amended, the defendant’s obligations were in full force and effect at the time of the alleged breach; thus, conventional reasoning would support a conclusion that the defendant’s obligations were not illusory.
That is not to say that the result in Harris was wrong or that the contract was not an illusory one. But the unilateral right to amend the contract had nothing to do with the contract’s illusory nature. Even if the contract had not given the defendant a unilateral right to amend, its terms provided the plaintiff with only one avenue of relief for breach — an individual arbitration proceeding in an inconvenient location. Any damages awarded for breach were likely to be very low. Given the expense and risk of seeking that relief and the inability to commence any class action proceeding, no rational plaintiff would have commenced arbitration. In other words, the terms of the contract posed no real risk to the defendant that its obligations would be enforced by legal process. Contractual promises which, if breached, pose no threat of liability are the very prototype of illusory promises.
Understanding the real defect of the contract in Harris also reveals that there is no meaningful difference between calling a contract unenforceable because it is “illusory” (a doctrinal argument) and calling it unenforceable because of what the courts in Feeney and Fiser described as public policy arguments – regardless of how one labels the nature of the reasoning, the contracts in all three of those cases were invalid because they provided the plaintiff consumers with no feasible means of enforcing the defendants’ promises. Why should the law prefer justifications based on strained interpretations of contract theory originating centuries ago over justifications based on the real world consequences underlying that theory?
Even more important to me as a lawyer drafting contracts for clients, I’d far prefer to know what factual and ethical considerations render a given provision unenforceable than to base my drafting decisions on my ability to parse the semantics of theories originating in times ruled by very different values and institutional practices. I am not suggesting contract doctrine is not important; nor am I suggesting that I do not need to parse the semantics of common law doctrine. What I am suggesting is that the law is a means of serving the policies that inform that doctrine. It is the substance, not the form, that matters most.
Thus, the decision by the New Mexico Supreme Court in Fiser in June and the decision by the Massachusetts Supreme Judicial Court in Feeney in July were refreshing in cutting straight to the unjust consequences of mandatory arbitration clauses and class action waivers in consumer transactions. The decisions made obvious and undeniable that in consumer contracts arbitration is often used not to serve its legitimate purposes but instead to shield sellers of goods and services from most or even all liability for breach of their contractual obligations.
When a legal innovation provides real world advantages it eventually becomes widely accepted. After its widespread acceptance, people stop questioning the benefits resulting from the innovation, taking for granted that the benefits are the inevitable consequences of the innovation. At that point, some people begin to exploit the unquestioned acceptance of the innovation, finding ways to use it to advance less scrupulous ends. Eventually, our legal institutions adjust, begin to distinguish between the productive uses of the innovation and the unscrupulous uses, and curb the use of the unscrupulous uses.
The history of arbitration, like many legal innovations, has thus far followed precisely this historical pattern, Feeney and Fiser are not novel in curbing the abuse of arbitration agreements. Courts years over the past ten years have struck down mandatory arbitration clauses and class action waivers in consumer transactions on the grounds that they are “unconscionable.” See, e.g., Scott v. Cingular Wireless, 160 Wash.2d 843, 161 P.3d 1000 (2000)(refusing to enforce mandatory arbitration clause and class action waiver on grounds of unconscionability); Lowden v. T–Mobile USA, Inc., 512 F.3d 1213, 1218 (9th Cir. 2007)(same). Nevertheless, it is only with the opinions in Feeney and Fiser that courts are finally making explicit the practical ways in which arbitration’s purposes are being perverted and grounding their decisions on on the injustice of those perversions.
But it is not only the lucidity with which the courts describe the injustices at issue in Feeney and Fiser that make those decisions judicially legitimate. For at least 16 years, courts have been willing to strike down arbitration provisions and awards on the basis of judicial articulations of public policy. In Exxon Shipping Co. v. Exxon Seamen’s Union, 11 F.3d 1189, 1196 (3d. Cir. 1993), for example, the court struck down an arbitration award reinstating an able-minded seaman on an oil tanker who was found to be highly intoxicated while on duty. The court held that enforcement of the arbitration award was against public policy implicit in, among other sources, federal environmental laws, and stated expressly that the result was appropriate even though the award ordered no conduct that violated any statute, regulation, or other manifestation of positive law. In Alexander v. Anthony International, L.P., 341 F.3d 256, 270, (3d Cir. 2003), the court refused to enforce agreement to arbitrate requiring 30-day notice, restricting remedies and attorney’s fees, and requirements regarding arbitrator’s fees simply because they were “one sided and unreasonable.”
Finally, there is no compelling reason to interpret the FAA in a way that would foreclose state courts from invalidating mandatory arbitration clauses and class action waivers on public policy grounds. Congress in enacting the FAA explicitly preempted the power of state courts to invalidate agreements to arbitrate merely only to the extent state policy applies only to agreements to arbitrate. But Section 2 of the FAA also makes explicitly states that agreements to arbitrate can be invalidated for the same reasons any contracts can be invalidated:
[A]n agreement in writing to submit to arbitration an existing controversy . . . shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract. (emphasis added).
Thus, the FAA deprives state courts of the power to invalidate agreements to arbitrate on grounds that apply only to certain contracts, not all contracts. Thus, for example, in Southland Corp. v. Keating, 465 U.S. 1, 17 (1984), the Supreme Court struck down the California Franchise Investment Law because that statute invalidated franchise agreements merely if they contained mandatory arbitration provisions. But, under the FAA, a franchise agreement containing a mandatory arbitration provision necessarily is “valid, irrevocable, and enforceable” unless there is some defect in it that would make any contract invalid. There was no evidence in Southland that any such defect existed.
As explained above, judicial formulations of public policy constitute “grounds . . . in law or in equity for the revocation of any contract.” Thus, the FAA expressly reserves to the states the power to invalidate arbitration provisions that violate judicially recognized public policy as long as that public policy applies to any contract. Any contract that provides no feasible remedy for breach is contrary to the very foundation of contract law – giving the promisee the benefit of his bargain. Surely, then, the FAA permits striking down consumer transactions that, by means of mandatory arbitration provisions and class action waivers, deprive parties of any meaningful means of enforcing the terms of those transactions.
In short, courts that have invalidated mandatory arbitration provisions and class action waivers are promoting the very purposes of contract law. Courts that have faced most squarely the real life injustices caused by such provisions are especially to be commended, and it would be contrary to common or commercial sense to suggest that the mere presence in these contracts of arbitration clauses could mean otherwise.
Tags: Class Action Waiver, Class Arbitration, Disputing, FAA Section 2, Federal Arbitration Act, Federal Preemption, Feeney v. Dell Inc., guest post, Kiser v. Dell Inc., Mandatory Arbitration Agreements, Massachusetts Supreme Judicial Court, New Mexico Supreme Court, Online Arbitration Agreements, Online Transactions, Professor Peter Friedman, Public Policy, Southland Corp. v. Keating, State Public Policy, Unconscionability
[…] There is a solution, however, and it’s one that hit a high gear 50 years ago only to peter out in the wake of our more recent passion for unregulated free markets — consumer protection laws that dictate what terms can and cannot be imposed on consumers. As the situation now stands, we are left with a patchwork effort to find traditional contract rules to come up with fair results (such as invalidating mandatory arbitration clauses that deprive consumers of any meaningful remedies for wro…). […]