Arbitration and preemption

Larry Ribstein —  16 November 2010

Ok, so here’s the deal.  AT&T sells two cellular phones for nothing with a two-year contract term, and then charges $30.22 in sales tax.  Customers complain about the sales tax. The contract provides for individual arbitration where the customer resides. AT & T will pay double attorneys fees and $7,500 if the arbitrator awards the customer more than AT & T’s last written settlement offer before the arbitrator was selected and all arbitration costs and fees for non-frivolous claims.  Customers pay no attorneys’ fees to AT & T if they lose, retain full court remedies, and can choose in-person, telephonic, or no hearing at all for claims less than $10,000.

There’s just one problem:  customers do not get a right to class arbitration. 

Does this sound to you like an unconscionable contract?  A California federal court said so in Laster v. AT & T Mobility LLC, 584 F.3d 849 (9th Cir. 2009), applying California law set forth in Discover Bank v. Sup.Ct., 36 Cal.4th 148, 30 Cal.Rptr.3d 76, 113 P.3d 1100 (2005).  The court was not deterred from this result by the fact that the above rules made it cost-effective to arbitrate, or that customers could use AT&T’s informal claims process.  

According to the court, the problem is “that a person normally will not find it worth the time or the hassle to try to recover such a small amount, even if that person spends no money to hire an attorney or to invoke the arbitration process.”  The possibility of a consumer making that perfectly rational decision makes the contract unconscionable because without class actions, no one will enforce the law.

Perhaps this is a reasonable conclusion.  Why should AT&T be able to get away with a contract that lets it rip off people a little at a time? 

The answer is that a federal law lets it do so.  That law is the Federal Arbitration Act, which requires all U.S. courts to enforce arbitration provisions except on “grounds as exist at law or in equity for the revocation of any contract.” In other words, states may not develop a separate body of law to restrict the enforcement of arbitration clauses.  They can invalidate an arbitration clause only under generally applicable contract doctrine, such as fraud, duress, and unconscionability.  

Laster and other California cases say they are applying a general rule of unconscionability that invalidates a class action waiver in an arbitration clause if the agreement is a “contract of adhesion,” disputes are likely to involve small amounts of money, and “the party with superior bargaining power has carried out a scheme deliberately to cheat large numbers of consumers out of individually small sums of money.”  But this general rule forcing class actions in arbitration looks suspiciously arbitration-specific.

Aiding the determination of whether this is a general or arbitration-specific rule is the significant policy that is at stake. Congress enacted the Federal Arbitration Act in order to ensure that national firms could effectively contract for arbitration without fear of being hauled into a non-enforcing state court.  There is ample evidence that Congress took this step to preserve the U.S.’s international competitiveness.  While the California rule does not forbid arbitration, it undermines its efficiency by forcing firms in arbitration to contend with class actions.  Many firms might therefore choose to forego arbitration altogether and thwart Congress’s national market policy.

Some might think that this is a judgment the states ought to make.  But the Constitution, including the Commerce Clause, says that Congress can enact laws preserving a national market. The Supremacy Clause makes these laws effective by trumping inconsistent state laws.  California accordingly shouldn’t be able to defeat Congress’s national market strategy embodied in the FAA.  It follows that the FAA preempts the California law.

Of course this is only my opinion.  The Supreme Court granted cert in Laster to consider whether the FAA “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.”  It’s unclear from oral argument how the case will come out.  But it’s worth noting that Justice Alito said that the contract is “unconscionable because it doesn’t allow the enlistment of basically private attorneys general to enforce the law. And isn’t that quite different from ordinary unconscionability analysis?”

I’ll be discussing Laster as I present a paper at a Searle Civil Justice Institute this Thursday.  The paper analyzes preemption as a mechanism for preserving national markets.

Larry Ribstein

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Professor of Law, University of Illinois College of Law

3 responses to Arbitration and preemption

  1. 

    How exactly does “forcing firms in arbitration to contend with class actions” undermine efficiency? Certainly you would agree that resolving a breach of contract on a classwide basis is more efficient than individual resolution of each and every identical contract entered into between AT&T and its customers. The firm gets the benefit of resolving all claims at once, instead of each claim individually. The adhesive provisions in the contract benefit the firm only because they know that very few customers will excercise their individual right to arbitrate, even with the fee shifting and liquidated damages provisions (otherwise, why would they ever agree to such provisions). The analysis would be the same if the contract precluded court-based class adjudication, which undermines your argument that the Laster court’s analysis is “arbitration-specific.”

    Moreover, it does not follow that many firms would forego arbitration if they had to agree to class adjudications. Class wide arbitration would still be more efficient than litigation because the parties would still be able to contract the rules of evidence, proof and discovery in order to reduce the transaction costs of dispute resolution.

    Regarding Congressional policy of the FAA, is there any support in the legislative history that the purpose of the FAA was to discourage consumers from enforcing their contractual rights? I would doubt it. As you say, “Congress enacted the Federal Arbitration Act in order to ensure that national firms could effectively contract for arbitration without fear of being hauled into a non-enforcing state court.” Firms are not being forced into state court, they are being forced to choose between class arbitration or no arbitration.

    Assuming your premise, the fact that firms may choose no arbitration over class arbitration underscores that arbitration agreeements are being used to discourage consumers from enforceing their contractual rights, rather than for the efficiency enhancing purpose of reducing the transaction costs of litigation.

  2. 

    Not terribly persuasive. What you call a significant policy in favor of arbitration is trumped by the need to allow the types of actions to occur in the first place. Justice Alito may characterize it as “unconscionable because it doesn’t allow the enlistment of basically private attorneys general to enforce the law. And isn’t that quite different from ordinary unconscionability analysis?” But that just misses the point. This isn’t an issue of whether class action lawyers will get work. It’s an issue of whether ANY cases will EVER be brought if parties with remarkably unequal bargaining power can mandate these clauses. No lawyer will take a case over $30, so no case will be brought, and, so, ATT and others will reap trillions in wrongful gains as a result. The “significant” policy behind the FAA pales in comparison.

    In other words, you’re really missing the landscape here. The options aren’t (a) arbitration or (b) class action. The options are (a) class action or (b) no lawsuit ever and continued wrongdoing. If that’s not a “significant” policy concern, I’m not sure what is.

    [and let’s be clear here, this is not a freedom of contract issue. many (most? all?) people need cell phones and no one can bargain away the arbitration clause. there’s no free market here in which an alternative provider will sell cell phones w/o the clause. it is forced on all consumers, and all consumers must accept it if they want a phone.]

  3. 

    Completely outside the question being considered by the S.Ct., but something I’m curious about:

    In this case, is AT&T actually keeping the “sales tax” or passing it along to the state/fed government? That is, are they “ripping people off a little at a time”, or making an error that results in the consumer losing money, but is of no benefit to AT&T?