Archives For arbitration

“Just when I thought I was out, they pull me back in!” says Al Pacino’s character, Michael Corleone, in Godfather III. That’s how Facebook and Google must feel about S. 673, the Journalism Competition and Preservation Act (JCPA)

Gus Hurwitz called the bill dead in September. Then it passed the Senate Judiciary Committee. Now, there are some reports that suggest it could be added to the obviously unrelated National Defense Authorization Act (it should be noted that the JCPA was not included in the version of NDAA introduced in the U.S. House).

For an overview of the bill and its flaws, see Dirk Auer and Ben Sperry’s tl;dr. The JCPA would force “covered” online platforms like Facebook and Google to pay for journalism accessed through those platforms. When a user posts a news article on Facebook, which then drives traffic to the news source, Facebook would have to pay. I won’t get paid for links to my banger cat videos, no matter how popular they are, since I’m not a qualifying publication.

I’m going to focus on one aspect of the bill: the use of “final offer arbitration” (FOA) to settle disputes between platforms and news outlets. FOA is sometimes called “baseball arbitration” because it is used for contract disputes in Major League Baseball. This form of arbitration has also been implemented in other jurisdictions to govern similar disputes, notably by the Australian ACCC.

Before getting to the more complicated case, let’s start simple.

Scenario #1: I’m a corn farmer. You’re a granary who buys corn. We’re both invested in this industry, so let’s assume we can’t abandon negotiations in the near term and need to find an agreeable price. In a market, people make offers. Prices vary each year. I decide when to sell my corn based on prevailing market prices and my beliefs about when they will change.

Scenario #2: A government agency comes in (without either of us asking for it) and says the price of corn this year is $6 per bushel. In conventional economics, we call that a price regulation. Unlike a market price, where both sides sign off, regulated prices do not enjoy mutual agreement by the parties to the transaction.

Scenario #3:  Instead of a price imposed independently by regulation, one of the parties (say, the corn farmer) may seek a higher price of $6.50 per bushel and petition the government. The government agrees and the price is set at $6.50. We would still call that price regulation, but the outcome reflects what at least one of the parties wanted and  some may argue that it helps “the little guy.” (Let’s forget that many modern farms are large operations with bargaining power. In our head and in this story, the corn farmer is still a struggling mom-and-pop about to lose their house.)

Scenario #4: Instead of listening only to the corn farmer,  both the farmer and the granary tell the government their “final offer” and the government picks one of those offers, not somewhere in between. The parties don’t give any reasons—just the offer. This is called “final offer arbitration” (FOA). 

As an arbitration mechanism, FOA makes sense, even if it is not always ideal. It avoids some of the issues that can attend “splitting the difference” between the parties. 

While it is better than other systems, it is still a price regulation.  In the JCPA’s case, it would not be imposed immediately; the two parties can negotiate on their own (in the shadow of the imposed FOA). And the actual arbitration decision wouldn’t technically be made by the government, but by a third party. Fine. But ultimately, after stripping away the veneer,  this is all just an elaborate mechanism built atop the threat of the government choosing the price in the market. 

I call that price regulation. The losing party does not like the agreement and never agreed to the overall mechanism. Unlike in voluntary markets, at least one of the parties does not agree with the final price. Moreover, neither party explicitly chose the arbitration mechanism. 

The JCPA’s FOA system is not precisely like the baseball situation. In baseball, there is choice on the front-end. Players and owners agree to the system. In baseball, there is also choice after negotiations start. Players can still strike; owners can enact a lockout. Under the JCPA, the platforms must carry the content. They cannot walk away.

I’m an economist, not a philosopher. The problem with force is not that it is unpleasant. Instead, the issue is that force distorts the knowledge conveyed through market transactions. That distortion prevents resources from moving to their highest valued use. 

How do we know the apple is more valuable to Armen than it is to Ben? In a market, “we” don’t need to know. No benevolent outsider needs to pick the “right” price for other people. In most free markets, a seller posts a price. Buyers just need to decide whether they value it more than that price. Armen voluntarily pays Ben for the apple and Ben accepts the transaction. That’s how we know the apple is in the right hands.

Often, transactions are about more than just price. Sometimes there may be haggling and bargaining, especially on bigger purchases. Workers negotiate wages, even when the ad stipulates a specific wage. Home buyers make offers and negotiate. 

But this just kicks up the issue of information to one more level. Negotiating is costly. That is why sometimes, in anticipation of costly disputes down the road, the two sides voluntarily agree to use an arbitration mechanism. MLB players agree to baseball arbitration. That is the two sides revealing that they believe the costs of disputes outweigh the losses from arbitration. 

Again, each side conveys their beliefs and values by agreeing to the arbitration mechanism. Each step in the negotiation process allows the parties to convey the relevant information. No outsider needs to know “the right” answer.For a choice to convey information about relative values, it needs to be freely chosen.

At an abstract level, any trade has two parts. First, people agree to the mechanism, which determines who makes what kinds of offers. At the grocery store, the mechanism is “seller picks the price and buyer picks the quantity.” For buying and selling a house, the mechanism is “seller posts price, buyer can offer above or below and request other conditions.” After both parties agree to the terms, the mechanism plays out and both sides make or accept offers within the mechanism. 

We need choice on both aspects for the price to capture each side’s private information. 

For example, suppose someone comes up to you with a gun and says “give me your wallet or your watch. Your choice.” When you “choose” your watch, we don’t actually call that a choice, since you didn’t pick the mechanism. We have no way of knowing whether the watch means more to you or to the guy with the gun. 

When the JCPA forces Facebook to negotiate with a local news website and Facebook offers to pay a penny per visit, it conveys no information about the relative value that the news website is generating for Facebook. Facebook may just be worried that the website will ask for two pennies and the arbitrator will pick the higher price. It is equally plausible that in a world without transaction costs, the news would pay Facebook, since Facebook sends traffic to them. Is there any chance the arbitrator will pick Facebook’s offer if it asks to be paid? Of course not, so Facebook will never make that offer. 

For sure, things are imposed on us all the time. That is the nature of regulation. Energy prices are regulated. I’m not against regulation. But we should defend that use of force on its own terms and be honest that the system is one of price regulation. We gain nothing by a verbal sleight of hand that turns losing your watch into a “choice” and the JCPA’s FOA into a “negotiation” between platforms and news.

In economics, we often ask about market failures. In this case, is there a sufficient market failure in the market for links to justify regulation? Is that failure resolved by this imposition?

Over the weekend, Senator Al Franken and FCC Commissioner Mignon Clyburn issued an impassioned statement calling for the FCC to thwart the use of mandatory arbitration clauses in ISPs’ consumer service agreements — starting with a ban on mandatory arbitration of privacy claims in the Chairman’s proposed privacy rules. Unfortunately, their call to arms rests upon a number of inaccurate or weak claims. Before the Commissioners vote on the proposed privacy rules later this week, they should carefully consider whether consumers would actually be served by such a ban.

FCC regulations can’t override congressional policy favoring arbitration

To begin with, it is firmly cemented in Supreme Court precedent that the Federal Arbitration Act (FAA) “establishes ‘a liberal federal policy favoring arbitration agreements.’” As the Court recently held:

[The FAA] reflects the overarching principle that arbitration is a matter of contract…. [C]ourts must “rigorously enforce” arbitration agreements according to their terms…. That holds true for claims that allege a violation of a federal statute, unless the FAA’s mandate has been “overridden by a contrary congressional command.”

For better or for worse, that’s where the law stands, and it is the exclusive province of Congress — not the FCC — to change it. Yet nothing in the Communications Act (to say nothing of the privacy provisions in Section 222 of the Act) constitutes a “contrary congressional command.”

And perhaps that’s for good reason. In enacting the statute, Congress didn’t demonstrate the same pervasive hostility toward companies and their relationships with consumers that has characterized the way this FCC has chosen to enforce the Act. As Commissioner O’Rielly noted in dissenting from the privacy NPRM:

I was also alarmed to see the Commission acting on issues that should be completely outside the scope of this proceeding and its jurisdiction. For example, the Commission seeks comment on prohibiting carriers from including mandatory arbitration clauses in contracts with their customers. Here again, the Commission assumes that consumers don’t understand the choices they are making and is willing to impose needless costs on companies by mandating how they do business.

If the FCC were to adopt a provision prohibiting arbitration clauses in its privacy rules, it would conflict with the FAA — and the FAA would win. Along the way, however, it would create a thorny uncertainty for both companies and consumers seeking to enforce their contracts.  

The evidence suggests that arbitration is pro-consumer

But the lack of legal authority isn’t the only problem with the effort to shoehorn an anti-arbitration bias into the Commission’s privacy rules: It’s also bad policy.

In its initial broadband privacy NPRM, the Commission said this about mandatory arbitration:

In the 2015 Open Internet Order, we agreed with the observation that “mandatory arbitration, in particular, may more frequently benefit the party with more resources and more understanding of the dispute procedure, and therefore should not be adopted.” We further discussed how arbitration can create an asymmetrical relationship between large corporations that are repeat players in the arbitration system and individual customers who have fewer resources and less experience. Just as customers should not be forced to agree to binding arbitration and surrender their right to their day in court in order to obtain broadband Internet access service, they should not have to do so in order to protect their private information conveyed through that service.

The Commission may have “agreed with the cited observations about arbitration, but that doesn’t make those views accurate. As one legal scholar has noted, summarizing the empirical data on the effects of arbitration:

[M]ost of the methodologically sound empirical research does not validate the criticisms of arbitration. To give just one example, [employment] arbitration generally produces higher win rates and higher awards for employees than litigation.

* * *

In sum, by most measures — raw win rates, comparative win rates, some comparative recoveries and some comparative recoveries relative to amounts claimed — arbitration generally produces better results for claimants [than does litigation].

A comprehensive, empirical study by Northwestern Law’s Searle Center on AAA (American Arbitration Association) cases found much the same thing, noting in particular that

  • Consumer claimants in arbitration incur average arbitration fees of only about $100 to arbitrate small (under $10,000) claims, and $200 for larger claims (up to $75,000).
  • Consumer claimants also win attorneys’ fees in over 60% of the cases in which they seek them.
  • On average, consumer arbitrations are resolved in under 7 months.
  • Consumers win some relief in more than 50% of cases they arbitrate…
  • And they do almost exactly as well in cases brought against “repeat-player” business.

In short, it’s extremely difficult to sustain arguments suggesting that arbitration is tilted against consumers relative to litigation.

(Upper) class actions: Benefitting attorneys — and very few others

But it isn’t just any litigation that Clyburn and Franken seek to preserve; rather, they are focused on class actions:

If you believe that you’ve been wronged, you could take your service provider to court. But you’d have to find a lawyer willing to take on a multi-national telecom provider over a few hundred bucks. And even if you won the case, you’d likely pay more in legal fees than you’d recover in the verdict.

The only feasible way for you as a customer to hold that corporation accountable would be to band together with other customers who had been similarly wronged, building a case substantial enough to be worth the cost—and to dissuade that big corporation from continuing to rip its customers off.

While — of course — litigation plays an important role in redressing consumer wrongs, class actions frequently don’t confer upon class members anything close to the imagined benefits that plaintiffs’ lawyers and their congressional enablers claim. According to a 2013 report on recent class actions by the law firm, Mayer Brown LLP, for example:

  • “In [the] entire data set, not one of the class actions ended in a final judgment on the merits for the plaintiffs. And none of the class actions went to trial, either before a judge or a jury.” (Emphasis in original).
  • “The vast majority of cases produced no benefits to most members of the putative class.”
  • “For those cases that do settle, there is often little or no benefit for class members. What is more, few class members ever even see those paltry benefits — particularly in consumer class actions.”
  • “The bottom line: The hard evidence shows that class actions do not provide class members with anything close to the benefits claimed by their proponents, although they can (and do) enrich attorneys.”

Similarly, a CFPB study of consumer finance arbitration and litigation between 2008 and 2012 seems to indicate that the class action settlements and judgments it studied resulted in anemic relief to class members, at best. The CFPB tries to disguise the results with large, aggregated and heavily caveated numbers (never once actually indicating what the average payouts per person were) that seem impressive. But in the only hard numbers it provides (concerning four classes that ended up settling in 2013), promised relief amounted to under $23 each (comprising both cash and in-kind payment) if every class member claimed against the award. Back-of-the-envelope calculations based on the rest of the data in the report suggest that result was typical.

Furthermore, the average time to settlement of the cases the CFPB looked at was almost 2 years. And somewhere between 24% and 37% involved a non-class settlement — meaning class members received absolutely nothing at all because the named plaintiff personally took a settlement.

By contrast, according to the Searle Center study, the average award in the consumer-initiated arbitrations it studied (admittedly, involving cases with a broader range of claims) was almost $20,000, and the average time to resolution was less than 7 months.

To be sure, class action litigation has been an important part of our system of justice. But, as Arthur Miller — a legal pioneer who helped author the rules that make class actions viable — himself acknowledged, they are hardly a panacea:

I believe that in the 50 years we have had this rule, that there are certain class actions that never should have been brought, admitted; that we have burdened our judiciary, yes. But we’ve had a lot of good stuff done. We really have.

The good that has been done, according to Professor Miller, relates in large part to the civil rights violations of the 50’s and 60’s, which the class action rules were designed to mitigate:

Dozens and dozens and dozens of communities were desegregated because of the class action. You even see desegregation decisions in my old town of Boston where they desegregated the school system. That was because of a class action.

It’s hard to see how Franken and Clyburn’s concern for redress of “a mysterious 99-cent fee… appearing on your broadband bill” really comes anywhere close to the civil rights violations that spawned the class action rules. Particularly given the increasingly pervasive role of the FCC, FTC, and other consumer protection agencies in addressing and deterring consumer harms (to say nothing of arbitration itself), it is manifestly unclear why costly, protracted litigation that infrequently benefits anyone other than trial attorneys should be deemed so essential.

“Empowering the 21st century [trial attorney]”

Nevertheless, Commissioner Clyburn and Senator Franken echo the privacy NPRM’s faulty concerns about arbitration clauses that restrict consumers’ ability to litigate in court:

If you’re prohibited from using our legal system to get justice when you’re wronged, what’s to protect you from being wronged in the first place?

Well, what do they think the FCC is — chopped liver?

Hardly. In fact, it’s a little surprising to see Commissioner Clyburn (who sits on a Commission that proudly proclaims that “[p]rotecting consumers is part of [its] DNA”) and Senator Franken (among Congress’ most vocal proponents of the FCC’s claimed consumer protection mission) asserting that the only protection for consumers from ISPs’ supposed depredations is the cumbersome litigation process.

In fact, of course, the FCC has claimed for itself the mantle of consumer protector, aimed at “Empowering the 21st Century Consumer.” But nowhere does the agency identify “promoting and preserving the rights of consumers to litigate” among its tools of consumer empowerment (nor should it). There is more than a bit of irony in a federal regulator — a commissioner of an agency charged with making sure, among other things, that corporations comply with the law — claiming that, without class actions, consumers are powerless in the face of bad corporate conduct.

Moreover, even if it were true (it’s not) that arbitration clauses tend to restrict redress of consumer complaints, effective consumer protection would still not necessarily be furthered by banning such clauses in the Commission’s new privacy rules.

The FCC’s contemplated privacy regulations are poised to introduce a wholly new and untested regulatory regime with (at best) uncertain consequences for consumers. Given the risk of consumer harm resulting from the imposition of this new regime, as well as the corollary risk of its excessive enforcement by complainants seeking to test or push the boundaries of new rules, an agency truly concerned with consumer protection would tread carefully. Perhaps, if the rules were enacted without an arbitration ban, it would turn out that companies would mandate arbitration (though this result is by no means certain, of course). And perhaps arbitration and agency enforcement alone would turn out to be insufficient to effectively enforce the rules. But given the very real costs to consumers of excessive, frivolous or potentially abusive litigation, cabining the litigation risk somewhat — even if at first it meant the regime were tilted slightly too much against enforcement — would be the sensible, cautious and pro-consumer place to start.

____

Whether rooted in a desire to “protect” consumers or not, the FCC’s adoption of a rule prohibiting mandatory arbitration clauses to address privacy complaints in ISP consumer service agreements would impermissibly contravene the FAA. As the Court has made clear, such a provision would “‘stand[] as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress’ embodied in the Federal Arbitration Act.” And not only would such a rule tend to clog the courts in contravention of the FAA’s objectives, it would do so without apparent benefit to consumers. Even if such a rule wouldn’t effectively be invalidated by the FAA, the Commission should firmly reject it anyway: A rule that operates primarily to enrich class action attorneys at the expense of their clients has no place in an agency charged with protecting the public interest.

[The following is a guest post by Thomas McCarthy on the Supreme Court’s recent Amex v. Italian Colors Restaurant decision. Tom is a partner at Wiley Rein, LLP and a George Mason Law grad. He is/was also counsel for, among others,

So he’s had a busy week….]

The Supreme Court’s recent opinion in American Express Co. v. Italian Colors Restaurant (June 20, 2013) (“Amex”) is a resounding victory for freedom-of-contract principles.  As it has done repeatedly in recent terms (see AT&T Mobility LLC v. Concepcion (2011); Marmet Health Care Center, Inc. v. Brown (2012)), the Supreme Court reaffirmed that the Federal Arbitration Act (FAA) makes arbitration “a matter of contract,” requiring courts to “rigorously enforce arbitration agreements according to their terms.”  Amex at 3.  In so doing, it rejected the theory that class procedures must remain available to claimants in order to ensure that they have sufficient financial incentive to prosecute federal statutory claims of relatively low value.  Consistent with the freedom-of-contract principles enshrined in the FAA, an arbitration agreement must be enforced—even if the manner in which the parties agreed to arbitrate leaves would-be claimants with low-value claims that are not worth pursuing.

In Amex, merchants who accept American Express cards filed a class action against Amex, asserting that Amex violated Section 1 of the Sherman Act by “us[ing] its monopoly power in the market for charge cards to force merchants to accept credit cards at rates approximately 30% higher than the fees for competing credit cards.”  Amex at 1-2.  And, of course, the merchants sought treble damages for the class under Section 4 of the Clayton Act.  Under the terms of their agreement with American Express, the merchants had agreed to resolve all disputes via individual arbitration, that is, without the availability of class procedures.  Consistent with that agreement, American Express moved to compel individual arbitration, but the merchants countered that the costs of expert analysis necessary to prove their antitrust claims would greatly exceed the maximum recovery for any individual plaintiff, thereby precluding them from effectively vindicating their federal statutory rights under the Sherman Act.  The Second Circuit sided with the merchants, holding that the prohibitive costs the merchants would face if they had to arbitrate on an individual basis rendered the class-action waiver in the arbitration agreement unenforceable.

In a 5-3 majority (per Justice Scalia), the Supreme Court reversed.  The Court began by highlighting the Federal Arbitration Act’s freedom-of-contract mandate—that “courts must rigorously enforce arbitration agreements according to their terms, including terms that specify with whom [the parties] choose to arbitrate their disputes, and the rules under which that arbitration will be conducted.”  Amex at 2-3 (internal quotations and citations omitted).  It emphasized that this mandate applies even to federal statutory claims, “unless the FAA’s mandate has been overridden by a contrary congressional command.”  Amex at 3 (internal quotations and citations omitted).  The Court then briefly explained that no contrary congressional command exists in either the federal antitrust laws or Rule 23 of the Federal Rules of Civil Procedure (which allows for class actions in certain circumstances).

Next, the Court turned to the merchants’ principal argument—that the arbitration agreement should not be enforced because enforcing it (including its class waiver provision) would preclude plaintiffs from effectively vindicating their federal statutory rights.  The Court noted that this “effective vindication” exception “originated as dictum” in prior cases and that the Court has only “asserted [its] existence” without ever having applied it in any particular case.  Amex at 6.  The Court added that this exception grew out of a desire to prevent a “prospec­tive waiver of a party’s right to pursue statutory reme­dies,” explaining that it “would certainly cover a provision in an arbitration agreement forbidding the assertion of certain statutory rights.”  The Court added that this exception might “perhaps cover filing and administrative fees attached to arbitration that are so high as to make access to the forum impracticable,” Amex at 6, but emphasized that, whatever the scope of this exception, the fact that the manner of arbitration the parties contracted for might make it “not worth the expense” to pursue a statutory remedy “does not constitute the elimination of the right to pursue that remedy.”  Amex at 7.

The Court closed by noting that its previous decision in AT&T Mobility v. Concepcion “all but resolves this case.”  Amex at 8.  In Concepcion, the Court had invalidated a state law “conditioning enforcement of arbitration on the availability of class procedures because that law ‘interfere[d] with fundamental attributes of arbitration.’”   As the Court explained, Concepcion specifically rejected the argument “that class arbitration was necessary to prosecute claims ‘that might otherwise slip through the legal system’” thus establishing “that the FAA’s command to enforce arbitration agreements trumps any interest in ensuring the prosecution of low value claims.”  Amex at 9 (quoting Concepcion).  The Court made clear that, under the FAA, courts are to hold parties to the deal they struck—arbitration pursuant to the terms of their arbitration agreements, even if that means that certain claims may go unprosecuted.  Responding to a dissent penned by Justice Kagan, who complained that the Court’s decision would lead to “[l]ess arbitration,” contrary to the pro-arbitration policies of the FAA, Amex dissent at 5, the Court doubled down on this point, emphasizing that the FAA “favor[s] the absence of litigation when that is the consequence of a class-action waiver, since its ‘principal purpose’ is the enforcement of arbitration agreements according to their terms.”  Amex at 9 n.5 (emphasis added).

By holding parties to the deal they struck regarding the resolution of their disputes, the Court properly vindicates the FAA’s freedom-of-contract mandates.  And even assuming the dissenters are correct that there will be less arbitration in individual instances, the opposite is true on a macro level.  For where there is certainty in contract enforcement, parties will enter into contracts.  Amex thus should promote arbitration by eliminating uncertainty in contracting and thereby removing a barrier to swift and efficient resolution of disputes.