In a pro-business and pro-arbitration decision, the United States Supreme Court on April 27 struck down as preempted by federal law the California rule that class arbitration waivers in consumer adhesion contracts are unconscionable and thus unenforceable.  The Court’s decision in AT&T Mobility LLC v. Concepcion, 563 U.S. ___ (2011), hinged on Section 2 of the Federal Arbitration Act (“FAA”), which provides that agreements to arbitrate are “valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.”  In a 5-4 decision, the divided Court, in an opinion authored by Justice Scalia, concluded that the FAA prohibits states from conditioning the enforceability of certain arbitration agreements on the availability of class arbitration procedures.  The majority reaffirmed its recent pro-arbitration leanings, while at the same time seeming to reject arbitration as an appropriate venue for class claims.

The named plaintiffs, Vincent and Liza Concepcion, alleged that they entered into an agreement with AT&T Mobility LLC to purchase mobile phone service that was advertised as including free phones.  The Concepcions sought to represent a class of AT&T Mobility customers and alleged that AT&T Mobility had engaged in false advertising by charging sales tax based on the value of the phones it advertised as free.

The Concepcions’ contract with AT&T Mobility provided for arbitration of all disputes between the parties, but required that all claims be brought in a customer’s “individual capacity, and not as a plaintiff or class member in any purported class or representative proceeding.”  The agreement also contained provisions favorable to the customer, including that AT&T Mobility would pay claimants at least $7,500 and twice their attorney’s fees if the claimant obtained an arbitration award greater than the company’s last settlement offer.

Relying on the California Supreme Court’s 2005 ruling in Discover Bank v. Superior Court, the district court denied AT&T Mobility’s motion to compel arbitration, finding that, despite the pro-consumer features of the arbitration provision, the class arbitration waiver provision rendered it unconscionable and thus unenforceable.  In Discover Bank, the California Supreme Court held that when the party with inferior bargaining power alleges a deliberate scheme to defraud, class waivers in consumer contracts of adhesion involving small amounts of damages are unconscionable and unenforceable.  The Ninth Circuit affirmed and further held the Discover Bank rule was not preempted by the FAA.

Finding that the “overarching purpose” of the FAA is “to ensure the enforcement of arbitration agreements according to their terms so as to facilitate streamlined proceedings,” the majority held that the Discover Bank rule interfered with “fundamental attributes of arbitration” and thus was inconsistent with the FAA.  In particular, the majority noted that class arbitration is slower and more costly than bilateral arbitration; is by nature more complicated and formal; and greatly increases risks to defendants because of the extremely limited nature of judicial review of arbitration decisions.  The majority rejected the dissent’s argument that class proceedings are necessary to prosecute small claims that might not otherwise be advanced, noting that states “cannot require a procedure that is inconsistent with the FAA, even if it is desirable for unrelated reasons.” 

The Concepcion decision is consistent with recent U.S. Supreme Court decisions favoring the enforceability of arbitration provisions. The case is significant for businesses providing consumer products or services, which undoubtedly will increase the use of class arbitration waivers to minimize their exposure to expensive consumer class litigation.  Employers also may seek to include class waiver arbitration provisions in employment agreements to protect against employee class actions asserting, for example, wage and hour claims.

Additional content for this post was provided by M. Kay Martin, a litigation and torts partner in Crowell & Moring’s San Francisco office.