Opinion analysis: What counts as arbitration, and who decides?

By a vote of five to four, the Court on Wednesday held that the Federal Arbitration Act (“FAA”) pre-empts California state law, which deems class arbitration waivers in consumer contracts of adhesion unconscionable in disputes over small amounts of damages.  The Court struck down California’s rule on the ground that such a rule “interferes with arbitration” to an extent not tolerated by the FAA.

The case, AT&T Mobility v. Concepcion, arose under a cell phone contract that provided for arbitration of all disputes but required claims to be brought in an “individual capacity, not as a plaintiff or class member in any purported class or representative proceeding.”  In 2006, the Concepcions filed a complaint in federal district court against AT&T, alleging that the company defrauded consumers by charging sales tax – in their case, approximately thirty dollars – on phones advertised as free.  The complaint was consolidated with a class action.

AT&T moved to end the class action by filing a motion to compel individual arbitration, as provided for in the contract.  But the district court, in a decision affirmed by the Ninth Circuit, denied the motion.  It held that the class-action waiver in AT&T’s consumer contracts was unconscionable under the California Supreme Court’s decision in Discover Bank v. Superior Court.  Under the Discover Bank rule, a class proceeding waiver will be unconscionable if three criteria are met:  (1) it is in a contract of adhesion; (2) it governs disputes over small amounts of money; and (3) it is alleged to be part of a scheme to deliberately cheat consumers out of individually small amounts of money.

The Court granted certiorari, and on Wednesday it reversed, holding that the Discover Bank rule was preempted by the Federal Arbitration Act.  In an opinion by Justice Scalia, the Court explained that “requiring the availability of classwide arbitration interferes with fundamental attributes of arbitration and thus creates a scheme inconsistent with the FAA.”  For the majority, rules that dictate the procedures for arbitration can compromise the informality of arbitration to such an extent that the rules effectively prevent disputes from being arbitrated.  Buttressing this point, the Court pointed out that rules requiring the Federal Rules of Evidence to apply in arbitrations, or rules requiring judicially supervised discovery in arbitration, would prevent the “streamlined proceedings” that arbitration agreements are supposed to facilitate.  Laws requiring such procedural rules in arbitration are barred by the FAA, the Court concluded, regardless of whether they arise from a generally applicable rule of contract law such as unconscionability doctrine.

Applying this conclusion to class arbitration, the Court reasoned that California’s Discover Bank rule was “inconsistent with the FAA” because it unduly interfered with arbitration by requiring the availability of class proceedings in arbitration.  In other words, for the Court, class arbitration cannot be required under the FAA because it is as a practical matter not arbitration at all.  Moreover, the guaranteed availability of class proceedings was inconsistent with arbitration because class proceedings raise the stakes in arbitration, make dispute resolution less confidential, are lengthy and complicated, and require a great deal of formality to bind absent parties.  The Court was particularly worried that arbitration was ill-suited to the high stakes of class proceedings because errors made in the course of rendering large judgments would not be subject to any real appellate review.  Overall, the Court’s opinion portrays class arbitration as an ill-conceived procedure that combines the cost, delay and “procedural morass” of class litigation with the unreliability of arbitration to create a wholly irrational dispute resolution mechanism that bears no resemblance to traditional arbitration.

It is therefore difficult to avoid the conclusion that, at bottom, the majority struck down the Discover Bank rule under the FAA because class arbitration is inconsistent with its substantive conception of what arbitration should be.  In his dissent, which was joined by Justices Ginsburg, Sotomayor, and Kagan, Justice Breyer took the majority to task for this holding, arguing both that “class arbitration is consistent with the use of arbitration” and that the majority contravened basic federalism principles in forcing on the states its substantive conception of what arbitration.

In challenging the majority’s conclusion that class arbitration is inconsistent with the nature of arbitration, Justice Breyer notes that the American Arbitration Association regards class arbitration as “a fair, balanced, and efficient means of resolving class disputes.”  Moreover, high-stakes disputes are often settled in arbitration; although class arbitration is doubtless more complex than individual arbitration, it is far simpler and faster than full-blown class litigation.

Turning to federalism principles, Justice Breyer next emphasizes that the FAA contemplates a role for states in regulating arbitration contracts by allowing states to strike down arbitration agreements “upon such grounds as exist at law or in equity for the revocation of any contract.”  Although this principle prohibits states from discriminating against arbitration agreements, it allows them to regulate arbitration agreements just as they would other contracts.  Justice Breyer concludes that California should be entitled to weigh the pros and cons of class proceedings and create a general rule curtailing the circumstances in which a consumer can waive her right to initiate a class proceeding.  Justice Breyer suggests that the majority’s decision is motivated by its views regarding the “merits and demerits of class actions,” and that in doing so it treads on California’s federalism interests by foisting upon California its view that class arbitration has none of the benefits of arbitration due to its procedural deficiencies.

Although Justice Thomas joined the majority, he also filed a concurring opinion in which he made it clear that he did so only “reluctantly,” to “give lower courts guidance from a majority of the Court.”  In his opinion, Justice Thomas also articulated a novel textual analysis of the FAA, which led him to conclude that states may only render arbitration contracts revocable on grounds such as fraud or duress that challenge the formation of an arbitration agreement.  However, he noted, his textual analysis of the statute would generally lead to the same outcome as the principle announced in the majority’s opinion.

Given the majority’s holding, after Wednesday’s opinion the FAA can be regarded not only as a statute favoring arbitration, but also as a statute disfavoring class proceedings.  This holding leaves the states with no clear way to ban contracts that insulate companies from liability through class proceeding waivers.