Arbitration Showdown

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The U.S. Supreme Court enforces arbitration in the face of yet another challenge; will the California courts follow suit?

As those who read this blog regularly already know, courts have divided into two camps over the enforceability of contractual arbitration agreements. Both camps claim to have the same starting point: the Federal Arbitration Act (“FAA”) public policy favoring arbitration, under which parties who contractually agree to arbitrate a dispute are absolutely bound to do so unless the agreement is clearly “unconscionable;” i.e., so unreasonable that it shocks the conscience.

But one camp—led most notably by the United States Supreme Court—takes an expansive view of the policy favoring arbitration, and consequently takes an extremely narrow view of what makes an arbitration agreement unconscionable. The other camp, into which many California courts have fallen, takes a much narrower view of the public policy favoring arbitration and is therefore more willing to find an arbitration clause fatally unconscionable, usually using state law to do so. The trouble is, because the FAA is a federal statute; it preempts state law, and federal court decisions interpreting the statute are ultimately binding on state courts. This has set the stage for an inevitable showdown over U.S. Supreme Court decisions broadly favoring arbitration and state court decisions (including those of the California Supreme Court), which often seem to disfavor it.

The showdown intensified this summer, when the U.S. Supreme Court decided American Express v. Italian Colors Restaurant ("Amex"). AmEx’s merchant contract included an arbitration clause. It also included a class-action waiver, which said that the merchants had “no right or authority” to arbitrate any claim against AmEx “on a class action basis.” A group of merchants sued AmEx, alleging that the company used its monopoly power in the credit card industry to charge inflated fees in violation of federal antitrust laws. AmEx moved to enforce the arbitration agreement and argued that, under the class-action waiver, each merchant’s claim must be arbitrated individually. The merchants argued that that would be unfair because the cost of individually arbitrating each claim (several hundred thousand dollars) would dwarf any possible reward (a little over $10,000 per merchant).

The Supreme Court ruled against the merchants and upheld the arbitration agreement generally and the class-action waiver specifically. In doing so, the high court noted that the FAA’s strong public policy favoring arbitration isn’t trumped by mere economics in an individual case, and nothing in federal law guarantees plaintiffs “an affordable procedural path to the vindication of every claim.” In other words, arbitration isn’t “unconscionable” in a given case merely because it’s less economically viable than a class action.

This followed another landmark arbitration case—AT&T Mobility v. Concepcion—in which the Supreme Court invalidated a California Supreme Court rule holding unconscionable provisions of consumer contracts waiving the right to arbitrate claims on a class-action basis. The Supreme Court in Concepcion reiterated Congress’s intent in enacting the FAA to require arbitration whenever parties contractually agree to it. That a state court believes a consumer’s decision to waive his right to arbitrate class claims is unwise, the high court held, is no reason to invalidate a contract in which they plainly do so. A paternalistic view that courts know better what consumers should agree to, in other words, does not make the consumer’s actual contractual agreement “unconscionable.”

Both of these landmark decisions will come into play in Sonic-Calabasas A, Inc. v. Moreno and Sanchez v. Valencia Holding Co. LLC, two cases currently pending before the California Supreme Court.

In Sanchez, a consumer filed a class-action lawsuit against an auto dealer. The dealer moved to dismiss the case because the consumer had contractually agreed to arbitrate any dispute, and to so do only on an individual basis. The Court of Appeal held that the agreement was unconscionable because, among other things, individual arbitration would be far costlier, and less efficient, than a class-action lawsuit. Not surprisingly, the same Court of Appeal reached a nearly identical holding earlier this Summer in Vargas v. SAI Monrovia B, Inc. (the state’s high court has since issued a grant and hold order on this case). The state high court will now have to decide whether, in light of both AT&T Mobility v. Concepcion and American Express v. Italian Colors Restaurant, consumer class-action waivers are enforceable under the FAA notwithstanding California public policy disfavoring them.

Moreno is before the California Supreme Court on remand from the SCOTUS after the California Supreme Court held that the right to a Berman Hearing (the hearing an employee gets before the Labor Commissioner to recover unpaid wages) is an unwaivable statutory right and an agreement requiring the employee to waive that right in favor of arbitration is unconscionable. After Concepcion, the SCOTUS told the California Supremes they need to pay attention and reconsider the issue in light of its Concepcion decision. That case was all ready to be decided when the SCOTUS issued its Amex decision, prompting the California Supreme Court to request further briefing in light of Amex. A decision is expected in mid-October.

To quote Yogi Berra, predictions are hard to make, especially about the future. But if the California Supreme Court in Sanchez and Moreno applies recent U.S. Supreme Court precedent, it is hard to see how it could rule the arbitration agreements at issue in those cases unenforceable, notwithstanding its historic distaste for them.

On the other hand, the same could have been said of the Court of Appeal in Sanchez and Vargas—both of which appear to have been wrongly decided in view of U.S. Supreme Court precedent affirming the enforceability of arbitration agreements generally and class-action waivers specifically. Unless the California Supreme Court reverses those decisions, the great arbitration showdown will continue.