US Sup Ct Says FAA Preempts State Law Rule Allowing Invalidation of Class Action Waivers

As widely reported in the news, the Supreme Court of the United States recently held that the Federal Arbitration Act (FAA) preempted a state court rule that class action waivers in consumer arbitration agreements may be invalidated as unconscionable.


A copy of the opinion is available at

http://www.supremecourt.gov/opinions/10pdf/09-893.pdf.

Respondents-consumers (“Respondents”) entered into a contract for cell phones and service with AT& T. That contract provided for arbitration of all disputes between the parties, and disallowed class arbitration. After a dispute arose between the parties, Respondents filed a complaint in federal court in California. AT&T moved to compel arbitration.

Respondents opposed the motion on the grounds that the arbitration agreement was unconscionable.

The district court denied At & T’s motion, and the Ninth Circuit affirmed, finding the provision denying class arbitration unconscionable under state law. Both courts based their decision on the rule laid out in Discover Bank v. Superior Court, 36 Cal. 4th 148, 113 P. 3d 1100 (2005) (the “Discover Bank rule”). The Ninth Circuit further held that the Discover Bank rule was not preempted by the FAA. The Supreme Court granted certiorari.

As you may recall, the FAA 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.” See 9 U.S.C. §2.

The Discover Bank rule provides that class waivers in consumer arbitration agreements are unconscionable where the agreement is in an adhesion clause, the amount of damages are likely to be small, and the party with inferior bargaining power alleges a deliberate scheme to defraud. The Court’s decision turned on whether the Discover Bank rule was preempted by the FAA’s provision that agreements to arbitrate are generally valid, or consistent with the FAA’s provision that such agreements may be invalided upon legal or equitable grounds to revoke contracts.

In holding that the Discover Bank rule was preempted by the FAA, the United States Supreme Court began by examining the FAA, noting that it reflects a “liberal policy favoring arbitration” and was intended to allow for “efficient, streamlined procedures” to resolve disputes. The Court then laid out several flaws with class-wide arbitration, describing it as slower, costlier and more complicated than bilateral arbitration. The Court also raised a concern that if the Discover Bank rule were allowed to stand, then agreements to arbitrate might be invalidated on grounds that would effectively eliminate arbitration clauses from contracts (for example, on the grounds that such an agreement did not allow for judicially monitored discovery).

Further, the Court noted that the informal procedures of arbitration are

“poorly suited to the higher stakes of class litigation.” In particular,

the Court expressed doubt that defendants in arbitration matters would consent to class-wide arbitration, due to the risk of error, lack of judicial review, and the size of potential losses. Although the Court noted that defendants are often willing to accept those risks in bilateral arbitrations with smaller stakes, the Court stated that “[w]e find it hard to believe that defendants would bet the company with no effective means of review.”

Because “[r]equiring the availability of classwide arbitration interferes with fundamental attributes of arbitration and thus creates a scheme inconsistent with the FAA,” the Court held that the Discover Bank rule is preempted by the FAA.