Availability of Class Actions in Arbitration, Part 1
Certain rights conferred by statute are not susceptible to being waived by individuals on whom the statute confers those rights. Employment lawyers who deal in Fair Labor Standards Act (the FLSA)1 cases are made aware of this fact by the Supreme Court decision in Brooklyn Savings Bank v. O’Neil, 324 U.S 697 (1944).
It has been held in this and other courts that a statutory right conferred on a private party, but affecting the public interest, may not be waived or released if such waiver or release contravenes the statutory policy.…Where a private right is granted in the public interest to effectuate a legislative policy, waiver of a right so charged or colored with the public interest will not be allowed where it would thwart the legislative policy which it was designed to effectuate. With respect to private rights created by a federal statute, such as [29 U.S.C.] §16 (b), the question of whether the statutory right may be waived depends upon the intention of Congress as manifested in the particular statute.2
The court further reasoned that the legislative history of the FLSA showed a purpose to protect certain individuals who lacked bargaining power from substandard wages and that to “allow waiver of statutory wages by agreement would nullify the purposes of the [a]ct.” The court stated, “the same policy considerations which forbid waiver of basic minimum and overtime wages under the [a]ct also prohibit waiver of the employee’s right to liquidated damages.”3 This view was reiterated in Schulte v. Gangi, 328 U.S. 108, 114-15 (1946), in which the court ruled “the remedy of liquidated damages [in FLSA cases] cannot be bargained away by bona fide settlements of disputes over coverage.”
The reasoning in Brooklyn Savings Bank v. O’Neil and Schulti v. Gangi leads to the question of whether a waiver of the right to bring a class action4 is enforceable, whether it be in a judicial or arbitration forum. No bar to waiving the right to bring an employment claim in court has a force matching the prohibition against waiving substantive FLSA rights. Nonetheless, some courts have concluded that class action waivers in certain specific instances are unenforceable as against public policy. As might be expected, the courts are not unanimous on this issue.
Given that waiver of class action entitlements are not per seunenforceable as being in violation of public policy, the questions to be answered are when they will be enforced. In answering these questions, it is necessary to take into account the federal policy favoring class actions. This policy was forcefully articulated by the Supreme Court in Deposit Guaranty National Bank v. Roper, 445 U.S. 326, 338 (1980).
The use of the class-action procedure for litigation of individual claims may offer substantial advantages for named plaintiffs; it may motivate them to bring cases that for economic reasons might not be brought otherwise.n9 Plainly there has been a growth of litigation stimulated by contingent-fee agreements and an enlargement of the role this type of fee arrangement has played in vindicating the rights of individuals who otherwise might not consider it worth the candle to embark on litigation in which the optimum result might be more than consumed by the cost. The prospect of such fee arrangements offers advantages for litigation by named plaintiffs in class actions as well as for their attorneys. For better or worse, the financial incentive that class actions offer to the legal profession is a natural outgrowth of the increasing reliance on the “private attorney general” for the vindication of legal rights; obviously this development has been facilitated by Rule 23.
N9 A significant benefit to claimants who choose to litigate their claims in a class-action context is the prospect of reducing their costs of litigation, particularly attorney’s fees, by allocating such costs among all members of the class who benefit from any recovery. Typically the attorney’s fees of a named plaintiff proceeding without reliance on Rule 23 could exceed the value of the individual judgment in favor of any one plaintiff. Here the damages claimed by the two named plaintiffs totaled $1,006.00. Such plaintiffs would be unlikely be able to obtain legal redress at an acceptable cost, unless counsel were motivated by the fee-spreading incentive and proceeded on a contingent fee basis. This, of course, is a central concept of Rule 23.5
Policy Favoring Arbitration vs. Policy Favoring Class Actions
Decisions dealing with the enforceability of arbitration agreements take into consideration Congress’ intent to create a strong policy favoring arbitration as set forth in the Federal Arbitration Act (the FAA).6 This policy is embodied in 9 U.S.C. §2 (emphasis added):
A written provision in any maritime transaction or a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction, or the refusal to perform the whole or any part thereof, or an agreement in writing to submit to arbitration an existing controversy arising out of such a contract, transaction, or refusal, shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.
The Supreme Court established in Moses H. Cone Memorial Hosp. v. Mercury Construction Corp., 460 U.S. 1, 24 (1983), that “§2 is a Congressional declaration of a liberal federal policy favoring arbitration agreements, notwithstanding any state substantive or procedural policies to the contrary.”
Likewise, the Supreme Court focused on the salutary effect of the availability of class actions in Amchem Prods. v. Windsor, 521 U.S. 591, 617 (1997), when it quoted with approval the comments of the Seventh Circuit in Mace v. Van Ru Credit Corp., 109 F.3d 338, 344 (7th Cir. 1997).
The policy at the very core of the class action mechanism is to overcome the problem that small recoveries do not provide the incentive for any individual to bring a solo action prosecuting his or her rights. A class action solves this problem by aggregating the relatively paltry potential recoveries into something worth someone’s (usually an attorney’s) labor.
Any question of whether class actions in arbitration are permissible under the FAA was implicitly put to rest by the Supreme Court in Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20, 31 (1991), and Green Tree Financial Corp. v. Bazzle, 539 U.S. 444 (2003). In Gilmer, the appellant employee attacked the enforceability of the arbitration requirement in the New York Stock Exchange’s rules on the grounds that it would deprive ADEA plaintiffs of the ability to proceed collectively. The Supreme Court noted that NYSE rules specifically permitted class-type arbitration proceedings, implying their permissibility under the FAA. The Court further held in dicta, however, that even if collective proceedings were not available, the arbitration agreement would be enforceable. The dicta issue appears to have been the inability of an arbitral forum to provide class relief, not a waiver of the right by the parties. Subsequent to Gilmer, many of the major arbitration agencies, including AAA and JAMS, have developed class action rules and procedures, making the capability issue less significant.
In Bazzle, an arbitrator had allowed the two cases in issue to proceed as class arbitrations. The arbitrator’s rulings in favor of the classes were ultimately reviewed by the South Carolina Supreme Court, which held on a collateral attack that the arbitration agreements in question did not bar class-wide arbitrations. In the absence of a prohibition against class arbitrations in the arbitration agreement, they were found to be permissible. The U.S. Supreme Court reversed and remanded, holding that the arbitrator, not a court, should interpret the arbitration agreements to determine whether class arbitrations were permitted by the agreements.7
The questions of whether class actions are allowable in arbitrations and whether the right to bring a class arbitration can be waived by the agreement of the parties where the FAA applies were not directly discussed in the Bazzle decision. However the court’s decision indicates that the answer to both of these questions is yes. The court would not likely have remanded the case with a mandate giving the arbitrator the discretion to decide if the arbitration could proceed as classwide if such a proceeding was not permissible under the FAA. The fact that the arbitrator had the latitude to determine that classwide arbitration was barred under the agreement implies that the right may be waived.
The De Minimus Recovery Issue
Most courts post-Bazzle assume that waivers of class proceedings in arbitration agreements are not per se invalid. This does not mean, however, that courts have always found them enforceable. A number of decisions denying enforcement of classwide arbitration waivers involved what appears to have been clever attempts by regulated industries to essentially bar or at least limit individuals from obtaining relief where there has been a violation of their statutory rights. This was one of the premises on which a California appellate court in Szetela v. Discover Bank, 97 Cal. App. 4th 1094 (2002),found a waiver of the right to bring a classwide arbitration to be unenforceable as unconscionable. The amount claimed by the named plaintiff was $29, an over limit fee charged to his credit card account. Obviously such small sums discourage individual actions. The court explained that:
Unconscionability includes both substantive and procedural elements. Procedural unconscionability addresses the manner in which agreement to the disputed term was sought or obtained, such as unequal bargaining power between the parties and hidden terms included in contracts of adhesion. Substantive unconscionability addresses the impact of the term itself, such as whether the provision is so harsh or oppressive that it should not be enforced.8
The court rejected the argument that there is no procedural unconscionability where the party opposing the term is able to obtain the bargained for product from a source that would not require that provision.9 As to substantive unconscionability the court noted that it “traditionally involves contract terms that are so one-sided as to ‘shock the conscience,’ or that impose harsh or oppressive terms. The manifest one-sidedness of the no class action provision at issue here is blindingly obvious.”10 The court declared that:
While the advantages to Discover are obvious, such a practice contradicts the California Legislature’s stated policy of discouraging unfair and unlawful business practices, and of creating a mechanism for a representative to seek relief on behalf of the general public as a private attorney general. (See, e.g., Bus. & Prof. Code, §17200 et seq.) It provides the customer with no benefit whatsoever; to the contrary, it seriously jeopardizes customers’ consumer rights by prohibiting any effective means of litigating Discover’s business practices. This is not only substantively unconscionable, it violates public policy by granting Discover a “get out of jail free” card while compromising important consumer rights.11
The case was remanded to the trial court with a mandate to strike the clause prohibiting class arbitration, effectively severing that provision from the arbitration agreement and allowing the balance of the agreement to stand.
The defendant in Discover Bank v. Superior Court of Los Angeles, 36 Cal. 4th 148 (Cal. 2005),asked the court to remand a judicial putative class action for single-party arbitration based on a class action waiver in the parties’ agreement. The complaint included a count alleging that certain charges violated Delaware’s Consumer Fraud Act. Although the parties’ contract contained a Delaware choice-of-law provision, the court concluded that California law could apply to the enforcement of the waiver involved. It posited that “at least under some circumstances, the law in California is that class action waivers in consumer contracts of adhesion12 are unenforceable, whether the consumer is being asked to waive the rights to class action litigation or the right to classwide arbitration.”13
In considering various policy considerations the court quoted Vasquez v. Superior Court, 4 Cal. 3d 800, 808, 94 Cal. Rptr. 796, 484 P.2d 964 (1971):
Frequently numerous consumers are exposed to the same dubious practice by the same seller so that proof of the prevalence of the practice as to one consumer would provide proof for all. Individual actions by each of the defrauded consumers is often impracticable because the amount of individual recovery would be insufficient to justify bringing a separate action; thus an unscrupulous seller retains the benefits of its wrongful conduct. A class action by consumers produces several salutary by-products, including a therapeutic effect upon those sellers who indulge in fraudulent practices, aid to legitimate business enterprises by curtailing illegitimate competition, and avoidance to the judicial process of the burden of multiple litigation involving identical claims. The benefit to the parties and the courts would, in many circumstances, be substantial.14
The court also rejected the argument that the potential for recovery of attorneys’ fees by a prevailing plaintiff was sufficient incentive for an aggrieved person to proceed with an action limited to his or her own claim.15 It viewed class actions as “particularly in the consumer context, often inextricably linked to the vindication of substantive rights.”16 Nor was weight given to the argument that prosecution by government agencies is an adequate substitute for a classwide action.17
The guidance to the lower court on remand was first to decide whether a class action waiver was enforceable under Delaware law.18 It was to determine whether Delaware law was applicable by exploring whether the state’s law has “a substantial relationship to the parties or to their transaction… or there is any other reasonable basis for the parties’ choice of law.”19 If Delaware law was applicable, the appellate court was then to determine whether Delaware law was in fundamental conflict with California law. If the appellate court was to find that California has a “materially greater interest,” California law would apply.20
In Kristian v. Comcast Corp., 446 F.3d 25 (2d Cir. 2006), the Second Circuit struck a provision prohibiting class arbitrations in combined actions alleging violations of the Massachusetts Antitrust Act21 and the Clayton Antitrust Act respectively.22 The plaintiffs complained about swapping agreements which enabled Comcast to prevent people in their market area from using competing cable services. The court considered that although the prohibition of class actions in the agreement was limited to arbitrations, since arbitration was mandatory, there was no opportunity for the plaintiff to obtain classwide relief in any forum.23 Therefore, the arbitration agreement was in conflict with Rule 23 of the Federal Rules of Civil Procedure. Rule 23 in authorizing class actions allows plaintiffs to recover when the amount in issue is so small that there is a disincentive for individuals to bring single party actions to enforce their rights. In Kristian, individual recoveries would be too small for an individual to sue. The court observed that “[o]nly a lunatic or a fanatic sues for $30.”24
Expert testimony satisfied the court that the costs of bringing an antitrust suit such as the one in issue would be no less than $300,000 and could exceed $600,000.25 The potential for plaintiffs’ recovery would range from a few hundred dollars to a few thousand dollars. Considering the capital outlay to bring an antitrust action, the potential for recovering attorneys’ fees would not balance the considerable advance required to bring an individual claim.26 Thus, enforcing the waiver of the right to arbitrate as a class would effectively shield Comcast “from private consumer antitrust enforcement liability, even where it has violated the law.”27 Neither was the court swayed by the fact that government action could enforce the law. It opined that “[w]hen Congress enacts a statute that provides for both private and administrative enforcement, Congress envisions a role for both types of enforcement.”28
Finding that enforcement of the class arbitration waiver would make the plaintiffs “unable to vindicate their statutory rights,” the court struck it from the agreement and remanded the matter to be arbitrated on a classwide basis.29 The court rejected Comcast’s argument that the waiver was not severable and the entire arbitration agreement must fall. The court looked to savings language providing in part that the waiver of class actions would not apply if “your state’s law provides otherwise.”30
The availability the arbitration agreement afforded for potential plaintiffs to file small claims actions did not support Comcast’s attempt to “insulate itself from liability to a potential class of customers.”31 While holding the class action waiver substantively unconscionable, the court did not rule that class action waivers in arbitration were per se invalid. Rather, it decided that “enforceability of a class action waiver must be considered on a case by case basis considering the totality of the circumstances.”32 The prohibition on class claims in the agreement was severed and the matter was permitted to proceed as a class arbitration because of a severability clause and the policy favoring arbitration.33
The plaintiff in Powertell, Inc. v. Bexley, 743 So. 2d 570 (Fla. 1st DCA 1999),filed a judicial class action complaining of a $4.50 long distance charge for a call in her local service area, although her agreement provided such calls were not to be billed as long distance calls. Among other allegations, the plaintiff claimed violations of
Florida’s Unlawful and Deceptive Trade Practices Act (FDUPTA).34 Florida’s First District Court of Appeal affirmed the trial court’s denial of the defendant’s motion to remand the case to arbitration. The court found the subject arbitration clause to be adhesive as well as procedurally and substantively unconscionable. In reaching its decision, the district court of appeal remarked:
Although the states may not impose special limitation on the use of arbitration clauses, the validity of an arbitration clause is nevertheless an issue of state contract law. Section 2 [of the FAA] states that an arbitration clause can be invalidated on “such grounds as exist at law or in equity for the revocation of contracts.” Thus an arbitration clause can be defeated by any defense existing under the state law of contracts.35
The court initially had problems with the enforceability vel non of the agreement. The arbitration language was sent as a standardized insert in the customer’s monthly bills which was found to give inadequate notice of its existence. There was no give and take bargaining over its terms. Further, in barring customers from arbitrating as a class it deprived them of:
the most economically feasible remedy for the kind of claim that has been asserted here. The potential claims are too small to litigate individually, but collectively they may amount to a large sum of money. The prospect of class litigation ordinarily has some deterrent effect on a manufacturer or a service provider, but that is absent here. requiring arbitration of all claims, Powertel has precluded the possibility that a group of its customers may join together to seek relief that would be impractical for any of them to obtain alone.36
The decision points out the one-sided nature of the bilateral prohibition against class actions noting that only the customer would have occasion to invoke the class action procedure.37
An Ohio appellate court in Schwartz v. Alltell Corporation, Ohio Appellate Court, Eighth Cir., No. 86810 (June 29, 2006),declined to sever an offending class action waiver provision in a facially valid arbitration agreement. Instead it struck the entire arbitration agreement finding it procedurally and substantively unconscionable. The court stated “[b]y eliminating a consumer’s right to proceed through a class action, the arbitration clause directly hinders the consumer protection purposes of the [The Ohio Consumer Sales Protection Act] CSPA.”38 It reasoned that “[b]y prohibiting its customers from filing suit as a class, Alltell prevents the cost effective class action litigation that can end abusive practices by large corporations in those instances in which individual claims are ineffective.”39
The plaintiff in Kinkel v. Cingular Wireless, 223 Ill. 2d 1 (Ill. 2006), alleged that the company’s practice of charging a cancellation fee for dropping its service violated the Illinois Consumer Fraud and Deceptive Business Practices Act (Consumer Practices Act), 815 ILCS 505/1 et seq. In denying enforcement of a class action waiver, and in reviewing the precedent up to that point, the court reasoned that:
If there is a pattern in these [class action waiver] cases it is this: a class action waiver will not be found unconscionable if the plaintiff had a meaningful opportunity to reject the contract term or if the agreement containing the waiver is not burdened by other features limiting the ability of the plaintiff to obtain a remedy for the particular claim being asserted in a cost-effective manner. If the agreement is so burdened, the “right to seek classwide redress is more than a mere procedural device.”40
The court pointed to the Supreme Court’s statement in Deposit Guaranty: “Where it is not economically feasible to obtain relief within the traditional framework of a multiplicity of small individual suits for damages, aggrieved persons may be without any effective redress unless they may employ the class-action device.”
The Kinkel and Kristian decisions stand as fair synopses of the developing state of the law. It is likely that the trend of refusing to enforce class waivers in small recovery cases will continue.
But what does this line of cases mean for employment and labor litigation? The availability of noneconomic damages and statutory fees would seem to place Title VII claims outside the scope of these holdings. But FLSA recoveries could, in certain circumstances, be small enough that a court or arbitrator might be tempted to strike a waiver, even though statutory fees are available. So far, that possibility has not been addressed in a published decision, but it will likely happen at some point.
In part two, we will examine circumstances in which courts have enforced waivers, and try to draw some general principles to guide parties going forward. q
1 29 U.S.C. §201 et seq.
2 Brooklyn Savings Bank v. O’Neil, 324 U.S at 704-05 (1944) (internal citations and footnote omitted).
3 Id. at 706-07 (footnote omitted).
4 In this article the term class action will refer to any type of class or collective procedure.
5 Deposit Guaranty National Bank v. Roper, 445 U.S. 326, 338 (1980) (N10 omitted).
6 9 U.S.C. §1 et seq.
7 Green Tree Financial Corp.v. Bazzle, 539 U.S. at 447, 453 (2003).
8 Szetela v. Discover Bank, 97 Cal. App. 4th 1094, 1099 (2002) (internal citations and footnote omitted).
9 Id. at 1100.
10 Id. (quoting in part, 24 Hour Fitness, Inc. v. Superior Court, 66 Cal. App. 4th 1199, 1213).
11 Id. at1101.
12 Discover Bank v. Superior Court of Los Angeles, 36 Cal. 4th 148, 153 (Cal. 2005). What constitutes a contract of
adhesion was described in some detail in Kristian v. Comcast Broadcasting, 445 F3d 25, 32 N2 (2d Cir. 2006) (citations omitted): “Contracts of adhesion are contracts formed with the use of standard form documents. The party that prepared the contracts typically approaches the potential contractual relationship with a take-it-or-leave-it posture. See Todd D. Rakoff, Contracts of Adhesion: An Essay in Reconstruction, 96 Harv. L. Rev. 1173, 1177 (1983). Other characteristics include: (1) the document whose legal validity is at issue is a printed form that contains many terms and clearly purports to be a contract; (2) the form has been drafted by, or on behalf of, one party to the transaction; (3) the drafting party participates in numerous transactions of the type represented by the form and enters into these transactions as a matter of routine; (4) the form is presented to the adhering party with the representation that, except perhaps for a few identified items, the drafting party will enter into the transaction only on the terms contained in the document (this representation may be explicit or may be implicit in the situation, but it is understood by the adherent); and (5) the adhering party enters into few transactions of the type represented by the form — few, at least, in comparison with the drafting party.”
13 Id. at 153.
14 Vasquez v. Superior Court, 4 Cal. 3d 800, 808, 94 Cal. Rptr. 796, 484 P.2d 964 (1971). Id. at 156.
15 Id. at 161.
17 Id. at 162.
18 Id. at 173.
19 Id. at 173-74.
21 Mass. Gen. Laws, Ch. 93.
2215 U.S.C. §§15 and 26.
23 Kristian v. Comcast Corp., 446 F.3d at 54.
24 Id., quoting Carnegie v. Household Int’l, Inc. 376 F.3d 656, 661 (7th Cir. 2004).
25 Id. at58.
26 Id. at 58-9.
27 Id. at 61, 65.
28 Id. at 61.
29 Id. at 61, 65.
30 Id. at 96.
31 Kristian v. Comcast Corp., 446 F.3d at 41 (2d Cir. 2006).
32 Id. at42-43.
33 Id. at 46-47.
34 Fla. Stat. §501.001 et seq. (1997).
35 Id. at 574.
36 Id. at 576.
37 Id. Florida’s First DCA again ruled that a FDUPTA class action could not be barred by a waiver in an arbitration agreement in SDS Auto Inc. v. Chrzanowske, Fla. App. Lexis 18683 (Fla 1st D.C.A. 2007), finding that barring FDUPTA class actions would frustrate the statute’s purpose by effectively barring small claims involving violations of the act.
38 Schwartz v. Alltell Corporation, Ohio Appellate Court, Eighth Cir., No. 86810 (June 29, 2006),slip opinion at 10.
39 Id. at 11.
40 Kinkel v. Cingular Wireless, 223 Ill. 2d 1, 42 (Ill. 2006) (citations omitted).
Donald J. Spero is a graduate of the University of Michigan Law School who has practiced labor and employment law for over 30 years in both private practice and as in-house counsel for Sears, Roebuck and Co., from which he retired as senior employment counsel. He now devotes his time to serving as a mediator and an arbitrator. He is on the labor and employment arbitration panels of the American Arbitration Association and The Federal Mediation and Conciliation Service. He is board certified in labor and employment law.
This column is submitted on behalf of the Labor and Employment Law Section, Alan O. Forst, chair, and Frank E. Brown, editor.