United States: Consumer Arbitration Update

A case decided by the California Supreme Court may have marked the end of the use of arbitration as a means of dispute resolution for companies that do business with consumers using standard form contracts. Now, a company that uses consumer arbitration as a method of dispute resolution in California runs a significant risk that it may be forced to undertake classwide arbitration—something virtually no company has agreed to do, and something most are loathe to do without the protections afforded by a judicial proceeding.

Arbitration has become a common dispute resolution method for companies who serve consumers through standard form contracts. But even before Boehr, the California courts had begun to limit its utility. For example, claims seeking injunctive relief are inarbitrable in California. No other state follows that rule. Still, most companies have learned to live with that California aberration. Boehr might not be as easily accommodated.

On June 27th, the California Supreme Court issued its long-awaited ruling on consumer arbitration in Discover Bank v. Superior Court (Boehr), ___ Cal.4th ___, 2005 WL 1500866 (June 27, 2005). It addresses a clause common in many consumer account agreements—a clause requiring disputes to be arbitrated on an individual basis, frequently and pejoratively mislabeled a "no-class action" clause. This is a provision that prohibits classwide arbitration, and in many variations also prohibits a consumer from serving as a class representative.

An arbitration clause that prohibits classwide arbitrations or prohibits class actions is not per se unconscionable, but it will be unconscionable if three conditions are satisfied: (1) the waiver is found in a consumer contract of adhesion, (2) the dispute involves small amounts of damages for each individual consumer, and (3) it is alleged that the party with superior bargaining power deliberately sought to cheat large numbers of consumers out of individually small sums of money. If these conditions are satisfied, the Court held, then "at least to the extent the obligation at issue is governed by California law," the waiver is unconscionable and should not be enforced. Most disputes covered by such arbitration clauses would satisfy the first two conditions, and most plaintiffs’ lawyers will be willing to allege the third.

The Boehr court held that such a clause would be substantively unconscionable because it is tantamount to an illegal exculpatory contract (i.e., you can’t contract away your own intentional conduct). The Court also held that even though this unique California rule seemingly discriminates against arbitration, it nevertheless does not violate the Federal Arbitration Act.

The Boehr court fashioned a narrow exception. The clause might be enforced if the defendant is an out-of-state company and the account agreement has a "choice-of-law" clause calling for the application of the law of some other state. In the case before it, the clause happened to arise from an account agreement calling for application of Delaware law, so the Supreme Court remanded to the intermediate court of appeal to determine whether Delaware law (which enforces class action waivers) would be applicable.

Unfortunately, Boehr never answers the hard question squarely presented: Can a defendant that has expressly disclaimed its consent to classwide arbitration nevertheless be forced to undergo exactly that very thing? That seems odd; a court hearing a motion to compel arbitration is restricted to enforcing the parties’ agreement. But enforceable or not, the "no-class action" clause is a clear statement that at least one of the parties has not agreed in writing to classwide arbitration and, in fact, just the opposite. Still, Boehr suggests that could happen. Because it leaves that question unsettled, it means that a company that continues to use consumer arbitration in California runs the risk that it may be forced to undergo classwide arbitration. This risk cannot be eliminated entirely by drafting.

Boehr creates a great deal of uncertainty. But four things appear certain.

First, Boehr may be with us a long time. The procedural posture of the case, and the remand to the court of appeal, makes certiorari unlikely. The issue, however, is percolating in courts all around the country so it is possible that Boehr could be validated or invalidated should such a case reach the Supreme Court.

Second, if a class action waiver clause is found to be unenforceable under Boehr, there are worse consequences than forfeiting the right to arbitrate. As noted, a company might be forced to undergo classwide arbitration.

Third, a company could draw a class action suit under California’s unfair competition law (Bus. & Prof. Code § 17200) or the Consumers Legal Remedy Act (Civil Code § 1750) on the theory that the mere inclusion of an unenforceable clause in a standard-form consumer contract is itself an unfair business practice. We have seen class action suits exactly of this kind already.

Fourth, because this is another only-in-California rule followed by no other state (with the possible exception of West Virginia), California will become a magnet for class action litigation. In short, if a defendant doing business nationally has a consumer arbitration clause, and if lawyers contemplating where to sue should find their way to the Golden State, their path will have been illuminated by Boehr.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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