The United States Supreme Court’s decision in AT&T Mobility v. Concepcion, 563 U.S. 333 (2011), marked a turning point in California’s traditional hostility to arbitration of consumer disputes, especially as an alternative to class actions. The high court ruled that for consumer transactions involving interstate commerce, the Federal Arbitration Act (“FAA”) favored traditional one-on-one arbitration and trumped California’s policy against class action waivers. That policy had reached its zenith in Discover Bank v. Super. Ct., 36 Cal. 4th 148 (2005), which banned class action waivers for most consumer claims. Concepcion explicitly overruled Discover Bank, at least for any contract within the reach of the FAA. Arguably, this left the Discover Bank bar on class waivers available only for the rare case that did not in some way touch interstate commerce.
The ever-creative class action bar in California latched on to this limited local exception to Concepcion’s broad sweep to fashion what became known colloquially as the “poison pill.” Sanchez v. Valencia Holding Co., LLC, 61 Cal. 4th 899, 923 (2015). To understand it requires a brief look back at the evolution of consumer arbitration clauses in California before Discover Bank was reined in by Concepcion. Many arbitration clauses, like the one at issue in the auto finance contract in Sanchez, provided that if any part of the clause were deemed unenforceable, it could be severed so that arbitration would still be available to the parties. But those arbitration clauses also contained class action waivers, which if severed due to their unenforceability under Discover Bank, could have had the unintended consequence of allowing for a class arbitration. In order to protect against this eventuality, the severance provision of those clauses provided an exception under which the entire arbitration clause would be ineffective if the class waiver turned out to be unenforceable.
It is this exception to severance that the class action attorneys characterized as a “poison pill.” According to their theory, because class action waivers are still contrary to California policy, this exception to severance poisons the entire arbitration clause even for contracts within the purview of the FAA. In effect, the financial entity defendants were alleged to have contractually opted for a California policy that is inconsistent with the FAA. Although the trial court in Sanchez swallowed the “poison pill” argument, the Court of Appeal chose to duck it in light of the recently issued Concepcion decision. Sanchez v. Valencia Holding Co., LLC, 135 Cal. Rptr. 3d 19, 27-28 (2011). When plaintiff raised it again following a grant of review, the California Supreme Court threw in the towel. Sanchez, 61 Cal. 4th at 924 (“Because we conclude in light of Concepcion that the FAA preempts the trial court’s invalidation of the class waiver on unconscionability grounds, the agreement’s poison pill provision is inoperable.”).
One would think that having lost in the notoriously anti-arbitration California Supreme Court, the class action proponents would stop trying to peddle their poison pill argument. But too much was at stake—the gargantuan fee recoveries to which they had become accustomed—so they pressed on to the highest court in the land. In DirecTV, Inc. v. Imburgia, et al., ___ U.S. ___, 136 S. Ct. 463 (2015), the United States Supreme Court, in a 6-3 decision (J. Thomas dissenting on unrelated grounds), soundly rejected this thinly-veiled attempt to evade its earlier Concepcion decision. Justice Breyer, who had dissented in Concepcion, left little doubt as to the high court’s displeasure with the class proponents’ attempt to evade that earlier decision. DirecTV, 136 S. Ct. at 471 (“it does not give ‘due regard . . . to the federal policy favoring arbitration.’”). Although not explicit, the rebuke was also to the California Court of Appeal, whose decision adopted the poison pill argument (Imburgia v. DirecTV, Inc., 225 Cal. App. 4th 338, 347 (2014)), and to the California Supreme Court, which had declined to review it.
The Court of Appeal focused on the specific language of DirecTV’s arbitration clause, which contained a class waiver, but also provided that if “the ‘law of your state’ makes the waiver of class arbitration unenforceable, then the entire arbitration provision ‘is unenforceable’.” DirecTV, 136 S. Ct. at 466. The appellate court acknowledged that the arbitration clause was within the reach of the FAA and explicitly called out the FAA as its governing law. Nevertheless, its opinion concluded that the provision concerning unenforceability under state law trumped the FAA and acted as a poison pill that extinguished the entire arbitration clause. Id. at 466-67. It attempted to bolster this conclusion by noting that any ambiguity in the meaning of the arbitration clause must be interpreted against DirecTV. Id. at 467.
Justice Breyer systematically reviewed and rejected each of the points relied on by the lower court. As a preface, his opinion addressed whether the parties to an arbitration agreement are free to choose state law over the FAA. Id. at 468. In a highly quoted passage, Justice Breyer observed that “[i]n principle, they might choose to have portions of their contract governed by the law of Tibet, the law of pre-revolutionary Russia, or (as relevant here) the law of California including the Discover Bank rule and irrespective of that rule’s invalidation in Concepcion.” Id. What’s more, Justice Breyer recognized that the high court is bound by the interpretation given to such language by a state court. Id. That sounds like an ominous beginning for DirecTV, but it was far from the end of the story. Central to the controversy was whether such an interpretation by the state court was inconsistent with the FAA, as interpreted by Concepcion. Id.
In order to answer the question, Justice Breyer analyzed whether the lower court decision placed arbitration contracts “‘on equal footing with all other contracts,’” specifically whether under state law, “‘grounds . . . exist at law or in equity for the revocation of any contract.’” Id. It was all downhill from there, as Justice Breyer found a series of ways in which the lower appellate court had treated the DirecTV arbitration clause differently than other contracts. First, there was nothing “ambiguous” about the arbitration clause, as the reference to “unenforceable” under state law contemplated a valid state law, not one preempted by the FAA. Id. at 469. Second, no California precedent suggests that “law of the state” should be interpreted to include a law in conflict with federal law. Id. Third, the lower court decision improperly framed the discussion in terms of arbitration rather than general contract principles. Id. at 469-70. Fourth, no support exists for the suggestion that Discover Bank continues to be viable where the FAA applies. Id. at 470. Fifth, no general principle of California law was cited in which “law of your state” would be so interpreted in other contexts. Id. Finally, the lower court overlooked clear California precedent that would give retroactive effect to a valid meaning of a contract over a meaning held to be invalid. Id.
In a clear rebuke to the California courts, Justice Breyer observed that while “[l]ower court judges are certainly free to note their disagreement with a decision of this Court[,] . . . the ‘Supremacy Clause forbids state courts to dissociate themselves from federal law because of disagreement with its content or a refusal to recognize the superior authority of its source.’” Id. at 468 (quoting Howlett v. Rose, 496 U.S. 356, 371 (1990)). Hopefully, the message will get through to state courts—both in California and elsewhere—that under the FAA, arbitration agreements must be treated on a par with other contracts and must be enforced despite state policy to the contrary.
The untimely death of Justice Scalia—who wrote for the Concepcion majority—has raised concern as to whether the Umited States Supreme Court’s pro-arbitration posture, as exemplified by its DirecTV decision, would continue. Until recently, it appeared that the Court would have another opportunity to address the issue. It had granted certiorari in another California Court of Appeal decision that denied enforcement of an arbitration agreement and, in the process, ignored the normal rules governing severance of invalid contractual provisions. MHN Gov’t Services, Inc. v. Zaborowski, 136 S. Ct. 27 (Oct. 1, 2015). On the eve of oral argument and after the issuance of the DirecTV opinion, the parties settled and the petition for writ of certiorari was dismissed. MHN Gov’t Services, Inc. v. Zaborowski, 136 S. Ct. 1539 (Apr. 12, 2016).
Another highly visible case working its way through the federal court system likewise may provide a possible vehicle for testing the limits of DirecTV. In O’Connor v. Uber Technologies, Inc., the district court refused to enforce an arbitration clause and certified a class action of over 160,000 drivers on the basis of an unnecessarily broad anti-severance provision contained in the drivers’ contracts. 311 F.R.D. 547 (N.D. Cal. Dec. 9, 2015). On April 6, 2016, the Ninth Circuit granted Uber permission to appeal the class certification order under Rule 23(f) of the Federal Rules of Civil Procedure. And recently, the Ninth Circuit issued an opinion in a companion appeal rejecting the district court’s use of the same anti-severance provision – similar to the “poison pill” at issue in DirecTV, except involving PAGA rather than class claims – and granted Uber’s motion to compel arbitration. Mohamed v. Uber Technologies, Inc., 2016 WL 4651409 (9th Cir. Sept. 7, 2016). So stay tuned as there is talk that the related Uber cases may end up before the United States Supreme Court before they are resolved.
All of these decisions contain a lesson for practitioners drafting arbitration clauses: Be especially careful not to include excessively broad anti-severance provisions concerning class action waivers.
For more information regarding the DirecTV decision, or arbitration in general, please contact Donald. J. Querio at email@example.com.