How could anyone forget the original Star Wars Trilogy (later renumbered by George Lucas as Episodes 4 through 6)? In the original hit, the galaxy was under the spell of the Dark Side of the Force as personified by the Evil Emperor and his henchman, Darth Vader. Against all odds and thanks to their daring-do, the Jedi Knights and their compatriots leveled the playing field and set off a rebellion, bringing hope to the Galaxy. Then, in the sequel, the Emperor and Lord Vader made their comeback, leaving the audience hanging as to whether truth and justice would ever prevail. It was aptly named “The Empire Strikes Back.”
The same script could be easily adapted to the battle pitting the Federal Arbitration Act (“FAA”) against the ever-expanding empire of class actions. For years, the class action bar has expanded its reach into virtually every aspect of American life, from finance to foodstuffs. At its high-water mark, this growing cadre of self-proclaimed consumer advocates threatened to turn our judicial system into a regulatory powerhouse, displacing traditional legislatures and agencies as slow and inefficient. What better way to effect social policy than through the threat of annihilating damages? Judge Easterbrook was one of the first jurists to recognize the threat. He wrote, “[e]fficiency is a vital goal in any legal system–but the vision of ‘efficiency’ underlying this class certification is the model of the central planner.” In re Bridgestone/Firestone, Inc., 288 F.3d 1012, 1020 (7th Cir. 2002).
Against a well-funded and politically connected class action bar, the chances of restoring the legal system to its traditional role of adjudicating individual disputes on a case-by-case basis seemed slim. That is until a few brave souls found hope in a nearly century-old federal statute that guaranteed parties a simple, expeditious forum for resolving disputes: the FAA. For almost a decade, the advocates of arbitration as an alternative to impersonal and lawyer-driven class actions were derided as dreamers, cranks or worse. In fact, most courts, especially in states like California, created multiple doctrines that forestalled this mini-rebellion. Of course, the effect of these decisions was to upset the traditional order of precedent such that court-created procedural rules–Federal Rules of Civil Procedure Rule 23 and its state analogs–were held to trump a federal statute mandating the enforcement of private arbitration agreements.
All seemed lost, that is until the U.S. Supreme Court halted the class action stormtroopers in their tracks. In AT&T Mobility v. Concepcion, ___ U.S. ___, 131 S.Ct. 1740 (2011), which has, for good reason, been discussed heavily in these pages, the High Court held that with rare exception (for example, unconscionability), arbitration agreements affecting interstate commerce are enforceable according to their terms. Class action advocates were stunned and worried, especially for their pocketbooks. As the curtain came down, the class action juggernaut was in disarray, and the proponents of arbitration were jubilant about the possible restoration of the traditional Anglo-American method of resolving cases one at a time. Now for the sequel––the class action bar has struck back against arbitration on two fronts: the California Supreme Court and the Consumer Financial Protection Bureau (“CFPB”).
On the California front, class action advocates pressed the state Supreme Court to expand the doctrine of unconscionability as a way to undermine the FAA. As we noted in a previous newsletter, California historically has resisted the U.S. Supreme Court’s mandate that states abide by the FAA. See, e.g., Southland Corp. v. Keating, 465 U.S. 1 (1984). Traditionally, a contract had to be outrageous, even in California, to be deemed unconscionable–it had to “shock the conscience.” Pinnacle Museum Tower Ass’n v. Pinnacle Market Development, LLC, 55 Cal. 4th 223 (2012). Yet, when directed by the U.S. Supreme Court to reconsider one of its pre-Concepcion anti-arbitration decisions, the California Supreme Court suggested that “unconscionability” might have multiple meanings. Sonic-Calabasas A, Inc. v. Moreno, 57 Cal. 4th 1109 (2013). The majority opinion was drafted by the newly minted Justice Liu, who had been denied confirmation by the U.S. Senate because of his overly partisan approach to judicial decision making. Since Sonic-Calabasas, two new justices of the same ilk have been appointed by Governor Jerry Brown. Given the new makeup of the state Supreme Court, it is understandable why the class action bar pinned their hopes on California’s unconscionability doctrine as a way to undermine the FAA.
The battle at the state level came down to one case: Sanchez v. Valencia Holding Co. LLC, __ Cal. 4th __, 2015 WL 4605381 (Aug. 3, 2015). The plaintiff in Sanchez, a Mercedes-Benz purchaser, claimed the arbitration clause contained in the standard installment sale contract used by virtually every automobile dealer in California is unconscionable because it: (1) preserves self-help remedies, including repossession, and (2) provides for a special 3-arbitrator appeal for the losing party in the case of an outlier result (recoveries of zero or greater than $100,000, or the award of injunctive relief). At oral argument, the class action proponents were encouraged by Justice Liu’s questions, which strongly suggested that the 3-arbitrator review is unfair and that the unconscionability standard was not limited to provisions that “shock the conscience,” but had many different iterations. Other Justices asked rhetorically why they should not remand the case for a trial court to apply whatever unconscionability standard they articulated. It appeared that the California court was once again going to balk at abiding by the FAA’s mandate.
To the horror of the class action bar, Justice Liu’s majority opinion in Sanchez grudgingly held that the plaintiff had not made an adequate showing that the arbitration clause, in particular the provisions for self-help remedies and the 3-arbitrator appeal, was unconscionable. The opinion also held that all of the court’s various, prior formulations of unconscionability were really one and the same as “shock the conscience.” To be unconscionable, a plaintiff had to show more than buyer’s remorse over a bad bargain. Acceding to Concepcion, the opinion held that a party with the superior bargaining power was entitled to design the arbitration procedure to fit the needs of its industry, so long as the result was not grossly unfair to the customer. And, most important, the opinion reaffirmed the enforceability of the class action waiver as an integral part of traditional arbitration. Sanchez was a substantial victory for the proponents of arbitration and marks a turning point in California’s storied resistance to consumer arbitration.
Having suffered a major setback in California, the anti-Concepcion forces are redirecting their efforts on another front: the CFPB. In response to the 2008 financial crisis, Congress passed the massive and vague Dodd-Frank Act, which more often than not delegated the real decision making on policy issues to various agencies, especially the newly created CFPB. Section 1028 of the Act authorized the CFPB to “prohibit or impose conditions on the use of agreements” to arbitrate by consumer financial service providers if it finds that such regulatory action “is in the public interest and for the protection of consumers.” The only roadblock Congress created for the CFPB was a requirement that it conduct an investigation prior to proposing regulations concerning consumer arbitrations. The CFPB’s 728 page report was recently issued, and if anyone had any doubts about its objectivity, or lack thereof, they need only look at the title: “CFPB Study Finds That Arbitration Agreements Limit Relief for Consumers.” The report might as well have been drafted by the class action bar.
The CFPB report has two main criticisms of arbitration. The first is that the average consumer does not understand the implications of signing an arbitration agreement. This criticism can be leveled at most features of consumer contracts, but no matter. There are simple remedies–for example, additional consumer education, a separate signature line for arbitration clauses or the provision of a post-execution opt-out period for the consumer to elect against arbitration. The second criticism shows the CFPB’s true colors–it laments the loss of a class action remedy, which the report concludes benefits consumers far more than arbitration. There are multiple problems with this criticism, beginning with the fact that the system of consumer arbitration is still in its infancy, thanks to the anti-arbitration bias in major states like California. Also, the CFPB’s statistics concerning the supposed “benefits” of class actions are based on the aggregate class recoveries without any analysis of what class members actually receive. Anyone involved in litigating class actions knows that class members normally receive a pittance–especially compared to class counsel’s fee award–and that the prorated recovery is without regard to the actual merits of a given class member’s claim. In Judge Easterbrook’s words, this is a “central planner[’s]” concept of justice.
So, the only question concerning the arbitration rules to be promulgated by the CFPB is how draconian will they be? It is likely they will do more than strengthen the consumer’s awareness of the consequence of agreeing to arbitration. At worst, they will simply ban mandatory pre-dispute arbitration in all consumer financial contracts, at least those that preclude arbitration on a class basis. Given the limited review of arbitral decisions–one of the advantages of one-on-one arbitrations–no corporate defendant would willingly arbitrate a class claim with the ever-present threat of annihilating damages. A more subtle approach would be for the regulations to require all such contracts to have a post-dispute opt-out clause exercisable unilaterally by the consumer. Of course, subtlety has not been the hallmark of the CFPB in its brief existence as regulator by diktat. The 728 pages of justification notwithstanding, the real fight will come in the courts, which will have to decide whether Congress really intended to vest with the CFPB the power to repeal the FAA. According to English tradition as adopted in our own Constitution, it was not the prerogative of the executive or one of its agents to suspend legislation–that was a power reserved to the legislative branch of government. Dep’t of Transp. v. Ass’n of American Railroads, ___ U.S. ___, 135 S. Ct. 1225, 1241-42 (2015) (Thomas, J. concurring). Those constitutional constraints were a reaction to the abuses of a Medieval English super-regulator, the Star Chamber, an ancestor to the uniquely autonomous CFPB.
Let us hope that the Star Wars analogy holds true, for at the end of this sequel, the Imperial approach to governance is back in full swing with the forces of right and justice threatened on multiple fronts. In some ways, the battle before the California Supreme Court was merely a holding action, while the forces of darkness concentrate on delivering a hammer blow to arbitration through the CFPB. What is at stake is the very core of our system of dispute resolution. Will it continue to focus on each of us as an individual? Or will we deliver “justice” on a homogenized, mass market basis? Stay tuned for the final episode.
For more information about the Sanchez holding or the CFPB’s arbitration regulations, contact Donald J. Querio at email@example.com.