Supreme Court Rejects California's Attempt to Restrict Mandatory Arbitration
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UPDATED: Feb 13, 2016
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Arbitration is a popular method for resolving disputes between businesses and consumers. It is, at least, popular with the business community. Consumers, who rarely realize that a mandatory arbitration clause is included in the lengthy contracts or service agreements that they usually don’t read, are less enthused when they realize they have given up their right to pursue a civil suit.
Some state legislatures have tried to protect consumer rights by passing laws that restrict or limit the operation of mandatory arbitration clauses. Unfortunately for consumers, several Supreme Court cases have held that federal legislation favoring arbitration preempts those laws. The most recent Supreme Court decision, applauded by business groups but criticized by consumer advocates, concluded that California courts are not free to interpret mandatory arbitration clauses in a way that circumvents federal law.
What Is Arbitration?
Arbitration is a method of dispute resolution that, in many respects, is similar to a civil trial. Instead of a jury, the case is decided by an arbitrator who functions as would a judge in a bench trial (that is, a trial in which the judge, rather than a jury, decides whether the person bringing the claim is entitled to a remedy).
Many contracts and service agreements provide for mandatory arbitration of disputes. Those agreements provide that consumers give up their right to seek an award of damages in court but must instead have their claims decided in an arbitration proceeding. Cellphone service agreements, automobile purchase contracts, and credit card agreements are examples of contracts that typically include mandatory arbitration clauses.
Arbitration is usually quicker and less expensive than litigation. While consumers and businesses might both benefit from prompt dispute resolution, businesses usually prefer arbitration because they perceive arbitrators as being less consumer-friendly than juries. Businesses expect arbitrators to rule in favor of consumers less often than juries, and to award more limited remedies than juries might when consumers prevail in their claims.
Federal Arbitration Act
The enforceability of contracts has historically been governed by state law. Congress nevertheless passed the Federal Arbitration Act to limit the power of state legislatures to invalidate mandatory arbitration agreements. The Act requires that an arbitration clause in a contract must be regarded as “valid, irrevocable, and enforceable” unless the contract is unenforceable for reasons that are unrelated to the arbitration clause.
Individual consumers who experience relatively little financial harm from a corporation’s violation of a contract often turn to class action lawsuits to gain an effective remedy. If they are forced to bring individual lawsuits to collect a small sum of money, the cost of litigation outweighs the remedy they are likely to receive. Forcing consumers to bring individual lawsuits generally allows the corporation to get away with making unwarranted profits because consumers would spend more to sue the corporation than they could hope to gain from the lawsuit.
Consequently, many consumer contracts contain a provision that prohibits both class action lawsuits and class action arbitration. The California Supreme Court held in 2005 that those contract provisions were unconscionable under California law and should not be enforced. In 2011, however, the United States Supreme Court held that the Federal Arbitration Act deprived California courts of the power to nullify contract provisions that require consumers to participate in individual arbitration of their claims rather than class action litigation.
DIRECTV v. Imburgia
The Supreme Court recently revisited that ruling in another case from California. In DIRECTV v. Imburgia, two consumers brought a joint complaint in court alleging that DIRECTV had charged illegal late fees. Their service contract required arbitration of such claims and prohibited customers from joining their claims in a single arbitration proceeding. The contract also provided that if that provision was deemed unenforceable under “the law of your state,” the entire arbitration clause would become unenforceable.
The question in the Imburgia case was whether the arbitration clause in DIRECTV’s contract referred to California law as it existed without regard to the Federal Arbitration Act, or whether it referred to California law as modified by the Federal Arbitration Act. The California Court of Appeal held that California’s Consumers Legal Remedies Act invalidated the class action waiver and that the entire arbitration clause, pursuant to the terms of the contract, was therefore unenforceable. Since the contract referred to “the law of your state,” the court decided that the parties had agreed that the contract would be governed by California law, regardless of the terms of the Federal Arbitration Act.
The court also concluded that a separate clause stating that the contract would be governed by the Federal Arbitration Act created a conflict that rendered the contract ambiguous. The court applied a standard rule of contract interpretation by construing the ambiguity against DIRECTV, which drafted the contract and therefore had an obligation to make its meaning clear.
The United States Supreme Court disagreed. The majority concluded that the phrase “law of your state” did not refer simply to the laws passed by the state legislature, but must be read to include federal law to the extent that federal law preempts state law. While DIRECTV likely believed that California law made its class action waiver unenforceable at the time it drafted the contract, the Supreme Court concluded that it would be inconsistent with the Federal Arbitration Act to construe “law of your state” to include preempted laws. Since the Federal Arbitration Act preempts any state law that attempts to make arbitration clauses unenforceable, no enforceable state law in California could be deemed to invalidate the class action waiver.
While the Supreme Court recognized the general rule that a state court’s interpretation of a contract is binding on federal courts, that general rule applies to arbitration clauses only if the state court applies the same principles of contract interpretation to those clauses that it would apply to any other clause in a contract. The Court concluded that the California Court of Appeal would not have enforced an invalid state law when interpreting other contract clauses.
The Supreme Court Has the Last Word
In essence, the Supreme Court decided that the California Court of Appeal applied unreasonable rules of contract interpretation when it construed DIRECTV’s arbitration clause, and that the California court treated the arbitration clause differently because California disapproves of mandatory arbitration in consumer contracts. The majority’s decision all but says “our precedent is controlling and, like it or not, California needs to follow it.” As a result, the consumers in every state are subject to mandatory arbitration clauses in consumer contracts regardless of state law to the contrary.