Commercial Disputes – Class Action
Defense Alert
March 2009
Authors:
R. Bruce Allensworth
bruce.allensworth@klgates.com
+1.617.261.3119
Irene C. Freidel
That’s Unconscionable: An Update Regarding
the Enforceability of Arbitration Provisions in
Form Contracts
Introduction
irene.freidel@klgates.com
+1.617.951.9154
Phoebe S. Winder
phoebe.winder@klgates.com
+1.617.261.3196
William G. Potter
william.potter@klgates.com
+1.617.951.9127
Robert W. Sparkes III
A current hot topic in the ever-growing field of consumer finance litigation is the
enforceability of arbitration provisions in lending contracts. The enforceability of
such provisions, however, has become a thorny issue, and one that is increasingly
resolved in favor of the consumer. While the Federal Arbitration Act (“FAA”)
establishes a presumption in favor of the enforceability of arbitration agreements, the
courts have raised several roadblocks to prevent what they consider to be abuses of
the arbitral forum. An increasing number of courts have permitted consumers to
escape arbitration where the operative arbitration provision would effectively
eliminate the consumers’ ability to bring claims against the lender and where the
consumers did not have a meaningful opportunity to negotiate or reject that provision
of the contract.
robert.sparkes@klgates.com
+1.617.951.9134
K&L Gates comprises approximately
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The importance and fluidity of the enforceability issues surrounding arbitration
provisions in lending and other consumer finance contracts are highlighted by recent
opinions out of the Third Circuit Court of Appeals (Homa v. American Express Co.,
---F.3d---, 2009 WL 440912 (3d Cir. Feb. 24, 2009))1 and the United States District
Court for the Central District of California (Guadagno v. E*Trade Bank, ---F. Supp.
2d ---, 2008 WL 5479062 (C.D. Cal. Dec. 29, 2008)).2 In Homa, the Third Circuit
panel decision appears to retreat from a prior panel’s rationale upholding the
enforceability of class action waivers in arbitration clauses (and FAA preemption)
and to bring the Third Circuit in line with other federal courts on the issue.3 In
Guadagno, the Central District of California court found an arbitration clause and
class action waiver enforceable based, in part, upon the existence of an opt-out
provision related to the mandatory arbitration clause.4 In short, these opinions
exhibit the constantly evolving nature of the debate surrounding the enforceability of
arbitration provisions in consumer finance related contracts discussed below.
This client update discusses three of the most common roadblocks to the
enforceability of arbitration provisions:
1. excessive or one-sided “carve-out” exceptions;
2. inconspicuous waivers of the right to a jury trial; and
3. class action waivers that effectively eliminate consumers’ rights to seek redress
for damages.
Commerical Disputes – Class Action Defense Alert
The Federal Arbitration Act
The enforceability of any arbitration provision in the
consumer finance context will usually flow from the
FAA, 9 U.S.C. §§ 1 et seq. (2006). The FAA
requires courts to honor parties’ agreements to
resolve disputes through arbitration rather than
through the courts. The FAA preempts any
contradictory state law that specifically targets
arbitration.5 Accordingly, any state statute, or
provision in a state statute, that purports to
specifically govern arbitration agreements is
preempted by the FAA.6 For example, a state law
prohibiting class action waivers in arbitration
agreements would run afoul of the FAA. To avoid
preemption by the FAA, state statutes (and common
law) concerning the validity of contractual
agreements to arbitrate must apply to all types of
contracts.7 Consumers may escape from their
agreement to arbitrate only if they can show that
they will be unable to vindicate their statutory rights
in an arbitral forum, or if they can convince a court
(or an arbiter) that the arbitration provision should
be invalidated on the basis of some common law
principle such as unconscionability, duress, fraud, or
lack of consideration. Below, this client update
discusses three of the most common roadblocks to
enforcement of arbitration provisions. These
obstacles survive preemption by the FAA because
they spring from common law principles of general
applicability to contracts, rather than from
arbitration-specific prohibitions.
Carve-Outs
One common pitfall that may render an arbitration
provision void is the inclusion of excessive, onesided “carve-outs.” A carve-out is an exception to
an arbitration provision that limits the circumstances
in which the provision applies, usually to the
detriment of the consumer. A number of courts
have found arbitration provisions unconscionable
because they contained carve-outs that allowed the
drafter access to the courts, but restricted the
consumer to arbitration.
Because the doctrine of unconscionability is
ordinarily a common law principle applicable to all
contracts, the FAA will not operate to preempt an
unconscionability argument made by a consumer in
opposition to an arbitration agreement. Thus,
consumers may be able to challenge the validity of
an arbitration provision by arguing that the
provision is unconscionable under applicable state
law. For example, in Iberia Credit Bureau, Inc. v.
Cingular Wireless L.L.C.,8 the Fifth Circuit Court of
Appeals upheld two arbitration clauses but struck
down a third, finding the arbitration provision
unconscionable under Louisiana law because it
completely exempted the drafter from arbitration,
but did not similarly exempt the consumer. In so
ruling, the Fifth Circuit found that Louisiana law
concerning unconscionability applied with equal
force to all contracts and therefore was not
preempted by the FAA.9
To understand when an arbitration agreement will
be held unconscionable, it is important to first
understand what courts look for to determine
unconscionability. Before finding an agreement to
be unconscionable, courts usually require that there
be both “procedural” and “substantive”
unconscionability.10 Procedural unconscionability
focuses on the disparate bargaining power of the
parties, including whether one party was more
sophisticated than the other, and whether the
contract was one of adhesion11 – i.e., a standard
form contract drafted solely by one party and to be
signed by the party in the weaker position (typically
the consumer).12 Substantive unconscionability
measures whether the provisions of the agreement
itself are unfair as to one party.13 In the consumer
finance context, the consumer is typically less
sophisticated than the lender, and usually agrees to a
non-negotiable contract prepared by the lender.
Once the courts have found substantive
unconscionability in the provisions of an agreement,
they will typically find the agreements between
lenders and unsophisticated consumers to be
procedurally unconscionable as well. Thus, the
important question in most consumer finance cases
will be whether the agreement itself is so unfair as
to be substantively unconscionable – a question that
turns on state law.
There is no bright line that can be drawn between an
arbitration agreement that is merely unequal, but
nevertheless valid, and one that is so one-sided it
will be deemed unconscionable. Courts that have
considered this issue generally deem arbitration
provisions unconscionable where carve-outs exempt
the drafter from the obligation to arbitrate, but bind
the non-drafting party (i.e., the consumer) to the
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Commerical Disputes – Class Action Defense Alert
arbitral forum.14 A more difficult question arises
when the agreement contains carve-outs for specific
remedies, which are likely to be sought by the
drafter, but does not contain similar carve-outs for
remedies that the non-drafting party would likely
pursue. For example, in Ferguson v. Countrywide
Credit Industries, Inc., the Ninth Circuit held that an
arbitration provision in an employment contract was
unconscionable because it expressly included claims
that the employee might seek – breach of contract,
discrimination, and harassment – but exempted
remedies that the employer would likely pursue –
injunctive relief for intellectual property violations,
unfair competition, and use or disclosure of trade
secrets.15 The Ninth Circuit went on to find that
such an agreement was unfairly one-sided and
therefore substantively unconscionable.16
Jury Waivers
Another potential obstacle to arbitration provisions
arises when an agreement to arbitrate necessarily
involves waiving the right to have one’s case heard
by a jury. In most states, the right to a jury trial is
waivable, but in general, courts only enforce
predispute jury waivers that are entered into
“knowingly” and “voluntarily.”17 The exceptions to
this rule are California and Georgia where those
states’ courts have interpreted their respective
constitutions to forbid predispute jury waivers.18
Federal courts, however, will apply federal law to
determine whether a jury waiver is valid, even where
the federal court has jurisdiction only by way of
diversity.19
There is no standard test applied by courts to
determine whether a party’s waiver of the right to a
jury was made knowingly and voluntarily. Rather,
courts consider the totality of the circumstances to
decide whether a particular waiver should be
enforced.20 Federal courts frequently begin the
analysis with the maxim that there is a presumption
against denying a jury trial based on a waiver.21
That presumption, however, is not strictly enforced,
and federal courts generally uphold contractual jury
waivers.
Although there is no universal test that courts apply,
they frequently consider some or all of the following
factors in examining the totality of the
circumstances: 1) whether the contract is a
standardized form or newly drafted; 2) whether the
waiver is in fine print or large print; 3) whether the
waiver is distinct in some way based on the print
type; 4) whether the waiver is set apart in its own
paragraph; 5) whether the contract is one of
adhesion; 6) whether the contract was negotiated at
arm’s length; 7) the length of the contract and the
placement of the waiver within it; 8) whether there
was disparate bargaining power between the parties;
9) whether both parties waived the right to a jury;
10) whether the parties were sophisticated; 11)
whether the parties were represented by counsel;
and 12) whether the parties had an opportunity to
review the waiver.22
The above focus on disparate bargaining power and
standard form contracts seems to bode ill for jury
waivers in the consumer finance context, but for the
most part courts have upheld jury waivers so long as
they are clearly and conspicuously presented in the
contract.23
Class Action Waivers
Undoubtedly the hottest topic surrounding the
enforceability of arbitration agreements is whether
such agreements may prohibit consumers from
pursuing remedies on a class-wide basis. Most
federal circuits have concluded that class action
waivers in arbitration provisions are enforceable
where federal claims are at issue. The two main
arguments against this conclusion are that class
action waivers prevent plaintiffs from vindicating
their statutory rights, and that such waivers are
unconscionable. Federal courts have rejected these
arguments on the basis that the class action device is
merely a procedural mechanism and not a
substantive right. Therefore, no individual
substantive right or statutory cause of action is
precluded by a class action waiver. Similarly,
because the right to represent a class of individuals
or otherwise pursue class action claims is merely
procedural, and therefore waivable, it is not
unconscionable for parties to contract away that
right.24
Notably, there has been an institutional and
legislative push against mandatory arbitration
clauses in the mortgage lending context. Fannie
Mae and Freddie Mac have a stated policy that they
will not buy mortgages that contain such clauses.25
In 2007, a bill was introduced by Congressman
Barney Frank, and subsequently approved by the
March 2009
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Commerical Disputes – Class Action Defense Alert
House of Representatives, which contains a
provision that would ban the use of mandatory
arbitration clauses in residential mortgage
agreements.26 In its current form, the bill expressly
exempts “reverse” mortgages from this restriction.
Further, the bill does not prevent parties from
agreeing to arbitration after a dispute arises. The bill
is currently before the United States Senate.
From a judicial standpoint, two federal courts of
appeal have held a class action waiver invalid as a
matter of federal law. The first to do so was the
First Circuit Court of Appeals. In Kristian v.
Comcast Corp.,27 the First Circuit invalidated a
clause in an arbitration agreement expressly
prohibiting class action arbitration or consolidation.
The court found that the class action mechanism was
a procedural right, but held that where the denial of
that procedural right would effectively prevent
plaintiffs from vindicating a substantive right, the
prohibition on class arbitration was invalid. The
court reasoned that it would be impossible for
consumers to bring their claims - in this case,
antitrust claims - individually because the expense of
doing so would far outweigh any potential recovery.
Thus, the only practicable method of vindicating
consumers’ substantive rights was for the case to
proceed on a class basis. The court also rejected the
argument that antitrust abuses could be addressed by
administrative enforcement rather than private
enforcement, and stated that where Congress
provides for a private right of action, that right of
action may not be effectively destroyed by an
arbitration agreement.
It is important to note that Kristian was decided in
the context of antitrust claims, and that the First
Circuit distinguished but declined to expressly
disagree with prior federal cases, which were
decided primarily in the context of claims brought
under the Truth in Lending Act (“TILA”). The First
Circuit distinguished TILA claims from antitrust
claims on the grounds that the latter are ordinarily
far more factually complex and therefore more
expensive to litigate. The First Circuit concluded
that the plaintiffs in Kristian brought claims which
were so expensive to try that it would be
impracticable to pursue them on an individual basis.
Only the prospect of a large award obtained on
behalf of a class could persuade a reasonable litigant
to make the initial expenditure of time and money
necessary to see the case through. In the TILA
context, however, litigants may be able to try their
claims with less effort and expense, and may be able
to recover more on an individual basis, particularly
where rescission of the loan agreement is an
available remedy. For these reasons, the substantive
right to recover under TILA is less likely to be
foreclosed by the unavailability of a class action,
and therefore courts may be more willing to require
consumers to arbitrate TILA claims on an individual
basis.28
The Second Circuit Court of Appeals has recently
followed the First Circuit’s lead, in In re American
Express Merchants’ Litigation,29 and held a class
action waiver provision invalid as a matter of
federal law. In In re American Express, the Second
Circuit considered whether a class action waiver
provision included in American Express’s Credit
Card Acceptance Agreements’ mandatory
arbitration provisions was enforceable under the
FAA. As in Kristian, the plaintiffs in In re
American Express alleged claims under the
Sherman Antitrust Act.30 First, the court found that
the enforceability of the class action waiver
provision at issue was a question for the court, and
not a matter for the arbitrator.31 With respect to the
enforceability of the class action waiver at issue, the
court held that the class action waiver provision was
unenforceable under the FAA - or, as the court
described it, the “federal substantive law of
arbitrability” - because, while the “right” to proceed
as a class representative under Rule 23 of the
Federal Rules of Civil Procedure is merely a
procedural right,32 enforcement of the waiver would
be tantamount to the denial of a plaintiff’s
substantive right to vindicate his or her statutory
rights.33 In so holding, the court relied upon expert
testimony presented by the plaintiffs that the
complexity of the antitrust claims at issue and the
expenses involved in such litigation effectively
made individual claims economically prohibitive.34
In other words, the court reasoned that the only way
in which the plaintiffs may litigate their substantive
statutory rights under the antitrust laws was through
the class action mechanism.35
In so ruling, the Second Circuit also issued two
express caveats. First, the court noted that its
decision did not rest upon the status of the plaintiffs
– all “small” merchants (akin to individual
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Commerical Disputes – Class Action Defense Alert
consumers) – but instead depended entirely “upon a
showing that the size of the recovery received by
any individual plaintiff will be too small to justify
the expenditure of bringing an individual action.”36
Second, the court stressed that its opinion did not,
and should not be read to, hold that class action
waivers in arbitration agreements are per se
unenforceable or that such provisions are per se
unenforceable in the context of antitrust actions.37
Instead, the court noted that “each case which
presents a question of the enforceability of a class
action waiver in an arbitration agreement must be
considered on its own merits, governed with a
healthy regard for the fact that the FAA ‘is a
congressional declaration of a liberal federal policy
favoring arbitration agreements.’”38 Despite the
court’s express caveat, the combination of the First
Circuit’s decision in Kristian and the Second
Circuit’s decision in In re American Express
suggests that the federal courts are likely to strictly
scrutinize the enforceability of class action waivers
in the context of claims brought under the Sherman
Antitrust Act. How the First and Second Circuits’
scrutiny will apply with respect to “less-complex” or
to “non-prohibitively expensive” claims, however
those claims may be defined, is a matter that remains
undecided.
Some state courts have been less hospitable to class
action waivers. State statutes banning or limiting the
use of class action waivers are ordinarily of no effect
because they are expressly preempted by the FAA.39
The more difficult question, and one that state courts
have most often grappled with, is whether the FAA
preempts common law principles that would render
certain types of class action waivers unconscionable.
Several states have found that, in some
circumstances, class action waivers are
unconscionable and that the FAA does not preempt
such a determination under state law. These states
include Alabama, Florida, Missouri, New Mexico,
Pennsylvania, Washington, and West Virginia.40
The leading state case addressing unconscionability
is Discover Bank v. Superior Court.41 In that case,
the Supreme Court of California found that, under
limited circumstances, a class action waiver can be
unconscionable under California law. The court
held that when a class action waiver is found in a
non-negotiable consumer contract (a “contract of
adhesion”), in a setting in which disputes between
the contracting parties predictably involve small
amounts of damages, and when the party with the
superior bargaining power has carried out a scheme
to deliberately cheat large numbers of consumers
out of individually small sums of money, then the
waiver becomes, in practice, an exemption from
responsibility for fraud and willful injury. Under
these circumstances, such waivers are
unconscionable under California law. This case has
set the tone for what constitutes an unconscionable
use of class action waivers in subsequent state
cases, as well as in the First Circuit’s opinion in
Kristian.
The New Jersey Supreme Court’s two decisions in
companion cases, Muhammad v. County Bank of
Rehoboth Beach, Delaware, and Delta Funding
Corp. v. Harris,42 are also instructive. In both
cases, the court considered whether the FAA
preempts state law regarding unconscionability as it
pertains to arbitration agreements, and whether the
agreements were in fact unconscionable under New
Jersey law. The court held that the FAA did not
preempt this issue of state law, and found that
although the class action waiver in Harris was
valid, the waiver in Muhammad was
unconscionable. Specifically, the waiver at issue in
Muhammad was invalid because it was part of a
contract of adhesion and because the small amount
of damages at stake coupled with the high cost of
arbitration made it impractical for the plaintiffs to
pursue their claims on individual bases. The court
found that the impracticability of trying the lowvalue claims on an individual basis effectively
transformed the class action waiver into an
exculpatory clause. The waiver in Harris was
upheld because the plaintiff was seeking an
individual recovery of $100,000 and therefore had
adequate incentive to pursue the claim in the
absence of a class action procedure.
The Supreme Court of Illinois, in Kinkel v. Cingular
Wireless, LLC, and the Court of Appeals of
Wisconsin, in Coady v. Cross Country Bank, have
also joined the growing number of courts which
have held class action waivers unenforceable where
a class action is the only practical means of
vindicating consumers’ rights.43 The Supreme
Court of Illinois, collecting cases that have found
class action waivers unconscionable, observed that
“if there is a pattern in these cases it is this: a class
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Commerical Disputes – Class Action Defense Alert
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 class wide redress is more than a mere
procedural device.” The Kinkel court went on to
hold that the availability of the small claims court as
a forum would not suffice to render the class action
waiver enforceable because the costs of proceeding
in that court were still too high to justify pursuing
the plaintiff’s $150 claim. Echoing the First
Circuit’s opinion in Kristian, the court further held
that the possibility of enforcement by the state
attorney general was not sufficient to make up for
the complete loss of an individual’s substantive right
to reimbursement. Following the lead of the
Supreme Court of Illinois, the Court of Appeals of
Wisconsin, in Coady, struck down an arbitration
agreement on multiple grounds, and held that the
agreement’s class action waiver should at least be a
factor in determining unconscionability, and perhaps
would be sufficient on its own to render the
agreement unconscionable if the waiver were to act
as a complete bar to recovery.44
The Washington Supreme Court similarly has held,
in Scott v. Cingular Wireless,45 that an arbitration
provision containing a class action waiver was
unconscionable because it violated public policy and
acted, in effect, as an exculpatory clause. In Scott,
the putative class sought damages against Cingular
Wireless for allegedly overcharging customers
approximately $1 - $40 per month. The Scott court
noted that Cingular agreed, in the arbitration
agreement, to bear the costs of arbitration, but found
this concession insufficient to save the class action
waiver. The court reasoned that, even in the absence
of prohibitive arbitration costs, the time, energy and
stress of pursuing such small claims would
effectively discourage individual suits, thereby
allowing Cingular to essentially exculpate itself
from liability for the alleged overcharges. Because
the contract at issue in this case explicitly stated that
the arbitration clause and its class action waiver
were not severable, the court concluded that the
parties’ intent was to invalidate the entire arbitration
clause in the event that the class action waiver was
held unenforceable. The court thus invalidated the
entire arbitration clause. The court indicated,
however, that if this non-severability provision had
been omitted, it would have upheld the arbitration
provision, and struck only the class action waiver,
thereby permitting Scott et al. to arbitrate as a class.
The Supreme Court of Washington and the Ninth
Circuit, respectively, have recently upheld and
expressly followed the holding in Scott in McKee v.
AT&T Corporation46 and Lowden v. T-Mobile USA,
Inc.47
Moreover, the Ninth Circuit in Shroyer v. New
Cingular Wireless Services, Inc.,48 and the Eleventh
Circuit in Dale v. Comcast Corp.,49 have found
class action waivers to be unconscionable, under
California and Georgia law respectively, where the
waivers would effectively eliminate consumers’
ability to obtain redress for relatively small amounts
of alleged damages. In both cases, the arbitration
provisions were struck in their entirety because both
contained non-severability clauses that precluded
striking only the class action waiver, thereby
facilitating class-wide arbitration. The Shroyer
court expressly followed the holding in Discover
Bank, finding the two cases indistinguishable. The
Dale court invoked the First Circuit’s decision in
Kristian v. Comcast Corp., and refused to enforce a
class action waiver where subscribers alleged that
they had been overcharged approximately $10.56
each. Although it left the door open for enforcing
class action waivers in a case where plaintiffs would
automatically or likely recover attorney’s fees if
successful, the Dale court held that the mere
possibility of recovering attorney’s fees did not
alleviate the disincentive to sue a large corporation
over $10 and change, and that a class action was the
only effective way to prevent the small, but
numerous improprieties Comcast was alleged to
have committed.
In contrast to this trend, the Third Circuit, in Gay v.
CreditInform,50 upheld a mandatory arbitration
clause in an agreement between a consumer and a
credit repair organization. In that case, the
arbitration provision required individual arbitration
of all disputes arising out of the agreement. The
consumer argued that she had a right to bring a class
action under the federal Credit Repair Organization
Act and Pennsylvania’s Credit Services Act, and
that the waiver of that right in the agreement, which
was a contract of adhesion, was unconscionable.
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The Third Circuit disagreed and held that the right to
proceed on a class-wide basis was merely a
procedural right and therefore waivable. Although
the amount in controversy appeared to be relatively
small, the court refused to consider whether the
consumer would have a meaningful opportunity to
recover if she were barred from pursuing the claim
as a class action. Instead, the court ruled that the
arbitration provision was not, on its face, so
unreasonable that it could be considered
unconscionable under state law. Any further inquiry
into the effect of the provision, according to the
Third Circuit, would violate the FAA’s prohibition
on state rules which restrict or burden the
enforcement of agreements to arbitrate. In so
deciding, the Third Circuit expressly disagreed with
two Pennsylvania state court decisions, but did not
discuss the apparently contrary holdings in other
federal circuits. Thus, the Gay opinion suggested
that the Third Circuit would not follow what appears
to be the majority trend in addressing class action
waivers in arbitration provisions.
In February 2009, however, the Third Circuit
(through a different three-judge panel than the panel
that decided Gay) appears to have retreated from the
Gay analysis to fall more closely in line with the
majority trend in its decision in Homa v. American
Express Company.51 In Homa, the Third Circuit
addressed the enforceability of an arbitration
provision and class action waiver contained in an
agreement sent to American Express credit card
holders entitled “Agreement between American
Express Credit Cardmember and American Express
Centurion Bank.”52 The crux of the court’s analysis
turned on the choice of law between Utah (expressly
selected as applicable law under the parties’
agreement) and New Jersey law – the importance of
such analysis highlighted by the fact that Utah
statutory law expressly allows class action waivers
in consumer credit agreements.53 Applying the
choice of law rules for New Jersey (the forum in
which the district court sat), the Third Circuit found
that New Jersey had a fundamental public policy
against enforcing class action waivers in the context
of “a low-value consumer credit suit.”54 In so
finding, the court relied heavily upon the New Jersey
Supreme Court’s opinion in Muhammad v. County
Bank of Rehoboth Beach, Del., 912 A.2d 88 (N.J.
2006) (discussed above).55 As such, the court
applied New Jersey state law to the class action
waiver in American Express’s agreement and found
that “if the claims at issue are of such a low value as
effectively to preclude relief if decided individually,
then, under Muhammad, the application of Utah law
to the class-arbitration waiver is invalid and the
class-arbitration waiver is unconscionable.”56
In addressing the Gay opinion, the Homa court
found that New Jersey state law – as reflected in the
New Jersey Supreme Court’s Muhammad decision –
clearly applied to class action waivers in all
contracts and was not limited solely to arbitration
agreements.57 Thus, the court found that the
unconscionability principles espoused in
Muhammad were not preempted by the FAA.58 In
fact, the Homa court made clear that Gay cannot
stand for the proposition that the FAA preempts all
state laws directed at class action waivers unless
such law “is read as a blanket prohibition on
unconscionability challenges to class-arbitration
provisions.”59 In so ruling, the Homa court did not
overrule Gay and expressly refused to address the
Gay court’s analysis of Pennsylvania state law –
focusing, instead, on the clear public policy
expressed in New Jersey state law.60
Notwithstanding the Homa court’s distinguishing of
Gay, the Third Circuit’s opinion in Homa suggests
that the Third Circuit is prepared to fall in line with
the majority of state and federal courts in addressing
class action waivers in arbitration agreements.
Another very recent decision is worthy of note; that
is the United States District Court for the Central
District of California’s December 29, 2008 decision
in Guadagno v. E*Trade Bank.61 In Guadagno, the
District Court considered the enforceability of an
arbitration provision, including a class action
waiver, contained in an online agreement entered
into upon the plaintiff’s opening of an online
account with defendant E*Trade Bank (a so-called
“click-wrap” agreement).62 The agreement at issue
also contained an express “optout” provision that
allowed plaintiff to affirmatively optout of the
arbitration clause.63 First, the court held that
Virginia state law governed the interpretation of the
agreement, by virtue of the express choice of law
provision in the agreement and the court’s finding
that the arbitration provision at issue did not violate
California public policy.64 Specifically, the court
found that California had a fundamental policy
“against exculpatory class action waivers in
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consumer contracts of adhesion, because they are
unconscionable,”65 and that “[i]f an offerree has a
meaningful opportunity to freely opt out of a term
after assenting to the contract, and the terms of
contract are clear, then the contract is not being
offered on a take-it-or-leave-it basis” and is thus not
adhesionary.66 In addressing the provision at issue,
the court thus found – based primarily on the “optout” provision therein – that the agreement was not
adhesionary and not unconscionable. 67 In other
words, the arbitration provision at issue did not
violate California law or public policy.68 Second,
the court found that the arbitration provision was not
unconscionable as a matter of Virginia state law –
unconscionability is defined as an arbitration clause
that “is so unequal that it is clearly intended to
deprive the other party of all remedies and is part of
a contract of adhesion.”69 The court found that
because plaintiff failed to demonstrate with “detailed
proof,” or to even argue, that the cost of arbitration
was so high as to prevent her from vindicating her
rights through individual arbitration, the arbitration
clause was not unconscionable.70 In so holding, the
court acknowledged that the agreement contained a
“fee splitting” provision that provided that plaintiff
could seek an arbitration fee waiver from the
American Arbitration Association or petition the
defendant E*Trade to pay a higher share of the fee.71
In short, the Guadagno decision suggests that the
inclusion of an opt-out provision in an arbitration
clause may protect such arbitration clauses from
unconscionability challenges.
The Guadagno decision, however, appears to be an
outlier in the consumer finance context – where, as
noted above, contracts and agreements to arbitrate
are virtually presumed to be contracts of adhesion.
With the exception of Gay v. CreditInform, the case
law appears to reinforce the principle expressed in
Discover Bank, Kristian, and In re American
Express – that class action waivers should not be
permitted where the party to be bound did not have
a meaningful opportunity to negotiate or reject the
agreement, and the effect of the waiver would be to
extinguish a party’s claim entirely.
Hence, both state and federal courts are likely
progressing towards a two-pronged, fact-intensive
test, that will operate to invalidate a class action
waiver where: 1) the party to be bound did not have
a meaningful opportunity to negotiate or reject the
arbitration agreement portion of a contract; and 2) if
enforced, the waiver would effectively eliminate a
party’s right to seek redress because the expected
recovery is not large enough to justify the risks and
costs of litigation. This developing trend does not
bode well for most consumer finance oriented
agreements containing class action waiver
provisions.
suspect status, requiring instead that such provisions be placed
upon the same footing as other contracts” (internal quotations
omitted)).
8
1
Homa v. American Express Co., ---F.3d---, 2009
WL 440912 (3d Cir. Feb. 24, 2009).
Iberia Credit Bureau, Inc. v. Cingular Wireless L.L.C.,
379 F.3d 159, 170 (5th Cir. 2004).
9
2
Guadagno v. E*Trade Bank, ---F. Supp. 2d ---,
2008 WL 5479062 (C.D. Cal. Dec. 29, 2008).
3
4
5
6
7
See Homa, 2009 WL 440912, at *3-7.
See Guadagno, 2008 WL 5479062, at *4-6.
See 9 U.S.C. § 2.
See id.
See Doctor’s Assocs., Inc. v. Casarotto, 517 U.S.
681, 687 (1996) (“[G]enerally applicable contract defenses,
such as fraud, duress, or unconsionability, may be applied
to invalidate arbitration agreements without contravening
[the FAA]. Courts may not, however, invalidate arbitration
agreements under state laws applicable only to arbitration
provisions. By enacting § 2 [of the FAA], . . . Congress
precluded States from singling out arbitration provisions for
Id.
10
See, e.g., Adler v. Dell, Inc., No. 08-CV-13170, 2008
WL 5351042, at *9 (E.D. Mich. Dec. 18, 2008) (noting that test
for determining unconscionability under Michigan and Texas
state law is the same; a plaintiff must prove both procedure and
substantive unconscionability); La Torre v. BFS Retail and
Comm. Operations, LLC, No. 08-22046-CIV, 2008 WL
5156301, at *3 (S.D. Fla. Dec. 8, 2008) (“Under Florida law, in
order for a contract provision to be deemed unconscionable, it
must be shown that the provision is both procedurally and
substantively unconscionable.”).
11
BLACK’S LAW DICTIONARY 318-19 (7th ed. 1999)
(defining the term “adhesion contract”).
12
See, e.g., Adler, 2008 WL 5351042, at *9-10; La
Torre, 2008 WL 5156301, at *3-4.
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Commerical Disputes – Class Action Defense Alert
13
See, e.g., Adler, 2008 WL 5351042, at *9-10; La
Torre, 2008 WL 5156301, at *5 (“Substantive
unconscionability focuses on the actual agreement and
whether or not its terms are unreasonable and unfair.”).
14
See, e.g., Iberia Credit Bureau, Inc., 379 F.3d at
170; see also Wisconsin Auto Title Loans, Inc. v. Jones,
714 N.W.2d 155, 549-50 & n. 56 (Wis. 2006) (citing cases
finding same).
15
Ferguson v. Countrywide Credit Indus., Inc., 298
F. 3d 778, 784-85 (9th Cir. 2002); see also Abramson v.
Juniper Networks, Inc., 115 Cal. App. 4th 638, 664-66 (Cal.
Ct. App. 2004) (finding provision in employment contract
requiring parties to arbitrate all claims except those related
to trade secrets, confidential information and other
intellectual property lacking mutuality and thus
substantively unconscionable)
16
The majority of courts that have considered the
issue have held that exempting foreclosure actions from
arbitration agreements is not enough to render such an
agreement unconscionable. In fact, several courts have
affirmatively held that such an exemption is not
substantively unconscionable. See, e.g., Salley v. Option
One Mortgage Corp., 925 A.2d 115, 127-29 (Pa. 2007);
Walther v. Sovereign Bank, 872 A.2d 735, 748 (Md. 2005)
(“The mere fact that the arbitration agreement does except
from its purview . . . a foreclosure proceeding, does not
destroy mutuality and make the arbitration so one-sided as
to make it unconscionable.”). At least one court, however,
has found such an exemption substantively
unconscionable. See Tillman v. Commercial Credit Loans,
Inc., 655 S.E.2d 362, 372 (N.C. 2008) (finding substantive
unconscionability in the “one-sidedness” of a clause that
exempted foreclosure actions from arbitration).
17
See, e.g., Med. Air Tech. Corp. v. Marwan Inv.,
Inc., 303 F.3d 11 (1st Cir. 2002); Telum, Inc. v. E.F. Hutton
Credit Corp., 859 F.2d 835 (10th Cir. 1988); K.M.C. Co.,
Inc. v. Irving Trust Co., 757 F.2d 752 (6th Cir. 1985); Nat’l
Equip. Rental, Ltd. v. Hendrix, 565 F.2d 255 (2d Cir. 1977).
18
See Grafton Partners L.P. v. Superior Court, 116
P.3d 479 (Cal. 2005); Bank South N.A. v. Howard, 444
S.E.2d 799 (Ga. 1994). But see In re The Prudential Ins.
Co. of Am., 148 S.W.3d 124, 132-33 (Tex. 2004) (noting
that each federal court and “nearly every state court that
has considered the issue has held that parties may agree
to waive their right to trial by jury in certain future disputes,
including the supreme courts in Alabama, Connecticut,
Missouri, Nevada, and Rhode Island”). It is also worthy of
note that at least two federal courts have refused to extend
the holdings of Grafton Partners L.P. and Bank South N.A.
to arbitration agreements that require certain claims be
litigated in arbitration, but that do not explicitly waive the
right to a jury trial. See Caley v. Gulfstream Aerospace
Corp., 428 F.3d 1359, 1371-73 & n.15 (11th Cir. 2005)
(finding that “general contract principles govern the
enforceability of arbitration agreements and that no
heightened ‘knowing and voluntary’ standard applies, even
where the covered claims include federal statutory claims
generally involving a jury trial right” and finding Bank South
N.A. v. Howard inapplicable to mutual agreements to
arbitrate covered claims that otherwise provide a right to a
jury trial); Swallow v. Toll Broths., Inc., No. C-08-02311JCS, 2008 WL 4164773, at *7 (N.D. Cal. Sept. 8, 2008)
(finding that “[t]he holding in Grafton . . . does not apply to
arbitration agreements” because “[u]nlike predispute jury
waivers, predispute arbitration agreements are specifically
authorized by statute . . . . Moreover, . . . arbitration
agreements are distinguishable from waivers of the right to jury
trial in that they represent an agreement to avoid the judicial
forum altogether” (quoting Grafton Partners L.P., 116 P.3d at
484)).
19
See, e.g., Med. Air Tech. Corp., 303 F.3d at 18 (“In a
diversity jurisdiction suit, the enforcement of a jury waiver is a
question of federal, not state law.”); Telum, Inc., 859 F.2d at
837 (citing Simler v. Conner, 372 U.S. 221, 221-22 (1963));
K.M.C. Co., Inc., 757 F.2d at 755.
20
See, e.g., Med. Air Tech. Corp., 303 F.3d at 19 &
n.4.
21
See, e.g., id. at 18 (“There is a presumption against
denying a jury trial based on waiver, and waivers must be
strictly construed.”); Nat’l Equip. Rental, Ltd., 565 F.2d at 258
(same).
22
See, e.g., Med. Air Tech. Corp., 303 F.3d at 19 n.4
(noting that “[i]n analogous situations we have looked to the
‘totality of circumstances,’ including factors such as the waiving
party’s education and business experience, the respective
roles of the parties in determining the terms of the waiver, the
clarity of the agreement, the amount of time the waiving party
had to consider the waiver, whether the waiving party was
represented by counsel, and the consideration offered for the
waiver, to determine if the waiver was knowing and voluntary”);
Telum, Inc., 859 F.2d at 837 (listing “inconspicuous fine print or
a gross disparity in bargaining power” as factors weighing in
favor of invalidating a jury waiver provision); K.M.C. Co., Inc.,
757 F.2d at 757; Nat’l Equip. Rental, Ltd., 565 F.2d at 258.
23
For federal cases refusing to uphold jury waivers
based on the failure to present the waiver clearly, see, e.g.,
Popular Leasing USA, Inc. v. Terra Excavating, Inc., 2005 WL
2468069 (E.D. Mo. 2005) (invalidating jury waiver in a “take-itor-leave-it” contract where waiver was in 6-point font, not set
apart from other provisions, and set deeply and
inconspicuously in preprinted form contract); RDO Fin. Servs.
Co. v. Powell, 191 F. Supp. 811 (N.D. Texas 2002) (invalidating
one-sided waiver, which bound only one party and that was not
set apart from the rest of the text, was buried in a lengthy
paragraph, and was so small that it was difficult to read).
24
See, e.g., Pleasants v. Am. Express Co., 541 F.3d
853 (8th Cir. 2008) (finding, under Missouri law, that class
action waiver in arbitration clause was not unconscionable in
Truth in Lending Act case); Livingston v. Assocs. Fin., Inc., 339
F.3d 553 (7th Cir. 2003); Snowden v. CheckPoint Check
Cashing, 290 F.3d 631 (4th Cir. 2002); Randolph v. Green Tree
Fin. Corp.—Alabama, 244 F.3d 814 (11th Cir. 2001); Johnson
v. West Suburban Bank, 225 F.3d 366 (3d Cir. 2000).
25
See Fannie Mae Announcement 04-06, dated
September 28, 2004, available at
https://www.efanniemae.com/sf/guides/ssg/annltrs/pdf/2004/04
-06.pdf; Freddie Mac News Release, dated December 4, 2003,
available at http://www.freddiemac.com/news/archives/
afford_housing/2003/consumer_120403.html (noting that policy
becomes effective in August 2004).
26
See Mortgage Reform and Anti-Predatory Lending
Act of 2007, H.R. 3915, 110th Cong. § 206(h) (1st Sess. 2007).
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Commerical Disputes – Class Action Defense Alert
27
Kristian v. Comcast Corp., 446 F.3d 25 (1st Cir.
2006).
28
See id. at 56-59 (distinguishing class action
waivers in the TILA context versus such waivers in an
antitrust action and finding waiver unconscionable in the
antitrust context).
29
In re Am. Express Merchants’ Litig., --- F.3d ----,
2009 WL 214525 (2d Cir. Jan. 30, 2009).
30
See id. at *5-6.
31
Id. at *8. In so holding, the court noted that
challenges as to the enforceability of an arbitration clause,
or any provision therein, are questions appropriately
determined by the courts. Id. at *8 (citing Buckeye Check
Cashing, Inc. v. Cardegna, 546 U.S. 440, 444 (2006)). On
the other hand, challenges that attack a contract generally
– i.e., that are not specifically limited to an arbitration
provision therein – are properly resolved by the arbitrator.
Id.
32
Id. at *9.
33
Id. at *16-17 (“We therefore hold that the class
action waiver in the Card Acceptance Agreement cannot be
enforced in this case because to do so would grant Amex
de facto immunity from antitrust liability by removing the
plaintiffs’ only reasonably feasible means of recovery.”).
34
35
36
37
See id. at *13-17.
See id. at *17.
Id.
Id.
43
See Kinkel v. Cingular Wireless, LLC, 857 N.E.2d
250, 271-75 (Ill. 2006); Coady v. Cross Country Bank, 729
N.W.2d 732, 746-47 (Wis. Ct. App. 2007).
44
See Scott v. Cingular Wireless, 161 P.3d 1000
(Wash. 2007).
46
McKee v. AT&T Corp., 191 P.3d 845, 856-57 (Wash.
2008) (following Scott and explaining that under Washington
State law “an arbitration agreement may be substantively
unconscionable when it is used as a tool of oppression to
prevent vindication of small but widespread claims”).
47
Lowden v. T-Mobile USA, Inc., 512 F.3d 1213, 121822 (9th Cir. 2008) (“We conclude that the Washington State
Supreme Court’s decision in Scott v. Cingular Wireless . . .
establishes that T-Mobile’s arbitration provision is substantively
unconscionable and unenforceable under Washington state
law, and that there is no federal preemption in light of our
decision in Shroyer v. New Cingular Wireless Servs., Inc., 498
F.3d 976 (9th Cir. 2007).”).
48
Shroyer v. New Cingular Wireless Svcs., Inc., 498
F.3d 976 (9th Cir. 2007).
49
50
See Gay v. CreditInform, 511 F.3d 369, 378 (3d Cir.
2007); see also Litman v. Cellco Partnership, No. 07-CV4886(FLW), 2008 WL 4507573, at *5-6, n.4 (D. N.J. Sept. 29,
2008) (following Gay and holding that despite the fact that the
class arbitration waiver was unconscionable under New Jersey
state law, the arbitration clause was enforceable under Third
Circuit precedent).
51
Id. (quoting Moses H. Cone Memorial Hosp. v.
Mercury Constr. Corp., 460 U.S. 1, 24 (1983)).
52
39
53
40
Alabama, see Leonard v. Terminix Int’l. Co., 854
So. 2d 529 (Ala. 2002) (finding arbitration clause
unconscionable where the clause not only limited plaintiff’s
recovery of damages, but also contained a class action
waiver that effectively restricted plaintiffs “to a forum where
the expense of pursuing their claim far exceeds the amount
in controversy”); Florida, see Bellsouth Mobility L.L.C. v.
Christopher, 819 So. 2d 171 (Fla. Dist. Ct. App. 2002);
Missouri, see Whitney v. Alltel Commc’ns., Inc., 173 S.W.
3d 300 (Mo. Ct. App. 2005); New Mexico, see Fiser v. Dell
Comp. Corp., 188 P.3d 1215 (N.M. 2008); Pennsylvania,
see Thibodeau v. Comcast Corp., 912 A.2d 874 (Pa.
Super. Ct. 2006); Washington, see Al-Safin v. Circuit City
Stores, Inc., 394 F.3d 1254 (9th Cir. 2005); and West
Virginia, see State ex rel. Dunlap v. Berger, 567 S.E. 2d
265 (W.Va. 2002).
41
Discover Bank v. Superior Court, 113 P.3d 1100
(Cal. 2005).
42
Muhammad v. County Bank of Rehoboth Beach,
Delaware, 912 A.2d 88 (N.J. 2006); Delta Funding Corp. v.
Harris, 912 A.2d 104 (N.J. 2006).
See Dale v. Comcast Corp., 498 F.3d 1216 (11th Cir.
2007).
38
See section entitled “The Federal Arbitration Act,”
supra; see also 9 U.S.C. § 2.
See Coady, 729 N.W.2d at 746-47.
45
---F.3d---, 2009 WL 440912 (3d Cir. Feb. 24, 2009).
Id. at *1.
Id. at *2 (citing UTAH CODE ANN. § 70C-4-105)
54
Id. at *2-3, *4-5 (“we predict that the Supreme Court
of New Jersey would find that the class-arbitration waiver at
issue violates the fundamental public policy of New Jersey”).
55
56
See id.
Id. at *7.
57
Id. at *4-5 (“Muhammad plainly does not hold that an
agreement to arbitrate may be unconscionable simply because
it is an agreement to arbitrate” (internal quotations omitted)).
58
59
60
61
Id. (citing Doctor’s Assocs., 517 U.S. at 686-87).
Id.
Id.
---F. Supp. 2d ---, 2008 WL 5479062 (C.D. Cal. Dec.
29, 2008).
62
63
See id. at *1-2.
See id. at *2.
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Commerical Disputes – Class Action Defense Alert
64
65
66
67
68
69
70
71
Id. at *3-4.
Id. at *4.
Id.
Id.
Id.
Id. at *6.
Id.
Id.
March 2009
11