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Every business desires to reduce its litigation costs. Few expenditures are viewed with greater consternation than payments made for the attorneys’ fees of your adversary. Yet the ability to recover attorneys’ fees is one of the hallmarks of class action litigation. Equally troubling is the high visibility of much class action litigation, which can compromise a company’s brand or business. Ironically, notwithstanding its high cost, claimants often receive little benefit from class action litigation.
Class actions, characterized by a high expense-to-recovery ratio, are inefficient under any reasonable economic model. But class actions were not supposed to work this way. The procedural rules were intended to make it economically viable for plaintiffs to pursue small claims by banding together to press their grievances. And sometimes the theory does work in practice. All too often, though, the results are high transaction costs — in the form of litigation expenses — that net meager benefits for the class.
Class action litigation is also highly disruptive to a risk management scheme premised on a repair-and-replace warranty. Many product manufacturers create such warranties to permit their customers to efficiently seek redress for small product failure claims. But the risk management policies of large employers, franchisors, and other businesses are undermined by class action exposure. Therefore, managing the risk of class action litigation is critical to an overall sound risk management program. But doing so is often easier said than done.
The Role of the Arbitration Agreement
Businesses and employers have, for years, sought to manage their litigation costs through the use of arbitration agreements. By arbitrating disputes with customers and employees, businesses and employers sought to achieve resolution at a lower cost. In many cases, practice followed theory. But the efficiency of the arbitral process has lessened somewhat over the last decade due to a great number of conflicting decisions on a variety of arbitrability issues. The more a party must litigate over whether it can arbitrate a dispute, the less efficient the process becomes. The role of the arbitration agreement in the context of class-wide disputes has also been marked with uncertainty.
Until relatively recently, arbitration was not conducive to class-wide disputes. Few organizations responsible for administering arbitrations had adopted rules for such disputes. As a result, parties employing arbitration agreements in their contracts could be relatively confident that individual disputes would not morph into class actions. While from time to time courts and arbitration organizations have recognized the ability of arbitrators to hear and determine class actions, these were isolated decisions. In 2003, however, the legal landscape radically changed with the United States Supreme Court’s decision in a consumer loan dispute.
Greentree Financial Corp. v. Bazzle
In Greentree Financial Corp. v. Bazzle, 539 U.S. 444 (2003), the plaintiffs signed mandatory arbitration agreements in connection with certain home loans. The arbitration agreements were silent on the question of whether the arbitrator was authorized to consolidate disputes into a class action. In a plurality decision, Justice Stephen Breyer concluded that it was, indeed, the arbitrator, and not the judiciary, who should decide whether the arbitration agreement authorized class-wide arbitration. Because the arbitrator in Bazzle had not made an independent decision on the point, the court vacated the lower court’s judgment confirming two class awards, and remanded the case for further proceedings.
The Bazzle decision raises concerns for those who place a premium on predictability and consistency. The Supreme Court, while not directly addressing the issue, clearly suggests that there is nothing inherently problematic with an arbitrator hearing class-wide disputes. Of equal importance, the question of whether a dispute is to proceed as a class action is initially up to the arbitrator. In other words, the courts are pretty much sidelined in this threshold decision. Yet, unlike with the judicial process, there are very few procedural rules and little substantive law providing guidance as to when an arbitration is to proceed as a class action. It is much more a "frontier justice" type of approach with the arbitrator acting as the sheriff.
While a number of arbitration organizations have begun to issue rules addressing class action arbitrations, they are fairly rudimentary and untested. For example, in response to the Bazzle decision, the American Arbitration Association (AAA) issued an official policy on class action arbitration. The AAA stated, under its Policy on Class Arbitrations, that it will administer demands for class arbitration pursuant to its Supplementary Rules for Class Arbitrations if "(1) the underlying agreement specifies that disputes arising out of the parties’ agreement shall be resolved by arbitration in accordance with any of the Association’s rules, and (2) the agreement is silent with respect to class claims, consolidation or joinder of claims."
The risk inherent in this policy is that it could well suggest to an arbitrator that he or she is authorized to proceed on a class-wide basis where the arbitration agreement simply contains standard language to the effect that "all disputes" will be arbitrated. This is despite the fact that the Rules indicate that the arbitrator "shall not consider the existence of these Supplementary Rules" as a factor in deciding for or against a classwide arbitration—whatever that means. In short, there is little or no procedural process or substantive precedent governing the decision whether to allow an arbitration to proceed on a class basis.
Class Action Waivers
In light of Bazzle, parties are encouraged to directly address the arbitrator’s authority to proceed on a class-wide basis. There are a number of approaches one can take. If one is not particularly concerned about arbitrating class actions, but nevertheless is uncomfortable with allowing an arbitrator to decide whether a particular dispute should proceed in such a manner, the clause could remove the "class certification" issue from the arbitrator and place it with the court. This is not, however, the most common approach to the dilemma. The most common and direct approach is simply to prohibit the consolidation or joinder of claims, including prohibiting the arbitrator from proceeding with a class action.
These "class action waivers," as they are commonly called, have been challenged on a number of occasions, with a variety of results. One of the most discussed cases is the California Supreme Court’s decision in Discover Bank v. Superior Court, 113 P.3d 1100 (2005). Discover Bank amended its agreement with credit card holders by notifying them that disputes would be resolved through arbitration that prohibited class actions. This arbitration agreement was "accepted" by a cardholder’s continued use of the credit card. The suit claimed that the bank charged late fees of about $29 when payment was received after the due date. The bank sought an order compelling arbitration on an individual basis, and the plaintiff sought a class-wide arbitration. Ultimately, the court found the arbitration clause unconscionable and unenforceable, at least to the extent of the class action waiver. In so ruling, however, the California Supreme Court was careful to state that it was not holding that class action waivers are, per se, unconscionable:
We do not hold that all class action waivers are necessarily unconscionable. But when the waiver is found in a consumer contract of adhesion in a setting in which disputes between the contracting parties predictably involve small amounts of damages, and when it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of customers out of individually small sums of money, then, at least to the extent the obligation at issue is governed by California law, the waiver becomes in practice the exemption of the party "from responsibility for [its] own fraud or willful injury to the person or property of another." (Code §1668) Under these circumstances, such waivers are unconscionable under California law and should not be enforced. Discover Bank, 113 P.3d at 1110.
The Discover Bank decision also highlights the importance of choice-of-law provisions and makes it clear that the enforceability of class action waivers is a fact-sensitive inquiry. The contract provided that it was governed both by federal and Delaware law. The dissent (by three of the seven justices) would have decided the case under Delaware law, which it construed to allow class action waivers. As a result, the court remanded the case to the lower court for a decision on whether Delaware law applied.
A tally of jurisdictions reveals that a clear majority of the federal district courts considering the issue have found class action waivers to be enforceable. The same is true with most state courts, although fewer than half of the states have directly addressed the issue and the split is not so clearly in favor of enforceability as in the federal courts. One has to be careful, however, to make distinctions between different types of cases. Consumer cases tend to be more scrutinized than cases involving businesses, e.g., franchise disputes. Cases involving employees can turn on the process by which the employee agreed to arbitrate disputes. Still, notwithstanding the changing legal landscape with respect to the enforceability of class action waivers, they can play an important role in the management of class action risk.