Trial Magazine

Over the last decade, corporations have used the fine print to block the courthouse doors by forcing consumers and employees into arbitration. Arbitration’s proponents argue that it lowers costs and streamlines justice. But that’s far from the reality. Forced arbitration—increasingly prevalent in contracts that govern everyday life—has made it even more difficult for people to have their grievances heard at all, let alone achieve justice.

The Consumer Financial Protection Bureau (CFPB)—which conducted the most comprehensive study on the topic following a congressional mandate—found that forced arbitration clauses are in 44 percent of checking account contracts, 83 percent of prepaid card contracts, 86 percent of private student loan contracts, 99 percent of mobile wireless contracts, and 99 percent of storefront payday loan contracts.¹ This has chilled consumers’ ability to go to court and recover what they deserve.

Over the past year, the tide had started to turn. Action by federal agencies promised to curtail the use of forced arbitration clauses in contracts with government contractors, students, veterans, financial services customers, and beyond. And with Justice Antonin Scalia’s death, the U.S.Supreme Court’s pro-arbitration coalition lost its five-justice stronghold. But the recent presidential election—with its potential impact on both agency leadership and the Supreme Court—throws that possible shift into doubt. Regardless of what happens, attorneys fighting forced arbitration clauses can continue exploring several lines of attack.

A Growing Problem

The Supreme Court’s arbitration jurisprudence has its roots in the 1980s, when the Court began expanding arbitration beyond its original function of resolving disputes between businesses of equal power.² In the last decade, a series of decisions has accelerated arbitration’s expansion: In 2010, Rent-A-Center, West, Inc. v. Jackson held that arbitration clauses must be enforced even when they are part of an illegal contract;³ in 2011, AT&T Mobility LLC v. Concepcion granted companies the unfettered right to enforce class action bans;⁴ and in 2013, American Express Co. v. Italian Colors Restaurant required enforcement of arbitration clauses even when doing so has the practical effect of precluding redress under federal law.⁵

Even in the few years since these decisions, their negative effects have become clear—especially on class actions. The CFPB study’s findings are stark: Class action bans do not channel claims into a better, faster, or cheaper system of dispute resolution. Instead, they completely kill those claims. They shield corporate misconduct from public oversight, encourage future wrongdoing, and inhibit development of the law.⁶

The bureau’s research included a case study of recent class actions filed against banks for illegal excessive overdraft fees. Against 18 of the 23 banks, consumers reached more than 18 settlements, affecting more than 28 million people.⁷ But in cases against the five banks that were able to force their customers into individual arbitration, the bureau was unable to verify that even one consumer received any relief.⁸

Broader trends confirm this pattern. From 2006 to 2007, nearly 700 class actions were settled, according to one legal scholar’s analysis.⁹ Looking at just a subset of class action settlements relating to consumer financial services cases, the CFPB found that between 2008 and 2012, millions of class members had received or were scheduled to receive actual cash relief totaling $2 billion.¹⁰ In contrast, from 2010 to 2011, only 32 aggrieved consumers received compensation through the American Arbitration Association, the nation’s largest arbitration provider.¹¹

A Shift in the Right Direction

The political and consumer mood on arbitration has shifted significantly over the last two years, bringing new attention to the issue and (at least until recently) hope for wide-reaching change.¹² A swell of action from politicians and policymakers had also begun to have an impact.¹³ Through congressional mandates and agency action, the federal government took several steps during the Obama administration to protect consumers from the fine print.

In the Dodd-Frank Wall Street Reform Act of 2010, Congress banned forced arbitration in all residential mortgages and delegated broad authority to the Securities and Exchange Commission and the newly created CFPB to restrict arbitration in investor and consumer contracts. In May 2016, the CFPB released its long-awaited proposed rule, which, if enacted, would ban arbitration clauses that waive consumers’ right to band together in class actions.¹⁴ The rule would not completely eliminate arbitration in consumer financial services, but it would represent an important step to limit its worst effects and, through reporting requirements, shed more light on this secretive system.

A range of other federal agencies have also moved toward restricting forced arbitration clauses, class action bans, or both. This includes action by the Department of Labor (to protect investors saving for retirement), Department of Defense (to protect servicemembers from predatory lenders), the Department of Education (to protect students from for-profit colleges), and the Department of Health and Human Services (to protect nursing home patients).¹⁵

Challenging Arbitration Clauses

Unless and until these potential regulatory changes take hold, arbitration clauses remain nearly bulletproof—but not entirely. To avoid subjecting a client’s claims to arbitration, attorneys need to know the viable strategies that may render the clause unenforceable. Identifying the existence and potential weaknesses of any arbitration clause should be among your first steps when building a potential case. There are five key categories of defenses: formation, scope, waiver, unconscionability, and effective vindication.

Formation. Courts have been open to contract law arguments about whether the arbitration clause was part of a validly formed agreement. Attorneys confronting an arbitration clause should be sure to consider all of the traditional contract formation issues—including offer and acceptance, mutuality of obligation, capacity to contract, and whether there has been any fraud or duress.

Cases involving online agreements are particularly ripe for this kind of attack, as courts are only now grappling with these issues in the online context. A good example is Nguyen v. Barnes & Noble Inc., a Ninth Circuit decision tackling a major question: Do consumers assent to a website’s terms of use just by using the site’s services? The court concluded that merely posting a company’s terms of use—including an arbitration agreement—somewhere on the site is not good enough, because “consumers cannot be expected to ferret out hyperlinks to terms and conditions to which they have no reason to suspect they will be bound.”¹⁶ The onus instead is on website owners, who must properly “put users on notice.”¹⁷ Particularly when it comes to websites and mobile apps, the details often matter. Attorneys should carefully consider the placement and prominence of the arbitration terms presented to consumers.

Scope. In some cases, plaintiffs also have succeeded with a less direct line of attack—arguing that the arbitration clause does not cover their particular claims. In Holcombe v. DIRECTV, LLC, the plaintiff claimed that the television provider repeatedly tried to contact him via telephone after he canceled his service.¹⁸ The Northern District of Georgia found that the arbitration agreement Holcombe signed while he had DirecTV service only covered claims related to that service. The arbitration provision was broad but its scope was not limitless, and it could not cover solicitation calls that, in fact, “assume[d] the nonexistence of a contractual relationship with the recipient.”¹⁹
You can always challenge an arbitration agreement if the particular claims are beyond the scope of the contract. A typical arbitration clause covers “any dispute arising out of, or related to, or in connection with” the subject matter of the contract. The question will be whether your dispute has some significant relationship to the contract or whether it falls outside the contractual relationship entirely.

Waiver. A case’s procedural history also can create potential openings to challenge a motion to compel arbitration, particularly if the defendants have made a tactical move that, in effect, waived their right to arbitration. In Principal Investments, Inc. v. Harrison, the Nevada Supreme Court held that a debt collector waived its right to compel arbitration of collection-practices claims when it chose to sue its borrowers in small claims court and obtain default judgments en masse.²⁰

Waiver can be a fruitful line of attack, but it requires care—as the court noted, “waiver is not a favored finding and should not be lightly inferred.”²¹ The party seeking to demonstrate waiver must generally point to knowledge of an existing right to compel arbitration, acts inconsistent with that right, and prejudice to the party opposing arbitration resulting from those inconsistent acts. The timing is also frequently important to waiver questions: Did the defendant wait too long to compel arbitration, or did it wait until the litigation wasn’t going its way?

Unconscionability. Attorneys should look for terms in the arbitration agreement that are substantively or procedurally unconscionable. Substantive unconscionability generally refers to the terms of the contract itself and asks whether those terms are unreasonably favorable to the stronger party. Procedural unconscionability refers to the circumstances in which the weaker party purportedly consented to those terms—in other words, the “process” by which consent was obtained.

The Seventh Circuit’s 2014 decision in Jackson v. Payday Financial, LLC provides a good model for an unconscionability attack on an arbitration clause.²² A payday loan agreement included a forum selection clause specifying that disputes would be resolved in arbitration conducted by an authorized member of the Cheyenne River Sioux Tribal Nation and according to the tribe’s consumer-dispute rules.²³ But the Cheyenne River Sioux Tribal Nation had no consumer-dispute rules or any authorized arbitrators.²⁴ The Seventh Circuit concluded that this contract term was unconscionable in two respects: It was substantively unconscionable because the dispute-resolution mechanism did not exist and procedurally unconscionable because consumers agreeing to the terms had no way to know that they were agreeing to a sham process.²⁵

Effective vindication. Plaintiffs also have successfully pointed out that certain contract terms can make meaningful access to the arbitration forum impossible for a particular claim, preventing any effective vindication of the plaintiffs’ claims. This concept derives from the legal fiction that arbitration is simply a change of forum; it is not supposed to take away a person’s substantive rights. So if the consequence of arbitration is to prevent effective vindication of a person’s claim, the arbitration clause should not be enforced—at least in theory.

But this exception has limits, as set out in Italian Colors.²⁶ In that case, the Supreme Court refused to apply the judge-made effective vindication exception to a class action waiver even though plaintiffs would “have no economic incentive to pursue their antitrust claims individually in arbitration.”²⁷ The Court rejected the argument that a ¬barrier to proving a claim in arbitration was a -barrier to effective vindication of statutory rights.

Recently, the Tenth Circuit, in Nesbitt v. FCNH, Inc., reaffirmed the effective vindication exception, particularly in cases when barriers are high enough to completely keep claimants out of any forum at all.²⁸ In this Fair Labor Standards Act case, the court found that an agreement’s requirement that any potential claimants partially front the arbitration fee was a major hurdle that would prevent claims from reaching an arbitrator. As the court pointed out, “it is unlikely that an employee in [the plaintiff’s] position, faced with the mere possibility of being reimbursed for arbitrator fees in the future, would risk advancing those fees in order to access the arbitral forum.”²⁹

At the very least, an arbitration clause cannot be enforced when it would allow the arbitrator to ignore applicable state or federal law. In Hayes v. Delbert Services Corp.—a recent case with facts similar to Jackson v. Payday Financial—the court relied on this rationale to invalidate an arbitration agreement that included “a categorical rejection of the requirements of state and federal law.” The Fourth Circuit explained that the FAA “does not protect the sort of arbitration agreement that unambiguously forbids an arbitrator from even applying the applicable law.”³⁰
Agency action is making inroads against forced arbitration, but in the meantime, finding key weaknesses in arbitration clauses can be essential to getting clients their day in court.

---

Deepak Gupta is a principal of Gupta Wessler in Washington, D.C. He can be reached at deepak@guptawessler.com.

---

Notes

1. Consumer Fin. Prot. Bureau, Arbitration Study: Report to Congress Pursuant to Dodd-Frank Wall Street Reform and Consumer Protection Act §1028(a), §2,
   at 8 (2015).
2. See, e.g., Southland Corp. v. Keating, 465 U.S. 1 (1984); Allied-Bruce Terminix Cos. Inc. v. Dobson, 513 U.S. 265 (1995).
3. 561 U.S. 63 (2010).
4. 563 U.S. 333 (2011).
5. 133 S. Ct. 2304 (2013).
6. Discover Fin. Servs., Annual Report (Form 10-K) 43 (2015); Consumer Fin. Prot. Bureau, Prepared Remarks of Director Richard Cordray at the Field Hearing on Arbitration Clauses (May 5, 2016), http://bit.ly/1UCGKWT.
7. CFPB study, supra note 1, §8, at 39–46 (discussing In Re Checking Account Overdraft Litig. MDL No. 2036, 685 F.3d 1269 (11th Cir. 2012)).
8. CFPB study, supra note 1, §8, at 39–46.
9. Brian T. Fitzpatrick, An Empirical Study of Class Action Settlements and Their Fee Awards, 7 J. Emp. Legal Stud. 811, 813 (2010) (noting 688 class action settlements totaling $33 billion were approved by district court judges in 2006 and 2007).
10. CFPB study, supra note 1, §8, at 3–4.
11. CFPB study, supra note 1, §5, at 13.
12. Perry Cooper, Political Mood Shifting on Arbitration: Will the Courts Come Too?, Bloomberg BNA Class Action Litig. Rep., Aug. 3, 2016, at 1.
13. For example, the Democratic Party added forced arbitration to its 2016 platform: www.demconvention.com/wp-content/uploads/2016/07/Democratic-Party-Platform-7.21.16-no-lines.pdf.
14. Consumer Fin. Prot. Bureau, Arbitration Agreements, 81 Fed. Reg. 32830 (May 24, 2016).
15. See, e.g., 81 Fed. Reg. 68,688 (Oct. 4, 2016) (Department of Health and Human Services limiting use of forced arbitration by long-term care facilities receiving federal funds); 81 Fed. Reg. 39330 (June 16, 2016) (Department of Education proposing prohibition on schools participating in direct loan program from using pre-dispute arbitration agreements); 81 Fed. Reg. 21,003 (Apr. 8, 2016) (Department of Labor limiting use of forced arbitration clauses with class-action bans for fiduciaries in retirement-investment context); 80 Fed. Reg. 43559 (July 22, 2015) (Department of Defense banning arbitration in certain loans made to service members). The nursing home and investor rules were both recently challenged in litigation, and AAJ filed briefs in the rules’ defense. See Br. of Am. Ass’n for Justice, in Am. Health Care Ass’n v. Burwell, No. 3:16-cv-233-MPM-RP (N.D. Miss. Oct. 31, 2016); Br. of Am. Ass’n for Justice, in Chamber of Commerce of the U.S. v. Perez, No. 3:16-cv-1476-M (N.D. Tex. Aug. 26, 2016).
16. 763 F.3d 1171, 1179 (9th Cir. 2014).
17. Id.
18. 159 F. Supp. 3d 1337 (N.D. Ga. 2016).
19. Id. at 1342–43.
20. 366 P.3d 688 (Nev. 2016) (Because “the named plaintiffs’ claims all concern, at their core, the validity of the default judgments Rapid Cash obtained against them in justice court,” the state’s highest court upheld the district court’s conclusion “that Rapid Cash waived its right to an arbitral forum.”).
21. Id. at 697.
22. 764 F.3d 765 (7th Cir. 2014).
23. Id. at 768.
24. Id. at 776.
25. Id. at 778.
26. 133 S. Ct. 2304.
27. Id. at 2310.
28. 811 F.3d 371 (10th Cir. 2016).
29. Id. at 378.
30. 811 F.3d 666 (4th Cir. 2016).