Litigation Over Arbitration
Courts Differ on Enforceability of Mandatory Clauses
Posted Jan 25, 2005 4:20 AM CDT
By Martha Neil
Is this the best of times or the worst of times for arbitrating disputes in the United States? The answer to that question depends on whom you ask.
Arbitration is extremely popular among U.S. companies that view it as a manageable and efficient vehicle for resolving disputes with other commercial entities and consumers while avoiding time consuming, costly litigation.
“Why are businesses getting into the business of doing arbitration?” asks Douglas A. Darch, a Chicago attorney who represents companies in employment cases. “The answer is, the federal civil system—where most employment cases are litigated—is broken. It is so time consuming and so expensive that companies that want to resolve disputes are looking for other ways to do it.”
And even though arbitrating a matter might end up costing almost as much as litigation, businesses like being able to limit discovery, set their own rules for presenting evidence, schedule proceedings at their own convenience and select the third party who will decide their cases, says Richard Chernick of Los Angeles, the immediate past chair of the ABA Section of Dispute Resolution.
But many consumer advocates detest mandatory arbitration, which increasingly is the only dispute resolution mechanism available to consumers, employees and medical patients under their agreements with retail businesses and financial institutions, employers, and insurance providers.
Consumer advocates often dislike arbitration for many of the same reasons businesses prefer it. In the consumer view, mandatory arbitration puts consumers and employees on an uneven playing field that tilts toward the opposition. They see arbitration as an expensive process that, at the same time, puts consumers at a disadvantage by imposing procedural limitations on their ability to pursue their cases.
Moreover, consumer advocates say the system creates an inclination by arbitrators to decide cases in favor of businesses.
High Court Cited
Some advocates say much of the trouble started in 1995 when the U.S. Supreme Court ruled that mandatory arbitration agreements could be enforced under federal law. Allied Bruce Terminix Companies v. Dobson, 513 U.S. 265. Since then, mandatory arbitration clauses have become common in a myriad of consumer contracts, employment agreements and benefit plans.
In Terminix, the Alabama Supreme Court had upheld the right of homeowners to sue the company in state court over a termite infestation. The court ruled that a mandatory arbitration clause in their contracts with Terminix was invalidated by a state law declaring that clauses in which parties agree to arbitration before an actual dispute arises are unenforceable.
The Supreme Court overturned that ruling. In a 7 2 decision, the court said the Federal Arbitration Act, which sets standards for enforcing arbitration agreements, preempted the state law.
“The Supreme Court has turned this whole arbitration field into what I’ll call a legal atrocity,” says Cliff Palefsky, who practices consumer and civil rights law in San Francisco. “The law at this point is incomprehensible. They have pre empted all the consumer protection legislation that existed in the states. Because there’s no federal consumer protection legislation, they’ve basically eliminated it rather than replace it. So there’s a huge void.”
The act sets standards concerning the enforcement of arbitration agreements, but Palefsky notes it was never intended to serve as a consumer protection statute. Thus, he and other consumer advocates say, additional federal legislation is needed to create guidelines that will help protect individuals from abusive arbitration provisions. There is no real movement in Congress right now, however, to do that. Instead, mandatory arbitration clauses are being challenged in lawsuits that experts in the field estimate to be in the hundreds each year.
Disputes between businesses still dominate the U.S. arbitration field, says Chernick. Due to the financial stakes involved in a typical case, commercial cases give rise to most of what he calls the “back end” litigation over enforceability of arbitration awards. At the same time, nearly all the front end litigation in the field is brought by individuals challenging mandatory arbitration clauses in consumer, employment and health plan contracts, Chernick says.
Debate Heating Up
The controversy over mandatory arbitration clauses in consumer agreements is becoming so intense; say some in the field, that it’s even putting the overall credibility of arbitration at risk.
“With all the controversy over the enforceability of arbitration in the consumer and employment area, arbitration might be getting a bad name in the commercial area, where it has been providing a valuable service for decades,” says David A. Hoffman of Boston, who chairs the ABA’s Dispute Resolution Section. “So lawyers may be shying away from arbitration because they fear it may be controversial or unenforceable,” he says, “when, in fact, it’s very well-accepted in the courts—in the commercial area.”
Hoffman also sees another trend.
“Arbitration is beginning to look more and more like litigation,” he says. “There’s more discovery. There’s more motion practice. There are concepts such as summary judgment that until recent years were foreign to the world of arbitration.”
Nevertheless, says Hoffman, arbitration offers significant opportunities for commercial parties “to tailor the process” in seeking to resolve disputes.
Litigation challenging mandatory arbitration clauses in consumer contracts is virtually epidemic, but the courts have yet to agree on a cure. Nor do experts foresee a consensus developing anytime soon.
The starting point in the debate is the fundamental question of whether mandatory arbitration clauses in consumer agreements are fair. If they are unable to meet that threshold test, courts may strike them down as unconscionable. But there is no consensus among the courts on what exactly makes a mandatory arbitration clause unconscionable.
In a leading decision last summer, for example, the 5th U.S. Circuit Court of Appeals, based in New Orleans, applied the unconscionability standard to invalidate a mandatory arbitration clause that required cellular phone customers—but not the company providing the service to arbitrate all disputes. Iberia Credit Bureau v. Cingular Wireless, 379 F.3d 159 (2004).
At the same time, however, the court upheld the validity of mandatory arbitration clauses in other cell phone service contracts that did not contain the one way arbitration requirement. These other contracts were not unconscionable despite their fine print, confidentiality requirements and ban on class actions, the 5th Circuit decided, differing with the 9th Circuit on the class actions issue, for instance.
Another important issue on which “the courts are all over the place” is whether to invalidate an entire arbitration clause or only the specific language that is ruled to be unconscionable, says Fred Gittes, an attorney in Columbus, Ohio. He is immediate past president of the National Employment Lawyers Association.
“To me, those courts that are severing are missing the heart of the problem,” says Gittes, because they don’t recognize the chilling effect that the entire provisions can have on consumers and employees seeking to pursue claims. “Most people, when they see those kinds of things in an arbitration agreement, don’t come into a law office and discuss it. They just give up.”
Applying that rationale, the Atlanta based 11th U.S. Circuit Court of Appeals voided a mandatory arbitration agreement in which an employer in Florida had attempted to do an end run around Title VII’s requirement that prevailing plaintiffs in employment discrimination cases be awarded attorney fees. The employer sought to evade the statutory requirement through a provision that called for any employees arbitrating discrimination claims to share the costs of doing so with the company. Perez v. Globe Airport Security Services, 253 F.3d 1280 (2001).
“If an employer could rely on the courts to sever an unlawful provision and compel the employee to arbitrate, the employer would have an incentive to include unlawful provisions in its arbitration agreements,” reasoned the opinion issued by the 11th Circuit panel.
But other courts have taken a different approach to the severance issue, preferring to eliminate the offending language but not the entire arbitration clause.
One of the hottest issues right now is whether mandatory arbitration clauses may prohibit consumers from arbitrating disputes with companies on a class action basis.
In one recent victory for consumers, the 9th U.S. Circuit Court of Appeals, based in San Francisco, ruled that individuals challenging mandatory arbitration provisions in their telephone service agreements could not be prevented from arbitrating on a class action basis because the ban was “manifestly one sided.” Darcy Ting v. AT&T, 319 F.3d 1126. The court recognized that, technically, the class action ban applied to the telephone company as well as its customers. But, the court stated in its opinion, “It is not only difficult to imagine AT&T bringing a class action against its own customers, but AT&T fails to allege that it has ever or would ever do so.”
The Supreme Court declined to hear the case, but at some point the justices will have to consider whether class action arbitrations can be prohibited because there is a “huge division” among the appellate courts on the issue, says F. Paul Bland Jr. He helped represent consumers in the case as a staff attorney with Trial Lawyers for Public Justice in Washington, D.C.
In previous cases, Bland notes, the Supreme Court has held that class actions can be decided by arbitration.
Even provisions that are not always found to be unconscionable still impose practical limitations on consumers who try to pursue claims under agreements that con tain them. “It’s very common to see clauses that require consumers to pay very large costs of arbitration,” says Bland. “And it’s still common to see arbitration clauses that require consumers to travel significant distances to arbitrate their claims.”
Cleveland attorney Joan M. Burda says an arbitrator may well charge $1,000 a day, with the consumer or employee required to pay half of that amount.
Plus, Burda points out, arbitrators ordinarily do not award attorney fees to the prevailing party even if he or she is pursuing a statutory claim that would award attorney fees if it was litigated.
“Basically, it boils down to, if you have a five day arbitration and the arbitrator is charging a thousand bucks a day, and [the ruling goes] against the consumer, the consumer is still on the hook for the arbitration charges,” says Burda, a council member for the ABA General Practice, Solo and Small Firm Section.
But if a consumer goes into court and loses, Burda points out, “Many attorneys will be taking it to trial based on getting their fees under a consumer statute. So, in a contingency case, they may not be out any attorney fees at all.”
Even when the cost of an arbitration isn’t prohibitive for the individual party, it can still be a less than friendly forum, consumer advocates say. There is, for instance, what Cliff Palefsky describes as the “repeat user” factor.
Palefsky explains that arbitrations generally are once in a lifetime experiences for individuals. But businesses often engage in arbitration on a regular basis. Naturally, they tend to rehire arbitrators who have rendered favorable decisions in the past, a pattern that doesn’t fail to miss the notice of the arbitrators themselves.
It is ironic, too, that at the same time businesses are sharing more information with each other in commercial arbitrations, mandatory arbitration clauses in consumer agreements often impose strict limits on disclosing information during arbitrations.
Gittes explains that the party that wants to conceal documents is often the party that possesses them. In an employment dispute, for example, employers control relevant documents, while other employees may be reluctant to come forward with information. Meanwhile, the arbitrating employee typi cally has very little information that the employer needs to argue its case. Sensing a stacked deck, many consumers simply let their claims go, says Bland, feeling that there’s no point in pursuing the case.
Consumer Friendly Clauses
Arbitration clauses also can promote the interests of consumers. For instance, the Kaiser Foundation Health Plan Inc., a well known health maintenance organization in California, has an arbitration arrangement that costs the patient nothing if a single arbitrator is used, because the health plan pays the fees. The arbitration provision also permits discovery and does not attempt to restrict statutory remedies, says Sharon Oxborough. The Los Angeles lawyer serves as independent administrator for the health plan’s arbitration system.
“I think that our program is probably as good as you can make mandatory arbitration,” says Oxborough. But, she adds, “If you dislike mandatory arbitration, you’re still going to dislike my program, because it is mandatory arbitration.”
The Kaiser program even offers individuals some advantages over the traditional court system, says Oxborough. These include its low cost—a $150 filing fee that can be waived if the individual falls within low income guidelines—and a process that an individual can more easily navigate without the help of an attorney. (Detailed information about Kaiser’s arbitration system can be found at www.oiakaiserarb.com.)
There are some indications that the use of mandatory arbitration provisions in consumer, employment and medical benefits agreements may have hit high tide.
David D. Kadue, a lawyer in Darch’s firm who practices in California, says the increasing use of litigation techniques in commercial cases is slowly spreading to the consumer field. As a result, he says, he is becoming more reluctant to recommend that companies use arbitration across the board to resolve disputes with employees.
Thus, says Kadue, the cost savings from arbitration that help to counterbalance any disadvantages it has in comparison to litigation—such as the absence of judicial review—are shrinking.
Now, says Kadue, an employer with a strong case may prefer to have the matter handled in court rather than through arbitration because a judge may be likely to grant a pretrial motion to dismiss. An arbitrator is much more likely to try such a case, he says, because pretrial motions are not favored in arbitration.
One consumer area where mandatory arbitration clauses are becoming less common is mortgages, says Nina F. Simon, an attorney who works for AARP in Washington, D.C. This is the result of decisions by the nation’s major purchasers of mortgages, Freddie Mac and Fannie Mae, not to allow mandatory arbitration provisions in mortgages they buy, following considerable lobbying by consumer advocates.
Previously, mandatory arbitration clauses were often found in subprime mortgages (which generally offer less favorable terms to borrowers with borderline credit ratings), although they generally weren’t used in standard mortgages offered to borrowers with good credit, she says. “We think these are horrible,” says Simon. “They’ve actually protected the worst lenders from having the merits of any of these claims decided. What was happening was the most abusive lenders were able to protect themselves from any legal redress, unless it was brought as an enforcement action by government officials.”
Although the actions by Freddie Mac and Fannie Mae still don’t prevent subprime mortgage lenders from using mandatory arbitration clauses, Simon says the change will help persuade judges that this practice is wrong.
“It should make it easier to prove that these provisions are unconscionable,” says Simon, “because it’s really not considered an acceptable practice in the mainstream market anymore.”
But at the same time that the use of mandatory arbitration clauses might be on the wane, businesses are trying new approaches that might give them advantages in resolving disputes with customers and employees.
One issue drawing more attention, says Douglas Darch, is whether companies may ask customers to waive the right to a jury trial long before any actual dispute arises. Sometimes the company simply wants to take the case to court without the difficulty and expense of trying it before a jury, he says.
Like mandatory arbitration clauses, however, jury trial waivers are controversial—and might not be enforceable, say experts in the field.
In one early case addressing the issue, the Supreme Court of Texas held as a matter of first impression that a jury trial waiver would be upheld in a commercial lease. There was no mandatory arbitration clause, so the case was referred for trial before a judge, as the waiver provided. In re Prudential Insurance Co. of America, No. 02 0690 (Sept. 3, 2004).
Reading the Boilerplate
Arbitration clauses in most consumer agreements are boilerplate in nature, part of the fine print of a contract in place long before any dispute arises. This adhesionary language, drafted with little or no input from the individual concerned, often gives the consumer a choice only between accepting the contract as is or going without the job, product or service in question.
Even so, consumers may have more power than they realize in dealing with arbitration clauses. The first thing they should do is simply read the fine print in their credit card agreements and other consumer contracts—it might prove to be worth their while. A growing number of credit card companies, for instance, are now including opt out provisions in their arbitration clauses in an effort to portray them as voluntary, says Bland. Thus, with a little effort, a consumer can find the provision, follow its instructions and send a brief letter to the company rejecting the arbitration provision. Then, if a dispute later arises and can’t be resolved directly with the company, the consumer can take the issue to court.
“Ninety nine percent of consumers never read or see these things, or understand them,” says Bland. “But we urge people to look for these things when they get credit cards.” And even when opt out provisions are absent, it may be possible for a resourceful individual to prevail against a large corporation. Burda recounts that a woman she represented found the mandatory arbitration provision in a consumer contract and crossed it out. When a dispute arose some time later and the business tried to arbitrate, the woman called the prepaid consumer legal services plan to which she belonged.
The plan put Burda on the case, and the company—after litigating to the appellate court level the issue of whether the original dispute was subject to mandatory arbitration—finally agreed to settle. As Burda recalls, “They said they were tired of being bullied by me.”
Martha Neil, a lawyer, is a legal affairs writer for the ABA Journal.