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Class Actions in Arbitration
By Thomas J. Cunningham
Are provisions in arbitration agreements that expressly prohibit class arbitration enforceable in Illinois? And if the agreement doesn't include a prohibition, what happens then? Plaintiffs' and defense attorneys alike will want to familiarize themselves with recent developments.
It is no surprise that corporate America would prefer not to be troubled by class action lawsuits, which are costly to defend and settle. They are also numerous – in the federal courts in 2002, 2,916 new class action cases were filed and 4,835 were pending.1
Against this backdrop, this article reviews recent developments in the law governing class arbitration. Highlights include the U.S. Supreme Court's 2003 decision in Green Tree Financial Corp v Bazzle,2 where the court allowed class actions in arbitrations when the agreement between the parties was silent on the question; the American Arbitration Association's promulgation of new rules governing class arbitration, which were drafted in response to Green Tree; and recent Illinois Appellate Court decisions upholding the enforceability of arbitration provisions that explicitly prohibit class actions. The article also looks at unresolved issues in class arbitration.
The Green Tree Case
The strategy of using arbitration agreements to avoid class actions has largely been endorsed by the federal courts. The seventh circuit held in Champ v Siegel Trading Co, Inc3 that courts lack the power to consolidate claims in arbitration proceedings. The ruling thus prevents class-wide arbitration unless the arbitration agreement in question specifically permits it. The Champ decision has been followed in the third, fourth, sixth, eighth, and eleventh circuits, as well as by a host of district courts, making it the prevailing view among federal courts today.
Last year the United States Supreme Court addressed arbitration agreements in Green Tree Financial Corp v Bazzle. In Green Tree, the South Carolina Supreme Court held that in the absence of language to the contrary, consumer claims could be arbitrated on a class-wide basis.4
On appeal to the United States Supreme Court, Green Tree argued that arbitration on a class-wide basis should not be permitted unless explicitly provided for in the applicable agreement. The Supreme Court held that whether claims could be arbitrated on a class-wide basis was a decision an arbitrator – not the courts – should make when no provision expressly prohibits class action in arbitration.5
American Arbitration Association Class Arbitration Rules
In response to Green Tree, the American Arbitration Association (the "AAA") on July 11, 2003, issued a "Policy on Class Arbitration." That policy provides as follows:
[T]he American Arbitration Association will administer demands for class arbitration…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.6
On October 8, 2003, the AAA published its Supplementary Rules for Class Arbitrations (the "Supplementary Rules"). The Supplementary Rules contain many provisions that parallel those found in Federal Rule of Civil Procedure 23, which governs class actions.
The Supplementary Rules require an arbitrator to initially determine whether the applicable arbitration provision permits arbitration on a class basis.7 Presumably, if the provision expressly prohibits class relief in arbitration, the arbitrator will determine that the matter cannot be maintained on a class-wide basis in arbitration.
The arbitrator must enter a decision as to whether the applicable provision permits arbitration. This decision is called the "clause construction award." The Supplementary Rules provide for a 30-day stay of further action following entry of the clause construction award, specifically to permit the parties to seek judicial review of the initial determination by the arbitrator of whether the action can proceed in arbitration on a class-wide basis.
Once the arbitrator has decided that the action can proceed on a class-wide basis in arbitration and that decision has either been upheld by a court or neither party has sought review, the next step is class certification. Like FRCP 23(a), the Supplementary Rules require the arbitrator to consider how large the plaintiff group is, whether the prospective class representatives' complaints are typical of the group, whether the group shares common issues of law or fact, and whether the putative parties adequately represent the class.
Supplementary Rule No. 4 also requires that each class member have entered into a "substantially similar" arbitration clause. The arbitrator must further find that common questions of law or fact "predominate over any questions affecting only individual [class] members, and that a class arbitration is superior to other available methods for the fair and efficient adjudication of the controversy."
The arbitrator is to consider four factors in making this determination: (1) the interest of members of the class in individually controlling the prosecution or defense of separate arbitrations; (2) the extent and nature of any other proceedings concerning the controversy already commenced by or against members of the class; (3) the desirability or undesirability of concentrating the determination of the claims in a single arbitral forum; and (4) the difficulties likely to be encountered in the management of class arbitration.8
If the arbitrator decides that a class meets all of the requirements of the Supplementary Rules and should be certified, he or she will enter an award called the "class determination award." As with the clause construction award, the Supplementary Rules provide for an automatic stay of further action pending an opportunity to have the class determination award reviewed by a court. The class determination award must define the class, identify the class representative and counsel, and the issues and defenses. It must also provide for a means for class members to opt out of the class arbitration.
Once the class determination award has been entered and favorably approved by a reviewing court, or if 30 days pass without a request for judicial review, the arbitrator is to direct that notice be provided to class members. Like FRCP 23, the AAA Supplementary Rules require the arbitrator to make a meaningful effort to identify all members and to provide notice by the best means practicable.
The notice itself must include the following information: (1) the nature of the action; (2) the definition of the class certified; (3) the class claims, issues or defenses; (4) that a class member may enter an appearance through counsel if the member so desires, and that any class member may attend the hearings; (5) that the arbitrator will exclude from the class any member who requests exclusion, stating when and how members may elect to be excluded; (6) the binding effect of a class judgment on class members; (7) the identity and biographical information about the arbitrator, the class representative(s) and class counsel that have been approved by the arbitrator to represent the class; and (8) how and to whom a class member may communicate about the class arbitration, including information about the class arbitration docket.9 The Supplementary Rules also contain provisions for entry of a final award and rules governing settlement in class arbitrations.
Altogether, the Supplementary Rules provide for a complete system for administering arbitrations on a class-wide basis, complete with opportunities for judicial review at appropriate stages. The new rules do not resolve the outstanding issues of class-wide arbitration, however. As discussed at the end of this article, a number of issues still require judicial resolution, and the Supplementary Rules have created some new issues that will require careful scrutiny.
Enforceability of Class Action Waivers
The Green Tree decision and the AAA Supplementary Rules governing class arbitrations both imply that a provision in an arbitration agreement explicitly waiving the ability to prosecute a claim as a class action, whether in arbitration or otherwise, will be enforced.
That is the clear implication from Green Tree, for if claims could always be considered on a class-wide basis in the absence of a provision to the contrary, the Court would simply have held that claims could be pursued on a class-wide basis and there would have been no need for an arbitrator to make a decision.
The Court's decision necessarily implies that there is something for the arbitrator to decide and that the decision could go either way. If that is the case, an arbitration agreement with an explicit prohibition of class arbitration would almost certainly be enforceable. |
FYI . . . |
The AAA Supplementary Rules explicitly provide for an initial determination of whether an arbitration agreement permits class-wide arbitration. As observed earlier, this provision in the rules suggests that if an arbitration provision explicitly prohibits the maintenance of a class action in arbitration, the arbitrator will honor that prohibition.
For these reasons, a plaintiff's attorney pursuing a class action where the plaintiff has entered into an agreement that explicitly prohibits class action relief must seek to invalidate the arbitration agreement itself. Plaintiffs have thus attacked arbitration agreements containing class-action waivers as being unconscionable under state laws governing contracts. While most arbitration agreements will incorporate the Federal Arbitration Act ("FAA"), 9 USC § 2, courts have consistently held that the state law of contracts governs whether an arbitration agreement is unconscionable.10
Most courts have held that class action waivers in arbitration agreements are enforceable. Plaintiffs have advanced a number of arguments attacking arbitration clauses as unconscionable, notably including the purported high cost of arbitration and the lack of meaningful relief for an individual consumer who has incurred only a small amount of damage. These arguments have been rejected virtually everywhere they have been tried.
California Courts Split
California courts, however, never afraid to go their own way, are undecided. In Szetela v Discover Bank11, the California Appellate Court for the Fourth District held that an arbitration provision in Discover Bank's contracts with its customers that precluded class actions was unenforceable pursuant to a California consumer protection statute.
But on January 14, 2003, the California Court of Appeal for the Second District held in Discover Bank v Superior Court12 that Szetela was "wrongly decided" because it failed to consider the impact of the FAA. The second district held that if an arbitration agreement covered by the FAA prohibits class arbitration, a state court may not refuse to enforce that provision, even if it would be unconscionable under the state's law applicable to contracts. The California Supreme Court has granted review of the Discover Bank decision and should therefore resolve the conflict between Discover Bank and Szetela soon.
Meanwhile, the U.S. Court of Appeals for the Ninth Circuit considered the same issues as Discover Bank and Szetela in Ting v AT&T13 and concluded that the FAA did not preempt California state law. Under the general California laws applicable to contracts, the ninth circuit found the arbitration agreement at issue to be unconscionable and therefore unenforceable, stressing that AT&T customers had not had an opportunity to negotiate the provisions of the arbitration agreement, which had been sent in such a way that customers were not aware they had received a contract.
Shortly after its decision in Ting, the ninth circuit held in Ingle v Circuit City Stores, Inc14 that a prohibition of class action relief in an arbitration provision contained in an employment agreement was unconscionable. In Ingle, the ninth circuit held that its decision was consistent with the FAA, which it said did not "supplant state law governing the unconscionability of adhesive contracts."15
Illinois Courts Uphold Waivers
In Illinois, the Illinois Appellate Court, First District, recently decided two cases that reviewed the enforceability of arbitration provisions containing class action waivers. In Hutcherson v Sears Roebuck & Company16 the court reversed and remanded a trial court's denial of a motion to compel arbitration in a putative class action case (the trial court found that the arbitration provision was both procedurally and substantively unconscionable).
The plaintiff in Hutcherson relied heavily upon Szetela in arguing on appeal that the decision should be affirmed. The agreement in Hutcherson contained a choice of law provision that required the court to analyze the issue pursuant to Arizona law. Finding little guidance from Arizona courts on the issue, the Hutcherson court turned to the decisions of numerous other states and federal courts to determine that class action waivers did not render agreements unconscionable.
The court specifically held that it was "not convinced by the court's analysis in Szetela."17 Although it recognized that class actions were an "important tool for protecting consumers," it could not "ignore the strong policy that favors enforcement of arbitration provisions."18
Just a few months later the Illinois appellate court considered the same issue, this time applying Illinois law. In Rosen v SCIL, LLC, 19 the plaintiff alleged that the arbitration provision in his Saks Fifth Avenue credit card agreement was unconscionable. He contended that a class action waiver was per se unconscionable.
The court rejected that argument, holding that if the plaintiff wanted to preserve his ability to pursue disputes as class actions, he could have simply chosen not to use his Saks credit card and would not have been obligated to arbitrate rather than pursue a class action. The plaintiff argued that he maintained a "right" to pursue a class action. The court found that the existence of such a "right" was "a question of public policy, which we suggest should be addressed by the legislature."20
The court also explicitly rejected Rosen's argument that the arbitration provision was unconscionable because it waived Rosen's right to recover his attorneys' fees in the event he was successful. The agreement did not modify the normal rule that each party bears its own fees and expenses. While Rosen argued that the provision would prevent an arbitrator from awarding fees in an action premised upon the Illinois Consumer Fraud and Deceptive Business Practices Act, the court was not persuaded. Saks' agreement provided that each party would bear its own fees and costs "unless unlawful." In the case of an action based upon the Illinois Consumer Fraud and Deceptive Business Practices Act, which provides for recovery of fees and costs by a successful plaintiff, it would be "unlawful" for the arbitrator to refuse to award the plaintiff his fees and costs.
The court also rejected Rosen's argument that the arbitration provision was unconscionable because it imposed high costs upon the plaintiff. Saks had agreed to pay any costs of arbitration in Rosen's case, and the agreement provided for Saks to advance the costs of the arbitration upon request in any event. Moreover, the court held that Rosen had failed to prove that he would incur prohibitive costs even in the absence of Saks' offer to pay those costs. The court pointed out that Rosen's initial fee for arbitration would be only $125, while it cost him $221 to file a complaint in the Circuit Court of Cook County.21
The court in Rosen did not find it necessary to determine whether the FAA preempted Illinois law with respect to the enforcement of arbitration provisions because, although the two statutes do have some differences, the Illinois Uniform Arbitration Act (the "Illinois Act") and the FAA have common origins and Illinois courts look to federal court decisions based upon the FAA in deciding issues pursuant to the Illinois Act.
Unless the logic of Hutcherson and Rosen opinions is rejected by the Illinois Supreme Court or other appellate court districts, arbitration provisions will be enforced in Illinois and will not be held unconscionable merely because they waive a plaintiff's ability to maintain a class action.
Unresolved Issues
While it appears that arbitration provisions will be enforced in Illinois where they expressly prohibit class arbitration, it is unclear how an arbitration provision that fails to contain an express prohibition will be treated. The Supreme Court has indicated that this is an issue for the arbitrator, and the AAA has promulgated rules for arbitrators to use in administering class arbitrations.
Taken together, this likely means that a company that has an arbitration provision but fails to expressly prohibit class arbitration is running the risk that it will be faced with such actions. Moreover, a company that has simply adopted the rules of the AAA in its arbitration provision may be found to have expressly accepted and adopted the new AAA Supplementary Rules governing class arbitration.
How the AAA Supplementary Rules will affect class action litigation remains to be seen. Some believe that a certain segment of the plaintiff's class-action bar will prefer class arbitration as a lower-cost and quicker route to lucrative settlements. Litigation initiated by "class" members unhappy with the result of a class arbitration is sure to follow, and courts will be presented with arguments by such class members that they should not be bound by the decision of an arbitrator in the absence of a contractual provision expressly providing that they are bound by a decision in a class arbitration.
Thus, while some issues have been resolved, new ones have arisen.
1. Administrative Office of the United States Courts, 2002 Annual Report, Tables X-4 and X-5, <http://www.uscourts.gov/judbus2002/appendices/x04sep02.pdf>.
2. 539 US 444, 123 S Ct 2402 (2003).
4. Bazzle v Green Tree Financial Corp, 351 SC 244, 569 SE2d 349 (2002).
5. Green Tree, 123 S Ct at 2407.
6. AAA Policy on Class Arbitration, available at <http://www.adr.org/index2.1.jsp?JSPssid=16235&JSPsrc=upload/livesite/
Rules_Procedures/Topics_Interest/Class%20Action.htm>.
7. Supplementary Rules for Class Arbitrations, No 3, Construction of the Arbitration Clause; <http://www.adr.org/index2.1.jsp?JSPssid=16235&JSPsrc=upload/livesite/Rules_Procedures/Topics_Interest/
AAAClassaction.htm>.
8. Id at No 4, Class Certification.
9. Id at No 6, Notice of Class Determination. For information about the Class Arbitration Docket, see Supplementary Rule 9.
10. See Doctor's Associates, Inc v Casarotto, 517 US 681 (1996).
11. 97 Cal App 4th 1094, 118 Cal Rptr 2d 862 (4th D 2002).
12. 105 Cal App 4th 326, 129 Cal Rptr 2d 393 (2d D 2003), review granted, 65 P3d 1285, 132 Cal Rptr 2d 526 (Cal 2003).
13. 319 F3d 1126, 1150 (9th Cir 2003).
14. 328 F3d 1165 (9th Cir 2003).
16. 342 Ill App 3d 109, 793 NE2d 886 (1st D 2003).
17. Id at 122, 793 NE2d at 895.
18. Id at 124, 793 NE2d at 896.
19. 343 Ill App 3d 1075, 799 NE2d 488 (1st D 2003).
20. Id at 1082, 799 NE2d at 494.
21. In her concurring opinion in Green Tree Financial Corp-Alabama v Randolph, Justice Ginsberg stated that a $125 fee to arbitrate a claim was reasonable. 531 US 79, 95, 121 S Ct 513, 524 (2000).
AAA Policy on Class Arbitration
AAA Supplementary Rules
Federal Arbitration Act
<http://www4.law.cornell.edu/uscode/9/ch1.html>
Green Tree v Bazzle
Rosen v SCIL, LLC
<http://www.state.il.us/court/Opinions/AppellateCourt/2003/1stDistrict/
October/Html/1030814.htm>
Thomas J. Cunningham <tcunningham@lordbissell.com> is a partner at Lord, Bissell & Brook, LLP in Chicago. He helped represent Saks Fifth Avenue in Rosen v SCIL, LLC.