Despite recent U.S. Supreme Court decisions strongly upholding the enforceability of class action waivers in arbitration agreements, opposition to class action waivers on both the political and legal fronts persists, especially in California. As interpreted by California courts, the state’s law traditionally has looked with disfavor on the enforcement of class action waivers, and that attitude continues despite repeated rebukes from the federal courts and the U.S. Supreme Court. Now, the Supreme Court, in a 6-3 decision, has held that the California Court of Appeal’s restrictive interpretation of an arbitration agreement is inconsistent with the Federal Arbitration Act (FAA), and that the FAA requires that the arbitration agreement, including the class action waiver, be enforced. DirecTV, Inc. v. Imburgia, et al.No. 14-462 (Dec. 14, 2015).

The Facts

An arbitration agreement in DirecTV’s customer contract required claims relating to the agreement or the company’s service to be decided by binding arbitration on an individual basis. Arbitration on a class basis was specifically prohibited. At the time Amy Imburgia signed the agreement, the controlling California law was the “Discover Bank rule,” announced by the California Supreme Court in 2005. Under the rule, almost all consumer arbitration agreements with class action waivers were deemed unconscionable and, therefore, unenforceable.

In recognition of the Discover Bank rule, and to avoid the possibility of defending class claims in arbitration, DirecTV’s arbitration agreement contained a non-severability clause providing that if “the law of your state would find [the class action waiver] unenforceable,” then the entire arbitration agreement would be inapplicable and unenforceable. (Emphasis added.) The next section of the agreement provided that “notwithstanding the foregoing,” the arbitration agreement “shall be governed by the Federal Arbitration Act.”

In 2008, Imburgia brought a class action against DirecTV in California state court. In deference to the Discover Bank rule, DirecTV did not invoke its arbitration agreement at that time. Then, in 2011, the U.S. Supreme Court decided, in AT&T Mobility v. Concepcion, 563 U.S. 333, that California’s Discover Bank rule was preempted by the Federal Arbitration Act and could no longer be applied to invalidate class action waivers in arbitration agreements. After Concepcion came down, DirecTV moved to compel individual arbitration of Imburgia’s claim.

The trial court denied DirecTV’s motion and the California Court of Appeal affirmed. The appellate court held the phrase, “the law of your state,” in the arbitration agreement referred to the Discover Bank rule, even though that rule was no longer in effect after Concepcion. As reliance on the Discover Bank rule (if it were still in effect) would have resulted in the class action waiver being unenforceable, the appellate court ruled the entire arbitration agreement unenforceable under the terms of the agreement itself. The appellate court also ruled that because DirecTV had drafted the arbitration agreement, ambiguity in the agreement as to the meaning of “the law of your state” would be construed against DirecTV. The California appellate court explicitly declined to follow the decision of the U.S. Court of Appeals for the Ninth Circuit (in San Francisco) in Murphy v. DirecTV, Inc., 724 F.3d 1218 (9th Cir. 2013), enforcing the very same DirecTV arbitration agreement. The Ninth Circuit’s decision in Murphy expressly rejected the same argument relied upon by the California courts in Imburgia, calling that argument “nonsensical.”

The U.S. Supreme Court accepted the case to answer the question, “Whether the California Court of Appeal erred by holding, in direct conflict with the Ninth Circuit, that a reference to state law in an arbitration agreement governed by the Federal Arbitration Act requires the application of state law preempted by the Federal Arbitration Act.”

The Decision

Justice Stephen Breyer wrote for the six-person majority. The opinion began by describing three overriding legal principles:

  1. The Supremacy Clause of the U.S. Constitution, pursuant to which federal law generally must be applied over conflicting state law, in this case the FAA over the California Discover Bank rule.
  2. Parties to an arbitration agreement are generally free to select the law that will govern the agreement, including enforceability questions. Thus, the parties in this case could have elected to have the enforceability of the agreement governed by the now-invalidated Discover Bank rule.
  3. The interpretation of contracts, including arbitration agreements, is ordinarily a matter of state law in which federal courts defer to state courts.

At the October oral argument, the Justices appeared to struggle with how to reconcile these principles in the face of a state court decision that many observers believed had gone out of its way to invalidate the arbitration agreement and its class action waiver.

Justice Breyer stated the issue before the Court as: “Although we may doubt that the [California] Court of Appeal correctly interpreted California law, we recognize that California courts are the ultimate authority on that law. While recognizing this, we must decide whether the decision of the California court places arbitration contracts ‘on an equal footing with all other contracts.’” In other words, whether the purportedly neutral contract interpretation of the California court actually demonstrated hostility toward, and effectively discriminated against, arbitration agreements in violation of the FAA.

Justice Breyer then closely examined the grounds and rationale of the California court’s decision, concluding that “the California courts would not interpret contracts other than arbitration contracts the same way” — i.e., the decision below had in effect singled out the parties’ arbitration agreement for special, unfavorable treatment.

The opinion noted several factors that led to this conclusion. First, the Court stated that “law of your state” was not ambiguous. Its normal meaning is “valid state law,” and neither the parties nor the dissenting Justices cited any other California court decisions that interpreted “state law” to refer to “invalid state law.”

Second, the Court said California’s general contract principles, as the California Supreme Court has held, provide that references to “California law” are deemed to include subsequent changes to existing law. The California appellate court decision was contrary to this principle of California law, indicating that arbitration agreements were being singled out.

Finally, the Court rejected the notion that the California appellate court was simply applying the neutral contract interpretation principle of construing ambiguous contract provisions against the drafter (in this case, against DirecTV). The Court reiterated that “law of your state” was not ambiguous and concluded, “The fact that we can find no similar case interpreting the words ‘law of your state’ to include invalid state laws indicates … that the antidrafter canon would not lead California courts to reach a similar conclusion in similar cases that do not involve arbitration.”

The Dissent

Justice Ruth Ginsburg, joined by Justice Sonya Sotomayor, dissented, advancing two principal contentions. (Justice Clarence Thomas dissented on a narrow ground not relevant here.)

The dissent’s first argument was that the contract provision saying “the law of your state” reasonably referred to the law of California, without considering the preemptive effect of the FAA, which was how the California courts had interpreted the provision.

The second argument was that the Court’s majority decision, like Concepcion and other recent Supreme Court decisions upholding class waivers, misread the FAA, which the dissent argued was passed in 1925 as a response to judicial reluctance to enforce “commercial arbitration agreements between merchants with relatively equal bargaining power.” The Supreme Court’s recent decisions upholding class waivers, according to the dissent, have deprived consumers of their rights and “insulated powerful economic interests from liability.” This argument, in effect, is a well-developed, policy-based argument against the expansion of the FAA.

Takeaways

DirecTV v. Imburgia is another pro-arbitration decision from the Supreme Court, and perhaps another “rebuke” to California courts that remain resistant to the full enforcement of arbitration agreements. Nevertheless, opposition to class action waivers in California and elsewhere is unlikely to abate.

The Supreme Court has made it clear that it will scrutinize anti-arbitration decisions that are based on contract interpretation or issues of contract formation that single out arbitration agreements for special treatment, either directly or indirectly.

Nothing in the decision affects the viability of actions brought under California’s Private Attorney Generals Act (PAGA) as an avenue to avoid the effects of a class waiver. A PAGA claim is a type of government enforcement action where the representative employee acts as the state’s proxy. Given this “loophole,” the number of PAGA class actions probably will increase as plaintiffs’ counsel include such claims in their complaints, if for no other reason than to avoid arbitration.

Finally, as shown by the dissent, opponents of class action waivers will continue to press their views, especially in the legislative or political realms.