AT&T v Concepcion: implications for franchising

Introduction
Background
Supreme Court decision
Application to franchising relationships

Introduction

Arbitration clauses are prevalent in many form contracts, including franchise agreements.(1) Section 2 of the Federal Arbitration Act makes such agreements to arbitrate "valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract".(2) However, since its enactment some states have redeveloped bodies of case law that have effectively decreased parties' ability to enforce certain arbitration provisions. It is against this backdrop that the Supreme Court recently examined "whether the [act] prohibits States from conditioning the enforceability of certain arbitration agreements on the availability of classwide arbitration procedures" in AT&T Mobility LLC v Concepcion.(3) In an opinion authored by Justice Scalia and joined by Chief Justice Roberts and Justices Kennedy, Thomas and Alito, the court held that it does. Specifically, Concepcion overturned a body of California case law that previously allowed parties subject to an arbitration provision to proceed as a class (in arbitration), even if the agreement did not allow for such proceedings.

This update summarises Concepcion's key holdings as they impact on franchisor/franchisee relations.

Background

The arbitration provision at issue in Concepcion was part of AT&T Mobility LLC's cellular service agreement,(4) which required arbitration of all disputes between the parties and provided that claims must be brought in the parties' "individual capacity, and not as a plaintiff or class member in any purported class or representative proceeding".(5)

Customers could initiate the dispute proceedings by completing a one-page 'notice of dispute' form available on AT&T's website, at which point AT&T could offer to settle the claim.(6) If AT&T did not make such an offer, or if the dispute was not resolved within 30 days, the customer could then invoke arbitration by filing a separate 'demand for arbitration', also available on AT&T's website.(7) Once arbitration proceedings began, the agreement specified that:

"AT&T must pay all costs for nonfrivolous claims; that arbitration must take place in the county in which the customer is billed; that, for claims of $10,000 or less, the customer may choose whether the arbitration proceeds in person, by telephone, or based only on submissions; that either party may bring a claim in small claims court in lieu of arbitration; and that the arbitrator may award any form of individual relief, including injunctions and presumably punitive damages."(8)

The arbitration agreement also provided that AT&T could not seek reimbursement of its attorney's fees but, in the event that a customer received an award greater than AT&T's last written settlement offer, he or she would be entitled to a guaranteed minimum recovery of $10,000 plus twice the amount of his or her attorney's fees.(9)

In 2002 Vincent and Liza Concepcion entered into a cellular service agreement with AT&T that contained the arbitration provision described above.(10) At the time, AT&T was advertising that purchase of its service would allow customers to obtain certain free cell phones. The Concepcions purchased AT&T's service and one of the free cell phones. They were not charged for the phone, but they were charged $30.22 in sales tax based on the phone's retail value.

In 2006 the Concepcions filed a complaint against AT&T in the US District Court for the Southern District of California. The complaint was later consolidated with a putative class action that alleged, among other things, that AT&T had engaged in false advertising and fraud by charging sales tax on phones that it advertised as free.

AT&T moved to compel arbitration. The Concepcions opposed the motion based on Discover Bank v Superior Court, a California Supreme Court decision interpreting two sections of the California Civil Code.(11) The first section invalidates any contract that "directly or indirectly... exempt[s] anyone from responsibility for his own... violation of law".(12) The second section authorises courts to "limit the application of any unconscionable clause" in a contract to "avoid any unconscionable result".(13) The court in Discover Bank concluded that class action waivers contained within arbitration agreements in consumer contracts of adhesion are unenforceable under both Civil Code sections if:

• disputes arising out of the contract would predictably involve small amounts of damages; and
• the plaintiff alleges "that the party with superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money".(14)

Despite viewing AT&T's arbitration provision as generally favourable to consumers – and indeed recognising that proceeding as a class action would likely leave the class representatives worse off than allowing them to proceed individually in arbitration proceedings(15) – the district court denied AT&T's motion to compel arbitration based on Discover Bank. The Ninth Circuit affirmed, also relying on Discover Bank. In so holding, the Ninth Circuit rejected AT&T's preemption argument, concluding that "Discover Bank placed arbitration agreements with class action waivers on the exact same footing as contracts that bar class action litigation outside" of the arbitration context.(16)

Supreme Court decision

In a five-to-four decision, the Supreme Court reversed the Ninth Circuit's ruling. The majority opinion began by concluding that the Federal Arbitration Act preempts states from imposing contract doctrines (eg, unconscionability) onto arbitration agreements in such a way as to interfere with the act's fundamental goals of:

• enforcing valid, private agreements; and
• encouraging efficient and speedy dispute resolution.(17)

The court then went on to examine California's application of its unconscionability doctrine to arbitration agreements under Discover Bank.

In finding that that the Discover Bank rule interfered with the act's goals, the court concluded that although Discover Bank "does not require classwide arbitration, it allows any party to a consumer contract to demand it ex post".(18) The court went on to hold that by judicially imposing class arbitration terms onto parties that did not agree to them, Discover Bank's application of the unconscionability doctrine falls at odds with the act for three reasons:

• the imposition of class arbitration on parties that did not otherwise agree to it "sacrifices the principal advantage of arbitration – its informality – and makes the process slower, more costly and more likely to generate procedural morass than final judgment";(19)
• class arbitration requires procedural formality that would not otherwise be part of a dual party arbitration proceeding and that would not have been contemplated by the parties at the time of execution;(20) and
• class arbitration "greatly increase[s] risks to defendants" because "the absence of multilayered [appellate] review makes it more likely that errors will go uncorrected".(21)

For these reasons, the majority concluded that class arbitration – "to the extent it is manufactured by Discovery Bank rather than consensual[ly]" agreed to by the parties – was inconsistent with the act's two primary purposes.(22) Additionally, "[b]ecause it stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress", the Discovery Bank rule is preempted by federal law.(23)

Thomas entered a concurring opinion proposing a different interpretation of Section 2 of the act, while Breyer's dissent, which was joined by Justices Ginsburg, Sotomayor and Kagan, disagreed with the majority's conclusion that Discovery Bank's rule disproportionately impacted arbitration agreements.

Application to franchising relationships

Concepcion will have an impact on almost all business sectors, including franchising. Franchisees and franchisors alike should be aware of, and find ways to take advantage of, the decision.

Arbitration provision implications
Many franchise agreements contain some form of arbitration provision. In the past, some courts' application of the unconscionability and other doctrines limited the enforceability of these provisions.(24) Now franchisors will be able to enforce class action prohibitions in arbitration provisions, even in contracts of adhesion and even in states such as California that have previously refused to enforce such prohibitions.

The Concepcion majority opinion underscores the importance of furthering the Federal Arbitration Act's principal purpose – to ensure that private arbitration agreements are enforced according to their terms. It recognises that: "[t]he point of affording parties discretion in designing arbitration processes is to allow for efficient, streamlined procedures tailored to the type of dispute".

State contract defences – such as that found in Discover Bank – that create schemes inconsistent with the act's purpose will be preempted. Indeed, beyond schemes that prohibit class action waivers, the court made note of several other areas where the act would preempt state contract doctrines, such as those imposing state rules of procedure or discovery burdens onto arbitration proceedings. Franchisors and franchisees alike should keep this in mind when drafting and negotiating franchise agreements. Based on Concepcion, it is much more likely that in addition to class action waivers, other procedural requirements contained within arbitration agreements will be enforced.

Concepcion is also important to franchisors and franchisees because it specifically rejects any distinction between the enforceability of arbitration provisions in contracts negotiated at arm's length and those contained within contracts of adhesion. Under certain circumstances, courts have deemed franchise agreements to be contracts of adhesion.(25) However, franchisees should be aware that, after Concepcion, it will be much harder to escape arbitration clauses contained within franchise agreements, even if they are deemed to be adhesion contracts. Recognising that "the times in which consumer contracts were anything other than adhesive are long past", Concepcion specifically rejects imposing any additional burden on the enforceability of arbitration provisions, even if such provisions are contained within contracts of adhesion. Although states can implement rules to address their concerns about adhesion contracts (eg, requiring arbitration provisions to be bolded or highlighted), those steps cannot be at odds with the act. Consequently, arguing that a franchise agreement is a contract of adhesion will likely not help a franchisee escape enforcement of the agreement's arbitration terms.

Class action implications
Franchisors and franchisees alike can benefit from Concepcion's enforcement of AT&T's class action waiver in its arbitration provision. Franchisors can avoid facing franchisee classes by adding a class action waiver to their franchise agreements' arbitration provisions. It is not uncommon for franchisees to raise class claims against franchisors.(26) However, because franchise relationships tend to be inherently individualised, class actions tend to be inefficient and inappropriate proceedings to handle such franchise disputes.(27) Accordingly, franchisors that do not currently have class action waivers within their franchise agreements may want to consider adding such waivers in the future.

Franchisees, on the other hand, may want to incorporate class action waivers and arbitration provisions into their own end-consumer contracts. Concepcion involved a form consumer agreement. After Concepcion, class action waivers in arbitration provisions will be enforced, even if they are in end-consumer contracts. Franchisees can therefore avoid being subject to class action proceedings arising from their own activities by incorporating such waivers into arbitration provisions contained within their end-consumer agreements.

For further information on this topic please contact Sarah M Kellner or Jeffrey A Brimer or at Faegre & Benson LLP by telephone (+1 303 607 3500), fax (+1 303 607 3600) or email ([email protected] or [email protected]).