A recent Kentucky Supreme Court decision, Schnuerle v. Insight Communications Co.,[1] declares that Kentucky courts may no longer strike down a Class Action Waiver Clause, found as part of a contractual Arbitration clause, based on a per se theory of unconscionability.  This ruling is a dramatic reversal of the Court’s previously issued opinion in this same case, which had ruled such waivers “substantively unconscionable."[2]

To explain this radical shift, a look at the procedural history of the case is necessary.  Insight’s customers filed a class action complaint against the internet service provider based on customer service issues and outages occurring in 2006.  The Service Agreement, signed by all customers, included an arbitration clause that not only required disputes to go to arbitration, but also “barred class action litigation against Insight by its customers.”[1]  On December 16, 2010, the Kentucky Supreme Court issued an opinion finding the waiver unenforceable as  unconscionable.[2]  Four months later, the United States Supreme Court faced a very similar case in AT&T Mobility LLC v. Concepcion.[3] Below the California courts applied a theory of per se unconscionability to strike down the arbitration clause.  The U.S. Supreme Court reversed, ruling the common law that might otherwise apply is preempted by the Federal Arbitration Act.  As a result of the decision of our nation’s highest court, the Kentucky Supreme Court ordered supplemental briefing and oral arguments on the application of the Concepcion case to the Schnuerle facts.[4]  On August 23, 2012, the court withdrew its December 2011 opinion and entered a new opinion upholding the Class Action Waiver Clause based on the reasoning of the U.S. Supreme Court in Concepcion.[5]

The Supreme Court’s reasoning in Concepcion was based on the “liberal federal policy favoring arbitration”[6] and the belief that allowing state courts to invalidate class action waivers based on per se unconscionability thwarted the purposes of the Federal Arbitration Act (the “FAA”).[7]  At issue in this case was the California “Discover Rule,” which held that:

When the waiver is found in a consumer contract of adhesion in a setting in which disputes between the contracting parties predictably involve small amounts of damages, and when it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums  of money, then … the waiver becomes in practice the exemption of the party ‘from responsibility for [its] own fraud, or willful injury to the person or property of another.’     Under these circumstances, such waivers are unconscionable under California law and   should not be enforced.[8]

While doctrines applicable to all contracts such as duress and unconscionability are not expressly displaced by the FAA, they can still be so displaced if “applied in a fashion that disfavors arbitration.”[9]  The court found that California’s Discover Rule did so disfavor and interfere with arbitration on a number of counts.[10]  First, class-treatment would frustrate the key point of arbitration which is “to allow for efficient, streamlined procedures tailored to the type of dispute … [thereby] reducing the cost and increasing the speed of dispute resolution.”[11]  The Court also expressed concerns that confidentiality would suffer,[12] it would be difficult to find an arbitrator with relevant experience,[13] forcing an arbitrator to make decisions about certifying a class would “generate procedural morass,”[14] and allowing class action would make the stakes of arbitration too high.[15]  In regard to this last point, the Court noted that the absence of “multilayered review”[16] to the arbitration process made it an inherently riskier method of dispute resolution, but that parties are often “willing to accept the costs”[17] because they are “presumably outweighed by savings from avoiding the courts.”[18]  However, “when damages allegedly owed to tens of thousands of potential claimants are aggregated and decided at once, the risk of an error will often become unacceptable.”  Therefore, the Court held that California’s Discover Rule was preempted by the FAA and, thereby, unenforceable

The Kentucky Supreme Court’s first Schnuerle opinion was based on a theory that the “[e]conomic reality dictates that [litigation involving many small claims] proceed as a class action or not at all.”[19]  Its reasoning was substantially similar to that of the California court in applying the “Discover Rule,” in that the court felt that class action waiver clauses in cases of contracts of adhesion, where the amounts claimed by each individual would be small, operate to prevent recovery and, therefore, should be invalidated as unconscionable under Kentucky common law.[20]  Because of the strong similarities between the court’s reasoning and that of the California court in Concepcion, the court was “constrained” upon its second Schnuerle opinion “to conclude that under contracts like the one now before us, which contain a class action waiver and also require disputes to be arbitrated under the FAA, the federal policy favoring arbitration preempts any state law or policy invalidating the class action waiver as unconscionable based solely upon the grounds that the dispute involves many de minimis claims which are, individually, unlikely to be litigated.”[21]

Therefore, under the reasoning of Concepcion and its application in Schnuerle, Kentucky’s businesses, including our financial institutions, should now consider including Class Action Waiver Clauses as part of their Arbitration Clauses in retail consumer contracts and demand deposit account agreements.  However, this new option will still be limited in several regards.  First, the Kentucky Supreme Court did include in its opinion a warning to those who might begin including such clauses

In light of Concepcion, we are constrained to further note that in future cases closer  scrutiny of the positioning and prominence of class action waiver provisions will likely  be necessary.  Future application of Concepcion may be expected to limit the ability of   consumers to band together under state law in a class action to vindicate important rights.    It therefore follows that heightened attention should be afforded in providing a full and clear disclosure when those limitations are placed in adhesion contracts.  It is fundamental that the prominence of the disclosure should be commensurate with the  importance of the right being taken away.[22]

Second, businesses need to be careful in using a Class Action Waiver Clause within the context of a larger Arbitration Clause, and then one where the Federal Arbitration Act is cited as providing the governing law.  Since much of the Supreme Court’s reasoning in Concepcion is based on the policies favoring arbitration and effectuating the purposes of arbitration, one may reasonably question if that decision provides protection for a clause existing independent of an enforceable agreement to arbitrate. 

Lastly, Concepcion and Schnuerle imply what a very recent 11th Circuit case expressly states, “After Concepcion, we have stated that ‘generally applicable contract defenses’ that challenge ‘defects in the making of the arbitration agreement’ and that ‘do not apply only to arbitration or derive their meaning from the fact that an agreement to arbitrate is at issue’ are ‘not affected by [Concepcion ].’”[23]  Therefore, the new protection for Class Action Waiver Clauses applies only in cases like Concepcion and Schnuerle where the court would attempt to invalidate such a clause solely based on its application in conjunction with an Arbitration clause and not based on any other “generally applicable contract defense” such as duress or unconscionability.