Summary

On February 24, 2009, in a departure from its decision rendered a little over one year ago in Gay v. CreditInform, 511 F.3d 369 (3d Cir. 2007), the Third Circuit voided a class-arbitration waiver provision, finding that the Federal Arbitration Act ("FAA") did not require the Court to enforce the provision.

In Homa v. American Express, the Court determined that it could ground its decision on the size of the claim. In so doing, the Court found that there was a distinction in New Jersey state law for cases involving small amounts of damages where class-arbitration waivers are concerned. Homa v. American Express Co., No. 07-2921 (3d Cir. Feb. 24, 2009). As a result, we can expect that the enforcement of a class-arbitration waiver provision, at least in the Third Circuit, may depend on the size of the claim involved as compared to whether the provision itself is enforceable.

Analysis

Homa involved an appeal from the District of New Jersey's dismissal of plaintiff's class action complaint in favor of individual arbitration. G.R. Homa, purportedly on behalf of a class of New Jersey consumers who obtained a Blue Cash American Express card, claimed that the credit card company misrepresented the terms of the card's rewards program in violation of the New Jersey Consumer Fraud Act.

The credit card agreement contained a class-arbitration waiver provision that provided that all claims must be arbitrated upon the election of either party. The agreement also had a choice of law provision that stated that Utah law would govern any dispute between the parties. Although the parties agreed the class-arbitration waiver was valid under Utah law, Mr. Homa argued that the Court should apply New Jersey law and not enforce the waiver because Utah law violated New Jersey's policy against certain class-arbitration waivers.

As observed by the Court, New Jersey courts will enforce choice of law provisions in a contract unless to do so would violate New Jersey's public policy. Mr. Homa relied on the New Jersey Supreme Court's decision in Muhammad v. County Bank of Rehoboth Beach, Del., 912 A.2d 88 (N.J. 2006), to support his argument that the class-arbitration waiver at issue would violate New Jersey's public policy. Muhammad involved a consumer contract between a customer and a bank that gave out "pay day loans." The Muhammad Court determined that waiving the right to bring a class-wide claim, whether by arbitration or litigation, would effectively prevent individuals from bringing suit when the dispute involved "predictably small amounts of damages." Id. at 99. The Muhammad Court therefore struck the class-arbitration waiver as unconscionable, finding that the public interest implicated by the agreement was the "most important" consideration in its holding.

In countering the decision in Muhammad, Appellees argued that the decision in Gay should be read as a blanket prohibition on unconscionability challenges to class-arbitration provisions. In Gay, the Third Circuit, in dicta, rejected two state law decisions finding class-arbitration waivers unconscionable, as preempted by the FAA. Gay, 511 F.3d at 395. The Homa Court disagreed, and determined that such a reading conflicts with the Supreme Court's holding that "generally applicable contract defenses, such as . . . unconscionability, may be applied to invalidate arbitration agreements without contravening § 2." Homa, No. 07-2921, at *11 (quoting Doctors' Assocs., Inc. v. Casarotto, 517 U.S. 681, 686-87 (1996)). Therefore, the FAA did not preclude it from applying state law unconscionability principles to void a class-arbitration waiver.

Relying on Muhammad, the Third Circuit predicted that the courts of New Jersey would find that the class-arbitration waiver at issue violated New Jersey public policy. The Third Circuit reasoned that, similar to the issue in Muhammad, the Homa case, which focused on less than 5 percent of the cardholder's overall balance, was a low-value case, involving predictably small damages. The Court also found that the agreement at issue was a contract of adhesion. Based on these findings, the Third Circuit reversed the District Court decision in favor of arbitration and remanded for further proceedings.

Conclusion

The decision in Homa essentially concludes that the FAA does not preclude a court from applying state law contract defenses, such as unconscionability, to avoid class-arbitration waivers. State laws like the New Jersey Consumer Fraud Act provide great protections for consumers. With the Court's decision in Homa, defendants should be mindful that agreements with consumers, even if they provide for the application of another state's law, may not be enforced as written. At least in New Jersey, class-arbitration waivers in consumer agreements involving predictably small damages may not be enforceable, even if the agreement provides for the application of the law of a state that recognizes such waivers.