Internet giant Paypal recently joined Sony, Microsoft, and Netflix to become one of the latest major companies to include a provision banning consumer class actions in its terms of service. Such waivers now frequently appear in consumer agreements along with arbitration clauses, governing law provisions, and confidentiality terms. These provisions are designed in part to help reduce the litigation costs these businesses face each year.

Until recently, however, whether these provisions were even enforceable in Kentucky was uncertain. Now, thanks to a recent case by the Kentucky Supreme Court, businesses have more clarity on the enforceability of these provisions in the state and whether they should be included in consumer agreements.

Schnuerle v. Insight Communications, L.P. involved a class action complaint brought by Kentucky residents against Insight Communications, their internet service provider. The plaintiffs alleged damages due to service outages that occurred when Insight upgraded its internet services. Insight’s consumer service agreement contained an arbitration clause that required customers to submit any damage claim against Insight over $1,500 to arbitration and barred class action litigation against Insight. The trial court held that the class action ban in the consumer service agreement was enforceable and the Kentucky Court of Appeals agreed. The Kentucky Supreme Court (the “Court”) then considered the consumer challenges to the enforceability of the arbitration agreement, the class action waiver, the confidentiality clause, and the choice of law provision in Insight’s consumer service agreement. Initially, the Court ruled that those terms were void as unconscionable provisions in a consumer adhesion contract. However, because the U.S. Supreme Court issued an opinion on federal arbitration law after the Court’s initial decision in Schnuerle, the Court chose to revisit the Schnuerle case.

Upon a second look at the dispute, the Court reluctantly concluded that both the class action waiver and the arbitration clause in the consumer service agreement were enforceable under federal law and must be upheld. The Court found that the federal policy favoring arbitration preempted any state law or policy invalidating the class action waiver as unconscionable based solely on the grounds that a class action dispute may involve many de minimis claims that are unlikely to be litigated by individual consumers on their own. The Court made it clear that it was inclined to join courts in other states that had invalided provisions of consumer adhesion contracts barring class action suits, but found itself constrained by federal law to rule otherwise.

To underscore its concerns, the Court issued a warning that Kentucky courts should apply “closer scrutiny” to class action waiver provisions in the future, including the “positioning and prominence” of these provisions in the consumer service agreement. The Court instructed that these clauses require “heightened attention” and “a full and clear disclosure” in the context of consumer service agreements, which the Court called “adhesion contracts.”

With regard to arbitration clauses, the Court cautioned that the recent U.S. Supreme Court decision does not preclude all attacks on the fairness of arbitration provisions. Rather, Kentucky courts may strike arbitration clauses out of consumer contracts if they are unconscionable because they “strip claimants of a statutory right, which cannot be vindicated by arbitration, because, for example, the arbitration costs on the plaintiff are prohibitively high; or the location of the arbitration is designated as a remote location.”

Despite the Court’s expressed concerns, the Schnuerle opinion should be seen as encouraging to Kentucky businesses interested in including class action waivers and mandatory arbitration clauses in their terms and conditions in consumer service agreements. However, businesses should proceed with caution. Despite upholding Insight’s arbitration agreement and class action waiver in its consumer service agreement, the Court used its power to disregard the governing law provision in Insight’s standard contract, which provided that New York law would apply to interpret the contract and would govern any disputes about the contract, and instead determined that it was appropriate to apply Kentucky law to disputes involving Kentucky consumers. The Court also ruled that the confidentiality provision contained in the arbitration clause was unconscionable and unenforceable based on the perceived absence of social utility to the provision.

Ultimately, while the Schnuerle case provides some assistance to businesses in determining which provisions will likely be enforceable in their standard consumer service agreements, companies should be mindful of the ever evolving state of the law. Class action waivers and mandatory arbitration clauses must be drafted carefully to ensure that they are “prominent” in a consumer service contract – which Kentucky courts will consider to be “contracts of adhesion” –and consider closely how to prevent such terms from being “unconscionable” as against the consumer. Companies and their attorneys should take heed of the Court’s holdings and concerns in Schnuerle when drafting these contracts, so that businesses can do their best on the front end to avoid the potential hazards that could lie ahead when the terms are used and the contract is brought to court.