In Fensterstock v. Education Finance Partners and Affiliated Computer Services, Inc., plaintiff Fensterstock commenced a class action lawsuit in the Southern District of New York against Education Finance Partners and Affiliated Computer Services for engaging in fraudulent and deceptive practices in connection with the issuance of student loans. The defendant lenders moved to stay the action and compel individual arbitration in accordance with the loan agreement’s binding arbitration clause. The agreement was governed by California law and the arbitration clause mandated that at the request of any party, disputes would be settled by binding arbitration and on an individual basis only. The clause therefore precluded the possibility of Festerstock’s class action suit either in litigation or arbitration.

Fensterstock opposed the motion to compel arbitration on the grounds that the arbitration clause was unconscionable under California law because it constituted a contract of adhesion and was thus void as against public policy. Applying California law, the District Court held that although the Federal Arbitration Act (“FAA”) requires a court to stay a proceeding pending the outcome of an arbitration between the parties, the requirement does not apply where the arbitration clause itself is unconscionable. The court held that the class-action waiver made the arbitration clause unconscionable and denied the defendant’s motion to compel.

During oral argument before the Second Circuit, counsel for the defendants argued that if the court determined that the class-based waiver clause was unenforceable, the agreement’s severability provision allowed the court to enforce the remainder of the arbitration provision absent that clause. The Second Circuit held that the class-action waiver provision was unenforceable and addressed whether it could still compel arbitration in accordance with the remainder of the arbitration provision. The defendants’ oral argument, as cited by the court, did not specify whether they sought to compel individual or class-based arbitration, but the Second Circuit proceeded to address the issue as a request to compel the latter. Relying upon the Supreme Court’s recent decision in Stolt-Nielsen S.A. et al. v. AnimalFeeds International Corp., No. 08-1198 (Apr. 27, 2010), which held that the FAA did not authorize a court to compel class-based arbitration absent an express provision in the contract allowing this procedure, the Second Circuit held that simply striking a clause that prohibited class-based arbitration did not permit the court to otherwise compel arbitration. The court, having struck the class-based waiver clause, was left with an arbitration agreement that was silent as to the possibility of class-based arbitration. Accordingly, in the absence of an express agreement to arbitrate on a class-action basis, the court had no authority under Stolt-Nielsen to compel arbitration, and the motion to stay the court proceedings was denied.

Click here to review a copy of the Second Circuit’s decision, captioned Fensterstock v. Education Finance Services, No. 09-1562-cv (2d Cir. July 12, 2010).