On April 27, 2011, the Supreme Court in AT&T Mobility v. Concepcion1 held that mandatory arbitration provisions that prohibit classwide arbitration are enforceable. The Court’s holding overturned a California Supreme Court decision that found similar provisions unconscionable and unenforceable. While not an employment law case, the Supreme Court’s decision could have far-reaching implications on employment class action litigation.

Factual Background In February 2002, Vincent and Lisa Concepcion entered into an agreement for the sale and servicing of cellular telephones with AT&T. AT&T had advertised free cellular telephones with the purchase of wireless service. When the Concepcions purchased AT&T service, they were not charged for the cellular telephones, but were charged $30.22 in sales tax based upon their retail value.

The Concepcion’s contract with AT&T provided for mandatory arbitration of all disputes between the parties, and required that any claims be brought “in the parties’ individual capacity, and not as a plaintiff or class member in any purported class or representative proceeding.”2

In March 2006, the Concepcions filed a complaint against AT&T in the United States District Court for the Southern District of California. The complaint was subsequently consolidated with a putative class action alleging, among other things, that AT&T had engaged in false advertising and fraud by charging sales tax on phones that it had advertised as free.3

In March 2008, AT&T moved to compel arbitration pursuant to the arbitration provision in its contract with the Concepcions. The Concepcions opposed the motion and argued that the arbitration provision was unconscionable and unenforceable under California law because it prohibited classwide procedures.

Lower Courts’ Decisions and the Discover Bank Rule The district court denied AT&T’s motion.4 The court relied upon the California Supreme Court’s decision in Discover Bank v. Superior Court5 in finding that the arbitration provision at issue was unconscionable because AT&T had not demonstrated that bilateral arbitration adequately substituted for the deterrent effects of class actions.

Under California law, courts may refuse to enforce any contract found “to have been unconscionable at the time it was made,” or may “limit the application of any unconscionable clause.”6   A finding of unconscionability requires “a  ‘procedural’ and a ‘substantive’ element, the former focusing on ‘oppression’ or ‘surprise’ due to unequal bargaining power, the latter on ‘overly harsh’ or ‘one-sided’ results.”7

In Discover Bank, the California Supreme Court applied the above framework to class action waivers in arbitration agreements. The Court held that when the waiver is found in a consumer contract of adhesion in a setting in which disputes between the 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,” such waivers are unconscionable and should not be enforced.8  California courts have frequently applied the Discover Bank rule to invalidate arbitration agreements.

Although the district court found that the arbitration provision set forth in the Concepcion’s contract with AT&T was consumer friendly, noting, for example, that the informal dispute resolution process was quick and easy to use, the court held that its prohibition on class proceedings was unconscionable under governing California law.

The Ninth Circuit affirmed the district court’s decision.9 The court agreed that the arbitration provision was unconscionable under California law as announced in Discover Bank.10 The court also found that the Discover Bank rule was not preempted by the Federal Arbitration Act (FAA), which generally requires courts to enforce commercial arbitration agreements according to their terms.11

Section 2 of the FAA provides that “a written provision in any maritime transaction or a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction...shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.”12

The Ninth Circuit held that the Discover Bank rule was simply “a refinement of the unconscionability analysis applicable to contracts generally in California,” and therefore was consistent with Section 2 of the FAA.13

The Supreme Court’s Decision The primary issue before the Supreme Court was whether the FAA prohibits states from conditioning the enforceability of certain arbitration agreements on the availability of classwide arbitration procedures. In holding that it does, the Court reasoned that “[r]equiring the availability of classwide arbitration interferes with the fundamental attributes of arbitration and thus creates a scheme inconsistent with the FAA.”14

The Court rejected the Concepcions’ argument that the Discover Bank rule, with its origins in California’s unconscionability doctrine, is a ground that “exists at law or in equity for the revocation of any contract” under Section 2 of the FAA.15 The Court reasoned that the application of Section 2’s savings clause “becomes more complex when a doctrine normally thought to be generally applicable, such as…unconscionability, is alleged to have been applied in a fashion that disfavors arbitration.”16 The Court noted that while the FAA preserves generally applicable contract defenses, “nothing in it suggests an intent to preserve state law rules that stand as an obstacle to the accomplishment of the FAA’s objectives.”

The Court further held that a federal statute’s savings clause cannot be construed as permitting a common law right which would be absolutely inconsistent with the provisions of the act. In other words, “the act cannot be held to destroy itself.”17

The Court emphasized that the FAA’s “principal purpose” is to “ensure that private arbitration agreements are enforced according to their terms.”18 The Court noted that the point of affording parties discretion in designing arbitration processes is to allow for efficient, streamlined procedures tailored to a specific type of dispute. Indeed, the Court has repeatedly described the FAA as “embod[ying] [a] national policy favoring arbitration.”19

Classwide Arbitration Inconsistent with FAA Applying these principals, the Court found that California’s Discover Bank rule “interferes with arbitration” in that it allows any party to a consumer contract to demand classwide arbitration “ex post.”20 The Court reasoned that class arbitration is inconsistent with the FAA for several reasons. First, class arbitration, as opposed to bilateral arbitration, sacrifices the principal advantage of arbitration–its informality–and makes the dispute resolution process slower, more costly, and increases “procedural morass.”21

Second, class arbitration requires procedural formality to protect the rights of absent class members. Third, class arbitration greatly increases risks to defendants due to its informal procedures and lack of multi-layered judicial review. Consequently, the Court concluded that “arbitration is poorly suited to the higher stakes of class litigation.”22

The Court ultimately held that the FAA preempts California’s Discover Bank rule “because it stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress.”23

Dissenting Opinion Justice Stephen Breyer wrote the dissenting opinion and Justices Ruth Bader Ginsburg, Sonia Sotomayor, and Elena Kagan joined. The dissent argued that the Discover Bank rule was consistent with the FAA’s language in that it “falls directly within the scope of the Act’s exception permitting courts to refuse to enforce arbitration agreements on grounds that exist ‘for the revocation of any contract.’”24 The dissent further argued that the Discover Bank rule is consistent with the FAA’s basic purpose of “ensuring judicial enforcement of arbitration agreements” since it puts agreements to arbitrate and agreements to litigate “upon the same footing.”25  The dissent disagreed with the majority’s conclusion that the Discover Bank rule increases the complexity of arbitration procedures and noted that class arbitration is “consistent with the use of arbitration” and is “well known in California and followed elsewhere.”26

The dissent also emphasized what would clearly have been the most compelling reason for enforcing the Discover Bank rule: that class proceedings are necessary to prosecute small dollar claims that might otherwise slip through the legal system. Justice Breyer wrote: “what rational lawyer would have signed on to represent the Concepcions in litigation for the possibility of fees stemming from a $30.22 claim?”27 The majority responded to this concern in concluding that “states cannot require a procedure that is inconsistent with the FAA, even if it is desirable for unrelated reasons.”28

This debate is likely to continue as lower courts begin applying the AT&T Mobility decision and Congress considers legislative responses to issues regarding class action litigation.

Impact of Decision on Employment Class Actions While the Supreme Court’s decision in AT&T Mobility did not arise in the employment context, there is no reason to believe that the Court would not reach the same decision if the class action at issue were a wage and hour claim. The courts are generally less protective over employees than consumers, and this decision is likely to apply to agreements to arbitrate employment disputes. As such, many employers with mandatory arbitration provisions in employment contracts may now include class action waivers and/or requirements for individual arbitration if their agreements do not already contain them. Such limiting arbitration provisions in employment contracts could preclude representative litigation such as wage and hour and discrimination class actions.

For example, in Vilches v. The Travelers Co. Inc.,29 a decision that predates the Supreme Court’s decision in AT&T Mobility, the Third Circuit considered whether a class arbitration waiver in an employment contract was enforceable under New Jersey law. The plaintiffs had filed a class and collective action under the Fair Labor Standards Act30 and the New Jersey Wage and Hour Law.31 The Court held that the issue of whether the parties had agreed to the waiver, which the employer had added to the parties’ contract by amendment, was an issue for the arbitrator to determine.

Nonetheless, the court considered whether, if determined to be binding, the waiver provision was unconscionable. The court noted that under New Jersey law, such provisions are not unconscionable per se, but that the analysis becomes more difficult when a waiver is found in a consumer contract of adhesion. The court held that in the employer/employee context at issue, the unequal bargaining power of the parties alone was not enough to make the agreement to arbitrate a contract of adhesion, and that the plaintiff had failed to demonstrate unconscionability otherwise.

To the extent that the Third Circuit’s decision suggests class arbitration waivers in adhesion contracts are unconscionable, the Supreme Court’s decision in AT&T Mobility overrules it, as the Court specifically upheld a class arbitration waiver in an adhesion contract and even noted that “the times in which consumer contracts were anything other than adhesive are long past.”32  

Employers must keep in mind that, although they may be able to limit class action litigation through arbitration provisions in employment contracts, they cannot necessarily preclude employees from filing administrative charges, or bar agencies from asserting their statutory rights. Further, arbitration presents several potential drawbacks for employers, such as the increased cost of arbitration fees and the limited judicial review of arbitration awards. Despite these concerns, arbitration of employment disputes is likely to become far more prevalent based upon the AT&T Mobility decision.