On November 10, 2014, the U.S. Court of Appeals for the Ninth Circuit continued its recent trend of declining to enforce arbitration clauses after finding that the contracts containing those clauses were never actually formed in the first place.

Earlier this year, in Nguyen v. Barnes & Noble, Inc., 763 F.3d 1171 (9th Cir. 2014), the court had held that conspicuous references to hyperlinked terms of use on Barnes & Nobles’ website, “without more,” did not bind website users to those terms – including an arbitration provision and class action waiver. That case was detailed in a previous Pepper Hamilton Client Alert. Now, the Ninth Circuit has again made clear that common law contract formation elements must be established before it will require enforcement of an arbitration provision.

In Knutson v. Sirius XM Radio, Inc., Case No. 12-56120, plaintiff Knutson purchased a Toyota automobile which included a 90-day trial satellite radio subscription with Sirius XM. A few weeks later, he received a “Welcome Package” from Sirius containing a contract with an arbitration provision and class waiver. That “Welcome Package” also stated that the plaintiff was deemed to accept the terms of the agreement within three days of his Sirius XM package’s activation unless he notified Sirius XM otherwise – even though the “Welcome Package” was not delivered until weeks after activation took place.

When Knutson received unwanted calls from Sirius XM during his trial period, he brought a class action against Sirius XM for alleged violations of the Telephone Consumer Protection Act. Sirius XM responded by moving to dismiss and to compel arbitration based on the provisions found in the “Welcome Package,” which the trial court granted.

The Ninth Circuit reversed, and found that the record did not show that Knutson knew he was entering into a contract with Sirius XM when he purchased his Toyota, let alone one with an arbitration provision and class waiver that would be provided weeks later in a “Welcome Package.” Sirius failed to show that the plaintiff assented to the contract’s terms, the court held. Nor was there evidence that he had reason to know that the later-received “Welcome Package” contained a contract that he should open and review, so his continued use of his satellite radio after that point did not constitute consent to its terms.

In other words, the court found – on the record before it – that Knutson did not know there was an agreement, and that Sirius XM had not met its burden to compel arbitration.

Importantly, the Ninth Circuit offered its thoughts on how businesses might avoid this situation:

[The] lack of notice regarding the terms of the Sirius XM Customer Agreement could be easily remedied by Toyota. The Toyota purchase agreement could clearly state that Toyota has a relationship with Sirius XM to provide Toyota customers with a trial service, and that therefore the Toyota customer is entering into a contractual relationship with Sirius XM. Toyota could also provide its customers with literature that similarly explains the agreement between Sirius XM and the Toyota customer and ask for assent to such agreement.

But the court did not address the feasibility of altering Toyota’s (or any other car company’s) purchase agreements in this manner, and of requiring Toyota employees to provide Sirius XM literature to customers and ask for contractual assent. Clearly, though, it is more than a small burden. Likewise, it may not be feasible for Sirius XM to place representatives in thousands of car dealerships (assuming the dealerships provide permission) to ensure contracts are properly formed. On the other hand, the profit earned by companies like Sirius XM in connection with these sorts of deals – not to mention the avoidance of litigation – may justify any additional demands by the Toyotas of the world to undertake these additional services.

One possible alternative not discussed by Knutson is for businesses like Sirius XM to require a call with, or website visit from, a customer before providing services that may come bundled with another company’s product, at which time it can be explained that there are terms of use or a contract at play.1 The point is that companies that provide services to customers must ensure that those customers understand that they are entering into a contract.

Either way, companies that choose to mimic the Sirius XM model – provide the service first and send the contract later – should be wary, especially if they want enforceable arbitration agreements. Two district court decisions,Bischoff v. DirecTV, Inc., 180 F. Supp. 2d 1097 (C.D. Cal. 2002), and Lozano v. AT&T Wireless, 216 F. Supp. 2d 1071 (C.D. Cal 2002), order vacated on other grounds by Lozano v. AT&T Wireless, 2003 WL 2558566 (C.D. Cal. Aug. 18., 2003), have held that the mere “fact that the customer purchased the service and was later sent the contract terms does not render the contract unenforceable.” However, Knutson ultimately distinguished these two cases,2 and at the same time left the door open to a possible ruling down the line that this business practice may not result in a binding contract at all.

Should a company nevertheless insist on the “send the contract later” approach and argue that continued use of a later-sent contract constitutes assent to that contract, Knutson suggests that the company still must “clearly and effectively communicate” to customers that:

  1. the contract contains a right to cancel and contains a provision requiring that continued use of the service constitutes acceptance of the contract’s terms
  2. the customer needs to open and review that document, and
  3. the customer will be bound by that contract unless they take specified steps.

However, since a plaintiff could easily claim that such a later-sent contract was never received (“it must’ve gotten lost in the mail!”) or that the complained-of activity occurred before the contract was sent, presumably such “clear and effective” statements should be given at the start of the relationship. At that point, depending on the business model and economic realities, the company may be better off simply providing the contract at that time. Companies opting to send the contract after the fact should also try to make such “clear and effective” statements on any mailing enclosing the contract, providing that the mailing contains a contract or terms that need to be opened and reviewed. Again, this is not a sure-fire approach and comes with risks, but such steps will at least provide a company with arguments that a purchaser is bound to the contract.

In summary, the Ninth Circuit has made clear that it will respect the long-established policy of enforcing arbitration agreements, as well as the enforceability of class action waivers, but has likewise clarified that it will hold defendants to their threshold burden of establishing an enforceable arbitration agreement.