Courts weigh in on class action bans in arbitration.

Mandatory arbitration clauses are common in all types of consumer agreements, and many also contain bans on class actions. But if people with small-value claims are forced to go to arbitration and are denied class-based treatment there, they are left with no real recourse, consumer advocates say.

Some courts are beginning to agree. In April, the First Circuit struck down a class action ban in an arbitration agreement but upheld the agreement itself. As a matter of first impression, the court held that the ban prevented the plaintiffs from vindicating their statutory rights against cable TV giant Comcast Corp.

"If the class mechanism prohibition here is enforced, Comcast will be essentially shielded from private consumer antitrust enforcement liability, even in cases where it has violated the law," Circuit Judge Kermit Lipez wrote for the three-judge panel. (Kristian v. Comcast Corp., 446 F.3d 25 (1st Cir. 2006).)

A group of Comcast subscribers sued the company for charging them inflated prices for cable service, arguing that its anticompetitive practices violated antitrust laws. The plaintiffs said that certain provisions in their contracts, including those barring the use of class mechanisms and the recovery of treble damages, prevented them from vindicating their statutory rights under federal and state law.

The court concluded that these provisions were invalid and severable from the agreement--and that they conflicted with the Federal Rules of Civil Procedure, which provide for class actions. Because the agreement "creates a mandatory arbitration regime, a ban on class arbitration effectively forecloses the use of any class-based mechanism," Lipez wrote.

The court quoted a Seventh Circuit decision that said, "The realistic alternative to a class action is not 17,000,000 individual suits, but zero individual suits, as only a lunatic or a fanatic sues for $30." (Carnegie v. Household Int'l, Inc., 376 F.3d 656 (7th Cir. 2004).)

The Kristian decision was the first to hold that a class action ban frustrated the enforcement of federal statutory rights, said Barry Barnett, a Dallas lawyer who represents the plaintiffs. Paul Bland, a staff attorney at Trial Lawyers for Public Justice, called the decision "an enormous victory for consumers."

The First Circuit cited two decisions from other courts that "emphasize that a class mechanism bar can impermissibly frustrate the prosecution of claims in any forum, arbitral or judicial." The Ninth Circuit in Ting v. AT&T(319 F.3d 1126 (9th Cir. 2003)) and the California Supreme Court in Discover Bank v. Superior Court (113 P.3d 1100 (Cal. 2005)) struck down class action bans as unconscionable under California law.

Some courts have enforced these bans, even after Kristian. In June, a North Carolina appeals court found in favor of a consumer loan company, holding that a class action ban does not make the arbitration agreement unenforceable. (Tillman v. Commercial Credit Loans, Inc., 629 S.E.2d 865 (N.C. Ct. App. 2006).)

But other courts have mirrored the First Circuit's reasoning. An Ohio appeals court recently found an arbitration agreement unconscionable, saying, "By prohibiting its customers from filing suit as a class, Alltel prevents the cost-effective use of class action litigation that can end abusive practices by large corporations in those instances in which individual claims are ineffective." (Schwartz v. Alltel Corp., No. CV-453730 (Ohio Ct. App. June 29, 2006).)

And in July, a federal district court found a ban unenforceable because it prevents vindication of rights under Michigan consumer protection law. The parties had agreed that if the court found the ban unenforceable, the case would be resolved in court rather than in arbitration. (Wong v. T-Mobile USA, Inc., No. 05-73922, 2006 WL 2042512 (E.D. Mich. July 20, 2006).)

"Kristian is a little unusual because [the court] decided to sever the class action ban and enforce the arbitration provisions," Barnett said. "In a way, that's the worst possible outcome for the defendant," because the rules are more flexible in classwide arbitration, so companies are more vulnerable. "Their fate in that instance would be in the hands of a single arbitrator, with no appellate rights," he added.

After the First Circuit remanded the case to the lower court, Comcast withdrew its motions to compel arbitration.

"As soon as the opinion came out," Barnett said, "the defense lawyers came to us and said, 'Hey, we really don't want to have a class action in an arbitration, so why don't we agree that we won't assert any of the arbitration provisions as a defense in a lawsuit or as a barrier to class certification, if you'll agree to go back to court and forgo the arbitration on a class basis.'"

Now, Kristian is going forward in court, and the plaintiffs will move for class certification, which Barnett said he expects Comcast to oppose. However, he added, "one of the big arrows they thought they had in their quiver is gone because they traded it away."

Barnett said class action bans in mandatory arbitration clauses are relatively new--emerging in the last 10 years or so--but are becoming more common. Bland noted that many financial services, phone, and computer companies use them, and he expects them to spread to other industries.

"Originally, most companies used arbitration clauses that were silent on the matter of class mechanisms," Bland said. They believed "they did not need to ban class actions in their contracts, because it was inherent to the nature of arbitration that it had to be individual."

The Supreme Court addressed this issue in Green Tree Financial Corp. v. Bazzle, concluding that an arbitrator should decide whether the company's contracts allowed class arbitration because they didn't explicitly ban it. (539 U.S. 444 (2003).) Companies interpreted that to mean that if they didn't clearly ban class actions, they might find themselves in class arbitration, Bland said.

"In the wake of Bazzle, all the companies rushed out to ban class actions in arbitration clauses," he said.

The end of arbitration?

Consumer advocates are watching how companies react to judicial disapproval of class action bans. If more courts say companies can't prohibit class arbitration, will they--like Comcast be less likely to force arbitration? Will the very aspects of arbitration that attracted companies drive them away if they must allow class arbitration?

Some defendant companies and the U.S. Chamber of Commerce have argued that taking away the class action ban will spell the end of arbitration.

"Superimposing a class action requirement onto contractual agreements to arbitrate individually will effectively eliminate the virtues of arbitration, while multiplying the stakes exponentially," the Chamber said in an amicus brief. "The risk to businesses of litigating a class action in the arbitral forum is simply too high...." (Cingular Wireless v. Mendoza, cert. denied, 126 S. Ct. 2353 (Mem.) (June 5, 2006).)

But a class action ban "isn't inherent to arbitration at all," Bland said. "There are a number of companies who don't have class action bans but do have individual arbitration."

Companies don't want to be stuck in class arbitration, Bland said. Generally, the arbitrator has an incentive to find for the company, which chooses the arbitration firm it uses. But because the arbitrator gets paid more for larger cases, he or she has an incentive to allow a class action, he explained. More arbitrators are allowing classes, "which is driving businesses crazy," he said, adding that companies tend to be settling these cases.

"These cases are not about arbitration," Bland said. "The companies want to ban class actions."

Myriam Gilles, a professor at Cardozo School of Law in New York City, agreed. "I've always viewed these class action bans as companies immunizing themselves against class liability and potentially all liability," she said.

Courts may send the case to an arbitrator to decide whether it should proceed on an individual or classwide basis. Then, Gilles asked, "if more and more arbitrators say 'let's do a class arbitration'--which it's in their self-interest to do, because they make tons of money with these classes--will companies decide that it's one thing to decide in court with the rules of evidence and appealability, and it's a whole other thing to do it in this private, slightly crazy world where the rules of evidence don't apply?"

She added, "That's a hard thing to explain to your shareholders: why you've lost a huge judgment that you can't appeal."

Barnett agreed. "Their fate in that instance would be in hands of single arbitrator, with no appellate rights," he said. "I think mandatory arbitration will be less common in cases involving consumers with small claims."

More to come

Despite recent rulings favoring plaintiffs, the issue of class arbitration is far from settled, and many cases remain pending around the country.

In a case that a group of merchants brought against American Express, the plaintiffs argued that "to arbitrate their antitrust claims individually would impose such punishing costs as to preclude vindication in that forum." The trial court disagreed, upholding the waiver and granting American Express's motion to compel arbitration. (In re Am. Express Merchants' Litig., No. 03 CV 9592, 2006WL662341 (GBD) (S.D.N.Y. Mar. 16, 2006).)

The plaintiffs are appealing to the Second Circuit, Gilles said, and their argument is similar to that of the Kristian plaintiffs--that "there's a problem here with antitrust laws not being enforced." For these and other types of federal rights, she added, "we have implicitly relied on the private bar, not public enforcement."

Other cases are pending before the state supreme courts of Washington (Scott v. Cingular Wireless, 125 P.3d 478 (Wash. 2005)), New Jersey (Muhammad v. County Bank of Rehoboth Beach, Del., 883 A.2d 1054 (NJ. 2006)), Illinois (Kinkel v. Cingular Wireless, No. 100925 (Ill. argued May 9, 2006)), and California (Gentry v. Superior Court, 37 Cal. Rptr. 3d 790 (2006)).

Historically, "some of the biggest cases with the greatest social importance were class actions," Gilles said. "What would the world be like if these cases couldn't be brought or if they were brought privately, with no opinion issued, and no understanding of exactly what happened or why?"

"The stakes of this issue are huge," Bland said. "Arbitration clauses are not supposed to be a get-out-of-jail-free card."