GUEST-POST | Part Two: The Emergence in the Last Month of an Express Judicial Recognition that Arbitration Clauses Barring Class Relief in Consumer Agreements Are Void

By Peter Friedman

In Part One, we asked whether there is any solution to the problem created by mandatory arbitration clauses and class action waivers in consumer online transactions. As a general rule, courts hold that mandatory arbitration clauses are enforceable. Thus, for example, the Pennsylvania Law Encyclopedia explains that under the Uniform Arbitration Act, a version of which governs the use of arbitration in virtually 36 states, mandatory arbitration clauses in contracts are enforceable and irrevocable except “upon such grounds as exist at law or in equity relating to the validity, enforceability or revocation of any contract”:

The Uniform Arbitration Act provides that a written agreement to subject any existing controversy to arbitration or a provision in a written agreement to submit to arbitration any controversy thereafter arising between the parties is valid, enforceable and irrevocable, save upon such grounds as exist at law or in equity relating to the validity, enforceability or revocation of any contract, and the constitutionality thereof has been upheld against the objection that the exception of contracts for personal services is an improper basis of classification.

P.L.E., Contracts § 536 (Matthew Bender 2007)(footnotes omitted). Under generally applicable precedent, mandatory arbitration clauses in online transactions are upheld on the grounds that these transactions are not “take it or leave it” propositions. This was the reasoning applied by the New York state appellate court sitting in Manhattan in upholding a mandatory arbitration clause in a contract for the purchase of a computer by telephone or mail in Brower v. Gateway 2000, Inc., 246 A.D.2d 246, 676 N.Y.S.2d 569, 37 U.C.C. Rep. Serv. 2d 54 (N.Y. App. Div. 1st Dep’t 1998). The court explained first that “although the parties clearly do not possess equal bargaining power, this factor alone does not invalidate the contract as one of adhesion. As the [trial court] observed, with the ability to make the purchase elsewhere and the express option to return the goods, the consumer is not in a ‘take it or leave it’ position at all; if any term of the agreement is unacceptable to the consumer, he or she can easily buy a competitor’s product instead–either from a retailer or directly from the manufacturer–and reject Gateway’s agreement by returning the merchandise.” Id. at 251. The court also examined the trial court’s determination that “while a class action lawsuit . . . may be a less costly alternative to the arbitration (which is generally less costly than litigation),” that fact does not alter the binding effect of the valid arbitration clause contained in the agreement. Thus, the court affirmed the enforceability of the agreement to arbitrate while nonetheless holding that the specific forum for arbitration specified by the contract at issue was unreasonably expensive. Accordingly, the court remanded the case “so that the parties have the opportunity to seek appropriate substitution of an arbitrator pursuant to the Federal Arbitration Act (9 USC § 1 et seq.), which provides for such court designation of an arbitrator upon application of either party, where, for whatever reason, one is not otherwise designated (9 USC § 5).” Id. at 255.

Fortunately, however, courts have very recently begun to refuse to enforce mandatory arbitration clauses in consumer transaction because they are recognizing, as the Pennsylvania Law Encyclopedia quoted above states, there are “grounds in law or in equity” for doing so. Two years ago, in Douglas v. Talk America (9th Cir. 2007), the plaintiff challenged, by means of a class action complaint, the validity of an amendment made to the contract governing his telephone service. The amendment to the contract, among other things, required arbitration of all disputes arising under the contract. Moreover, the amendment was made unilaterally and without any notice other than the posting of the revision on the defendant’s web site. The U.S. Court of Appeals for the 9th Circuit, applying California law, held that the amended contract, including the arbitration provision, was unenforceable and dismissed the defendant’s motion to compel arbitration. The court rejected the reasoning applied by the New York courts that the plaintiff had “meaningful alternative choices for telephone service.” Id. at 8. The court also made clear that, absent the inclusion of the arbitration clause in the defendant’s unilateral modification of the original contract, a relinquishment of the right to bring a class action also “may be” unenforceable under California law, though it would be enforceable under New York law. Id. at 8-9. Douglas, however, may be of limited use as precedent in challenging mandatory arbitration clauses even outside of New York because the arbitration clause was added by means of the defendant’s unilateral amendment to the contract, an amendment that was unenforceable merely by virtue of the fact that a party can’t unilaterally change the terms of a contract; it must obtain the other party’s consent before doing so.” Id. at 4 (citations omitted).

This 9th Circuit’s reasoning in Douglas was extended in Harris v. Blockbuster, Inc. (N.D. Tex. April 15, 2009). In Harris, the court, applying Texas law, refused to enforce a mandatory arbitration clause in an online transaction despite the fact the clause was in the original contract and the contract had not been amended. Nonetheless, the court reasoned that the contract was unenforceable merely because the defendant had reserved the right to unilaterally amend its all of its terms, including the arbitration clause. Thus, the court concluded, the original contract had been “illusory.” Harris represents an extension of Douglas in that the right to amend even in the absence of amendment voids the entire contract. Nonetheless, as a matter of contract doctrine the case is problematic, at least outside of Texas. Generally, courts will find consideration supporting a contract that has not been amended, even if the contract purports to grant a right of unilateral amendment. Given the presence of consideration, the unmodified original contract would not be “illusory.” Indeed, the court in Douglas seemed to be operating on the assumption that under California law the contract in that case would have been enforceable had it not been amended (though the unmodified original contract in Douglas did not require arbitration).

Even more recently, however, the New Mexico Supreme Court faced squarely the consumer protection concerns implicated by mandatory arbitration clauses and refused to enforce a mandatory arbitration clause in an online transaction without engaging in strained academic application of the doctrine of consideration. Fiser v. Dell Computer Corp., ___ P.3d ___ (N.M. June 27, 2008). Instead, the court in Fiser struck down the arbitration provision and class action waiver precisely because the agreed upon arbitration procedure would preclude class action arbitration or litigation and was therefore “contrary to fundamental New Mexico public policy.” Id. at 4. The plaintiff in Fiser had filed a class action complaint against Dell Computer alleging, among other things, violations of New Mexico’s laws governing unfair business practices and false advertising. The complaint alleged that Dell Computer had “systematically misrepresent[ed] the memory size of its computers.” Id. at 3. Importantly, the complaint also alleged that the monetary damage suffered by each class member was only $10-$20. Id. Dell moved to stay the class action and compel arbitration of the plaintiff’s individual claim based on the mandatory arbitration clause set forth in the online agreement pursuant to which the plaintiff had purchased his Dell computer. Id. at 3-4. The trial court granted the motion, the court of appeals affirmed, and the New Mexico Supreme Court granted the plaintiff’s petition for a writ of certiorari. Id.

The court made clear that “New Mexico strongly supports the resolution of consumer claims, regardless of the amount of damages alleged.” Id. at 4. Moreover, the court noted, for precisely the reasons discussed above, that the class action is a vital means of enforcing consumer rights:

The opportunity to seek class relief is of particular importance to the enforcement of consumer rights because it provides a mechanism for the spreading of costs. The class action device allows claimants with individually small claims the opportunity for relief that would otherwise be economically infeasible because they may collectively share the otherwise prohibitive costs of bringing and maintaining the claim. See, e.g., 1 Alba Conte & Herbeli B. Newberg, Newberg on Class Actions § 21 1.6, at 26 (4th ed. 2002). “In many cases, the availability of class action reIief is a sine qua non to permit the adequate vindication of consumer rights.” State ex reI. 2 Dunlap v. Berger, 567 S.E.2d 265, 278 (W. Va. 2002). “The class action is one of the few legal remedies the small claimant has against those who command the status quo.” Eisen v. Carlisle & Jacquelin, 417 U.S. 156, 186 (1974) (Douglas, J., dissenting in part).

Id. at 5-6.

Given (a) the importance public policy objective, expressed through a number of different consumer protection statutes, to protect consumers against wrongdoing and (b) the necessity of the class action to remedy and deter such wrongdoing when the consumer has so little at stake the device is the only rational means at his disposal to do so, the court felt compelled to hold that the mandatory arbitration clause was void:

[B]eyond merely a procedural tool, the class action functions as a gatekeeper to relief when the cost of bringing a single claim is greater than the damages alleged. When viewed in this light, a contractual provision that purports to ban class actions for small claims implicates not just the opportunity for a class action but the more fundamental right to a meaningful remedy for one’s claims. This Court has recognized that the right of access to the courts is part of the right to petition for redress of grievances guaranteed by both the United States and New Mexico constitutions. Jiron v. Mahlab, 99 N.M. 425, 426, 659 P.2d 311, 312 (1983); see also U. S. Const. amends. I, XIV; N.M. const., art. II, § 18. While the class action ban may or may not rise to the level of a constitutional violation, a prohibition on class relief where there is no meaningful alternative for redress of injury certainly does not provide for effective vindication of rights. See Mitsubishi Motors Corp., v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 637 (1985) (“[S]o long as the prospective litigant effectively may vindicate its statutory cause of action in the arbitral forum, [a] statute will continue to serve both its remedial and deterrent function.”).

Id. at 7-8. In short, “by attempting to prevent him from seeking class relief, [Dell Computer] has essentially foreclosed the possibility that Plaintiff may obtain any relief.” Id. at 8 (emphasis in original).

Five days after the decision in Fiser, on July 2, the Supreme Judicial Court of the Commonwealth of Massachusetts followed the New Mexico Supreme Court’s lead and struck down contact provision in a consumer contract requiring individual arbitration of disputes because the enforcing it would be “contrary to the fundamental public policy of the Commonwealth favoring consumer class actions.” Feeney v. Dell, Inc., ___ N.E.2d ___ (Mass. Jul. 2, 2009). The plaintiff in Feeney had filed a class action complaint alleging that Dell Computer (again) had “improperly collected Massachusetts sales tax on the purchase of optional service contracts sold in connection with the purchase of Dell computers when . . . no such tax was due, and that the collection of such tax violated the Massachusetts consumer protection act.”

First, the court in Feeney made clear that technical contract doctrine was not going to stand in the way of vindicating consumer rights, stating that “[i]t is ‘universally accepted’ that public policy sometimes outweighs the interest in freedom of contract, and in such cases the contract will not be enforced.” Public policy requires disregarding mandatory arbitration clauses because “the class action . . . ‘was designed to meet a pressing need for an effective private remedy’” and “’traditional technicalities are not to be read into the statute in such a way as to impede the accomplishment of substantial justice.’” In addition, the class action is a means of achieving substantial justice in consumer contracts because “[p]ermitting consumers to sue as a class cure[s] the defect inherent in the consumer protection statute that no matter how egregiously a consumer might have been wronged, ‘the economics of a litigation designed to seek redress precluded an effective attack.’” (citations omitted.) And, of course, “[t]he right to a class action in a consumer protection case is of particular importance where . . . aggregation of small claims is likely the only realistic option for pursuing a claim.”

An additional point the court emphasized in Feeney is the class action’s deterrent effect: “Permitting Dell to prohibit class actions against it through its contracts with its customers would . . . undermines the public interest in deterring wrongdoing. Finally, the court observed that “the loss of an individual consumer’s right to bring a class action negatively affects the rights of those unnamed class members on whose behalf the class action would proceed.” The court made clear that it was not averse to class arbitrations and made a point of the fact they are available:

[C]lass arbitrations do in fact occur. See In re Am. Express Merchants’ Litig., [554 F.3d 300, 310 n.7 (2d Cir. 2009)], quoting Clancy, An Uninvited Guest: Class Arbitration and the Federal Arbitration Act’s Legislative History, 63 Bus. Law. 55, 56 (2007) (“It is apparent that ‘[c]lass arbitration is a swiftly growing phenomenon'”); McKee v. AT&T Corp., 164 Wash. 2d 372, 395 (2008) (“Class actions are often arbitrated”). Moreover, a majority of the Justices of the United States Supreme Court has, at least implicitly, indorsed class arbitrations as consistent with the FAA. See Shroyer v. New Cingular Wireless Servs., Inc., 498 F.3d 976, 992 (9th Cir. 2007), citing Green Tree Fin. Corp. v. Bazzle, 539 U.S. 444, 454 (2003).

Accordingly, the court left the door open to the approval of contract provisions requiring class arbitrations, limiting the force of its ruling to “small value” consumer transactions in which any “clause effectively prohibit[s] class proceedings in any forum.” (emphasis added.)

Contract law should not be a means of enforcing performance of actions whose legitimate purposes are being perverted in a particular deal. The purpose of arbitration is not to be a procedural snare to trap a party into a situation in which he can get no feasible remedy for a legal wrong; its purpose is to promote efficient dispute resolution. Courts finally, in the last month, are making this point explicit. No doubt these issues will continue to be litigated in the immediate future; already, at least one firm has announced that it will be filing a class action against Amazon for breach of the Kindle end user license agreement in connection with Amazon’s recall of 1984 and Animal Farm. More importantly, the U.S. Supreme Court, toward the end of its recent term, has agreed to hear Stolt-Nielsen S.A., et al. v. AnimalFeeds International Corp., in which the Court will decide “[w]hether imposing class arbitration on parties whose arbitration clauses are silent on that issue is consistent with the Federal Arbitration Act.”

Courts are acting in legitimate ways when they require disputes to be resolved in ways that provide relief for and deterrence of wrongdoing. Institutions that administer arbitrations are beginning to recognize the problems as well. This month, the National Arbitration Forum (“NAF”) has entered into a consent decree, settling a suit brought by the Minnesota Attorney General, pursuant to which the NAF has agreed to refrain from arbitrating consumer transactions altogether. And the American Arbitration Association (“AAA”) has voluntarily imposed a moratorium on the administration of debt collection arbitration programs in all consumer transaction cases. It is time for legislatures to step in as well.

Peter Friedman is a Visiting Assistant Professor at the University of Detroit Mercy Law School, where he teaches Contracts and Core Concepts. Peter also teaches U.S. Contract Law at the University of Windsor and the Universiteit van Amsterdam. He is currently on leave from the Case Western University School of Law, where he has been on the faculty since January 1996. Prior to his entry into academia, Peter practiced law for eleven years as a commercial litigator in New York City, most recently as a partner in the New York City office of Akin Gump Strauss Hauer & Feld. He graduated with his J.D. from the University of Michigan Law School in 1984 and his A.B. in Ancient Greek and Latin from Brown University in 1981.

Peter also writes a blog, Ruling Imagination: Law and Creativity, which explores the ways law affects creative endeavors and the ways creativity informs the practice of law. Prior to beginning Ruling Imagination, he authored What is Fair Use?, a blog exploring issues pertaining to copyright and fair use.

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