Insights

On Tuesday November 9, 2010, the U.S. Supreme Court heard oral arguments in AT&T Mobility, LLC v. Concepcion. In AT&T, the high court will consider whether the Federal Arbitration Act (FAA) preempts state bans on class action waivers in arbitration agreements.

In 2002, Vincent and Liza Concepcion signed a wireless service agreement (WSA) with AT&T for cell phone service and the purchase of new cell phones. By agreeing to the new two year contract term, the Concepcions received the cell phones without charge, except that AT&T charged them sales tax on the retail value of the phones. The WSA contained an arbitration clause, which required any dispute to be submitted to arbitration, as well as a class action waiver clause, which required any dispute between the parties to be brought in an individual capacity.

In March 2006, the Concepcions filed a class action lawsuit against AT&T alleging that the practice of charging sales tax on a phone advertised as free was fraudulent. In March 2008, AT&T moved to compel arbitration.

The Concepcions argued that the class action waiver in the arbitration clause was unconscionable. The district court denied AT&T’s motion, holding that the class waiver provision was unconscionable under California law. The district court applied the standard in Discover Bank v. Super. Ct., 36 Cal. 4th 148 (2005), which specifically addresses class action waivers.

Under the Discover Bank test, a class action waiver is unenforceable if it is found in a consumer contract of adhesion, if it is found in a setting in which disputes between the contracting parties predictably involve small amounts of damages, and when it is alleged that the party with superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money. The district court further held that the FAA did not preempt California law.

AT&T appealed the trial court’s decision. The U.S. Court of Appeals for the Ninth Circuit affirmed the denial of the motion to compel. The Ninth Circuit also followed the Discover Bank standard and based its determination largely on the fact that consumers would recover predictably small damages under an arbitration proceeding given the nature of disputes that AT&T would have with its customers. The Concepcions, for example, suffered actual damages of only $30. The Ninth Circuit also rejected AT&T’s FAA preemption argument. Again, AT&T appealed.

The question presented to the Supreme Court was: whether the FAA preempts states from conditioning the enforceability of an arbitration agreement on the availability of particular procedures – here, class-wide arbitration – when those procedures are not necessary to ensure that the parties to the arbitration agreement can vindicate their claims.

Section 2 of the FAA provides that arbitration agreements are enforceable except on any ground that exists at law or equity for the revocation of any contract. This provision of the FAA is intended to preempt state laws that disfavor or discriminate against arbitration. AT&T argues that the Discover Bank standard differs in several respects from the more traditional common law unconscionability standard. Under California’s Discover Bank standard, unconscionability is assessed at the time the dispute arose (ex post), rather than at the time the contract was drafted (ex ante). Additionally, Discover Bank looks at the effect of unconscionability on consumers as a whole, rather than on the specific parties to the case. AT&T argues that, for these reasons, and because the application of Discover Bank is limited to the context of dispute resolution, it unfairly discriminates against arbitration and is subject to preemption by FAA.

The Concepcions, on the other hand, argue that because the Discover Bank standard applies beyond simply the arbitration context, it is a ground for the revocation of “any” contract and therefore does not discriminate against arbitration. The Concepcions also argue that California has every right to articulate a broader standard for unconscionability to be applied to its citizens.

During the argument of AT&T’s attorney, Andrew Pincus, Justice Scalia expressed hesitation about interfering with a state’s ability to apply a particular standard of unconscionability. Most of the questioning, however, focused on whether the Discover Bank test discriminates against arbitration; several justices seemed to think it does not.

Justice Ginsburg commented that there was no difference in the standards of unconscionability, except that California’s definition or test was broader. Ginsburg also commented that it did not appear that arbitration was being disfavored under California’s law, which was the underlying purpose for the FAA.

Justice Breyer stated that the Discover Bank case applies to both arbitration and litigation and that it does not appear to discriminate against arbitration. Justices Kagan and Breyer seemed to think that the Discover Bank standard did not discriminate against arbitration and asked Pincus why it was problematic for California to adopt a stricter unconscionability standard than the traditional common law test. Justice Kagan in particular questioned Pincus about the standard he wanted the court to adopt in determining when a state law discriminates against arbitration. Kagan told Pincus that the test he seemed to be offering would be difficult to apply. Pincus tried to explain the differences between the Discover Bank standard and a general common law unconscionability standard that demonstrate the former’s discrimination against arbitration. Justice Kennedy also seemed to think that the Discover Bank standard applied broadly and did not discriminate against arbitration.

The Concepcions’ lawyer, Deepak Gupta, took issue with AT&T’s characterization of the Discover Bank standard as discriminatory. He argued that Discover Bank adopts an ex ante approach, not an ex post approach, and further argued that considering the effects on consumers as a whole is a legitimate inquiry.

Chief Justice Roberts questioned Gupta quite a bit on this point, and appeared to be sympathetic to AT&T’s position that the Discover Bank standard disfavors arbitration. Justice Alito joined in Roberts’ questioning and wanted to know how the Concepcions would benefit from the ability to bring a class action. Mr. Gupta responded that, taking an ex ante approach, the Concepcions as individuals would be discouraged from bringing a single action against AT&T, but the ability to join with other affected consumers makes the ability to bring a class action claim for fraud “economically justifiable.” Justice Alito asked whether this analysis of the broader effects was a distinction that separates Discover Bank from a more traditional unconscionability analysis. Mr. Gupta responded that this kind of procedural limitation has always been found to be unconscionable.

Other justices, particularly Justice Sotomayor, asked what standard the Court should use in distinguishing facially neutral contract law defenses that implicitly discriminate against arbitration from those that do not. Mr. Gupta offered an objective standard by which the Court should look at whether states are engaged in subterfuge to deny parties federally protected rights.

It is always difficult to predict how the Court will rule based on oral argument. We expect a ruling from the Court in the spring of 2011.

Meghan S. Musselman is an associate in the Maryland office of Hudson Cook, LLP. Meghan can be reached at 410-865-5403 or by email at mmusselman@hudco.com.