Retailers have won a major procedural legal victory against credit-card issuers when a federal appellate court in New York refused to force them to individually arbitrate claims against the financial institutions, despite the existence of an arbitration agreement that mandated such arbitration. The litigation creates a split among federal courts regarding the enforceability of these mandatory arbitration agreements when they conflict with other federal laws.
The merchants' victory may by a Pyrrhic one, because consumers may use the same rules to invalidate arbitration provisions and file class-action lawsuits against the merchants themselves.
Mandatory arbitration agreements are really great when you benefit from them, and terrible when you don't. Merchants and employers use these agreements all the time (typically in the small print on a Web site) to ensure their customers cannot file lawsuits against them and, more importantly, cannot file class-action lawsuits against them. Most famously, a purchaser of a "free" AT&T cell phone was, like tens of thousands of other cell phone purchasers, billed $60 from the telecommunications company for fees and taxes on the "free" phone.
The subscriber agreement with AT&T permitted him to initially shell out $175 to start an arbitration proceeding and get his $60 bucks back. But what lawyer would spend hundreds of hours and tens of thousands of dollars in an effort to recover $60? So the lawyer, on behalf of the consumer, filed a class-action lawsuit against AT&T on behalf of all the consumers who were billed for what they thought was a free phone.
The U.S. Supreme Court ruled that the arbitration agreement on the company’s Web site precluded such class-action lawsuits, or even class arbitrations, and that the Federal Arbitration Act trumped a California law that made such class-action waivers inherently suspect. Even if you have a right to sue, and even if you have a right to sue in class action, you can waive that right. And by buying an AT&T phone, that's exactly what the consumer did, according to the Supremes.
Class-action waivers and arbitration agreements can be great for merchants. Imagine putting a notice at a grocery store stating that by entering the store you agree not to sue the store for negligence but instead to arbitrate any disputes. Slip and fall? No lawsuit. Find half a mouse in your food? Arbitrate.
Arbitration has a lot of advantages for companies. First, unlike in court, where you get the luck of the draw, you get a say in selecting the arbitrator. Moreover, arbitrators (unlike judges) are paid by the litigants. If you are frequently arbitrating these types of cases, then you are frequently paying the arbitrator. Arbitrators are only paid if they are selected to arbitrate, and you are not likely to select an arbitrator who consistently rules against you, right?
Next, there is almost no "discovery" in arbitration—meaning that the person seeking a remedy from the company cannot rummage through that company's files looking for even relevant evidence. And arbitrations are generally secret. So if a company loses the arbitration, there is no precedent that another arbitrator is bound to follow. The arbitration agreement can set out the rules for the arbitration: How many arbitrators there will be, who pays the costs, what law applies to the arbitration, where the arbitration must occur, whether it must be attended in person, etc. It's like running your own little private justice system.
Class-action waivers are even better for defendants.Class-action waivers are even better for defendants. Many perceived harms may impact each person only a little but overall have a huge effect. It's not only unlikely but wholly uneconomical for tens of thousands of AT&T customer to file individual claims (either in small claims court or for arbitration) to recover $30 to $60. By eliminating the possibility of class action, a merchant can substantially reduce the likelihood that it will ever have to pay for something objectionable—whether the company is guilty of wrongdoing or not. The transactional costs of proceeding are too high and the rewards too low.
So mandatory arbitration agreements and class-action waivers are awesome for merchants, right? Not so fast. What if the merchant itself is subject to such a waiver?
Merchants love certain American Express cards and hate others. The ones with low fees to merchants and high-income business users who have a high propensity to spend and a low propensity to default, are awesome for merchants. The ones with high fees, lower income customers and high defaults, not so much. But American Express requires a merchant that wants to take one card (whether it is a debit, charge, stored value or credit card) to take all cards. This, according to a bunch of merchants, is an unlawful "tying" arrangement in violation of federal antitrust law—specifically, the Clayton antitrust act. So the merchants got together as a class and sued American Express.
You guessed what was next. Of course, the agreement with American Express had a mandatory arbitration provision. You can't sue, the card issuer argued. The Supreme Court had just ruled in the AT&T free phone case that state laws impacting a valid arbitration agreement are unenforceable and that federal law presumes arbitration agreements are good and enforceable.
The litigation bounced back and forth. Finally, this week, the United States Court of Appeals for the Second Circuit agreed to let stand an earlier ruling that essentially said the merchants could proceed with their federal antitrust class-action lawsuit despite agreeing to a binding contractual arbitration agreement saying that they wouldn't file such a suit. The contract was unenforceable, according to the federal appeals court, because it prevented the merchants from effectively enforcing a right granted by federal antitrust law. The Court noted that it was impractical to have each individual merchant file an individual arbitration, hire expert witnesses, gather evidence, do the needed antitrust economic analysis necessary to prove anticompetitive practices, and then recover only a nominal amount for all of this work. So the merchants won! Woohoo!
I suppose there could be a rule that arbitration agreements are enforceable when I want them to be but unenforceable when I don't want them to be. If I were making the rules, that's what I would write. But the American Express litigation again puts the enforceability of arbitration agreements in a state of flux, particularly where the litigation is intended to vindicate a right created by federal law. The Court giveth, and the Court taketh away. For now, merchants should assume that arbitration agreements are enforceable, but recognize that this may not continue to be the case. Ultimately, either the Supreme Court or Congress or both may have to step in to resolve this issue. And what could go wrong then?
If you disagree with me, I'll see you in court, buddy. If you agree with me, however, I would love to hear from you.