Commercial Disputes Class Action Defense Alert March 2009 - - PDF document

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Authors:

• R. Bruce Allensworth

bruce.allensworth@klgates.com +1.617.261.3119 Irene C. Freidel irene.freidel@klgates.com +1.617.951.9154 Phoebe S. Winder phoebe.winder@klgates.com +1.617.261.3196 William G. Potter william.potter@klgates.com +1.617.951.9127 Robert W. Sparkes III robert.sparkes@klgates.com +1.617.951.9134 K&L Gates comprises approximately 1,900 lawyers in 32 offices located in North America, Europe, and Asia, and represents capital markets participants, entrepreneurs, growth and middle market companies, leading FORTUNE 100 and FTSE 100 global corporations, and public sector entities. For more information, please visit www.klgates.com.

Commercial Disputes – Class Action Defense Alert

March 2009

That’s Unconscionable: An Update Regarding the Enforceability of Arbitration Provisions in Form Contracts

Introduction

A current hot topic in the ever-growing field of consumer finance litigation is the enforceability of arbitration provisions in lending contracts. The enforceability of such provisions, however, has become a thorny issue, and one that is increasingly resolved in favor of the consumer. While the Federal Arbitration Act (“FAA”) establishes a presumption in favor of the enforceability of arbitration agreements, the courts have raised several roadblocks to prevent what they consider to be abuses of the arbitral forum. An increasing number of courts have permitted consumers to escape arbitration where the operative arbitration provision would effectively eliminate the consumers’ ability to bring claims against the lender and where the consumers did not have a meaningful opportunity to negotiate or reject that provision

• f the contract.

The importance and fluidity of the enforceability issues surrounding arbitration provisions in lending and other consumer finance contracts are highlighted by recent

• pinions out of the Third Circuit Court of Appeals (Homa v. American Express Co.,
• --F.3d---, 2009 WL 440912 (3d Cir. Feb. 24, 2009))1 and the United States District

Court for the Central District of California (Guadagno v. E*Trade Bank, ---F. Supp. 2d ---, 2008 WL 5479062 (C.D. Cal. Dec. 29, 2008)).2 In Homa, the Third Circuit panel decision appears to retreat from a prior panel’s rationale upholding the enforceability of class action waivers in arbitration clauses (and FAA preemption) and to bring the Third Circuit in line with other federal courts on the issue.3 In Guadagno, the Central District of California court found an arbitration clause and class action waiver enforceable based, in part, upon the existence of an opt-out provision related to the mandatory arbitration clause.4 In short, these opinions exhibit the constantly evolving nature of the debate surrounding the enforceability of arbitration provisions in consumer finance related contracts discussed below. This client update discusses three of the most common roadblocks to the enforceability of arbitration provisions:

• 1. excessive or one-sided “carve-out” exceptions;
• 2. inconspicuous waivers of the right to a jury trial; and
• 3. class action waivers that effectively eliminate consumers’ rights to seek redress

for damages.

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Commerical Disputes – Class Action Defense Alert The Federal Arbitration Act

The enforceability of any arbitration provision in the consumer finance context will usually flow from the FAA, 9 U.S.C. §§ 1 et seq. (2006). The FAA requires courts to honor parties’ agreements to resolve disputes through arbitration rather than through the courts. The FAA preempts any contradictory state law that specifically targets arbitration.5 Accordingly, any state statute, or provision in a state statute, that purports to specifically govern arbitration agreements is preempted by the FAA.6 For example, a state law prohibiting class action waivers in arbitration agreements would run afoul of the FAA. To avoid preemption by the FAA, state statutes (and common law) concerning the validity of contractual agreements to arbitrate must apply to all types of contracts.7 Consumers may escape from their agreement to arbitrate only if they can show that they will be unable to vindicate their statutory rights in an arbitral forum, or if they can convince a court (or an arbiter) that the arbitration provision should be invalidated on the basis of some common law principle such as unconscionability, duress, fraud, or lack of consideration. Below, this client update discusses three of the most common roadblocks to enforcement of arbitration provisions. These

• bstacles survive preemption by the FAA because

they spring from common law principles of general applicability to contracts, rather than from arbitration-specific prohibitions.

Carve-Outs

One common pitfall that may render an arbitration provision void is the inclusion of excessive, one- sided “carve-outs.” A carve-out is an exception to an arbitration provision that limits the circumstances in which the provision applies, usually to the detriment of the consumer. A number of courts have found arbitration provisions unconscionable because they contained carve-outs that allowed the drafter access to the courts, but restricted the consumer to arbitration. Because the doctrine of unconscionability is

• rdinarily a common law principle applicable to all

contracts, the FAA will not operate to preempt an unconscionability argument made by a consumer in

• pposition to an arbitration agreement. Thus,

consumers may be able to challenge the validity of an arbitration provision by arguing that the provision is unconscionable under applicable state

• law. For example, in Iberia Credit Bureau, Inc. v.

Cingular Wireless L.L.C.,8 the Fifth Circuit Court of Appeals upheld two arbitration clauses but struck down a third, finding the arbitration provision unconscionable under Louisiana law because it completely exempted the drafter from arbitration, but did not similarly exempt the consumer. In so ruling, the Fifth Circuit found that Louisiana law concerning unconscionability applied with equal force to all contracts and therefore was not preempted by the FAA.9 To understand when an arbitration agreement will be held unconscionable, it is important to first understand what courts look for to determine

• unconscionability. Before finding an agreement to

be unconscionable, courts usually require that there be both “procedural” and “substantive” unconscionability.10 Procedural unconscionability focuses on the disparate bargaining power of the parties, including whether one party was more sophisticated than the other, and whether the contract was one of adhesion11 – i.e., a standard form contract drafted solely by one party and to be signed by the party in the weaker position (typically the consumer).12 Substantive unconscionability measures whether the provisions of the agreement itself are unfair as to one party.13 In the consumer finance context, the consumer is typically less sophisticated than the lender, and usually agrees to a non-negotiable contract prepared by the lender. Once the courts have found substantive unconscionability in the provisions of an agreement, they will typically find the agreements between lenders and unsophisticated consumers to be procedurally unconscionable as well. Thus, the important question in most consumer finance cases will be whether the agreement itself is so unfair as to be substantively unconscionable – a question that turns on state law. There is no bright line that can be drawn between an arbitration agreement that is merely unequal, but nevertheless valid, and one that is so one-sided it will be deemed unconscionable. Courts that have considered this issue generally deem arbitration provisions unconscionable where carve-outs exempt the drafter from the obligation to arbitrate, but bind the non-drafting party (i.e., the consumer) to the

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arbitral forum.14 A more difficult question arises when the agreement contains carve-outs for specific remedies, which are likely to be sought by the drafter, but does not contain similar carve-outs for remedies that the non-drafting party would likely

• pursue. For example, in Ferguson v. Countrywide

Credit Industries, Inc., the Ninth Circuit held that an arbitration provision in an employment contract was unconscionable because it expressly included claims that the employee might seek – breach of contract, discrimination, and harassment – but exempted remedies that the employer would likely pursue – injunctive relief for intellectual property violations, unfair competition, and use or disclosure of trade secrets.15 The Ninth Circuit went on to find that such an agreement was unfairly one-sided and therefore substantively unconscionable.16

Jury Waivers

Another potential obstacle to arbitration provisions arises when an agreement to arbitrate necessarily involves waiving the right to have one’s case heard by a jury. In most states, the right to a jury trial is waivable, but in general, courts only enforce predispute jury waivers that are entered into “knowingly” and “voluntarily.”17 The exceptions to this rule are California and Georgia where those states’ courts have interpreted their respective constitutions to forbid predispute jury waivers.18 Federal courts, however, will apply federal law to determine whether a jury waiver is valid, even where the federal court has jurisdiction only by way of diversity.19 There is no standard test applied by courts to determine whether a party’s waiver of the right to a jury was made knowingly and voluntarily. Rather, courts consider the totality of the circumstances to decide whether a particular waiver should be enforced.20 Federal courts frequently begin the analysis with the maxim that there is a presumption against denying a jury trial based on a waiver.21 That presumption, however, is not strictly enforced, and federal courts generally uphold contractual jury waivers. Although there is no universal test that courts apply, they frequently consider some or all of the following factors in examining the totality of the circumstances: 1) whether the contract is a standardized form or newly drafted; 2) whether the waiver is in fine print or large print; 3) whether the waiver is distinct in some way based on the print type; 4) whether the waiver is set apart in its own paragraph; 5) whether the contract is one of adhesion; 6) whether the contract was negotiated at arm’s length; 7) the length of the contract and the placement of the waiver within it; 8) whether there was disparate bargaining power between the parties; 9) whether both parties waived the right to a jury; 10) whether the parties were sophisticated; 11) whether the parties were represented by counsel; and 12) whether the parties had an opportunity to review the waiver.22 The above focus on disparate bargaining power and standard form contracts seems to bode ill for jury waivers in the consumer finance context, but for the most part courts have upheld jury waivers so long as they are clearly and conspicuously presented in the contract.23

Class Action Waivers

Undoubtedly the hottest topic surrounding the enforceability of arbitration agreements is whether such agreements may prohibit consumers from pursuing remedies on a class-wide basis. Most federal circuits have concluded that class action waivers in arbitration provisions are enforceable where federal claims are at issue. The two main arguments against this conclusion are that class action waivers prevent plaintiffs from vindicating their statutory rights, and that such waivers are

• unconscionable. Federal courts have rejected these

arguments on the basis that the class action device is merely a procedural mechanism and not a substantive right. Therefore, no individual substantive right or statutory cause of action is precluded by a class action waiver. Similarly, because the right to represent a class of individuals

• r otherwise pursue class action claims is merely

procedural, and therefore waivable, it is not unconscionable for parties to contract away that right.24 Notably, there has been an institutional and legislative push against mandatory arbitration clauses in the mortgage lending context. Fannie Mae and Freddie Mac have a stated policy that they will not buy mortgages that contain such clauses.25 In 2007, a bill was introduced by Congressman Barney Frank, and subsequently approved by the

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House of Representatives, which contains a provision that would ban the use of mandatory arbitration clauses in residential mortgage agreements.26 In its current form, the bill expressly exempts “reverse” mortgages from this restriction. Further, the bill does not prevent parties from agreeing to arbitration after a dispute arises. The bill is currently before the United States Senate. From a judicial standpoint, two federal courts of appeal have held a class action waiver invalid as a matter of federal law. The first to do so was the First Circuit Court of Appeals. In Kristian v. Comcast Corp.,27 the First Circuit invalidated a clause in an arbitration agreement expressly prohibiting class action arbitration or consolidation. The court found that the class action mechanism was a procedural right, but held that where the denial of that procedural right would effectively prevent plaintiffs from vindicating a substantive right, the prohibition on class arbitration was invalid. The court reasoned that it would be impossible for consumers to bring their claims - in this case, antitrust claims - individually because the expense of doing so would far outweigh any potential recovery. Thus, the only practicable method of vindicating consumers’ substantive rights was for the case to proceed on a class basis. The court also rejected the argument that antitrust abuses could be addressed by administrative enforcement rather than private enforcement, and stated that where Congress provides for a private right of action, that right of action may not be effectively destroyed by an arbitration agreement. It is important to note that Kristian was decided in the context of antitrust claims, and that the First Circuit distinguished but declined to expressly disagree with prior federal cases, which were decided primarily in the context of claims brought under the Truth in Lending Act (“TILA”). The First Circuit distinguished TILA claims from antitrust claims on the grounds that the latter are ordinarily far more factually complex and therefore more expensive to litigate. The First Circuit concluded that the plaintiffs in Kristian brought claims which were so expensive to try that it would be impracticable to pursue them on an individual basis. Only the prospect of a large award obtained on behalf of a class could persuade a reasonable litigant to make the initial expenditure of time and money necessary to see the case through. In the TILA context, however, litigants may be able to try their claims with less effort and expense, and may be able to recover more on an individual basis, particularly where rescission of the loan agreement is an available remedy. For these reasons, the substantive right to recover under TILA is less likely to be foreclosed by the unavailability of a class action, and therefore courts may be more willing to require consumers to arbitrate TILA claims on an individual basis.28 The Second Circuit Court of Appeals has recently followed the First Circuit’s lead, in In re American Express Merchants’ Litigation,29 and held a class action waiver provision invalid as a matter of federal law. In In re American Express, the Second Circuit considered whether a class action waiver provision included in American Express’s Credit Card Acceptance Agreements’ mandatory arbitration provisions was enforceable under the

• FAA. As in Kristian, the plaintiffs in In re

American Express alleged claims under the Sherman Antitrust Act.30 First, the court found that the enforceability of the class action waiver provision at issue was a question for the court, and not a matter for the arbitrator.31 With respect to the enforceability of the class action waiver at issue, the court held that the class action waiver provision was unenforceable under the FAA - or, as the court described it, the “federal substantive law of arbitrability” - because, while the “right” to proceed as a class representative under Rule 23 of the Federal Rules of Civil Procedure is merely a procedural right,32 enforcement of the waiver would be tantamount to the denial of a plaintiff’s substantive right to vindicate his or her statutory rights.33 In so holding, the court relied upon expert testimony presented by the plaintiffs that the complexity of the antitrust claims at issue and the expenses involved in such litigation effectively made individual claims economically prohibitive.34 In other words, the court reasoned that the only way in which the plaintiffs may litigate their substantive statutory rights under the antitrust laws was through the class action mechanism.35 In so ruling, the Second Circuit also issued two express caveats. First, the court noted that its decision did not rest upon the status of the plaintiffs – all “small” merchants (akin to individual

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consumers) – but instead depended entirely “upon a showing that the size of the recovery received by any individual plaintiff will be too small to justify the expenditure of bringing an individual action.”36 Second, the court stressed that its opinion did not, and should not be read to, hold that class action waivers in arbitration agreements are per se unenforceable or that such provisions are per se unenforceable in the context of antitrust actions.37 Instead, the court noted that “each case which presents a question of the enforceability of a class action waiver in an arbitration agreement must be considered on its own merits, governed with a healthy regard for the fact that the FAA ‘is a congressional declaration of a liberal federal policy favoring arbitration agreements.’”38 Despite the court’s express caveat, the combination of the First Circuit’s decision in Kristian and the Second Circuit’s decision in In re American Express suggests that the federal courts are likely to strictly scrutinize the enforceability of class action waivers in the context of claims brought under the Sherman Antitrust Act. How the First and Second Circuits’ scrutiny will apply with respect to “less-complex” or to “non-prohibitively expensive” claims, however those claims may be defined, is a matter that remains undecided. Some state courts have been less hospitable to class action waivers. State statutes banning or limiting the use of class action waivers are ordinarily of no effect because they are expressly preempted by the FAA.39 The more difficult question, and one that state courts have most often grappled with, is whether the FAA preempts common law principles that would render certain types of class action waivers unconscionable. Several states have found that, in some circumstances, class action waivers are unconscionable and that the FAA does not preempt such a determination under state law. These states include Alabama, Florida, Missouri, New Mexico, Pennsylvania, Washington, and West Virginia.40 The leading state case addressing unconscionability is Discover Bank v. Superior Court.41 In that case, the Supreme Court of California found that, under limited circumstances, a class action waiver can be unconscionable under California law. The court held that when a class action waiver is found in a non-negotiable consumer contract (a “contract of adhesion”), in a setting in which disputes between the contracting parties predictably involve small amounts of damages, and when the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers

• ut of individually small sums of money, then the

waiver becomes, in practice, an exemption from responsibility for fraud and willful injury. Under these circumstances, such waivers are unconscionable under California law. This case has set the tone for what constitutes an unconscionable use of class action waivers in subsequent state cases, as well as in the First Circuit’s opinion in Kristian. The New Jersey Supreme Court’s two decisions in companion cases, Muhammad v. County Bank of Rehoboth Beach, Delaware, and Delta Funding

• Corp. v. Harris,42 are also instructive. In both

cases, the court considered whether the FAA preempts state law regarding unconscionability as it pertains to arbitration agreements, and whether the agreements were in fact unconscionable under New Jersey law. The court held that the FAA did not preempt this issue of state law, and found that although the class action waiver in Harris was valid, the waiver in Muhammad was

• unconscionable. Specifically, the waiver at issue in

Muhammad was invalid because it was part of a contract of adhesion and because the small amount

• f damages at stake coupled with the high cost of

arbitration made it impractical for the plaintiffs to pursue their claims on individual bases. The court found that the impracticability of trying the low- value claims on an individual basis effectively transformed the class action waiver into an exculpatory clause. The waiver in Harris was upheld because the plaintiff was seeking an individual recovery of $100,000 and therefore had adequate incentive to pursue the claim in the absence of a class action procedure. The Supreme Court of Illinois, in Kinkel v. Cingular Wireless, LLC, and the Court of Appeals of Wisconsin, in Coady v. Cross Country Bank, have also joined the growing number of courts which have held class action waivers unenforceable where a class action is the only practical means of vindicating consumers’ rights.43 The Supreme Court of Illinois, collecting cases that have found class action waivers unconscionable, observed that “if there is a pattern in these cases it is this: a class

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action waiver will not be found unconscionable if the plaintiff had a meaningful opportunity to reject the contract term or if the agreement containing the waiver is not burdened by other features limiting the ability of the plaintiff to obtain a remedy for the particular claim being asserted in a cost-effective

• manner. If the agreement is so burdened, the right

to seek class wide redress is more than a mere procedural device.” The Kinkel court went on to hold that the availability of the small claims court as a forum would not suffice to render the class action waiver enforceable because the costs of proceeding in that court were still too high to justify pursuing the plaintiff’s $150 claim. Echoing the First Circuit’s opinion in Kristian, the court further held that the possibility of enforcement by the state attorney general was not sufficient to make up for the complete loss of an individual’s substantive right to reimbursement. Following the lead of the Supreme Court of Illinois, the Court of Appeals of Wisconsin, in Coady, struck down an arbitration agreement on multiple grounds, and held that the agreement’s class action waiver should at least be a factor in determining unconscionability, and perhaps would be sufficient on its own to render the agreement unconscionable if the waiver were to act as a complete bar to recovery.44 The Washington Supreme Court similarly has held, in Scott v. Cingular Wireless,45 that an arbitration provision containing a class action waiver was unconscionable because it violated public policy and acted, in effect, as an exculpatory clause. In Scott, the putative class sought damages against Cingular Wireless for allegedly overcharging customers approximately $1 - $40 per month. The Scott court noted that Cingular agreed, in the arbitration agreement, to bear the costs of arbitration, but found this concession insufficient to save the class action

• waiver. The court reasoned that, even in the absence
• f prohibitive arbitration costs, the time, energy and

stress of pursuing such small claims would effectively discourage individual suits, thereby allowing Cingular to essentially exculpate itself from liability for the alleged overcharges. Because the contract at issue in this case explicitly stated that the arbitration clause and its class action waiver were not severable, the court concluded that the parties’ intent was to invalidate the entire arbitration clause in the event that the class action waiver was held unenforceable. The court thus invalidated the entire arbitration clause. The court indicated, however, that if this non-severability provision had been omitted, it would have upheld the arbitration provision, and struck only the class action waiver, thereby permitting Scott et al. to arbitrate as a class. The Supreme Court of Washington and the Ninth Circuit, respectively, have recently upheld and expressly followed the holding in Scott in McKee v. AT&T Corporation46 and Lowden v. T-Mobile USA, Inc.47 Moreover, the Ninth Circuit in Shroyer v. New Cingular Wireless Services, Inc.,48 and the Eleventh Circuit in Dale v. Comcast Corp.,49 have found class action waivers to be unconscionable, under California and Georgia law respectively, where the waivers would effectively eliminate consumers’ ability to obtain redress for relatively small amounts

• f alleged damages. In both cases, the arbitration

provisions were struck in their entirety because both contained non-severability clauses that precluded striking only the class action waiver, thereby facilitating class-wide arbitration. The Shroyer court expressly followed the holding in Discover Bank, finding the two cases indistinguishable. The Dale court invoked the First Circuit’s decision in Kristian v. Comcast Corp., and refused to enforce a class action waiver where subscribers alleged that they had been overcharged approximately $10.56

• each. Although it left the door open for enforcing

class action waivers in a case where plaintiffs would automatically or likely recover attorney’s fees if successful, the Dale court held that the mere possibility of recovering attorney’s fees did not alleviate the disincentive to sue a large corporation

• ver $10 and change, and that a class action was the
• nly effective way to prevent the small, but

numerous improprieties Comcast was alleged to have committed. In contrast to this trend, the Third Circuit, in Gay v. CreditInform,50 upheld a mandatory arbitration clause in an agreement between a consumer and a credit repair organization. In that case, the arbitration provision required individual arbitration

• f all disputes arising out of the agreement. The

consumer argued that she had a right to bring a class action under the federal Credit Repair Organization Act and Pennsylvania’s Credit Services Act, and that the waiver of that right in the agreement, which was a contract of adhesion, was unconscionable.

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The Third Circuit disagreed and held that the right to proceed on a class-wide basis was merely a procedural right and therefore waivable. Although the amount in controversy appeared to be relatively small, the court refused to consider whether the consumer would have a meaningful opportunity to recover if she were barred from pursuing the claim as a class action. Instead, the court ruled that the arbitration provision was not, on its face, so unreasonable that it could be considered unconscionable under state law. Any further inquiry into the effect of the provision, according to the Third Circuit, would violate the FAA’s prohibition

• n state rules which restrict or burden the

enforcement of agreements to arbitrate. In so deciding, the Third Circuit expressly disagreed with two Pennsylvania state court decisions, but did not discuss the apparently contrary holdings in other federal circuits. Thus, the Gay opinion suggested that the Third Circuit would not follow what appears to be the majority trend in addressing class action waivers in arbitration provisions. In February 2009, however, the Third Circuit (through a different three-judge panel than the panel that decided Gay) appears to have retreated from the Gay analysis to fall more closely in line with the majority trend in its decision in Homa v. American Express Company.51 In Homa, the Third Circuit addressed the enforceability of an arbitration provision and class action waiver contained in an agreement sent to American Express credit card holders entitled “Agreement between American Express Credit Cardmember and American Express Centurion Bank.”52 The crux of the court’s analysis turned on the choice of law between Utah (expressly selected as applicable law under the parties’ agreement) and New Jersey law – the importance of such analysis highlighted by the fact that Utah statutory law expressly allows class action waivers in consumer credit agreements.53 Applying the choice of law rules for New Jersey (the forum in which the district court sat), the Third Circuit found that New Jersey had a fundamental public policy against enforcing class action waivers in the context

• f “a low-value consumer credit suit.”54 In so

finding, the court relied heavily upon the New Jersey Supreme Court’s opinion in Muhammad v. County Bank of Rehoboth Beach, Del., 912 A.2d 88 (N.J. 2006) (discussed above).55 As such, the court applied New Jersey state law to the class action waiver in American Express’s agreement and found that “if the claims at issue are of such a low value as effectively to preclude relief if decided individually, then, under Muhammad, the application of Utah law to the class-arbitration waiver is invalid and the class-arbitration waiver is unconscionable.”56 In addressing the Gay opinion, the Homa court found that New Jersey state law – as reflected in the New Jersey Supreme Court’s Muhammad decision – clearly applied to class action waivers in all contracts and was not limited solely to arbitration agreements.57 Thus, the court found that the unconscionability principles espoused in Muhammad were not preempted by the FAA.58 In fact, the Homa court made clear that Gay cannot stand for the proposition that the FAA preempts all state laws directed at class action waivers unless such law “is read as a blanket prohibition on unconscionability challenges to class-arbitration provisions.”59 In so ruling, the Homa court did not

• verrule Gay and expressly refused to address the

Gay court’s analysis of Pennsylvania state law – focusing, instead, on the clear public policy expressed in New Jersey state law.60 Notwithstanding the Homa court’s distinguishing of Gay, the Third Circuit’s opinion in Homa suggests that the Third Circuit is prepared to fall in line with the majority of state and federal courts in addressing class action waivers in arbitration agreements. Another very recent decision is worthy of note; that is the United States District Court for the Central District of California’s December 29, 2008 decision in Guadagno v. E*Trade Bank.61 In Guadagno, the District Court considered the enforceability of an arbitration provision, including a class action waiver, contained in an online agreement entered into upon the plaintiff’s opening of an online account with defendant E*Trade Bank (a so-called “click-wrap” agreement).62 The agreement at issue also contained an express “optout” provision that allowed plaintiff to affirmatively optout of the arbitration clause.63 First, the court held that Virginia state law governed the interpretation of the agreement, by virtue of the express choice of law provision in the agreement and the court’s finding that the arbitration provision at issue did not violate California public policy.64 Specifically, the court found that California had a fundamental policy “against exculpatory class action waivers in

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consumer contracts of adhesion, because they are unconscionable,”65 and that “[i]f an offerree has a meaningful opportunity to freely opt out of a term after assenting to the contract, and the terms of contract are clear, then the contract is not being

• ffered on a take-it-or-leave-it basis” and is thus not

adhesionary.66 In addressing the provision at issue, the court thus found – based primarily on the “opt-

• ut” provision therein – that the agreement was not

adhesionary and not unconscionable. 67 In other words, the arbitration provision at issue did not violate California law or public policy.68 Second, the court found that the arbitration provision was not unconscionable as a matter of Virginia state law – unconscionability is defined as an arbitration clause that “is so unequal that it is clearly intended to deprive the other party of all remedies and is part of a contract of adhesion.”69 The court found that because plaintiff failed to demonstrate with “detailed proof,” or to even argue, that the cost of arbitration was so high as to prevent her from vindicating her rights through individual arbitration, the arbitration clause was not unconscionable.70 In so holding, the court acknowledged that the agreement contained a “fee splitting” provision that provided that plaintiff could seek an arbitration fee waiver from the American Arbitration Association or petition the defendant E*Trade to pay a higher share of the fee.71 In short, the Guadagno decision suggests that the inclusion of an opt-out provision in an arbitration clause may protect such arbitration clauses from unconscionability challenges. The Guadagno decision, however, appears to be an

• utlier in the consumer finance context – where, as

noted above, contracts and agreements to arbitrate are virtually presumed to be contracts of adhesion. With the exception of Gay v. CreditInform, the case law appears to reinforce the principle expressed in Discover Bank, Kristian, and In re American Express – that class action waivers should not be permitted where the party to be bound did not have a meaningful opportunity to negotiate or reject the agreement, and the effect of the waiver would be to extinguish a party’s claim entirely. Hence, both state and federal courts are likely progressing towards a two-pronged, fact-intensive test, that will operate to invalidate a class action waiver where: 1) the party to be bound did not have a meaningful opportunity to negotiate or reject the arbitration agreement portion of a contract; and 2) if enforced, the waiver would effectively eliminate a party’s right to seek redress because the expected recovery is not large enough to justify the risks and costs of litigation. This developing trend does not bode well for most consumer finance oriented agreements containing class action waiver provisions.

1

Homa v. American Express Co., ---F.3d---, 2009 WL 440912 (3d Cir. Feb. 24, 2009).

2

Guadagno v. E*Trade Bank, ---F. Supp. 2d ---, 2008 WL 5479062 (C.D. Cal. Dec. 29, 2008).

3

See Homa, 2009 WL 440912, at *3-7.

4

See Guadagno, 2008 WL 5479062, at *4-6.

5

See 9 U.S.C. § 2.

6

See id.

7

See Doctor’s Assocs., Inc. v. Casarotto, 517 U.S. 681, 687 (1996) (“[G]enerally applicable contract defenses, such as fraud, duress, or unconsionability, may be applied to invalidate arbitration agreements without contravening [the FAA]. Courts may not, however, invalidate arbitration agreements under state laws applicable only to arbitration

• provisions. By enacting § 2 [of the FAA], . . . Congress

precluded States from singling out arbitration provisions for suspect status, requiring instead that such provisions be placed upon the same footing as other contracts” (internal quotations

• mitted)).

8

Iberia Credit Bureau, Inc. v. Cingular Wireless L.L.C., 379 F.3d 159, 170 (5th Cir. 2004).

9

Id.

10

See, e.g., Adler v. Dell, Inc., No. 08-CV-13170, 2008 WL 5351042, at *9 (E.D. Mich. Dec. 18, 2008) (noting that test for determining unconscionability under Michigan and Texas state law is the same; a plaintiff must prove both procedure and substantive unconscionability); La Torre v. BFS Retail and

• Comm. Operations, LLC, No. 08-22046-CIV, 2008 WL

5156301, at *3 (S.D. Fla. Dec. 8, 2008) (“Under Florida law, in

• rder for a contract provision to be deemed unconscionable, it

must be shown that the provision is both procedurally and substantively unconscionable.”).

11

BLACK’S LAW DICTIONARY 318-19 (7th ed. 1999) (defining the term “adhesion contract”).

12

See, e.g., Adler, 2008 WL 5351042, at *9-10; La Torre, 2008 WL 5156301, at *3-4.

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13

See, e.g., Adler, 2008 WL 5351042, at *9-10; La Torre, 2008 WL 5156301, at *5 (“Substantive unconscionability focuses on the actual agreement and whether or not its terms are unreasonable and unfair.”).

14

See, e.g., Iberia Credit Bureau, Inc., 379 F.3d at 170; see also Wisconsin Auto Title Loans, Inc. v. Jones, 714 N.W.2d 155, 549-50 & n. 56 (Wis. 2006) (citing cases finding same).

15

Ferguson v. Countrywide Credit Indus., Inc., 298

• F. 3d 778, 784-85 (9th Cir. 2002); see also Abramson v.

Juniper Networks, Inc., 115 Cal. App. 4th 638, 664-66 (Cal.

• Ct. App. 2004) (finding provision in employment contract

requiring parties to arbitrate all claims except those related to trade secrets, confidential information and other intellectual property lacking mutuality and thus substantively unconscionable)

16

The majority of courts that have considered the issue have held that exempting foreclosure actions from arbitration agreements is not enough to render such an agreement unconscionable. In fact, several courts have affirmatively held that such an exemption is not substantively unconscionable. See, e.g., Salley v. Option One Mortgage Corp., 925 A.2d 115, 127-29 (Pa. 2007); Walther v. Sovereign Bank, 872 A.2d 735, 748 (Md. 2005) (“The mere fact that the arbitration agreement does except from its purview . . . a foreclosure proceeding, does not destroy mutuality and make the arbitration so one-sided as to make it unconscionable.”). At least one court, however, has found such an exemption substantively

• unconscionable. See Tillman v. Commercial Credit Loans,

Inc., 655 S.E.2d 362, 372 (N.C. 2008) (finding substantive unconscionability in the “one-sidedness” of a clause that exempted foreclosure actions from arbitration).

17

See, e.g., Med. Air Tech. Corp. v. Marwan Inv., Inc., 303 F.3d 11 (1st Cir. 2002); Telum, Inc. v. E.F. Hutton Credit Corp., 859 F.2d 835 (10th Cir. 1988); K.M.C. Co.,

• Inc. v. Irving Trust Co., 757 F.2d 752 (6th Cir. 1985); Nat’l
• Equip. Rental, Ltd. v. Hendrix, 565 F.2d 255 (2d Cir. 1977).

18

See Grafton Partners L.P. v. Superior Court, 116 P.3d 479 (Cal. 2005); Bank South N.A. v. Howard, 444 S.E.2d 799 (Ga. 1994). But see In re The Prudential Ins.

• Co. of Am., 148 S.W.3d 124, 132-33 (Tex. 2004) (noting

that each federal court and “nearly every state court that has considered the issue has held that parties may agree to waive their right to trial by jury in certain future disputes, including the supreme courts in Alabama, Connecticut, Missouri, Nevada, and Rhode Island”). It is also worthy of note that at least two federal courts have refused to extend the holdings of Grafton Partners L.P. and Bank South N.A. to arbitration agreements that require certain claims be litigated in arbitration, but that do not explicitly waive the right to a jury trial. See Caley v. Gulfstream Aerospace Corp., 428 F.3d 1359, 1371-73 & n.15 (11th Cir. 2005) (finding that “general contract principles govern the enforceability of arbitration agreements and that no heightened ‘knowing and voluntary’ standard applies, even where the covered claims include federal statutory claims generally involving a jury trial right” and finding Bank South N.A. v. Howard inapplicable to mutual agreements to arbitrate covered claims that otherwise provide a right to a jury trial); Swallow v. Toll Broths., Inc., No. C-08-02311- JCS, 2008 WL 4164773, at *7 (N.D. Cal. Sept. 8, 2008) (finding that “[t]he holding in Grafton . . . does not apply to arbitration agreements” because “[u]nlike predispute jury waivers, predispute arbitration agreements are specifically authorized by statute . . . . Moreover, . . . arbitration agreements are distinguishable from waivers of the right to jury trial in that they represent an agreement to avoid the judicial forum altogether” (quoting Grafton Partners L.P., 116 P.3d at 484)).

19

See, e.g., Med. Air Tech. Corp., 303 F.3d at 18 (“In a diversity jurisdiction suit, the enforcement of a jury waiver is a question of federal, not state law.”); Telum, Inc., 859 F.2d at 837 (citing Simler v. Conner, 372 U.S. 221, 221-22 (1963)); K.M.C. Co., Inc., 757 F.2d at 755.

20

See, e.g., Med. Air Tech. Corp., 303 F.3d at 19 & n.4.

21

See, e.g., id. at 18 (“There is a presumption against denying a jury trial based on waiver, and waivers must be strictly construed.”); Nat’l Equip. Rental, Ltd., 565 F.2d at 258 (same).

22

See, e.g., Med. Air Tech. Corp., 303 F.3d at 19 n.4 (noting that “[i]n analogous situations we have looked to the ‘totality of circumstances,’ including factors such as the waiving party’s education and business experience, the respective roles of the parties in determining the terms of the waiver, the clarity of the agreement, the amount of time the waiving party had to consider the waiver, whether the waiving party was represented by counsel, and the consideration offered for the waiver, to determine if the waiver was knowing and voluntary”); Telum, Inc., 859 F.2d at 837 (listing “inconspicuous fine print or a gross disparity in bargaining power” as factors weighing in favor of invalidating a jury waiver provision); K.M.C. Co., Inc., 757 F.2d at 757; Nat’l Equip. Rental, Ltd., 565 F.2d at 258.

23

For federal cases refusing to uphold jury waivers based on the failure to present the waiver clearly, see, e.g., Popular Leasing USA, Inc. v. Terra Excavating, Inc., 2005 WL 2468069 (E.D. Mo. 2005) (invalidating jury waiver in a “take-it-

• r-leave-it” contract where waiver was in 6-point font, not set

apart from other provisions, and set deeply and inconspicuously in preprinted form contract); RDO Fin. Servs.

• Co. v. Powell, 191 F. Supp. 811 (N.D. Texas 2002) (invalidating
• ne-sided waiver, which bound only one party and that was not

set apart from the rest of the text, was buried in a lengthy paragraph, and was so small that it was difficult to read).

24

See, e.g., Pleasants v. Am. Express Co., 541 F.3d 853 (8th Cir. 2008) (finding, under Missouri law, that class action waiver in arbitration clause was not unconscionable in Truth in Lending Act case); Livingston v. Assocs. Fin., Inc., 339 F.3d 553 (7th Cir. 2003); Snowden v. CheckPoint Check Cashing, 290 F.3d 631 (4th Cir. 2002); Randolph v. Green Tree

• Fin. Corp.—Alabama, 244 F.3d 814 (11th Cir. 2001); Johnson
• v. West Suburban Bank, 225 F.3d 366 (3d Cir. 2000).

25

See Fannie Mae Announcement 04-06, dated September 28, 2004, available at https://www.efanniemae.com/sf/guides/ssg/annltrs/pdf/2004/04

• 06.pdf; Freddie Mac News Release, dated December 4, 2003,

available at http://www.freddiemac.com/news/archives/ afford_housing/2003/consumer_120403.html (noting that policy becomes effective in August 2004).

26

See Mortgage Reform and Anti-Predatory Lending Act of 2007, H.R. 3915, 110th Cong. § 206(h) (1st Sess. 2007).

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27

Kristian v. Comcast Corp., 446 F.3d 25 (1st Cir. 2006).

28

See id. at 56-59 (distinguishing class action waivers in the TILA context versus such waivers in an antitrust action and finding waiver unconscionable in the antitrust context).

29

In re Am. Express Merchants’ Litig., --- F.3d ----, 2009 WL 214525 (2d Cir. Jan. 30, 2009).

30

See id. at *5-6.

31

• Id. at *8. In so holding, the court noted that

challenges as to the enforceability of an arbitration clause,

• r any provision therein, are questions appropriately

determined by the courts. Id. at *8 (citing Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, 444 (2006)). On the other hand, challenges that attack a contract generally – i.e., that are not specifically limited to an arbitration provision therein – are properly resolved by the arbitrator. Id.

32

• Id. at *9.

33

• Id. at *16-17 (“We therefore hold that the class

action waiver in the Card Acceptance Agreement cannot be enforced in this case because to do so would grant Amex de facto immunity from antitrust liability by removing the plaintiffs’ only reasonably feasible means of recovery.”).

34

See id. at *13-17.

35

See id. at *17.

36

Id.

37

Id.

38

• Id. (quoting Moses H. Cone Memorial Hosp. v.

Mercury Constr. Corp., 460 U.S. 1, 24 (1983)).

39

See section entitled “The Federal Arbitration Act,” supra; see also 9 U.S.C. § 2.

40

Alabama, see Leonard v. Terminix Int’l. Co., 854

• So. 2d 529 (Ala. 2002) (finding arbitration clause

unconscionable where the clause not only limited plaintiff’s recovery of damages, but also contained a class action waiver that effectively restricted plaintiffs “to a forum where the expense of pursuing their claim far exceeds the amount in controversy”); Florida, see Bellsouth Mobility L.L.C. v. Christopher, 819 So. 2d 171 (Fla. Dist. Ct. App. 2002); Missouri, see Whitney v. Alltel Commc’ns., Inc., 173 S.W. 3d 300 (Mo. Ct. App. 2005); New Mexico, see Fiser v. Dell

• Comp. Corp., 188 P.3d 1215 (N.M. 2008); Pennsylvania,

see Thibodeau v. Comcast Corp., 912 A.2d 874 (Pa.

• Super. Ct. 2006); Washington, see Al-Safin v. Circuit City

Stores, Inc., 394 F.3d 1254 (9th Cir. 2005); and West Virginia, see State ex rel. Dunlap v. Berger, 567 S.E. 2d 265 (W.Va. 2002).

41

Discover Bank v. Superior Court, 113 P.3d 1100 (Cal. 2005).

42

Muhammad v. County Bank of Rehoboth Beach, Delaware, 912 A.2d 88 (N.J. 2006); Delta Funding Corp. v. Harris, 912 A.2d 104 (N.J. 2006).

43

See Kinkel v. Cingular Wireless, LLC, 857 N.E.2d 250, 271-75 (Ill. 2006); Coady v. Cross Country Bank, 729 N.W.2d 732, 746-47 (Wis. Ct. App. 2007).

44

See Coady, 729 N.W.2d at 746-47.

45

See Scott v. Cingular Wireless, 161 P.3d 1000 (Wash. 2007).

46

McKee v. AT&T Corp., 191 P.3d 845, 856-57 (Wash. 2008) (following Scott and explaining that under Washington State law “an arbitration agreement may be substantively unconscionable when it is used as a tool of oppression to prevent vindication of small but widespread claims”).

47

Lowden v. T-Mobile USA, Inc., 512 F.3d 1213, 1218- 22 (9th Cir. 2008) (“We conclude that the Washington State Supreme Court’s decision in Scott v. Cingular Wireless . . . establishes that T-Mobile’s arbitration provision is substantively unconscionable and unenforceable under Washington state law, and that there is no federal preemption in light of our decision in Shroyer v. New Cingular Wireless Servs., Inc., 498 F.3d 976 (9th Cir. 2007).”).

48

Shroyer v. New Cingular Wireless Svcs., Inc., 498 F.3d 976 (9th Cir. 2007).

49

See Dale v. Comcast Corp., 498 F.3d 1216 (11th Cir. 2007).

50

See Gay v. CreditInform, 511 F.3d 369, 378 (3d Cir. 2007); see also Litman v. Cellco Partnership, No. 07-CV- 4886(FLW), 2008 WL 4507573, at *5-6, n.4 (D. N.J. Sept. 29, 2008) (following Gay and holding that despite the fact that the class arbitration waiver was unconscionable under New Jersey state law, the arbitration clause was enforceable under Third Circuit precedent).

51

• --F.3d---, 2009 WL 440912 (3d Cir. Feb. 24, 2009).

52

• Id. at *1.

53

• Id. at *2 (citing UTAH CODE ANN. § 70C-4-105)

54

• Id. at *2-3, *4-5 (“we predict that the Supreme Court
• f New Jersey would find that the class-arbitration waiver at

issue violates the fundamental public policy of New Jersey”).

55

See id.

56

• Id. at *7.

57

• Id. at *4-5 (“Muhammad plainly does not hold that an

agreement to arbitrate may be unconscionable simply because it is an agreement to arbitrate” (internal quotations omitted)).

58

• Id. (citing Doctor’s Assocs., 517 U.S. at 686-87).

59

Id.

60

Id.

61

• --F. Supp. 2d ---, 2008 WL 5479062 (C.D. Cal. Dec.

29, 2008).

62

See id. at *1-2.

63

See id. at *2.

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64

• Id. at *3-4.

65

• Id. at *4.

66

Id.

67

Id.

68

Id.

69

• Id. at *6.

70

Id.

71

Id.