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September 18, 2013

Supreme Court Holds That Class Actions Can Be Prohibited Through Arbitration Clauses

By Brian Farkas

Last term, the Supreme Court continued its intensifying focus on class action arbitration. American Express Co. v. Italian Colors Restaurant, decided on June 20, 2013, limited the ability of plaintiffs to use class procedures after agreeing to one-on-one arbitration--even when the costs of such individual arbitrations would greatly exceed the potential recovery by any single plaintiff. The Supreme Court has now made it clear that the Federal Arbitration Act (FAA) allows parties to prohibit class procedures entirely through an arbitration clause. Some have already called the decision a blow to consumers and small businesses, while others have praised it for honoring the freedom of contract principles on which arbitration is traditionally based.

The underlying controversy began in 2003, when Italian Colors--a family-style Italian restaurant in Oakland, California--signed a standard Card Acceptance Agreement with American Express in order to be able to accept AmEx credit cards from customers. Like most of AmEx's merchant agreements, this agreement included two important stipulations: First, if Italian Colors wanted to be able to take AmEx credit cards, they also had to take AmEx debit cards (which result in high fees for merchants). Second, any dispute that arose would be settled by arbitration. This arbitration clause included a line that "[t]here shall be no right or authority for any claims to be arbitrated on a class action basis"--in other words, plaintiffs could not join together and arbitrate against AmEx as a class.

Later that year, Italian Colors and other small businesses decided to challenge AmEx's debit card requirement, claiming that it was an antitrust violation. Specifically, they claimed that AmEx violated Section 1 of the Sherman Act by "us[ing] its monopoly power in the market for charge cards to force merchants to accept [debit] cards at rates approximately 30% higher than the fees for competing credit cards."

The Southern District of New York (SDNY) initially agreed to join the claims together to form a class action. But AmEx insisted that any dispute by the plaintiffs needed to be handled by one-on-one arbitration, and not by class action. The company moved to compel individual arbitrations. Such individual arbitrations, however, would impose prohibitive costs on the plaintiff merchants. The attorneys and experts needed to prove their individual antitrust claims would greatly exceed the maximum recovery for any individual business. Indeed, the merchants estimated the costs of proving each antitrust claim would be at least several hundred thousand dollars, compared to potential recoveries of roughly $12,000-$38,000. Any business--especially a small family restaurant--would never jump into such a money pit. Therefore, individual arbitrations would render the merchants effectively unable to vindicate their federal statutory rights under the Sherman Act.

The district court ultimately sided with AmEx's motion to dismiss, emphasizing the traditional supremacy afforded to waivers under the FAA. But the Second Circuit reversed that determination, holding that the prohibitive costs the merchants would face for individual arbitration rendered the class action waiver in the Card Acceptance Agreement unenforceable. The panel, which included then-Second Circuit judge Sonia Sotomayor, also noted that the waiver effectively insulates AmEx from civil antitrust liability--a troubling result.

In a 5-3 decision [http://www.supremecourt.gov/opinions/12pdf/12-133_19m1.pdf], the Supreme Court sided with American Express and reversed the Second Circuit. (Justice Sotomayor recused herself because of her earlier involvement with the case). The majority opinion, written by Justice Scalia and joined by Chief Justice Roberts and Justices Alito, Kennedy and Thomas, rejected the theory that class actions must remain available to claimants to ensure that they have sufficient financial incentive to prosecute federal statutory claims. Italian Colors, the Court reasons, voluntarily entered into a contract containing a bilateral arbitration provision; it cannot escape that clause merely because the claim it now wishes to bring is economically unfeasible.

The majority pointed to the language of the FAA, which was "enacted... in response to widespread judicial hostility to arbitration." 9 U.S.C. §2 describes the intent of Congress: "A written provision in any... contract evidencing [the desire] to settle by arbitration a controversy... shall be valid, irrevocable, and enforceable." Justice Scalia writes that "consistent with that text, courts must 'rigorously enforce' arbitration agreements according to their terms." Prohibitively high costs, the majority held, are not a sufficient basis for a court to overrule an arbitration clause that forbids class actions. Nothing in federal antitrust law guarantees plaintiffs "an affordable procedural path to the vindication of every claim." The decision rejected the notion that "effective vindication" of statutory claims must be possible, noting that the doctrine "originated as [mere] dictum" in prior cases and that it has never been applied in any particular case. Arbitration is a matter of contract, and the Court found no basis "to reject the waiver of class arbitration here."

The majority rested much of its decision on AT&T Mobility v. Concepcion [http://www.supremecourt.gov/opinions/10pdf/09-893.pdf], its 2011 case that, according to Justice Scalia, "specifically rejected the argument that class arbitration was necessary to prosecute claims 'that might otherwise slip through the legal system.'" That case held that under the FAA, California courts must enforce arbitration agreements even if the agreement requires that consumer complaints be arbitrated individually instead of on a class basis.

Justice Scalia concludes by highlighting a potential danger of the Second Circuit's "effective vindication" scheme: If the parties had to litigate "the legal requirements for success on the merits claim-by-claim and theory-by-theory, the evidence necessary to meet those requirements, the cost of developing that evidence, and the damages that would be recovered... [then these litigation] hurdles would undoubtedly destroy the prospect of speedy resolution that arbitration... was meant to secure. The FAA does not sanction such a judicially created superstructure." In other words, the notion of "effective vindication" could easily turn a speedy arbitration into a litigious mess.

Justice Kagan penned a fiery dissent, joined by Justices Ginsburg and Breyer. In one of the more memorable opening paragraphs of the term, Kagan summarized the case as follows: "The monopolist gets to use its monopoly power to insist on a contract effectively depriving its victims of all legal recourse. And here is the nutshell version of today's opinion, admirably flaunted rather than camouflaged: Too darn bad." If the arbitration clause is enforceable, the dissent continues, "AmEx has insulated itself from antitrust liability--even if it has in fact violated the law."

The dissent instead endorses the Second Circuit's concept of effective vindication. The effective vindication doctrine, Justice Kagan writes, "bars applying such a clause when... it operates to confer immunity from potentially meritorious federal claims. In so doing, the rule reconciles the [FAA] with all the rest of federal law." The arbitration clause used by AmEx, the dissent explains, has virtually the same effect as an exculpatory clause banning whole categories of liability for one of the parties. Justice Kagan attacks the conservative majority for allowing its apparent contempt for class actions to color its interpretation of this case: "To a hammer, everything looks like a nail. And to a Court bent on diminishing the usefulness of Rule 23, everything looks like a class action, ready to be dismantled." In the hands of the majority, she continues "arbitration threatens to become... a mechanism easily made to block the vindication of meritorious federal claims and insulate wrongdoers from liability."

The decision has already been met with criticism from many academics, consumer groups, and lawyers. Some writers have warned[http://cardozojcr.com/wp-content/uploads/2013/05/CAC307.pdf] that the decision could allow larger corporations to evade statutory responsibilities, or at least limit civil liability, by inserting a simple arbitration clause into a contract. Italian Colors is just the latest in a string of cases that have shown the Court's general favor for binding arbitration and general disfavor for class actions. This very term, Justice Kagan wrote for a unanimous court in Oxford Health Plans LLC v. Sutter [http://www.supremecourt.gov/opinions/12pdf/12-135_e1p3.pdf], which held that when an arbitrator determines that the parties to an arbitration intended to authorize class-wide arbitration, that determination survives judicial review under § 10(a)(4) of the FAA. By contrast, the Court has decided numerous cases against the certification of classes--most famously, perhaps, the 2011 case of Wal-Mart v. Dukes [http://www.supremecourt.gov/opinions/10pdf/10-277.pdf] in which the Court prohibited the certification of 1.5 million female workers suing Wal-Mart for sex discrimination.

The Italian Colors case took a full decade to wind its way through the federal courts--so long that Alan Carlson, the restaurant's owner, long ago stopped following the case's progress. He only heard about the Supreme Court decision from a customer [http://www.eastbayexpress.com/oakland/supreme-court-rules-against-italian-colors-in-amex-suit/Content?oid=3619448]. There is surely some irony in the fact that arbitration exists, in part, to ensure the rapid resolution of disputes. As this case demonstrates, the Supreme Court continues to interpret the FAA to prevent bilateral arbitral claims from getting ensnared in protracted class actions--indeed, to prevent situations just like this one.

Brian Farkas is an associate at the New York office of Goetz Fitzpatrick LLP. He holds his B.A. from Vassar College, and his J.D. from Cardozo School of Law, where he was editor-in-chief of the Cardozo Journal of Conflict Resolution.

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