Editors Note: The Consumer Financial Protection Bureau has just issued a regulation that will restore some of the rights denied to consumers, as detailed in this article by Katherine Stone from our Spring 2016 issue. Subscribe here.
The death of Antonin Scalia and the prospect of several new appointments to the Supreme Court in the next few years have led progressives to hope for a more worker-friendly Court. One area where much-needed change could come is arbitration law. The pervasive use of mandatory arbitration by employers and retailers in their dealings with their workers and consumers is rapidly destroying innumerable rights that were legislated by Congress over more than a century. Those rights include overtime pay, safe working conditions, safe products, as well as protections against employment discrimination, predatory lending, and overcharges by telecommunications and credit card companies. I have addressed the widespread use and frequent abuse of mandatory arbitration in previous articles in the Prospect (see "Signing Away Our Rights," March 2011; "The Feeble Strength of One," Summer 1993). The issue was also spotlighted recently in a three-part series in The New York Times.
How might the situation be fixed, and worker and consumer rights effectively restored?
One strategy is legislation. Each year for the past several years, an Arbitration Fairness Act has been introduced in Congress. The act would exempt employment, consumer, antitrust, and civil-rights cases from the operation of the Federal Arbitration Act, effectively eliminating the use of mandatory pre-dispute arbitration in those areas. The most recent iteration was introduced in April 2015 by Senator Al Franken. Like its predecessors, Franken's Arbitration Fairness Act is languishing in committee, fiercely opposed by business. Unless a Democratic Congress is elected in November, such legislation is unlikely to gain traction.
A second possible strategy is executive action. For example, in July 2014, President Barack Obama signed the Fair Pay and Safe Workplaces Executive Order. It included a provision banning the use of mandatory pre-dispute arbitration by defense contractors for employment disputes alleging sexual assault, sexual harassment, or workplace discrimination claims. The business community has mounted fierce opposition, and plans several legal challenges when the order goes into effect later this year. The Consumer Financial Protection Bureau has proposed a regulation that would prohibit mandatory arbitration coupled with class-action waivers to prevent class-action lawsuits in consumer financial transactions. They are encountering a barrage of opposition from the American Bankers Association, the Financial Services Roundtable, the Consumer Bankers Association, and other business groups.
That leaves the courts. Until now, courts have been the primary force enabling corporations to use mandatory arbitration to strip workers and consumers of their statutory rights. However, the death of Justice Scalia and the possibility of a more liberal Court allow for a revisiting of these issues.
How We Got Here
The current arbitration assault has its origins in the 1980s, when the Supreme Court reinterpreted a little-known federal law called the Federal Arbitration Act (FAA) and gave it expansive scope. Today, courts allow mandatory arbitration, substantially on corporate terms, to settle disputes of all types, overriding contractual claims and statutory rights, whether brought in a federal or a state court. The expansive interpretation of the FAA dates entirely from the era of conservative domination of the Supreme Court.
The FAA was originally enacted in 1925, before the enactment of broad consumer and worker rights. The statute was the result of a lengthy campaign by the commercial bar of New York to convince the courts, the legal profession, and legislatures of the superiority of arbitration for business disputes. In that era, trade associations were proliferating, and they promoted arbitration systems, which they required their members to use. The business community advocated self-regulation by insiders. Thus they wanted courts to move business disputes out of the courts, force recalcitrant parties to arbitrate, and use courts to enforce arbitral awards and otherwise keep out.
The FAA provides that when a dispute involves a contract that has a written arbitration clause, a court must, upon motion, stay litigation so that the dispute can go to arbitration. The FAA narrows the power of courts to review an arbitral award, no matter how erroneous it might be. An award can only be set aside on four grounds: It was procured by fraud, the arbitrator was biased, the arbitrator refused to hear relevant evidence, or the arbitrator exceeded his or her power as set out in the parties' arbitration agreement. There is no provision for overturning an award based on errors of fact, contract interpretation, or law.
When it was drafted, the legislators, commentators, and courts assumed that the FAA applied only to commercial disputes in federal courts. However, in the 1980s, the Supreme Court radically expanded the scope of the statute far beyond its initial business-related purposes. The Supreme Court's arbitration decisions that decade were the hidden revolution of the Reagan Court. Both liberal and conservative justices favored expanding the scope of the FAA, but in different ways. The liberal wing wanted to expand federal control of arbitration and ensure that the FAA would preempt any state law that restricts arbitration. The conservative wing favored expanding arbitration to disputes over federal statutory rights.
In 1983, the Supreme Court set the stage for the revolution that followed with a pronouncement, in Moses H. Cone Memorial Hospital v. Mercury Construction Corp., that courts, when deciding whether a particular dispute comes within an arbitration clause, should resolve all doubts in favor of arbitration. It said that a presumption in favor of arbitration furthered the "liberal federal policy favoring arbitration agreements." The case itself was a business-to-business dispute over charges for delay in a hospital construction contract; it did not concern consumer or worker rights.
The second pivotal development was a preemption case. In 1984, in Southland Corp. v. Keating, the Court rejected the view that the FAA only applied to cases brought in federal courts under federal law. Once again, labor and consumer rights were not at issue. The dispute was between a California 7-Eleven franchisee and the behemoth franchisor, Southland Corporation. Keating sued Southland in state court, alleging several state law violations, including violation of the California Franchise Investment Law (CFIL), which was designed to protect small franchisees from overreach and misconduct by powerful franchisors. The CFIL also had a provision requiring judicial, not arbitral, consideration of all claims. The Supreme Court held that the state law was preempted. Thereafter, any state's efforts to regulate arbitration to protect weaker parties would be preempted by the FAA. Southland was decided 7–2. Chief Justice Warren E. Burger wrote the majority opinion to which Justices William J. Brennan Jr., Byron White, Thurgood Marshall, Harry Blackmun, Lewis F. Powell Jr., and John Paul Stevens joined. Only Justices William Rehnquist and Sandra Day O'Connor dissented.
The third pivotal development of the 1980s concerned the types of disputes subject to the FAA. Whereas previously the FAA had been found to apply only to contractual disputes, in 1985, in Mitsubishi Motors v. Soler Chrysler-Plymouth, the Supreme Court held that the FAA also compelled arbitration of statutory disputes. In the case, an auto dealer accused the manufacturer and its joint venture partner of conspiring to destroy its business, in violation of the federal antitrust law. The Supreme Court ruled 5–3 that the antitrust issue had to go to arbitration. The Court's liberal members, Justices Stevens, Marshall, and Brennan, dissented.
The majority opinion in Mitsubishi by Justice Blackmun added an important caveat. Arbitration can only be ordered, he wrote, if the complaining party can vindicate his or her statutory rights in the arbitration forum. Subsequently, lower courts applied this "effective vindication doctrine" to ensure that parties that were forced to go to arbitration would still have an adequate opportunity to enforce their statutory rights. But that doctrine was recently called into question by the high court.
In 1991, the Court ruled for the first time that the Arbitration Act could be used to undermine workers' rights. Robert Gilmer was hired by the Johnson Lane stock brokerage firm in 1981 and was fired in 1987 at the age of 62. He sued, alleging that he had been fired in violation of the Age Discrimination in Employment Act (ADEA). Johnson Lane moved to compel arbitration on the basis of an arbitration provision contained in the standard securities industry registration form that Gilmer had been required to complete when he was hired. Gilmer argued that compelling arbitration of his age discrimination claim was inconsistent with the statutory framework of the ADEA because the statute embodied important social policies that should not be determined in a private tribunal. In Gilmer v. Interstate/Johnson Lane Corp., the Supreme Court disagreed and ruled that Gilmer had to assert his age-discrimination complaint in arbitration.
That majority opinion in Gilmer was written by Justice White. A dissent by Justices Stevens and Marshall contended that Congress did not intend ADEA claims to be subject to mandatory arbitration. Since Gilmer, lower federal courts have upheld arbitration for disputes concerning all types of employment-related statutes, including Title VII of the Civil Rights Act, the Whistleblower Protection Act, and the Employee Polygraph Protection Act. The Gilmer decision thus opened the door for extensive use of arbitration in non-union employment settings.
The Assault on Workers' and Consumers' Rights
In the decades that followed, the Supreme Court further expanded the scope of the FAA and repeatedly rebuffed attempts by states to enact legislation to protect consumers and workers from unfair arbitration agreements. For example, in 1996, the Court applied Southland to strike down a Montana law designed to ensure that consumers gave "knowing consent" to arbitration clauses in their contracts with large corporations. Paul Casarotto, a Subway franchisee in Montana, sued the owner of the Subway chain in state court for fraud. The Subway corporation's standard franchise agreement called for arbitration of all disputes, with arbitration to be held in Bridgeport, Connecticut. Casarotto contended that it would be prohibitively expensive for him to travel to Connecticut and retain a Connecticut lawyer. Fortunately, Montana had a law that required all arbitration clauses in contracts to appear in capital letters on the first page of the contract. In this case, the arbitration clause appeared on page nine, a violation that would have rendered the arbitration clause invalid. Unfortunately for him, though, in Doctor's Associates, Inc. v. Casarotto, the Supreme Court held that the Montana law was preempted because it was restrictive of arbitration.
In 2000, the Court went even further, requiring a complaining party to arbitrate a claim even when she could not afford to do so. In Green Tree Financial Corp.-Ala. v. Randolph, Larketta Randolph had purchased a mobile home with financing from Green Tree Financial Corporation. The contract called for binding arbitration. Subsequently, when Green Tree attempted to repossess the mobile home, Randolph argued that the loan agreement violated the Truth in Lending Act, a federal statute designed to protect individual borrowers in their dealings with large financial institutions. She also claimed that the lender's arbitration procedure was so expensive that, if she were required to arbitrate, she would not be able to bring her claim at all. She lost 5–4 in the Supreme Court. The majority opinion was written by Chief Justice Rehnquist; Justices Ruth Bader Ginsburg, Stevens, David Souter, and Stephen Breyer dissented.
The Supreme Court has also curtailed the ability of consumers and employees to avoid arbitration on the grounds that a contract is illegal, fraudulent, or otherwise unenforceable. Through a sleight of hand known as the "separability doctrine," the Court has held that even if an entire contract is invalid, the promise to arbitrate is enforceable because it is separable from the rest of the contract. To add insult to injury, the arbitrator, rather than a court, gets to decide whether the contract is valid. The Supreme Court has applied the separability doctrine to require arbitration of contracts that were alleged to be fraudulent, illegal, and unconscionable.
Until recently, the Court allowed an exception to separability in cases where illegality, fraud, or some other fatal defect was alleged in the arbitration clause itself. But even that escape hatch was recently narrowed to a vanishing point in 2010, in a 5–4 opinion authored by Justice Scalia in Rent-A-Center West, Inc. v. Jackson.
Antonio Jackson worked at a Rent-A-Center in Nevada, where he repeatedly sought a promotion. After one rebuff, he complained to his store manager. He was subsequently promoted, but then fired two months later. He sued, alleging he had been denied a promotion because of his race and fired in retaliation for complaining. There was an arbitration clause in his employment contract. Jackson resisted arbitration on the grounds that the arbitration clause was unconscionable under existing state law, due to its coverage, excessive cost, and lack of rights of discovery.
Unconscionability is a well-established contract doctrine that says when a contract is grossly unfair in its terms and/or in the manner in which it was procured, it will not be enforced. Unconscionability claims are often lodged against arbitration clauses that specify procedures that prevent parties from engaging in adequate discovery, impose onerous burdens of proof, or otherwise make it difficult for a complaining party to prevail.
The Supreme Court ruled that Jackson had to arbitrate his discrimination claim. Writing for the majority, Scalia announced a new principle-a party who claims the arbitration clause itself is unconscionable under state law has to bring that claim to arbitration in most circumstances.
The decision drew a strong dissent. Justice Stevens explained, in a dissent that was joined by Justices Ginsburg, Breyer, and Sonia Sotomayor:
[The separability doctrine] allow[s] a court to pluck from a potentially invalid contract a potentially valid arbitration agreement. Today the Court adds a new layer of severability-something akin to Russian nesting dolls-into the mix: Courts may now pluck from a potentially invalid arbitration agreement even narrower provisions that refer particular arbitrability disputes to an arbitrator. [Emphasis in original.]
After Rent-A-Center, it is almost impossible for a party to challenge a one-sided arbitration clause on unconscionability grounds, no matter how unfair it is.
And it has gotten even worse.
The most egregious expansion of the FAA has been to undermine class actions. Employers have aggressively used the "liberal federal policy favoring arbitration" from the Moses H. Cone case to eliminate class-action lawsuits. Whereas previously, employers had faced massive potential liability from class actions based on employment legislation designed to protect individual employees, they found they could design arbitration systems that would ban class actions and thus stack the deck in their favor. It has become common for corporations to impose on their consumers and workers a clause that requires arbitration of all disputes and provides that no claim can be taken to arbitration or a court on a collective or class basis.
Composite arbitration and class-action waiver clauses are nearly universal in contracts required by credit card companies, banks, cell phone providers, and providers of many other common services. They are also used with increasing frequency in employment contracts. Composite clauses are designed to prevent lawsuits in which large numbers of plaintiffs each have small dollar-amount claims-claims so small that no individual can afford to sue by themselves but which can cost a corporation a lot of money when brought as a class action. When a composite class-action waiver/arbitration clause is enforced, plaintiffs are forced to arbitrate claims on an individual basis, even if it is prohibitively expensive for them to do so, effectively destroying their remedies.
In 2011, in AT&T Mobility LLC v. Concepcion, the Court struck down a California doctrine that made class-action waivers in most consumer cases unenforceable. In that case, Vincent and Liza Concepcion purchased a cell phone service package that was advertised as including free phones. When they were subsequently charged a $30 sales tax on the "free" phones, they brought a lawsuit alleging that the company had engaged in fraudulent practices. They filed a class action on behalf of themselves and other customers similarly situated. The AT&T standard customer agreement included a mandatory arbitration clause and a ban on class actions and class-wide arbitration. The Ninth Circuit refused to enforce the ban because they found the composite arbitration/class-action waiver clause to be unconscionable under its Discover Bank rule, named for an earlier Ninth Circuit case. The Discover Bank rule says when there is a class-action waiver in a consumer contract and "when it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money, then ... the waiver [is] unconscionable under California law and should not be enforced."
AT&T Mobility appealed to the Supreme Court, where Scalia, writing for the majority, held that the California Discover Bank rule was preempted by the FAA. Justices Breyer, Ginsburg, Sotomayor, and Elena Kagan dissented. This represented an important departure for the liberal justices, who had previously supported broad FAA preemption.
In yet another recent case, American Express Co. v. Italian Colors Restaurant, several small merchants claimed they had been overcharged by American Express. Each merchant's contract with AmEx contained a clause that mandated arbitration and required that all disputes be arbitrated on an individual basis. The merchants brought a federal antitrust suit on a class-action basis. When AmEx moved to compel individual arbitration, the merchants argued that if they had to arbitrate the antitrust claim on an individual basis, it would cost each one hundreds of thousands of dollars, whereas each one's average recovery would be only $5,000. Hence, they claimed, without the ability to bring a class or collective action, they would lose their substantive rights. They based their argument on the "effective vindication" doctrine from Mitsubishi that says arbitration is only appropriate when a party can vindicate his or her substantive rights in arbitration.
The merchants won in the Second Circuit Court of Appeals, but in June 2013, the Supreme Court reversed the decision. The Court upheld the class-action waiver so that the merchants had to take their antitrust claims to arbitration on an individual basis. It did so despite irrefutable evidence that the cost of bringing an antitrust case was so high that without the ability to proceed as a class action, the case could not be brought.
Writing for the majority, Scalia challenged the effective-vindication principle. "The fact that it is not worth the expense involved in proving a statutory remedy does not constitute the elimination of the right to pursue that remedy."
Kagan delivered a powerful dissent that was joined by Ginsburg and Breyer. The overall effect of the opinion, she explained, is that "the monopolist gets to use its monopoly power to insist on a contract effectively depriving its victims of all legal recourse." She argued that the effective-vindication rule was essential to prevent stronger parties from using these and other means to eviscerate statutory protections.
Although the Italian Colors case itself involved a dispute brought by merchants, the majority's decision has important consequences for employment and consumer cases. By narrowing the effective vindication doctrine, the Court has potentially undermined all challenges to class-action waivers in arbitration clauses.
The National Labor Relations Act (NLRA) of 1935 made protection for worker collective action a central pillar of our national labor policy. The core of the statute, Section 7, protects employee efforts to engage in "concerted activities for … mutual aid and protection." The protection attaches when two or more employees act together to attempt to form a union, take political action, or engage in litigation to improve their wages, hours, and conditions. However, in light of the Supreme Court's class-action arbitration cases, employers increasingly insert a composite arbitration/class-action waiver clause in employment contracts and use them to prevent employees from acting collectively to pursue legal action.
The conflict between mandatory arbitration and workers' rights under the NLRA is currently very much alive in the lower courts. In 2012, the National Labor Relations Board ruled in D. R. Horton, Inc. that an employer's mandatory arbitration policy prohibiting collective or class actions violates Section 7 of the labor law, and that enforcing the arbitration/class-action waiver would interfere with the workers' substantive right to engage in collective action. Its decision was overturned by the Fifth Circuit Court of Appeals, and several other appeals courts have likewise disagreed with the NLRB. This issue may come to the Supreme Court in the near future. Although the Court has not yet considered this precise question, it has ruled on a similar issue in the context of consumer credit. It held in 2012's CompuCredit Corp. v. Greenwood that private arbitration trumps any rights granted under the consumer protection statute, which augurs poorly for the protection of collective labor rights.
Reversing the Arbitration Revolution
This string of cases provides vivid examples of Senator Elizabeth Warren's oft-stated declaration that "the rules are rigged." In this instance, rules crafted by courts to serve corporations have destroyed fundamental rights of redress created by a century's worth of hard-won labor, civil-rights, and consumer laws. Since many of the key cases were decided by 5–4 votes of the Supreme Court, a new court could make a huge difference.
Foremost, it is important to reverse the broad preemption doctrine of Southland that operates to nullify any state law that regulates enforcement of an arbitration clause. Secondly, it is necessary to reverse Green Tree and Italian Colors, which have narrowed the effective vindication doctrine, making it nearly impossible for parties to enforce federal rights in the face of an arbitration clause.
In addition, the Court should narrow the separability doctrine so that state law challenges to arbitration are decided by a court, not an arbitrator. And it should either refuse to enforce class-action waivers altogether or approve the use of class arbitration as a substitute, particularly for cases involving large numbers of claimants who each have small amounts at stake. And finally, the Court should reverse the 2001 Circuit City v. Adams case, which held that the FAA's employment-dispute exemption only applied to a narrow group of employees, and reinstate the actual intent of the FAA to exclude employment disputes from arbitration altogether. These proposals are not merely wishful thinking.
Preemption. While overruling a 30-year precedent may sound like a daunting challenge, one conservative member of the Court-Justice Clarence Thomas-has advocated overturning Southland consistently, most recently in 2015 in DIRECTV, Inc. v. Imburgia. Moreover, it appears that the liberal justices who previously supported broad FAA preemption have changed their position, as evidenced by Justices Breyer, Ginsburg, Sotomayor, and Kagan's dissent in AT&T v. Concepcion. Thus it might be a propitious time to revisit the issue of preemption under the FAA and restore the ability of states to protect consumers and workers from harsh and unfair arbitration agreements.
Restore a robust effective vindication doctrine. In the Italian Colors case, the Court narrowed the effective vindication doctrine practically out of existence. At the present time, it appears that Justices Kagan, Ginsburg, Breyer, and possibly Sotomayor (who did not participate in Italian Colors) would support a robust effective vindication doctrine. Here, too, one more vote on the Court could be decisive.
Eliminate or narrow the separability doctrine. In Rent-A-Center, separability was used to deprive the plaintiff of his rights under state law to challenge an unconscionable arbitration clause in court. In that case, Stevens, Ginsburg, Breyer, and Sotomayor dissented. Again, one more justice could preserve workers' and consumers' state-law protections against the enforcement of illegal, fraudulent, or unconscionable contracts.
Restore class actions. If these other cases are overturned, then parties would be more likely to succeed in invalidating arbitration clauses that are coupled with bans on class actions. Most composite clauses would either be found unconscionable on state-law grounds or unenforceable because they make it impossible for parties to vindicate their substantive rights.
Restore the FAA's exclusion for contracts of employment. There is one other Supreme Court case that, if reversed, would instantly restore workers' rights. Section 1 of the FAA contains an exemption for "contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce." In Circuit City, the Court read the exemption practically out of existence. In that case, employee Saint Clair Adams sued his employer, a national electronics retailer, for sexual harassment, constructive discharge, and discrimination. He sued in state court, alleging he had been fired because of his sexual orientation. Circuit City moved to dismiss because there was an arbitration clause in his initial contract of employment. Adams argued that he should not have to arbitrate his claims because the FAA did not apply to employment contracts. The Supreme Court disagreed. Kennedy, writing for the majority, read the exemption narrowly to only exclude workers who were like seamen and railroad employees-i.e., transportation workers whose work literally took them across state lines.
Four justices dissented in Circuit City: Stevens, Ginsburg, Breyer, and Souter. They argued that the legislative history of the FAA demonstrates that Congress intended to exclude all employees over whom it had power to legislate. In 1925, before the New Deal, courts had held that Congress only had the power to regulate the employment of seamen and railroad workers, not workers in manufacturing or other sectors. The dissenters in Circuit City contended that as Congress's commerce power was broadly expanded during the New Deal period, so too should the meaning of the exclusion. Under their view, the statute, by its explicit terms, excludes from its scope all workers engaged in interstate commerce.
Although Stevens and Souter are no longer on the Court, their replacements-Sotomayor and Kagan-together with one more liberal justice would constitute the five votes necessary to overturn that precedent. If that were done, the FAA would no longer apply to most employees.
For more than three decades, the expansion of arbitration by conservative courts has upended consumer and worker rights. Now, with a vacancy on the Supreme Court and the prospect of one or two more during the next presidential administration, the high court could remedy the situation. At stake are the fruits of a century's struggle for worker and consumer rights.
