Many consumer contracts contain arbitration clauses which require the consumer to waive his/her right to a jury trial and instead seek redress of his/her claims through arbitration. A question that is often raised here is whether these arbitration clauses are enforceable.
In 1925, in response to widespread judicial opposition to arbitration agreements, Congress enacted the Federal Arbitration Act (FAA), mandating the enforcement of arbitration agreements in contracts involving interstate commerce. The FAA, however, contains a so called “Savings Clause,” which preserves general contract defenses recognized by states such as fraud, duress, or unconscionability. Therefore, an arbitration agreement can still be challenged based on the same contract law principles that are applicable to other types of contract.
In AT&T Mobility v. Concepcion, 563 U.S. (2011) the U.S. Supreme Court examined the extent to which the FAA’s Savings Clause recognizes the states’ contract defenses. Concepcion involved a class-action lawsuit in which the class plaintiffs sued AT&T for false advertising. The agreement between AT&T and its customers required AT&T customers to arbitrate their disputes with AT&T. The agreement also prevented the customers from arbitrating their claims as class members in any class or representative proceeding. The federal district court and the Ninth Circuit Court of Appeals decided that under the California Discover Bank Rule, the waiver of class-wide proceedings in the arbitration agreement was unconscionable. Since a finding of unconscionability in a contract provision makes that provision unenforceable, the district court and the Ninth Circuit held that the AT&T’s arbitration agreement was invalid and unenforceable. However, in a five to four decision, the U.S. Supreme Court held that the California Discover Bank Rule is preempted by the FAA. According to the Supreme Court, the Discover Bank Rule is not within the ambit of the Savings Clause of the FAA since it does not constitute a valid contract defense as contemplated by the FAA. The Supreme Court reasoned that even general contract defenses, such as unconscionability, are preempted if they “stand as an obstacle to the accomplishment” of “ensuring that private arbitration agreements are enforced according to their terms.”
Recently, the Ninth Circuit, in Motensen v. Bresnan Communications, LLC, No. 11-35823 (9th Cir. July 15, 2013) interpreted Concepcion to decide whether the FAA preempts a Montana law that invalidates contracts of adhesion that are contrary to the reasonable expectations of a party. A contract of adhesion is an agreement that is strongly favorable to one party, therefore creating a presumption that the other party lacked bargaining power and did not enter into it freely.
In Mortensen, the class plaintiffs brought an action against a Montana cable company in federal district court, claiming violations of the Electronic Communications Privacy Act, the Computer Fraud and Abuse Act, and certain Montana invasion of privacy laws. The defendant filed a motion to compel arbitration on the basis that the agreement between the plaintiffs and the defendant required all claims to be arbitrated. The district court denied the defendant’s motion and the defendants appealed to the Ninth Circuit, which held that, under Concepcion, the Montana law is preempted by the FAA.
The Mortensen court interpreted Concepcion as holding that the FAA does not recognize any general state-law contract defense that has a disproportionate effect on arbitration agreements. According to Mortensen, Concepcion stands for the position that the FAA’s purpose is to “ensure that private arbitrations are enforced.” Hence, even generally applicable state-law rules are preempted if in practice they have a “disproportionate impact” on arbitration or “interfere with fundamental attributes of arbitration and thus create a scheme inconsistent with the FAA.”
In Mortensen, the Ninth Circuit applied the foregoing reasoning to determine whether the FAA preempts the Montana reasonable expectations/fundamental rights rule. According to Montana laws, a provision that was not in the reasonable expectations of both parties when contracting is void as against public policy. Montana finds arbitration agreements that are not made “voluntarily, knowingly, and intelligently” to be outside of consumers’ reasonable expectations. Montana law defines “voluntarily, knowingly, and intelligently” made as requiring a consumer to be informed of the consequences of a provision and to personally consent to waiver after receiving the proper information. Under this rule, only arbitration agreements explained to and initialed by consumers are valid and enforceable. The Ninth Circuit concluded that the Montana reasonable expectations/fundamental rights rule runs contrary to the FAA as interpreted by Concepcion because it applies to arbitration agreements disproportionately, invalidating them at a higher rate than other contract provisions. Hence, according to Mortensen, the FAA preempted the Montana law and therefore the arbitration agreement was valid and enforceable.
One may debate whether, as it claims, the Ninth Circuit in Mortensen has tried to put arbitration agreements on the same footing as other contracts or whether it has treated arbitration agreements as a special type of contract that deserve the highest protection. What remains clear is that the Mortensen case and its broad interpretation of Concepcion will make it more difficult for plaintiffs in the Ninth Circuit jurisdiction to challenge arbitration agreements based on general contract defenses. However, plaintiffs can still challenge the enforceability of arbitration agreements on other grounds such as defects in contract formation.