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Supreme Court takes California to task—again—on class arbitration

December 16th, 2015  |  Lisa Milam

By Lisa Milam-Perez, J.D.

Continuing to chip away at California’s “outlier” arbitration jurisprudence, the Supreme Court ruled this week that a state appeals court erred when it upheld a decision refusing to enforce an arbitration agreement that included a class waiver. In DirecTV v. Imburgia, the High Court reaffirmed the preemptive supremacy of the Federal Arbitration Act in a consumer arbitration case with important implications for class arbitration of labor and employment disputes.

Class arbitration waiver. DirecTV’s service agreement included a mandatory arbitration clause, and a provision waiving the right to class arbitration. The agreement would be unenforceable in its entirety, though, if class arbitration waivers were impermissible under “the law of your state.” In other words, DirecTV’s contract provided, if your state would force us into class arbitration, we won’t arbitrate at all.

At the time the agreement was drafted, controlling law in California was a 2005 state supreme court decision that rendered class arbitration waivers unenforceable. The wrinkle here: the U.S. Supreme Court subsequently issued AT&T Mobility LLC v. Concepcion, invalidating the state high court case as preempted under the FAA—and leaving the legal status of DirecTV’s contract clause uncertain.

Did the parties intend to apply now-invalid California law to its arbitration agreement? That would be “nonsensical,” DirecTV insisted in its petition for Supreme Court review. But a state court took DirecTV at its word and refused to compel arbitration in a dispute brought by consumers over early termination fees. Hewing to the specific terms of the contract, the court found that since the class waiver was unenforceable in California when drafted, the agreement itself should not be enforced. A state appeals court affirmed. Notwithstanding the 2011 Concepcion decision, and the fact that the FAA preempted California law, the parties were still free, in drafting their contract, to reference state law as it stood at the time, the appeals court reasoned, concluding the parties did just that.

“Considerable latitude.” But… The FAA gives parties “considerable latitude” to decide what law will govern their arbitration agreements, including class arbitration waivers embodied within those agreements. “In principle,” Justice Breyer supposed (writing for the majority), “they might choose to have portions of their contract governed by the law of Tibet, the law of prerevolutionary Russia, or (as is relevant here) the law of California… and irrespective of [its] invalidation in Concepcion.” In this instance, the state appeals court determined that the parties intended for the latter to apply. And deference is normally due state court interpretations of a contract, which is typically a matter of state law.

Having said all that, the High Court said the state appeals court simply would not have construed a contract outside the arbitration context in such a fashion—i.e., as including an invalid provision of law. As such, the appeals court failed to place arbitration contracts “on equal footing with all other contracts,” which the High Court could not abide.

“We can find nothing in that opinion (nor in any other California case) suggesting that California would generally interpret words such as ‘law of your state’ to include state laws held invalid because they conflict with, say, federal labor statutes, federal pension statutes, federal antidiscrimination laws, the Equal Protection Clause, or the like,” wrote the Court. The state appeals court seems to have based its reasoning on the fact that the specific contract before it was an arbitration agreement, “rather than a general principle that would apply to contracts using similar language but involving state statutes invalidated by other federal law.”

Notably, the “equal footing” argument appeared neither in the petition for cert nor at oral argument. Was it the majority’s sua sponte means of dodging an unsavory choice in a case that threatened to pit “the sanctity of contract” against undying devotion to arbitration? At any rate, it was the approach that won the day for DirecTV.

“Insulating” the powerful? Justice Ginsburg (joined by Justice Sotomayor) dissented on policy grounds, decrying the increasing prevalence of mandatory arbitration with no-class arbitration clauses in both the consumer and employment realms. Indeed, the now-routine use of such agreements, in Ginsburg’s view, is “in large part due to this Court’s decisions.” The High Court’s expansion of the FAA in this manner is “further degrading the rights of consumers and further insulating already powerful economic entities from liability for unlawful acts,” she lamented. “Acknowledging the precedent so far set by the Court, I would take no further step to disarm consumers, leaving them without effective access to justice.”

“Not once” in over 25 years had the Supreme Court reversed a state court ruling because it ostensibly misapplied state contract law in construing the meaning of a term in an arbitration agreement, Ginsburg pointed out. “Today’s decision is a dangerous first.”

California: we’re talking to you. The case sent “a strong message to California courts”—where most of these cases are coming from—“to pay more than lip service to the FAA’s general presumption of arbitrability of a dispute,” said Wendy A. Sugg, Of Counsel in Troutman Sanders’ Orange County office. The Supreme Court took the opportunity to emphasize once again that Concepcion is the law of the land and that “attempts to work around that decision will not be looked upon favorably,” she noted.

The head-scratcher, though, is that on the same day, the High Court declined an invitation to strike down as wrongheaded the state’s continued insistence that individuals cannot waive, via arbitration agreement, the right to bring claims under California’s Private Attorney General Act (PAGA). It was in fact the second time the Court refused to impose the long arm of the FAA on these representative actions, leaving intact the California Supreme Court’s 2014 decision in Iskanian v CLS Transportation Los Angeles, LLC, even as several federal court judges in the state have refused to follow it. Yet a third petitioner will likely step up, to seek the Court’s review of the September 2015 decision in Sakkab v. Luxottica Retail North America, Inc. (assuming that a pending request for en banc Ninth Circuit review provides no recourse). In that case, the federal appeals court held the FAA did not preempt the Iskanian rule barring waiver of PAGA claims through arbitration agreements. Since this latest decision falls right in line with the other cases that have failed to lure the Justices, though, there is little reason to expect that the third time’s the charm.

What does that mean for employers? If Iskanian continues to stand, “employers are likely going to face a two-track process in the future for resolution of employment disputes, with individual claims heard in arbitration and representative actions seeking PAGA penalties going forward in the courts,” Sugg cautioned. “This leads to inevitable fears of conflicting outcomes and uncertainty.”