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June 27, 2005

Anti-class-action clause was unconscionable

A bank-customer agreement's arbitration provision had a clause forbidding classwide arbitrations. The California Supreme Court (4-3) says that was unconscionable and unenforceable. Discover Bank v. Superior Court (California 06/27/2005).

Basic facts: Discover Bank amended its agreement with credit cardholders by sending them a notice that added a requirement that disputes be resolved through arbitration, and that prohibited class action arbitrations. Cardholders accepted the new arbitration provision by continuing to use their cards. The contract provided that it was "governed by federal law and the law of Delaware."

Cardholders' suit claimed that the bank charged late fees (about $29) when payment was received after 1:00 p.m. on the due date, resulting in damages that were small as to individuals but large in the aggregate.

The bank sought an order compelling arbitration on an individual basis.

Basic holding of the California Supreme Court:

  • The anti-class-action clause was unconscionable under California law.
  • The Federal Arbitration Act (FAA) does not preempt California law on the unconsionability of class-action waivers.
  • The whole case might be governed by Delaware law, so the court remanded for a lower court decision on that aspect.

The dissent (by three of the seven judges) agreed that the FAA did not preempt, but argued that the case should be decided under Delaware law which allows class action waivers. They saw no need to decide anything about unconsionability under California law.

My view:

  • The unconsionability reasoning was quite narrow. The court said:
    We do not hold that all class action waivers are necessarily unconscionable. But when the waiver is found in a consumer contract of adhesion in a setting in which disputes between the contracting parties predictably involve small amounts of damages, 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, at least to the extent the obligation at issue is governed by California law, the waiver becomes in practice the exemption of the party “from responsibility for [its] own fraud, or willful injury to the person or property of another.” (Civ. Code, § 1668.) Under these circumstances, such waivers are unconscionable under California law and should not be enforced.
    • What is a "consumer contract"?
    • What are "small amounts of damages"?
    • What is "a scheme to deliberately cheat large numbers of consumers"?
    • Will a choice of law clause (e.g., providing that Delaware law applies) result in enforcement of a clause that is lawful in the other state but unconscionable in California?

  • Pre-dispute arbitration clauses in employment agreements are left up in the air by this case.

    • Most such cases will involve much more than $29 in damages.
    • How many employment disputes can be characterized as "a scheme to deliberately cheat large numbers of consumers" or employees?

Posted by Ross Runkel, Editor at LawMemo, publisher of Employment Law Memo. Try it.

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