The third arbitration trilogy: Revelation, reaction and reflection on the direction of American arbitration

The following contribution to our arbitration symposium is by Thomas Stipanowich, the William H. Webster Chair and Professor of Law at Pepperdine and the Academic Director of the Straus Institute for Dispute Resolution (ranked first among academic dispute resolution programs by U.S. News for seven years in a row).  He is a widely published author, teacher, trainer, and policymaker.  For five years (from 2001-06), he served as CEO of the International Institute for Conflict Prevention & Resolution (CPR).  In 2008 he received the ABA Dispute Resolution Section’s highest honor, the D’Alemberte-Raven Award, for contributions to the field.

An extensive discussion of the themes addressed below may be found in Thomas J. Stipanowich, “The Third Arbitration Trilogy: Stolt-Nielsen, Rent-a-Center, Concepcion and the Future of American Arbitration,” American Review of International Arbitration (forthcoming), available here.

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The Supreme Court has been making new arbitration law at a pace unparalleled since the 1980s. Back then the Court declared that the Federal Arbitration Act (FAA), which extends to any transaction evidencing interstate commerce, pre-empts any state laws that lessen the enforceability of arbitration agreements. Now, a five-member majority led by Justice Antonin Scalia is aggressively building upon that “revealed” federal foundation, raising concerns even among some traditional proponents of arbitration. Two recent five-four decisions greatly expand the power of companies to impose and control agreements governed by the FAA. They dramatically reduce the ability of courts to ensure the fairness of private agreements requiring consumers and employees to arbitrate instead of bringing suit in court.

The authority of courts to deny or limit the enforcement of arbitration agreements “upon such grounds as exist at law or in equity for the revocation of any contract” has long provided a basis for judicial “gatekeeping” in the realm of arbitration agreements. The most important of these grounds, unconscionability, gives judges a flexible, potent tool to set boundaries on arbitration provisions in standardized contracts of adhesion involving employees and consumers. The doctrine has provided a basis for striking down prohibitions on, among other things, discovery, unfair arbitrator selection schemes, requirements to arbitrate in a distant venue, and remedy-stripping clauses. Although some worry that unconscionability affords courts too much discretion to strike down or modify arbitration agreements, there are currently no effective alternatives.

In Rent-A-Center, West Inc. v. Jackson (2010), an employment discrimination case, Scalia and the Court majority ruled that the FAA permits contractual “work-arounds” that trump the gatekeeping function of courts and leave questions of unconscionability and other defenses in the hands of arbitrators. They concluded that if a standardized employment agreement clearly and unmistakably delegates such functions to the arbitrator, the delegation will be enforced unless a court finds that the delegation provision itself is subject to a valid contractual defense. As a result, delegation provisions will probably become ubiquitous in employment and consumer contracts. A party seeking to avoid arbitration will then have to show a court that the delegation provision should not be enforced due to duress, fraud, unconscionability, or another valid contract defense.

Unfortunately, the Court has given us no indication of what kind of circumstances might justify denial of enforcement. Would delegation be effective if an adhesion contract gives a company unilateral control over the selection of arbitrators or the creation of a list of “acceptable” arbitrators? What if there are demonstrable conflicts of interest on the part of arbitrators or administrative bodies helping with selection? A Justice committed to maximal enforcement of arbitration provisions may be unwilling to find prejudice to an employee or a consumer in the absence of strong proof. Fairness issues will be left to the discretion of private arbitrators; employees or consumers who disagree with their determinations will have no choice but to wait until after an award has been rendered and seek vacatur on one of the limited procedural grounds of FAA Section 10. While this state of affairs may be preferable in most forms of business-to-business arbitration, and while most arbitrators undoubtedly perform their functions competently and in good faith, consumer and employee advocates see Rent-A-Center as enhancing the threat of procedural abuse under arbitration agreements.

The Court’s decision in AT&T Mobility LLC v. Concepcion (April 27, 2011) reinforces these concerns. Again, Scalia and a bare majority ruled that pro-arbitration federal policy trumps state law affecting arbitration agreements – in this case, California’s Discover Bank rule. Discover Bank is a variant of the unconscionability doctrine, which places certain limits on terms that purport to waive a consumer’s right to bring claims as part of a class action. According to the majority, the central policy of the FAA is to enforce arbitration agreements as they are written and pre-empt state law that treats arbitrate agreements differently from other kinds of contracts. Although the principles of Discover Bank are aimed at class action waivers in contracts with and without arbitration clauses – and hence, are not aimed particularly at agreements to arbitrate – the majority found that the impact of Discover Bank on arbitration was “unique.” This was because, by creating the possibility of consolidated proceedings in arbitration, it interfered with “fundamental attributes” of arbitration: “efficient, streamlined procedures tailored to the type of dispute.”

Because the contract at issue in Concepcion involved remedial provisions that appeared highly favorable to individual consumer claimants and were in some respects an arguably acceptable alternative to class-wide action, reasonable persons could reach different conclusions about the Court’s holding. The Court’s logic, however, is problematic.

First, the majority elevates efficiency and economy but completely ignores the requirement of fundamental fairness that permeates the law and practice of arbitration. In business-to-business arbitration, the goals of efficiency and economy are virtually always tempered by concerns about due process; in fact, there are currently multiple notable efforts to address what many consider to be an over-emphasis on litigation-like “due process” in commercial arbitration. Fundamental fairness is a central goal and theme of regulated securities arbitration, as well as the impetus for the due process protocols (employment, consumer, health care) that were developed through broad-based “community” efforts in the 1990s.

Second, the insistence that class action “changes the nature of arbitration” conflicts with the reality of arbitration as a potpourri of processes, some of which resolve complex multilateral disputes. Moreover, the majority’s expressed concern about the high risks for corporations of a “wrong” result in class-wide arbitration stands in sharp contrast to its repeated willingness to commit individuals (including, most notably, employees) to high-stakes arbitration.

Finally, Concepcion leaves one wondering what is left of the doctrine of unconscionability in arbitration setting. Concerns employees raise about arbitration are nearly always based upon contractual provisions that make arbitration less protective of their rights than corresponding judicial procedures, and courts have tended to use the baseline of court process as a rough measuring stick for unconscionability determinations. If any of these procedural safeguards arguably lessen efficiency and economy, however, they may be deemed inconsistent with the FAA.

Until recently, the Supreme Court’s aggressive expansion of arbitration law occurred in the absence of a response by Congress. However, there is now a flurry of legislative activity aimed at prohibiting or regulating pre-dispute agreements to arbitrate employment and consumer disputes. The 2010 Department of Defense Appropriations Act prohibits federal contractors who receive funds under the Act for contracts over $1 million from requiring their employees or independent contractors to arbitrate Title VII or tort claims “arising out of rising out of alleged sexual assault or harassment.” Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, a whistle-blowing employee cannot waive his right to a judicial forum. The pending Arbitration Fairness Act of 2011 would amend the FAA to prevent the use and enforceability of pre-dispute arbitration agreements in all consumer and employment contracts, and with respect to claims under disputes under statutes protecting civil rights.

Neither the extreme pro-arbitration position staked out by the Court nor the anti-arbitration stance of some legislators is supported by thoughtful consideration of the capabilities, limitations and real costs of different process choices in different transactional settings. If properly conducted, Dodd-Frank’s call for agency review of the operation of arbitration in financial services and securities investment settings may offer one starting point for dispassionate, thoughtful inquiry into the full range of procedural options. This must include discrete consideration of the single most contentious issue, class actions.

In the highly politicized struggle over employment and consumer arbitration, expectations shift dramatically with the political climate. The risks and uncertainties that confront all sides in this debate create the potential for thoughtful, dispassionate consideration of the operation of arbitration in these arenas, and the broader concerns and realities at play in consumer and employment dispute resolution.

Good decisions about the resolution of employment and consumer disputes must begin with a commitment to obtain and act upon better information. We need to move way beyond the meaningless “arbitration is good/arbitration is bad” dichotomy to look at the capabilities, limitations and real costs of different process choices in specific contractual settings. Since the Dodd-Frank Wall Street Reform and Consumer Protection Act decreed that agencies should examine arbitration in the context of different consumer finance transactions and of securities brokerage disputes, these arenas are obvious starting points. Recent empirical scholarship has given us more insights into these processes, but much more remains to be done.

Looking ahead, there are several alternative process models that ought to be considered by policymakers. For example, some studies indicate that well-administered arbitration under procedural “due process” standards enhances experiences and outcomes for consumers and employees. Such standards were first developed as “Due Process Protocols” in the 1990s, and were subsequently adopted in procedural rules by the American Arbitration Association, inspiring similar efforts by JAMS and other providers. Although the existing models are all privately administered and have legal effect only as elements of the agreement to arbitrate, some have proposed incorporating due process guidelines in the FAA as a minimum standard for the governance of consumer and employment arbitration. Statutory due process standards would provide much more extensive, uniform guidance for judicial policing of arbitration agreements, alleviating some of the concerns associated with the relatively imprecise and malleable primary tool now used by courts, unconscionability.

Such standards could be an effective way of overcoming the dramatic limitations placed by the Court on regulation of adhesion contracts under the rubric of federal preemption. There would, however, still be a role for courts in fleshing out the standards in application to specific factual settings. One would also expect arbitral discretion to remain in play regarding procedural issues like the precise extent of discovery.

Regulated securities arbitration suggests another model to be considered if pre-dispute arbitration agreements are still enforced. The history of securities arbitration under the auspices of securities self-regulatory organizations – now the Financial Industry Regulatory Authority – demonstrates how a framework that combines active agency oversight of rulemaking and administration with ongoing debate between advocates for investors and brokerage companies can engender a dynamic process that promotes greater fairness and response to change. Over the last two decades, the system has undergone procedural reforms affecting every aspect of the arbitration process, and offers a relatively efficient and economical framework for resolving investor claims. While extensive recent studies of securities arbitration present a mixed picture regarding investor claimants’ success rates and perceptions, the system continues to evolve under the supervision of the Securities and Exchange Commission. Such regulation, does, however, entail significant costs, much of which today is borne by the securities industry.

A third option is suggested by lemon laws, which provide an abbreviated, speedy, out-of-court arbitration process for disgruntled buyers, along with the option to go on to court if the buyer is unhappy with the result. Because lemon laws preserve the right to trial, they avoid the necessity of producing an effective full-blown substitute for court trial in the initial adjudicative stage. The out-of-court procedures are the essence of simplicity – rough and ready, and well suited to the subject matter. Whether the lemon law model is appropriate for broader application remains to be seen.

What of the litigation option? For most Americans, going to court is the implicit “measuring stick” for justice. But costs and delays have created access to justice concerns – concerns reinforced by current public budget cutbacks. We must heed the recent report of the American College of Trial Lawyers calling for reform of the “one-size-fits-all” approach to litigation and search for innovative process solutions. For example, some other countries have established public consumer tribunals or administrative employment tribunals that offer relatively efficient, effective alternatives to court.

In assessing current process choices, two important factors deserve special mention: the potential impact of online dispute resolution, and the role of class actions. Although we are only beginning to understand its possibilities and pitfalls, the rapidly developing world of electronic communications offers a completely new way of imagining consumer conflict resolution. Transparency and understanding may be promoted by online access to information about process choices through interactive, user-friendly platforms.

Virtual hearings are a way of overcoming time and distance and reducing the very real costs of adjudication, public or private. A new Online Dispute Resolution Working Group of the United Nations Commission on International Trade Law is exploring the creation of standards for the online resolution of cross-border e-commerce disputes, including business-to-consumer disputes. An important element of the discussion is the creation of a “global case database” available to participants worldwide, and, possibly, a system of universal service represented by a single logo or “trustmark.”

Finally, no discussion of arbitration or other process choices, public or private, can ignore the abiding issue of class actions, the policies supporting their use to vindicate the rights of consumers and employees, and the concerns that have motivated businesses to promote enforcement of contractual waivers of the right to sue on behalf of a class. In the arena of consumer and employment arbitration, class action waivers have been the primary point of contention between business and consumer/employee advocates.

In the field of consumer financial services, moreover, the avoidance of class actions are often the primary motivating factor supporting the use of arbitration provisions; there is evidence that, but for the ability to avoid class-wide suits, financial institutions would sooner take their chances in court. Though it is far more than an “arbitration issue,” the struggle over the role of class actions is a key element in determining the future role of arbitration and the contours of the broader landscape of civil justice.