Federal Law "Displaces" State Law

Many consumer contracts contain clauses that require disputes to be handled in arbitration. They also ban consumers from joining with others to bring a class action lawsuit.

However, some states have ruled that these contracts are not enforceable and have allowed class action suits to go forward. That is the crux of a Supreme Court case, which was decided on April 27, 2011.

Facts of the case: Vincent and Lisa Concepcion entered into a cell phone contract with AT&T Mobility LLC for the sale of phones and for service. The contract provided for arbitration of disputes in an "individual capacity" but it did not permit classwide claims. After the California couple were charged $30.22 sales tax on the retail value of phones advertised for "free" under their service contract, they sued the telephone company. Their suit was later consolidated with a class action alleging AT&T engaged in false advertising and fraud by charging sales tax on free phones.

AT&T moved to compel arbitration under the terms of the contract. The Concepcions argued arbitration was "unconscionable and unlawfully exculpatory under California law" because it disallowed classwide proceedings. The U.S. District Court for the Southern District of California denied AT&T's motion. Despite ruling in favor of the Concepcions, the District Court did describe the telephone company's arbitration process favorably, stating it was "quick, easy to use" and that consumers would likely be better off with it than they would be as members of a class.

The Ninth Circuit Court of Appeals agreed that the provision was unconscionable and therefore unenforceable. The case then headed to the Supreme Court. At issue is whether California law regarding contracts and arbitration is preempted by the Federal Arbitration Act (FAA), which was enacted back in 1925.

The question the high court had to answer: Does the FAA prohibit states from conditioning the enforceability of certain arbitration agreements on the availability of classwide arbitration procedures?

Justice Antonin Scalia, in delivering the opinion of the Supreme Court, wrote that the point of arbitration "is to allow for efficient, streamlined procedures tailored to the type of dispute...and the informality of arbitral proceedings is itself desirable, reducing the cost and increasing the speed of dispute resolution."

The Supreme Court ruled that the FAA "displaced" state law. "States cannot require a procedure that is inconsistent with the FAA, even if it is desirable for unrelated reasons," the Court ruling stated. (AT&T Mobility LLC v. Concepcion, No. 09-893)

What the ruling could mean: The potential impact of the case is significant. It will make it harder for some consumers to join in class action claims. In addition, more corporations may ask customers, vendors, employees and other parties that they transact business with to sign arbitration agreements with class action waivers. Companies with consumer agreements may want to revise them.

However, some wonder if the Dodd-Frank Act, enacted in 2010, may further change the arbitration landscape. The law requires the new Consumer Financial Protection Bureau (CFPB) to research and report to Congress about mandatory arbitration agreements on financial products. Still, changes that may stem from the CFPB are not going to happen in the near future.

If you have questions about contracts, arbitration, or class action litigation, consult with your attorney.