Arbitration: Unconscionability Gets a Class Action Waiver Struck by California Appeals Court (Web)

In an unpublished opinion, California's Second District Court of Appeals affirmed a trial court order denying a motion to compel arbitration on ground that the arbitration clause waiving class action arbitration rights was unconscionable and unenforceable.

The case, Merritt v. Cingular Wireless LLC, No. B178747, 2006WL 2744357 (Sept. 27, 2006)(available at www.courtinfo.ca.gov/opinions/nonpub/B178747.DOC), is a strong affirmation of the California Supreme Court’s Discover Bank ruling invoking unconscionability in striking down a ban on class action arbitration. Discover Bank v. Superior Court, 36 Cal.4th 148 (2005).

In April 2001, plaintiff Shannon Merritt entered into a wireless service agreement when she purchased a new Cingular phone and plan. The agreement included a mandatory arbitration clause under which the parties agreed to submit any dispute to final and binding arbitration, or take the dispute to a small claims court.

The agreement stated that the arbitration results would not be disclosed, and that the arbitrator could not order consolidation or class arbitration.

In July 2003, Cingular revised the arbitration provision by sending an insert to its customers, including Merritt, in their billing envelopes.

According to the revised arbitration provision, Cingular agreed to pay the American Arbitration Association filing, administration and arbitrators fees unless the arbitrator found the claim to be frivolous.

And if the customer prevailed in arbitration and “recovered the amount of her demand or more,” according to the California appellate panel opinion, Cingular agreed to reimburse “reasonable attorneys’ fees and expenses.”

The revision removed a prohibition on punitive damages and the confidentiality requirement. Cingular reiterated the class action prohibition, stating that “if this specific proviso is found to be unenforceable, then the entirety of this arbitration clause shall be null and void.”

In December 2003, Merritt and two other plaintiffs filed a class action against Cingular and SBC Communications in Los Angeles County Court, alleging that Cingular imposed per-minute roaming and expanded home plan “taxes,” which were not taxes imposed by the government, violating the California Unfair Competition Law (Bus. & Prof. Code, § 17200 et seq.), the False Advertising Law (id., § 17500 et seq.), and the Consumers Legal Remedies Act (Civ. Code, § 1750 et seq.).

Cingular asserted that the complainants were not California residents, and the statutes under which the nationwide class allegations were based only applied to California residents. Merritt amended her complaint in April 2004, deleting the allegations as to the other plaintiffs and SBC, and limiting the putative class to California residents.

In May 2004, Cingular's attorneys demanded Merritt dismiss this action and pursue her claims in arbitration. Merritt's attorney asserted that the arbitration provision was unconscionable and invalid.

On Sept. 7, 2004, Cingular filed a motion to compel arbitration. The opinion states that the trial court denied the motion to compel based on Szetela v. Discover Bank, 97 Cal.App.4th 1094 (2002), where a similar arbitration provision was held unconscionable. Cingular appealed.

The unpublished appeals court opinion relies heavily on Discover Bank v. Superior Court, last year’s California Supreme Court decision addressing the validity of an arbitration agreement provision prohibiting class-wide arbitration.

In Discover Bank, the Court agreed that some class action waivers in consumer contracts are unconscionable under the California law. The opinion notes two unconscionability situations: “First, when a consumer is given an amendment to its cardholder agreement in the form of a ‘bill stuffer’ that he would be deemed to accept if he did not close his account, an element of procedural unconscionability is present.”

Second, adhesive contracts containing class action waivers “may also be substantively unconscionable inasmuch as they may operate effectively as exculpatory contract clauses that are contrary to public policy.”

On appeal, Cingular acknowledged that the appeals court was bound by Discover Bank, but argued that the circumstance surrounding the arbitration provision in it was different, and Cingular's arbitration provision should be enforced.

The appeals panel opinion notes that the Szetela case “found procedural unconscionability in the adhesive nature of the contract,” along with “substantive unconscionability in the imposition of a one-sided and oppressive class action waiver provision.”

The Merritt appeals court, in fact, notes that Cingular's arbitration provision contained terms favorable to its customers. The appeals panel opinion states that the revised arbitration provision did not appear to be substantively unconscionable or contain “an allocation of risks or costs which is overly harsh or one-sided and is not justified by the circumstances in which the contract was made.” (Citations omitted.)

But the panel notes that the arbitration provision operates as an exculpatory clause in Cingular's favor, where Merritt's complaint involved allegations of a business practice that resulted in small losses to individual customers, but huge profits to the company.

A class action is “the only effective way to halt and redress such exploitation,” the opinion notes, quoting Discover Bank.

Drawing a parallel with Discover Bank, the opinion states, “Cellular service providers, like credit card companies, ‘typically do not sue their customers in class action lawsuits.’ Such one-sided, exculpatory contracts in a contract of adhesion, at least to the extent they operate to insulate a party from liability that otherwise would be imposed under California law, are generally unconscionable.” (Citations omitted.)

The panel observes that there was procedural unconscionability in the arbitration provision, because Cingular had greater bargaining power, depriving Merritt an opportunity to negotiate or respond. The case, the opinion notes, “therefore falls squarely within the holding of Discover Bank.”

The California court concluded that the class arbitration waiver was “found in a consumer contract of adhesion in a setting in which disputes between the contracting parties predictably involved small amounts of damages, [where] 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, . . . [and] the waiver becomes in practice the exemption of [Cingular] 'from responsibility for [its] own fraud, or willful injury to the person or property of another.’” (Civ. Code, § 1668.) Under these circumstances, [the class action waiver is] unconscionable under California law and should not be enforced.” Quoting Discover Bank, supra, at 162-163.

The appeals court concluded by discarding Cingular's preemption argument. It states that “Discover Bank does not establish ‘an across-the-board rule that class-action prohibitions are substantively unconscionable under California law.’” The principle was applicable to any contract, not only contracts to arbitrate.

California's Second District Court of Appeals held the arbitration provision to be void inasmuch as the class-wide arbitration waiver was unenforceable, and affirmed the trial court order.

--Ongmu Tshering, CPR intern