Supreme Court Undermines Unconscionability Defense to Arbitration Agreements

29 April 2011 Publication

Legal News Alert: Business Litigation & Dispute Resolution

Consumer contracts that prohibit class actions and require individual arbitrations are enforceable, the United States Supreme Court held this week. This ruling not only dramatically changes the class-action landscape in Wisconsin and throughout the United States, but has significant implications for non-consumer commercial arbitration as well.

In its decision in AT&T Mobility LLC v. Concepcion, No. 09-893 (April 27, 2011),, the high court found that contracts prohibiting class actions are not unconscionable and therefore there is no impediment to enforceability under the Federal Arbitration Act, 9 U.S.C. et seq.

Moreover, because the federal act pre-empts limitations imposed by states, the Supreme Court discredited the California Supreme Court’s decision in Discover Bank v. Superior Court, 36 Cal. 4th 148, 113 P.3d 1100 (2005), and similar decisions in Wisconsin and several other state courts. Those decisions had marked a trend toward recognizing unconscionability as a defense and allowing consumers to bring class actions despite the language in their contracts.

When the Concepcions sued AT&T Mobility LLC (AT&T) on claims relating to their cell phone contract, AT&T moved to compel arbitration pursuant to an arbitration clause in that contract. Because that clause required claims to be brought in the parties’ “individual capacity, and not as a plaintiff or class member in any purported class or representative proceeding,” the district court and the Ninth Circuit held that it was unconscionable as a matter of California law under Discovery Bank and, therefore, could not be enforced under the FAA. (Section 2 of that statute makes arbitration agreements “valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.”) In essence, the Ninth Circuit decided that the Discover Bank rule was just a specific application of the general doctrine of unconscionability and was therefore not preempted by the FAA because unconscionability is not a defense specific to arbitration but, on the contrary, is a ground recognized “at law or in equity for the revocation of any contract.”    

In a 5-4 decision written by Justice Scalia, the Court reversed the Ninth Circuit and held that the FAA’s preemptive sweep extended to the Discover Bank rule. The Court reasoned that the FAA’s purpose is to ensure the enforcement of arbitration agreements as written to facilitate informal, streamlined proceedings. The improvised class arbitrations contemplated by the Discover Bank rule would have been anything but informal and streamlined. Hence, the Court held that the FAA preempted the Discover Bank rule because that rule created a scheme inconsistent with the congressional intent informing the FAA.  

The AT&T ruling casts grave doubt on the viability of last year’s decision by the Wisconsin Court of Appeals in Cottonwood Fin. Ltd. v. Estes, 2010 WI App. 75, 325 Wis. 2d 749, 784 N.W.2d 726. Echoing Discover Bank, the Cottonwood court held that an arbitration provision that included a class action waiver was substantively unconscionable because it violated § 421.106(1) of the Wisconsin Consumer Act. The Wisconsin Supreme Court ordered that the lender’s petition for review be held in abeyance pending AT&T Mobility.

The significance of AT&T Mobility for arbitration clauses relating to consumer transactions is obvious. A more subtle implication is that use of the unconscionability defense as recognized in consumer cases as a springboard for importing that defense into non-consumer commercial disputes — a step taken by at least one court — now appears to be a seriously compromised strategy. More broadly still, AT&T Mobility sends yet another strong signal that the Supreme Court has no intention of retreating from its aggressive defense of arbitration against persistent efforts by state courts, state legislatures, and various special interest groups to chip away at the FAA’s protection of enforceability. That battle goes back at least as far as Southland Corp. v. Keating, 465 U.S. 1 (1984), and even before Cottonwood showed no signs of abating in Wisconsin or elsewhere. See e.g., Wisconsin Auto Title Loans Inc., v. Jones, 2006 WI 53, 290 Wis.2d 514, 714 N.W.2d 155. If anything, AT&T Mobility continues this trend and shows that the federal courts, and the U.S. Supreme Court in particular, will continue to enforce arbitration clauses as written. Against this background of continuing conflict, it bears emphasis that AT&T Mobility does not necessarily obviate the risk that organizations administering arbitrations, or individual arbitrators, will seek through internal rule-making procedures and creative contract interpretation to bring class actions in through the back door even though carefully drafted agreements appear to have closed the front door to them.  

Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues. If you have any questions about this update or would like to discuss this topic further, please contact your Foley attorney or the following:

Michael A. Bowen
Milwaukee, Wisconsin

Zachary J. Corey
Milwaukee, Wisconsin

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