United States: U.S. Supreme Court Rules That Federal Arbitration Act Pre-Empts CA Law Against Class Action Waivers

Action Item: The United States Supreme Court continues to find that federal law strongly favors arbitration clauses. The Supreme Court's decision in DIRECTV should provide some reassurance to companies that arbitration clauses in consumer contracts should be enforced by the courts.

In a 6-3 decision in DIRECTV, Inc. v. Imburgia et al., 577 U.S. ____ (2015),¹ the United States Supreme Court reversed the California Court of Appeal and held that state courts must enforce arbitration clauses even if a class action waiver in an arbitration clause would be unenforceable under state law, because the Federal Arbitration Act pre-empts conflicting state laws. Under the Federal Arbitration Act ("FAA"), 9 U.S.C. § 2, arbitration clauses are enforceable unless they can be revoked for the same legal or equitable reasons that allow any contract to be revoked. See 9 U.S.C. § 2.

Summary of Facts

DIRECTV entered into a service agreement with a number of California customers, including the named plaintiffs, Amy Imburgia and Kathy Grenier (the "Service Agreement"). Id. at 1. Section 9 of the Service Agreement provides that any disputes would be decided by arbitration and that the parties waived the right to bring class claims. Id. Although the Service Agreement stated that it would be governed by the FAA, 9 U.S.C. § 2, it also provided that if the law of the particular state made the waiver of class arbitration unenforceable, then the entire arbitration provision would also be unenforceable.Id.at p. 2.

The CA Court of Appeal Ruled that the Entire Arbitration Clause Was Unenforceable

The plaintiffs sued DIRECTV in California state court, seeking damages for early termination fees that they believe violate California law. Id. DIRECTV sought to enforce the arbitration clause, but the state trial court denied that request, and DIRECTV appealed. Id. On appeal, the California Court of Appeal held that the crucial issue was whether California law made the class waiver provision unenforceable, because, if the class waiver provision is not enforceable, the entire clause was unenforceable. Id.Although the California Supreme Court previously held that class waiver provisions are unenforceable because such provisions are unconscionable, the U.S. Supreme Court overturned the California court's decision in AT&T Mobility v. Concepcion, 563 U.S. 333, 352 (2011). See DIRECTV, 577 U.S. ____ (2015) at 3. In Concepcion, the U.S. Supreme Court found that the California rule was an obstacle to the accomplishment and execution of Congress's purpose in enacting the FAA, and thus the California rule was pre-empted by federal law. DIRECTV, 577 U.S. ____ (2015) at 3, citing Concepcion, 563 U.S. at 352.

Despite the U.S. Supreme Court's ruling in Concepcion, the California Court of Appeal found that the class action waiver is unenforceable under California law. DIRECTV, 577 U.S. ____ (2015) at 3. The California court found that because a California statute made class action waivers unenforceable, then the entire arbitration agreement was unenforceable under California state law. Id. Because the parties chose to have govern California law govern their agreement, the parties essentially contracted around the Concepcion decision. Id. Further, the California court found that the Service Agreement was ambiguous because the general language that the FAA would govern disputes was trumped by the specific language stating that the arbitration clause would be unenforceable if state law prevented class action waivers. Id. DIRECTV appealed to the U.S. Supreme Court.

The U.S. Supreme Court Overturns the CA Court

In deciding to overturn the California court, Justice Breyer explained that, although lower court judges "are certainly free to note their disagreement with a decision of this Court," state court judges are, of course, bound by the Supremacy Clause of the Constitution. Id. at 5. The FAA is a law of the United States and Concepcion "is an authoritative provision of that Act. Consequently, the judges of every State must follow it." Id. However, Justice Breyer noted that this elementary principle of federal law did not decide the case because the FAA allows parties to choose which law governs their agreement. Id. Because contract interpretation is ordinarily a matter of state law, the Supreme Court needed to decide whether the California Court's interpretation of the arbitration clause in this case was consistent with the FAA. Id. at 6. To do so, the Supreme Court considered whether the lower court opinion rested upon "grounds as exist at law or in equity for the revocation of any contract." Id. at 6, citing 9 U.S.C. § 2 (grounds in the FAA under which a court may find that an arbitration clause is unenforceable).

The Supreme Court then considered whether the California decision was based on a valid reason for finding that the Service Agreement was unenforceable. Id. at p. 6. To make that determination, the Supreme Court considered whether California treated arbitration clauses on equal footing with all other contracts. Id. Ultimately, the Supreme Court found that the California decision had treated arbitration clauses differently from how it would interpret other contracts. Id. Specifically, the Supreme Court noted that the California court had invalidated the arbitration clause because of a perceived ambiguity. DIRECTV, 577 U.S. ____ (2015) at p. 6. In contrast to the California court, the Supreme Court found that the contract is not ambiguous because the reference to state law could mean only valid state law, i.e., there was no suggestion that the parties intended to contract based on an unenforceable state law. Id. The Supreme Court evaluated several other possible scenarios for the California court's interpretation of the phrase "law of your state" to mean a law that has been invalidated under federal law and found that none of these were valid interpretations of the phrase. Id. at 7-9.

Justice Breyer concluded that the California court's interpretation of the phrase "law of your state" included legal principles that violate the Constitution. Id. at 10. The majority essentially found that the California court was using that phrase to strike down an otherwise enforceable arbitration clause and that this interpretation did not respect the FAA's policy favoring arbitration; thus, the California state law against class action waivers was pre-empted. Id. at 10.

Conclusion

The DIRECTV decision reiterates the U.S. Supreme Court's 2011 Concepcion decision, which held that the FAA pre-empts state law bans on class action waivers. The highest court's recent decision highlights that federal policy favors the enforceability of arbitration clauses and suggests that courts should continue to enforce such clauses. —©2015, Blank Rome LLP.

Mr. Streibich would like to thank Diana M. Eng and Joseph Patry for their assistance in developing this Alert.

Footnote

1 All citations refer to the copy of the decision that is posted on the Supreme Court's website at http://www.supremecourt.gov/opinions/15pdf/14-462_2co3.pdf (as accessed December 14, 2015).

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