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Muhammad v. County Bank-Class Action Defense Cases: FAA (Federal Arbitration Act) Governed Arbitration Clause Forbidding Class Actions Unconscionable New Jersey Supreme Court Holds

New Jersey Supreme Court Holds that Provision in Arbitration Agreement Prohibiting Class Actions is Unconscionable but Severable so that Plaintiff may Pursue Class-Wide Arbitration

A part-time college student filed a class action against a lender for alleged violations of New Jersey consumer-fraud statutes; the defense moved to compel arbitration of plaintiff’s individual claim based on a class-action bar in an arbitration agreement. Muhammad v. County Bank of Rehoboth Beach, Delaware, ___ A.2d ___, 2006 WL 2273448 (N.J. August 9, 2006). The student had received a short-term unsecured loan in the amount of $200 on May 23, 2003, which she promised to repay, together with a “finance charge” of $60, on June 13, 2003. This meant that the annual percentage rate of the loan was 608.33%. Slip Opn., at 4. She extended the loan twice; each extension required an agreement to pay a $60 finance charge. Unable to pay the loan, plaintiff filed a class action against the lender. Id., at 8.

The loan application signed by plaintiff contained an arbitration clause requiring that any dispute be arbitrated, and that barred “bring[ing], join[ing] or participat[ing] in any class action,” Slip Opn., at 5-6. Plaintiff also executed a “Loan Note and Disclosure” form that reiterated the prohibition against class actions. Id., at 6-7. The defense moved to compel arbitration; the trial court granted the motion and the appellate court affirmed. Id., at 9-10. The New Jersey Supreme Court addressed “whether a provision in an arbitration agreement that is part of a consumer contract of adhesion is unconscionable and therefore unenforceable because it forbids class-wide arbitration.” Slip Opn., at 2-3.

The Supreme Court recognized that the arbitration agreement at issue was governed by the Federal Arbitration Act (FAA), but concluded that the FAA “does not prevent us from examining the validity of the class-arbitration waiver” and so turned to the issue of whether the clause was unconscionable under state law. Slip Opn., at 15. Preliminarily, the Court noted that “[t]he class-action vehicle remedies the incentive problem facing litigants who seek only a small recovery,” id., at 18, and that it is “recognized to be valuable to litigants, to the courts, and to the public interest,” id., at 19. The Court also found that the arbitration agreement “is clearly a contract of adhesion,” id., at 20. “The focus of our analysis, however, is on the agreement’s mandatory arbitration provision that contains limits on discovery and bars class-wide arbitration.” Id., at 21.

The New Jersey Supreme Court focused on the fact that the claims at issue were “predictably” small, and that “rational” consumers may not pursue consumer-fraud lawsuits on an individual basis. Slip Opn., at 23. Because the amounts involved were small, the fact state law permitted recovery of attorney fees was “not dispositive” on the matter. Id., at 24. Importantly, the Court did not hold that class-action waivers were “per se unenforceable.” Id., at 26. Rather, it limited its holding to the “precise issue” of “whether the small amount of damages being pursued in this action involving complicated financial arrangements and multiple out-of-state entities effectively prevents plaintiff from being able to vindicate the public interests protected by [state law].” Id., at 26-27. The Court concluded, however, that the class-action waiver was severable from the arbitration clause, and found the balance of the arbitration agreement enforceable. Id., at 32.

NOTE: The Court noted that “[a]t some point, an amount of damages will be high enough to attract counsel if attorney’s fees are available, even though no counsel would take the same case if no attorney’s fees were available,” Slip Opn., at 25 n.5, but the Court did not identify the threshold at which point class-action waivers would be deemed enforceable.

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