Class Action Waiver Rendered Arbitration Clause Unconscionable “Notwithstanding the Availability of Market Alternatives” and Federal Arbitration Act (FAA) does not Preempt California State Court Holding that Class Action Waivers are Unconscionable under California Law
Plaintiffs filed a putative class action in California state court against T-Mobile alleging violations of the state’s unfair business practices statute arising out of the early termination fees charged cellular telephone service customers and the sale of “locked” cellular phones that customers cannot use if they switch to another carrier. Gatton v. T-Mobile USA, Inc., 152 Cal.App.4th 571, 61 Cal.Rptr.3d 344, 346 (Cal.App. 2007). The trial court denied a defense motion to compel arbitration pursuant to the service agreement’s arbitration clause, which included a class action waiver, id., at 346-47. The California Court of Appeal affirmed, holding that “the class action waiver rendered the arbitration provision unenforceable” and that the Federal Arbitration Act (FAA) did not “preempt any rule that class action waivers are unconscionable under California law.” Id., at 347. The appellate court therefore affirmed the trial court order, which permitted plaintiffs to prosecute the putative class action in state court. The appellate court’s discussion of the FAA’s impact on class action waivers is contained in a portion of the court’s opinion that, pursuant to California Rules of Court, is not published and therefore many not cited; accordingly, we summarize here only that part of the opinion holding that the class action waiver rendered the arbitration clause unenforceable.
Plaintiffs signed cellular telephone service agreements with T-Mobile, acknowledging that they had “received and reviewed the T-Mobile Terms and Conditions” and that “ All disputes are subject to mandatory arbitration in accordance with paragraph 3 of the Terms and Conditions.” Gatton, at 347. The introductory paragraph of the Terms and Conditions advised people to “carefully read these Terms and Conditions” and to “NOT USE THIS SERVICE OR YOUR UNIT” if they are unwilling to agree to be bound by the provisions contained therein. Id. Section 3 of the Terms and Conditions, entitled “Mandatory Arbitration; Dispute Resolution,” precluded customers from seeking class action relief, id., and the appellate court summarized at pages 347 and 348 that “The terms and conditions incorporated into each of the plaintiff’s agreements included a mandatory arbitration clause including a class action waiver.” The contract required each party to pay for their own attorney fees, and for customers to pay $25 toward the arbitrator’s fee (save for claims of less than $25, in which case T-Mobile would pay for the arbitrator’s fee). Id., at 348, n.3.
With respect to the early termination fees underlying the class action allegations of certain plaintiffs, the class action complaint alleged that customers who terminate service prior to the expiration of the service contract are required to pay approximately $200 per telephone, and that this fee is also charged if T-Mobile cancels the contract for nonpayment or other reasons. Gatton, at 348. According to the class action complaint, the early termination fee is the same “whether the contract has been in effect for several weeks or several months,” and this “flat-fee early termination penalty constitutes an unlawful penalty under Civil Code section 1671, subdivision (d), is unlawful under the unfair competition law [(UCL)] (Bus. & Prof. Code, § 17200 et seq.), and is unconscionable under the Consumers Legal Remedies Act (CLRA) (Civ. Code, § 1750 et seq.).” Id., at 348-49 (footnote omitted). With respect to the class action’s claims concerning handset, the complaint charges that it is unlawful require prevent customers to purchase a new phone if they switch service providers. Id., at 349. The class action alleged that T-Mobile locked the SIM card so that the phone could not be programmed to operate on the service network of a competitor, and that the SIM can be unlocked simply by entering a numerical code, id. The class action complaint alleges that T-Mobile falsely represents that its phones “are not compatible with and will not work with other wireless networks” in violation of the UCL and the CLRA. Id. The complaint further alleges that locking the SIM “makes it impossible or impracticable for subscribers to switch cell phone service providers without purchasing a new handset.” Id.
Defense attorneys moved to compel arbitration; plaintiffs countered that (1) claims for injunctive relief under the UCL and CLRA are not arbitrable, and (2) arbitration is not warranted as to the remaining claims because the arbitration clause is unconscionable. Gatton, at 349. The trial court agreed with plaintiffs, id., at 349-50.
After summarizing California law regarding unconscionability and the seminal California Supreme Court decision in Discover Bank v. Superior Court, 36 Cal.4th 148 (Cal. 2005), Gatton, at 350-51, the appellate court turned to whether the service contract was procedurally unconscionable and explained that this test addresses “the manner in which the contract was negotiated and the circumstances of the parties at that time,” including evidence of oppression or surprise, id., at 352 (citations omitted). In this regard, the Court of Appeal held that the class action waiver provision was fully disclosed and so “[a] finding of procedural unconscionability in this case cannot be based on the existence of surprise.” Id. The “oppression” inquiry, however, focuses on “‘an inequality of bargaining power that results in no real negotiation and an absence of meaningful choice,’” and the opinion notes that some courts have equated adhesion contracts with procedural unconscionability. Id., at 352-53 (citations omitted). Here the service agreement was an adhesion contract, but defense attorneys argued that the class action waiver provision was not procedurally unconscionable “because plaintiffs had the option of obtaining mobile phone service from one of two other providers whose agreements did not contain class action waivers.” Id., at 353.
The appellate court “reject[ed] the contention that the existence of market choice altogether negates the oppression aspect of procedural unconscionability.” Gatton, at 353. The court explained at page 353, “The existence of consumer choice decreases the extent of procedural unconscionability but does not negate the oppression and obligate courts to enforce the challenged provision regardless of the extent of substantive unfairness.” In other words, “The existence of consumer choice is relevant, but it is not determinative of the entire issue.” Id., at 354. In the Court of Appeal’s view, “there are provisions so unfair or contrary to public policy that the law will not allow them to be imposed in a contract of adhesion, even if theoretically the consumer had an opportunity to discover and use an alternate provider for the good or service involved.” Id., at 355. Accordingly, the appellate court held, “[A]absent unusual circumstances, use of a contract of adhesion establishes a minimal degree of procedural unconscionability notwithstanding the availability of market alternatives. If the challenged provision does not have a high degree of substantive unconscionability, it should be enforced. But, under [Armendariz, supra, 24 Cal.4th at p. 114 (Cal. —-], we conclude that courts are not obligated to enforce highly unfair provisions that undermine important public policies simply because there is some degree of consumer choice in the market.” Id., at 355-56 (footnote omitted).
With respect to substantive unconscionability, which “focuses on overly harsh or one-sided results,” the appellate court held that the class action waiver had “a high degree of substantive unconscionability.” Gatton, at 356. The court found wanting defense attempts to distinguish this case from Discover Bank, id., at 357-58, concluding that this case falls “directly within the scope of the holding in that case,” id., at 358. Accordingly, it affirmed the trial court order denying the motion to compel arbitration. Id.
The appellate court’s discussion of the impact of the FAA on the enforceability of class action waivers in arbitration clauses may be found in the Slip Opinion at pages ___ – ___. The author again cautions out-of-state attorneys that this portion of the opinion generally may not be cited in California.
NOTE: In a concurring and dissenting opinion, one justice argued that the while Discover Bank v. Superior Court, 36 Cal.4th 148 (Cal. 2005), compelled a finding the arbitration clause was substantively unconscionable because of the class action waiver, the service contracts were not procedurally unconscionable because “plaintiffs do not show, on the record before us, either surprise or oppression to support their procedural unconscionability claim.” Gatton, at 358. Because California law requires both procedural and substantive unconscionability to render an arbitration clause unenforceable, the dissenting opinion argues that it was error to deny the motion to compel arbitration. Id.