The Rise And Fall Of Class Arbitration

Article by John M. Townsend1

First published in AAA Yearbook on Arbitration & the Law 2010

Class arbitration is a useful procedural device in need of a friend. It is the first choice of almost no one as a means of resolving disputes involving large numbers of claimants or respondents. Rather, it is primarily a creature of the courts: The Supreme Court called it into existence in its Bazzle decision in 2003, and effectively disowned it in its Stolt-Nielsen decision in 2010.2 Nevertheless, it has real advantages to offer as a method of dispute resolution, if the adversaries in the ongoing battle over class actions would stop shooting at each other long enough to consider them.

Class arbitration is, in its origins, a reaction to a reaction to a reaction: A reaction of the courts to the reactions of class action lawyers to the reactions of corporations to class actions. The first reaction was of large corporations that do business with significant numbers of customers or employees against class actions, as that procedural device is used in American courts. Many corporations came to feel that class actions, used to aggregate claims of individuals for damages in small amounts that would not individually make it economical to retain a lawyer, were used primarily to enrich the lawyers who brought the class actions. They point to a history of such actions being settled after a class action was certified, when the risk of an adverse decision became great enough to persuade the defendant to agree to a settlement that would pay a large fee to the class action lawyer, but would only pay such a small amount to each class member that many class members never claimed their shares.3

Such corporations discovered that, by inserting arbitration clauses in contracts, they could often convince courts that an agreement to arbitrate any dispute was inconsistent with the resolution of disputes on a class basis, even though the individual claim of the class representative might be for such a small amount that he or she would be unable to pursue the claim on an individual basis.4 This was the approach taken for many years by the federal courts, which found an agreement to arbitrate to preclude a class action, and which also concluded that Section 4 of the Federal Arbitration Act forbids a court to order class arbitration where the parties' contract is silent on the question of whether arbitration may proceed on a class basis.5 Because the corporations using these contracts were usually engaged in interstate commerce, these arbitration clauses were enforceable under the Federal Arbitration Act, and were thus immune from anti-arbitration legislation that has sometimes been devised by state legislatures.6

The reaction to that reaction was that representatives of consumers and employees who wished to bring class actions in the face of contracts with arbitration clauses in them began to try to persuade courts that, if arbitration clauses had the effect of making the remedy of a class action unavailable, they must be unconscionable and could be set aside on that basis.7 Because unconscionability is a ground that "exist[s] at law or in equity for the revocation of any contract," federal law permits a state or federal court to set aside an unconscionable arbitration clause, or the entire contract in which it appears.8

The reaction of the courts to the reaction of the class action bar to the reaction of the corporations was to find a way to have it both ways -- to have both arbitration and class proceedings. This reaction did not originate in the federal courts, which were generally reluctant to find arbitration agreements unconscionable.9 Rather, the reaction began in state court in California, where many novel ideas originate.10 The California Court of Appeals was probably the first to arrive at the conclusion that the way to give effect to an agreement to arbitrate, while preserving to the plaintiff the ability to bring his claim on behalf of a class, was to order the case to "arbitration on a class-wide basis."11

The concept that state courts could certify class actions and then refer the class claims to arbitration spread to other states.12 One of those was South Carolina, where the case that was to result in the Supreme Court's first pronouncement on the subject originated. In the Bazzle case, plaintiffs challenging the legality of a home improvement loan contract had brought a class action in South Carolina state court.13 The defendant moved to stay the action and to compel arbitration on the basis of an arbitration clause in the underlying contract. The South Carolina court certified a class action, as requested by the plaintiff, and then granted the defendant's motion to compel arbitration by ordering the class action so certified to arbitration pursuant to the arbitration clause in the representative plaintiff's contract. The same arbitrator to whom that arbitration was assigned subsequently certified, without a court order, a second class arbitration brought by a different plaintiff against the same defendant involving a similar challenge to the legality of a mobile home purchase contract. Substantial awards in favor of both classes were subsequently confirmed by the South Carolina trial court and upheld by the Supreme Court of South Carolina.14 The United States Supreme Court granted certiorari to hear both cases.

The Supreme Court's decision in the Bazzle case is fragmented into four opinions, none of which commanded a majority of the Court. The plurality decision by Justice Breyer, for four justices, held that the South Carolina courts should have allowed the arbitrator to make the threshold determination of whether the arbitration clause in each contract permitted arbitration on a class basis, rather than deciding themselves that the arbitration clauses permitted class arbitration.15 Justice Stevens would have affirmed the South Carolina Supreme Court's decision, but concurred in the judgment in order to provide a majority decision.16 Chief Justice Rehnquist, writing for himself and two other justices, concluded that courts should make the threshold determination of whether class treatment is permitted by arbitration agreements, but that the South Carolina courts had erred in their reading of the contracts involved.17 On remand, the South Carolina Supreme Court, as instructed, put that question to the arbitrator. Unsurprisingly, he concluded that the contracts did in fact permit class arbitration.18

The practical effect of the Bazzle decision was prompt and far-reaching. Shortly after the decision came out, the American Arbitration Association (AAA) realized that the Supreme Court had opened the door for arbitrators to certify class proceedings without specific judicial direction, and concluded that new rules would be needed to handle what amounted to a new type of proceeding. The AAA accordingly drafted and issued Supplementary Rules for Class Arbitration in October 2003.19 The need for such rules was not underestimated. Within six years, 283 requests for class arbitration had been filed with and administered by the AAA under its new rules.20

Remarkably absent from all of the opinions of the Supreme Court in the Bazzle case was any expression of concern about the due process implications of allowing an arbitrator, empowered only by the agreement of the named parties, to make decisions binding on absent class members. But that concern was very much on the mind of the AAA's committee that drafted the Supplementary Rules for Class Arbitration. First, mindful that arbitrators do not have the status or powers of federal or state judges, and also mindful of the economic burden that any class proceeding puts on the respondent, the Supplementary Rules built automatic stays into the class arbitration process to allow any party to seek judicial review of the arbitrator's decisions at two critical points prior to the final award.21 The first such automatic stay follows the completion of the first step in the process, a partial final award (the "Clause Construction Award") in which the arbitrator is directed by the Supplementary Rules to address the question that Bazzle puts to the arbitrator: whether the arbitration agreement permits the arbitration to proceed as a class arbitration.22 Of the 283 cases filed with the AAA as class arbitrations, 135 had resulted in Clause Construction Awards by September 2009.23 No statistics are available concerning the number of Clause Construction Awards that have been the subject of applications to the courts for confirmation or vacatur, but there have been decisions both ways.24 In addition, at least one decision found a Clause Construction Award not ripe for judicial review.25

The second automatic stay, reached only if the arbitrator answers...