Class Action Waivers in Arbitration Clauses

Posted Tuesday, November 7, 2008

Illinois state and federal courts are currently grappling with a thorny issue that has been percolating through the courts in several important commercial jurisdictions: class action waivers in arbitration clauses.

Many consumer businesses have been turned on to the idea of putting arbitration clauses in their customer agreements or invoices.  Proponents of arbitration claim that arbitration is cheaper and quicker, provides for a knowledgeable arbitrator rather than an ignorant judge or jury, and is more private.  Reasons for opposing arbitration vary, but in the consumer context one commonly hears that arbitrators favor industry over the consumer and arbitrators do not award “fair” damages.

Now add the issue of class action waivers.  Large banks and other retail vendors have begun including carefully crafted class action waivers in the arbitration clauses in their customer agreements.  The arbitration clause broadly requires all disputes between the parties to be resolved in arbitration rather than litigation.  The class action waiver states that the customer affirmatively waives the right to assert any class or other type of representative claim against the vendor.  Together, these provisions effectively eliminate the possibility of a class action claim against the vendor by the customer.

All jurisdictions have some form of class action rule available to court plaintiffs.  When faced with a court challenge to class action waiver arbitration clauses, judges – who are used to their own procedural rules permitting class actions – have struggled.

Under recent Illinois case law, the issue comes down to the legal doctrine of “unconscionability.”  The Illinois Supreme Court will uphold arbitration clauses, even for claims where the claimant seeks a very small amount of money.  The harder issue becomes whether the court will also uphold a class action waiver within the arbitration clause.

For example, imagine a case where a bank customer believes the bank wrongly charged him a $37 overdraft fee (a case I recently litigated in court because the deposit agreement contained no arbitration clause).  If the deposit agreement has an arbitration clause, the claimant will have to arbitrate the claim.  He will not bother, however, unless he can pursue the claim as a class arbitration on behalf of all other customers who also paid this allegedly improper fee.  The Illinois Supreme Court will permit the class arbitration, even in the face of a class action waiver clause in the arbitration agreement, if the clause is “unconscionable.”  Whether a given clause is unconscionable or not depends on several vague factors set forth in the case law.  Because the difference between a class arbitration and an individual action can mean the difference between nominal damages and millions of dollars in liability, the unconscionability rule ineluctably leads to protracted and expensive litigation.  The stakes are too high on both ends to avoid it.

Lawyers for plaintiffs and defendants alike should find case law like this exasperating.  A legal test of “unconscionability” is nothing more than a license for result-oriented judicial decision-making.  One judge may find an agreement unconscionable, while another judge across the hall or across the state may find nothing wrong with the same agreement.  This sort of uncertainty does nobody any favors.  Businesses are entitled to know whether language in their contracts will be enforced or not, and if not, what contractual provisions they need to include in their form agreements to achieve the business purpose.  Businesses and consumers need to know what the law is so when they are inclined to participate in that market, either as a vendor or a consumer, they have adequate information to assess whether the benefits outweigh the risks or, alternatively, whether they should devote their resources elsewhere.

Send me an e-mail at mwilson@kkfplegal.com to receive KFP’s Special Report on Illinois Arbitration Class Action Waivers.

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