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Big businesses do not like class actions, and for good reasons. Class actions are meant to be the method available to individuals to allow them to hold their own against giant corporate defendants by allowing these plaintiffs to aggregate their singularly modest claims for damages. That is, class actions give individuals leverage. However, in an apparently successful attempt to insulate themselves from class action liability, companies are including mandatory binding arbitration clauses in their contracts of adhesion to compel consumers, employees and others to arbitrate, rather than litigate, claims. These companies, thus, are preventing class actions by contractually eliminating courts as a forum for dispute resolution. HISTORY AND THE FAA Until the early 20th century, there was a common refusal by courts to enforce agreements to arbitrate. This refusal was a remnant from ancient times when English judges, who were paid on the basis of the number of cases they decided, were hostile to arbitration, which infringed on their livelihoods. Also, English courts were unwilling to surrender their jurisdiction. American courts adopted this hostility until industrialization dramatically increased the number of business disputes, which in turn increased the costliness and delays of litigation. In 1924, the United States Supreme Court upheld a New York law that compelled arbitration in a dispute involving a maritime contract. The Court’s decision in Red Cross Line v. Atlantic Fruit Company [FOOTNOTE 1]opened the door for Congress to pass legislation that compelled the enforcement of arbitration agreements. When Congress passed the Federal Arbitration Act (FAA) in 1925, it was motivated by a desire to provide an efficient method for businesses to settle disputes among themselves. The arbitration agreements subject to the FAA were meant to be negotiated between relatively sophisticated parties with equal bargaining power. After all, businesses should be capable of deciding if they needed access to the courts or if the limited rights available in arbitration were sufficient. In about 1995, plagued by problems of overcrowded dockets and expensive litigation, courts began to uphold the wide-spread use of arbitration agreements in areas never intended by the FAA, namely consumer and employment contracts. There is no doubt that this renewed interest in arbitration was heavily encouraged by big business, which was familiar with drafting and interpreting arbitration agreements as a means of cutting costs and reducing exposure. As a result of the recent popularity of mandatory binding arbitration clauses in consumer credit and employment contracts, businesses have managed to leave the little guy without his day in court and without any hope for justice. In upholding mandatory binding arbitration clauses in consumer and employment contexts, the FAA has been stretched beyond reason. Section 2 of the FAA provides: A written provision in any maritime transaction or a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction, or the refusal to perform the whole or any part thereof, or an agreement in writing to submit to arbitration an existing controversy arising out of such a contract, transaction, or refusal, shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract. [FOOTNOTE 2] The precise scope of contracts “evidencing a transaction involving commerce” was not originally clear. Although Congress provided a definition for the term “commerce” in �1 of the FAA, it did not identify the extent to which a contract must evidence a transaction involving commerce before the FAA will apply. Prior to 1995, there was a split among courts interpreting this language. Some courts found that the FAA applied only to those contracts where the parties contemplated interstate commerce. Other courts held that �2 reached to the limits of Congress’s power under the Commerce Clause. In 1995, the Supreme Court determined that a broad interpretation of �2′s “involving commerce” language was appropriate and held in Allied-Bruce Terminix Companies Inc. v. Dobson [FOOTNOTE 3]that the term signaled the full exercise of Congress’ power under the Commerce Clause. After concluding that �2′s “involving commerce” language should be interpreted broadly, the Court further determined that the FAA applies to all contracts that involve commerce and does not require the contemplation of an interstate commerce connection by the parties. The Court found that a “contemplation of parties” requirement was inconsistent with the FAA’s basic purpose, since such a requirement invited litigation about what was, or was not, contemplated by the parties. The FAA was meant to put arbitration agreements on the same footing as other contracts. That is, the Act was particularly strongly worded in order to overcome the hostility that existed in pre-industrial America toward enforcing arbitration agreements. For example, ambiguities are supposed to be construed to allow arbitration if possible, even though this principle comes in direct conflict with the basic contract principle that ambiguities are construed against the drafter. Today, more than 70 years after the FAA was passed, there is no hostility toward arbitration agreements. The result of courts interpreting the strong language of the FAA against the current backdrop of respect for arbitration agreements has created an arbitration monster. Companies include arbitration agreements in all of their contracts, including consumer credit and employment agreements. With the exception of some authority in California, class actions cannot be maintained in an arbitral forum, and most courts have held that consolidated arbitrations may only proceed if the arbitration clause specifically provides for it. Logically, since companies are motivated by a desire to eliminate class actions, they do not provide for consolidated arbitration in their agreements. Thus, aggrieved individuals must pursue alone their claims against companies, even if these claims are ideally suited for class action treatment. The insistence of today’s courts on upholding arbitration agreements in form contracts with consumers or employees as though each clause were negotiated by the parties, or may have been negotiated by the parties, has deprived individuals of the only leverage that they ever had against big businesses: the class action. UPHOLDING CONTRACTS The FAA prohibits the states from placing greater restrictions on arbitration clauses than those that apply to other contract provisions. Since Congress did not want state and federal courts to reach different outcomes about the validity of arbitration, the FAA preempts state law, and state courts cannot apply state statutes that invalidate arbitration agreements. In the leading case of Doctor’s Associates, Inc. v. Casarotto, [FOOTNOTE 4]the Supreme Court determined that �2 of the FAA preempts contrary provisions in state law. The state statute at issue in Casarottoprovided that a contract subject to arbitration must contain a notice typed on the first page in capital letters and underlined, informing the parties of the arbitration clause. The Court reasoned that the notice requirement was invalid because it applied only to contracts that are subject to arbitration and not to “any contract” as provided in �2 of the FAA. When considering a motion to stay proceedings and compel arbitration under the FAA, a court has four tasks. First, it must determine whether the parties agreed to arbitrate. Second, it must determine the scope of the agreement. Third, if federal statutory claims are asserted, it must consider whether Congress intended those claims to be nonarbitratable. And fourth, if the court concludes that some, but not all, of the claims in the action are subject to arbitration, it must determine whether to stay the remainder of the proceedings pending arbitration. In determining whether the two parties agreed to arbitrate the particular dispute, courts consider four guiding principles: 1) the duty to arbitrate arises from the contract; 2) a question of arbitrability is a judicial question unless the parties clearly provide otherwise; 3) a court should not reach the underlying merits of the controversy when determining arbitrability; and 4) as a matter of policy, courts favor arbitration of disputes. As a rule, a contractual dispute is arbitrable unless the court can say with positive assurance that no interpretation of the arbitration clause could cover the particular dispute. The standards for determining whether a federal statutory claim is subject to arbitration were established by the Supreme Court in Gilmer v. Interstate/Johnson Lane Corp. [FOOTNOTE 5]in 1991. The Court stated that “it is now clear that statutory claims may be the subject of an arbitration agreement, enforceable pursuant to the FAA,” and went on to state: Although all statutory claims may not be appropriate for arbitration, having made the bargain to arbitrate, the party should be held to it unless Congress itself has evinced an intention to preclude a waiver of judicial remedies for the statutory rights at issue. . . . If such an intention exists, it will be discoverable in the text of the [statute], its legislative history, or an “inherent conflict” between arbitration and the [statute's] underlying purposes. [FOOTNOTE 6](citation omitted) The Gilmercourt also held that the burden is on the party opposing arbitration to show that Congress intended to prevent waiver of a judicial forum in favor of an arbitral forum for the statutory claims. The Court explained that an “inherent conflict” between the policies underlying a federal statute and the enforcement of an agreement to arbitrate claims under the statute does not exist simply because the statute is designed not only to address individual grievances, but also to further important social policies because, so long as the prospective litigant effectively may vindicate his or her statutory cause of action in the arbitral forum, the statute will continue to serve both its remedial and deterrent function. During its 2000-2001 term, the U.S. Supreme Court issued two decisions bolstering even further the use of arbitration agreements. In Green Tree Financial Corp. Atlanta v. Randolph, [FOOTNOTE 7]the Court concluded that the failure to identify the costs of arbitration in an arbitration agreement does not invalidate such agreement. In addition, on remand, the 11th U.S. Circuit Court of Appeals affirmed the judgment of the U.S. District Court for the Middle District of Alabama, which held that Congress did not intend to create a non-waiveable right to bring Truth in Lending Act claims in the form of a class action and that neither TILA’s language, nor its legislative history, rendered arbitration “inherently inconsistent” with the TILA enforcement scheme. The Green Treecase involved Randolph suing Green Tree for violations of the Truth in Lending Act and the Equal Credit Opportunity Act. She argued that Green Tree failed to disclose the insurance requirement as a finance charge and impermissibly required her to arbitrate her statutory claims. Randolph contended that the arbitration agreement’s failure to disclose the related costs and fees of arbitrating a claim created a risk that she would have to bear prohibitive costs if she pursued her claims in an arbitral forum. This financial risk forced her to forgo any claims she had against Green Tree and left her unable to vindicate her statutory rights in arbitration. The Court determined that the prohibitive costs identified by Randolph were too speculative to justify the invalidation of the arbitration agreement. The Court stated that where a party seeks to invalidate an arbitration agreement on the grounds that arbitration would be prohibitively expensive, she bears the burden of showing the likelihood of incurring such costs. Randolph failed to meet this burden. In Circuit City Stores v. Adams, [FOOTNOTE 8]the Court considered the FAA’s exemption clause in �1, which states that ” . . . nothing herein contained shall apply to contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce.” [FOOTNOTE 9]Adams, a sales counselor at Circuit City, signed an employment application that included an arbitration provision. After filing a state employment discrimination claim against Circuit City, a federal district court found that the FAA compelled Adams to arbitrate his claim. The 9th Circuit reversed, holding that the arbitration agreement was in a “contract of employment” within the exemption clause of �1, and thus was not subject to the FAA. The Supreme Court reversed and concluded that the �1 exemption clause should be given a narrow construction. The Court interpreted the exemption to apply only to contracts involving seamen, railroad employees, and other types of related transportation employees as these categories of employees were enumerated specifically by the FAA. The Court stated: “there would be no need for Congress to use the phrases ‘seamen’ and ‘railroad employees’ if those same classes of workers were subsumed within meaning of the ‘engaged in . . . commerce’ residual clause.” [FOOTNOTE 10] INVALIDATING AGREEMENTS An arbitration clause may be invalidated on such grounds as exist “at law or in equity for the revocation of a contract.” Thus, arbitration clauses can be defeated by any defense existing under the state law of contracts, such as fraud, duress or unconscionability. These defenses may be applied to invalidate arbitration agreements without contravening the FAA. The most common defense asserted to defeat a motion to compel arbitration is unconscionability. Establishing unconscionability involves consideration of such issues as the relative bargaining power of the parties and their ability to know and understand the disputed contract terms; the terms of the agreement and whether they are unreasonable and unfair; and whether any meaningful choice exists. The defense of unconscionability is particularly appropriate in cases of contracts of adhesion. Such a contract is a standardized form contract offered to consumers of goods and services on essentially a “take it or leave it” basis, without affording the consumer any realistic opportunity to bargain, and under such conditions that the consumer cannot obtain the desired product or services except by acquiescing to the terms of the form contract. Contracts of adhesion appear in many circumstances, such as consumer credit agreements and employment agreements, and are not per se unconscionable. But where an absence of meaningful choice on the part of one of the parties exists with contract terms that are unreasonably favorable to the other party, courts may find the arbitration clause unconscionable and thus unenforceable. [FOOTNOTE 11]For example, an agreement was found to be substantively unconscionable because it required customers to give up other legal remedies, the arbitration clause expressly limited the company’s liability to actual damages, the clause removed the company’s exposure to any remedy that could be pursued on behalf of a class of consumers, and the clause forced customers to waive important statutory remedies, including injunctive or declaratory relief. [FOOTNOTE 12] The unconscionability argument is clarified by a knowledge of how arbitration works. In arbitration, a private judge (or arbitrator), paid for by the parties, hears a dispute. Arbitration is often conducted in secret, with the possibility of heavy penalties for consumers or employees who publicly disclose the proceedings. There is no requirement for a public record of the proceedings, depriving complainants of information that might buttress their own cases. There is no reliance on precedent. Some mandatory arbitration clauses bar employees or consumers from subpoenaing corporate records or taking depositions from corporate officials. The fee-based nature of arbitration raises a question as to whether the arbitrators possibly can be neutral. Agreements to arbitrate generally contain a term identifying which arbitration forum must be used. In the case of consumer transactions, such as credit card agreements, the credit card agreement specifies an arbitral forum in its contract, and millions of consumers are bound by the same agreement. So, if the agreement specifies that, for example, the National Arbitration Forum will hear the claims, then the National Arbitration Forum will receive fees for all of those arbitrations. Consequently, arbitration clauses force individual complainants to have their claims heard before arbitrators who depend upon the respondent companies for a large volume — and sometimes a majority — of their business. To make matters worse, in order to overcome the criticism that arbitration fees are prohibitive to the individual, companies are agreeing to advance all arbitration fees, sometimes subject to an agreement that the arbitrator ultimately will decide which party should pay the complainant’s arbitration costs, thereby increasing even further the arbitrator’s reliance upon fees generated by respondent companies. Nevertheless, in their most recent decisions, courts have steadfastly maintained that arbitration clauses in consumer credit and employment contracts are not unconscionable. In Marsh v. First USA Bank, N.A., [FOOTNOTE 13]a class action brought by credit card holders against First USA Bank in Texas, the court stated: In the instant case, while the arbitration provision may have been presented in a take-it-or-leave-it manner, the Court cannot say that it is so lopsided in Defendant’s favor as to be oppressive or prejudicial. The arbitration provision standing alone does not present an opportunity for one party to gain an unfair advantage over the other in arbitration, any more than the inclusion of a forum selection clause would impede a just result in a court of law . . . the Court concludes that the arbitration provision is not unconscionable” (citation omitted) [FOOTNOTE 14] It is interesting to note that statistics disclosed in 2000 in a lawsuit against First USA Bank, the same defendant, in Montgomery, Ala., showed that the card issuer won 99.6 percent of the 19,705 consumer disputes that it sent to an arbitrator over the prior two years. CURRENT TRENDS Spurred on by courts’ favorable decisions, companies are escalating their use of arbitration agreements. They are changing contract terms by stuffing notices in with bills and attempting to establish that arbitration agreements can be retroactive and be applied to eliminate class actions in pending lawsuits. On the other hand, the Consumer Credit Fair Dispute Resolution Act of 2001, S.192, was introduced on Jan. 25, 2001, by Senators Russ Feingold, D-Wis., and Patrick Leahy, D-Vt. The Act would amend �2 of the FAA to make invalid or unenforceable mandatory binding arbitration clauses in any consumer credit contract to which the consumer never agreed. The Act would not affect arbitration agreements that are entered into by the parties to a consumer credit contract after a controversy has arisen. S.192 responds to the use of mandatory arbitration agreements by credit card companies and consumer credit lenders like Green Tree. The bill’s sponsors are particularly troubled by the practice of credit card companies and consumer credit lenders of inserting mandatory binding arbitration clauses in their consumer agreements without consumers’ knowledge or consent. For example, many credit card companies implement the mandatory binding arbitration clauses pursuant to changes in terms of the original credit agreement and slip consumers a copy of the arbitration clause along with their monthly bills. Perhaps courts should begin to re-examine whether any meaningful choice exists. Theoretically, consumers may avoid the effect of an arbitration clause by canceling their agreements with one credit issuer, for example, and signing an agreement with another credit issuer. However, because arbitration agreements in contracts of adhesion are so favorable for companies, virtually no credit card agreement exists that does not contain an arbitration clause. Thus, this so-called meaningful choice is mere illusion. In effect, by their dogged insistence on enforcing arbitration agreements, the courts have allowed big business to create its own private justice system, a system in which class actions do not exist. Emily Madoff is a partner at Wolf Popper LLPin New York City. ::::FOOTNOTES:::: FN1 Red Cross Line v. Atlantic Fruit Company, 264 U.S. 109 (1924). FN29 USCA �2. FN3 Allied-Bruce Terminix Companies Inc. v. Dobson, 513 U.S. 265 (1995). FN4 Doctor’s Associates Inc. v. Casarotto, 517 U.S. 681 (1996). FN5 Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20, 26 (1991). FN6 Id. FN7 Green Tree Financial Corp. Atlanta v. Randolph, 531 U.S. 79 (2000). FN8 Circuit City Stores v. Adams, 121 S. Ct. 1302, 1315 (2001). FN99 USCA �1. FN10 Id.at 1308. FN11 Brennan v. Bally Total Fitness, 01Civ. 0533, 2001 U.S. Dist. Lex 15 9882 (S.D.N.Y. July 16, 2001). FN12 Powertel v. Bexley, 743 So. 2d 570 (Fla. Dist. Ct. App. 1999). FN13 Marsh v. First USA Bank, N.A., 103 F.Supp.2d 909, 920 (N.D. Tex 2000). FN14 Id.

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