California Court of Appeal Clarifies Test for Class Arbitration Waivers

In Arguelles-Romero v. Superior Court (AmeriCredit Financial Services, Inc.) (May 13, 2010) ___ Cal.App.4th ___, the Court of Appeal clarified how to analyze a class action waiver in an arbitration clause.

The plaintiffs brought a putative class action for consumer loan violations. The defendant moved to compel individual arbitration. The Court of Appeal held:

While we hold the trial court did not err in finding the class action waiver was not unconscionable, we also conclude that it should have also performed a discretionary analysis on whether a class action is a significantly more effective practical means of vindicating the unwaivable statutory rights at issue. We therefore grant the petition and remand with directions.

Slip op. at 2.

After laying out the basics of California law on the enforcement of arbitration agreements and class arbitration waivers, the Court held:

The confusion in this case arises because plaintiffs seek to combine the doctrines set forth in Discover Bank and Gentry into a single test for unconscionability. Yet while Discover Bank is a case about unconscionability, the rule set forth in Gentry is concerned with the effect of a class action waiver on unwaivable statutory rights regardless of unconscionability. (Sanchez v. Western Pizza Enterprises, Inc., supra, 172 Cal.App.4th at p. 172.) While, in certain circumstances, a class action waiver may be both unconscionable and violate the rule of Gentry, the Supreme Court has established two separate tests which should be considered separately.

Slip op. at 13-14.

Discover Bank v. Superior Court (2005) 36 Cal.4th 148

Unconscionability in California is comprised of two parts, procedural unconscionability and substantive unconscionability. (Discover Bank, supra, 36 Cal.4th at p. 160.) Both must be present for a contract term to be considered unconscionable, although there is a sliding scale. “In other words, the more substantively oppressive the contract term, the less evidence of procedural unconscionability is required to come to the conclusion that the term is unenforceable, and vice versa.” (Armendariz, supra, 24 Cal.4th at p. 114.)

Slip op. at 14.

The Discover Bank court did not set forth a three-part test for unconscionability of a class action waiver in a consumer contract, although it is clear that the presence of three elements – (1) adhesion contract; (2) the dispute predictably involves small amounts of damages; and (3) allegations that the defendant has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money – was necessary to its analysis. (Discover Bank, supra, 36 Cal.4th at pp. 162-163.) For this reason, some federal cases applying Discover Bank have concluded that it established a three-part inquiry for determining the unconscionability of a class action waiver under California law. (See e.g., Shroyer v. New Cingular Wireless Services, Inc. (9th Cir. 2007) 498 F.3d 976, 983; In re Apple & AT&T Antitrust Litigation (N.D.Cal. 2008) 596 F.Supp.2d 1288, 1298; Stiener v. Apple Computer, Inc. (N.D. Cal. 2008) 556 F.Supp.2d 1016, 1024.) This is not strictly accurate. While it is true that the presence of the three Discover Bank factors is sufficient to establish the unconscionability of a class action waiver, the Supreme Court did not hold that class action waivers are unconscionable only when those three elements are present. (Cohen v. DIRECTV, Inc. (2006) 142 Cal.App.4th 1442, 1451.) A court is instead required to consider whether, to the extent the elements are not present, the facts might still compel the conclusion that the class action waiver is unconscionable. (Ibid.)

Slip op. at 16-17.

Gentry v. Superior Court (2007) 42 Cal.4th 443

In contrast, what we will call “the rule of Gentry” is not a rule of unconscionability. Indeed, the absence of procedural unconscionability is not relevant to striking a class action waiver as violative of the rule of Gentry. (Gentry, supra, 42 Cal.4th at p. 451.) 

The seeds for the rule of Gentry were planted not in Discover Bank, but in Armendariz, supra, 24 Cal.4th 83. Armendariz considered whether a plaintiff could be compelled to arbitrate discrimination claims brought under the Fair Employment and Housing Act (FEHA). The Supreme Court began with the premise that FEHA rights are unwaivable. (Armendariz, supra, 24 Cal.4th at p. 112.) The court agreed that, as a general matter, assuming the arbitral forum is adequate, an agreement to arbitrate a non-waivable statutory claim does not waive the claim, it simply submits its resolution to another forum. (Id. at pp. 98-99.) However, if the arbitral forum is not adequate, an agreement to arbitrate a non-waivable statutory claim may, in fact, improperly compel the claimant to forfeit his or her statutory rights. (Id. at pp. 99-100.) The Armendariz court then considered the minimum requirements that any arbitral forum would have to meet so that forcing a party to pursue non-waivable statutory claims in that forum would still enable the party to vindicate his or her rights. (Id. at p. 113.) These requirements included arbitrator neutrality, the provision of adequate discovery, a written decision that will permit a limited form of judicial review, and certain limitations on the costs of arbitration. (Id. at pp. 90-91.)   

The question that arose in Gentry was whether the right to a class arbitration should also be included among the Armendariz protections as a necessary minimum requirement for the arbitration of a non-waivable statutory right. The Supreme Court concluded that it should, “at least in some cases.” (Gentry, supra, 42 Cal.4th at p. 450.)  

Gentry involved a class of employees who alleged that their employer had improperly characterized them as exempt and therefore did not pay them overtime. (Gentry, supra, 42 Cal.4th at p. 451.) The statutory right to recover overtime is unwaivable. (Id. at p. 455.) The Supreme Court then concluded that, in wage and hour cases, a class action waiver would frequently have an exculpatory effect and would undermine the enforcement of the statutory right to overtime pay. (Id. at p. 457.) The court identified several factors which, if present, could establish a situation in which a class action waiver would undermine the enforcement of the unwaivable statutory right. These factors included: (1) individual awards “tend to be modest” (id. at p. 457); (2) an employee suing his or her current employer is at risk of retaliation (id. at p. 459); (3) some employees may not bring individual claims because they are unaware that their legal rights have been violated (id. at p. 461); and (4) even if some individual claims are sizeable enough to provide an incentive for individual action, it may be cost effective for an employer to pay those judgments and continue to not pay overtime – only a class action can compel the employer to properly comply with the overtime law (id. at p. 462). 

Gentry did not establish an absolute four-part test for the enforceability or unenforceability of class action waivers. Instead, “when it is alleged that an employer has systematically denied proper overtime pay to a class of employees and a class action is requested notwithstanding an arbitration agreement that contains a class arbitration waiver, the trial court must consider the factors discussed above: the modest size of the potential individual recovery, the potential for retaliation against members of the class, the fact that absent members of the class may be ill informed about their rights, and other real world obstacles to the vindication of class members' right to overtime pay through individual arbitration. If it concludes, based on these factors, that a class arbitration is likely to be a significantly more effective practical means of vindicating the rights of the affected employees than individual litigation or arbitration, and finds that the disallowance of the class action will likely lead to a less comprehensive enforcement of overtime laws for the employees alleged to be affected by the employer's violations, it must invalidate the class arbitration waiver to ensure that these employees can vindicate [their] unwaivable rights in an arbitration forum. [Citation.] (Gentry, supra, 42 Cal.4th at p. 463.) The Gentry court remanded to the trial court to determine “whether, in this particular case, class arbitration would be a significantly more effective means than individual arbitration actions of vindicating the right to overtime pay of the group of employees whose rights to such pay have been allegedly violated by [the defendant].” (Id. at p. 466.) As this determination is within the discretion of the trial court, and is similar to the inquiry made on a motion for class certification, we have previously held that the standard of review for a Gentry determination is abuse of discretion.15 (Sanchez v. Western Pizza Enterprises, Inc., supra, 172 Cal.App.4th at p. 169.)

Slip op. at 17-21.

Differences Between Discover Bank and Gentry 

Discover Bank and the rule of Gentry are, in the words of the Supreme Court, both applications “of a more general principle: that although '[c]lass action and arbitration waivers are not, in the abstract, exculpatory clauses' [citation], such a waiver can be exculpatory in practical terms because it can make it very difficult for those injured by unlawful conduct to pursue a legal remedy.” (Gentry, supra, 42 Cal.4th at p. 457.) One must be careful, however, not to attempt to distill a rule that any time a class action waiver is, in practical terms, exculpatory, the waiver cannot be enforced. This is so because some rights, even statutory ones, can be waived. (Armendariz, supra, 24 Cal.4th at p. 100.) Discover Bank and Gentry considered circumstances in which those waivers would not be upheld – either because they were procedurally and substantively unconscionable (Discover Bank), or because they were likely to result in a waiver of unwaivable statutory rights (Gentry).  

While Discover Bank and Gentry were applications of the same general principle, it is also apparent that they involved different legal theories. Discover Bank is based on unconscionability, which is a legal determination subject to de novo review, while Gentry is based on whether a class arbitration (or action) is a significantly more effective practical means of vindicating unwaivable statutory rights, which is a discretionary determination subject to abuse of discretion review.

Slip op. at 22.

Thus, the Court held that the trial court must "consider each test on its own merits, as it applies to the specific circumstances of a case."  

If the plaintiff can establish procedural unconscionability, the court should consider whether, under the circumstances alleged, the class action waiver is substantively unconscionable as a matter of law. If the plaintiff can establish a non-waivable statutory right is at issue, the court should make a discretionary determination under the rule of Gentry.  

Slip op. at 23.  

The opinion is available here.