• Hanson reports consumer arbitration bashed by California Supreme Court

Association of Business Trial Lawyers San Diego, ABTL Report, Volume XII No.4, November 2005:

By: John W. Hanson, JD, LLM

Rosner, Law & Mansfield



The California Supreme Court has begun to rain on the great parade of arbitration clauses in consumer contracts. In this Summer’s stormy 4-3 decision Discover Bank v. Superior Court (Boehr) (June 27, 2005) 36 Cal.4th 148, the Court held that where form contracts are used with consumers, and potentially small claims of damages may be involved, businesses cannot include an arbitration clause that waives the consumer’s right to proceed in a class action. Such arbitration clauses banning class actions are sometimes referred to as NCAACs for “No Class Action Arbitration Clauses.” Most consumer financial services (including the ten largest credit-card issuers), most telecommunications (including all the major cellular service providers), and even the majority of car dealerships now use such clauses. Although the holding of Discover Bank is quite broad in the number of contracts that will be affected, the dicta points to an even greater impact. The key question to consumer-law litigators and in-house counsel alike, therefore, is just how many business’s contracts will be affected by the run-off from Discover Bank. It is the position of this article that, to quote Bob Dylan, “it’s a hard, hard, hard, hard rain a gonna’ fall” for NCAACs. For many businesses that employ such clauses and fit the Discover Bank holding or its potentially even more expansive dicta, some important decisions are going to have to be made right away. And all businesses that deal with California consumers will have to assess whether they are in this group. For those in, they must now decide whether the “quick, cheap and final” decisions of arbitrators, so often trumpeted as beneficial to everyone in individual consumer cases, look quite so good when the stakes relative to businesses are higher.

Why did they do what they did? The answer is simple: the Court clearly believes that if consumers are prohibited from banding together their individually small claims into a single case an attorney will take, they will be effectively barred from any remedy. Individual cases or arbitrations for small amounts are simply not feasible, and knowledge of this fact together with a class action ban will create an incentive to do wrong on a massive scale for businesses willing to suffer the one judgment without collateral estoppel effect in favor of millions of incidents of profit.1

“Just the Facts, Ma’am” (and a Little Procedure):

The basic facts of Discover Bank are fairly simple. Plaintiff, Christopher Boehr, got a Discover Bank credit card in 1986. When he signed up, there was no NCAAC, or any arbitration clause at all. The agreement also contained a choice-of-law clause providing for the application of Delaware and federal law.

A few years later, Discover Bank stuffed into his monthly bill some papers announcing exciting facts such as: “Your Account involves interstate commerce” and “we are adding a new arbitration section,” and the gripping “neither you nor we shall be entitled to join or consolidate claims in arbitration by or against other cardmembers with respect to other accounts, or arbitrate any claim as a representative or member of a class or in a private attorney general capacity.” This last statement was the NCAAC. If he didn’t like the changes, the papers stated, he had to close his account. Mr. Boehr did not close his account.

Mr. Boehr then got a bee in his bonnet2 and decided to sue Discover Bank for its policy of assessing a $29 “late fee” and disallowing grace periods on new purchases where payments were in fact received on the due date, but after an undisclosed 1:00 p.m. “cut-off time.” Not only did he sue Discover Bank, he filed a nationwide class action, asserting violations of Delaware contract law and the Delaware Consumer Fraud Act.

When Discover Card received the class action complaint, it moved for the trial court to compel arbitration of Mr. Boehr’s individual claims and to dismiss the class action all pursuant to the “bill stuffer” agreement and its new arbitration and NCAAC clauses. The trial court initially applied Delaware law and granted Discover Bank’s motion entirely. However, Mr. Boehr moved to reconsider after a Court of Appeal decision found the exact same NCAAC unconscionable under California law. Pursuant to a choice-of-law analysis, the trial court found California law applied and the NCAAC unconscionable, but found the overall arbitration clause survived striking the NCAAC and giving Mr. Boehr the right to seek classwide arbitration. Discover Bank then filed a writ petition, and the Court of Appeal, Second Appellate District, issued an order to show cause.

The Court of Appeal held that the Federal Arbitration Act, 9 U.S.C. §1, et seq. (FAA) would preempt any California state law rule that NCAACs are unconscionable, but did not decide which state law (California or Delaware) applied. The California Supreme Court granted review of this case, as well as issuing grant-and-holds in several other cases.

The Known Criteria for Failure

The Court’s own stated holding lays out something like a four-part test for assessing the unenforceability and unconscionability of a business’s NCAAC. In order to fail the test of enforceability set out in the holding, one needs to satisfy four criteria: 1) a consumer contract of adhesion, 2) a relationship between business and consumer that predictably involves small amounts of damages, 3) an alleged scheme to cheat large numbers of consumers out of small sums of money, and 4) the application of California law. In setting out these criteria, the Court followed the standard unconscionability analysis. As the Court states, there are two necessary conditions to any conclusion that a clause is unconscionable: “procedural” and “substantive” unconscionability. “Procedural unconscionability,” the Court noted, focuses on “oppression” or “surprise” due to unequal bargaining power. “Substantive unconscionability” refers to “overly-harsh” or “one-sided” results. The Court set out its holding as follows:

“We do not hold that all class action waivers are necessarily unconscionable. But when the waiver is found in a consumer contract of adhesion in a setting in which disputes between the contracting parties predictably involve small amounts of damages, and when it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money, then, at least to the extent the obligation at issue is governed by California law, the waiver becomes in practice the exemption of the party “from responsibility for [its] own fraud, or willful injury to the person or property of another.” (Civ. Code, § 1668.) Under these circumstances, such waivers are unconscionable under California law and should not be enforced.”As discussed below, this article argues that even larger affects are on the horizon, as the dicta in Discover Bank refers extensively to the looming CLRA and its fundamental anti-waiver policy. In short, most of the NCAACs that might be enforceable under the unconscionability analysis and holding of Discover Bank, will likely fail where the CLRA is applicable. But first we should consider the four criteria.

Form, Consumer Contracts of Adhesion

No good news here for businesses wishing to keep arbitration provisions in their contracts without being subject to class arbitration. The Court had no trouble with finding procedural unconscionability in a form, “take it or leave it”contract. The Court did not labor over the circumstances of the contracts, seemingly taking for granted that adhesion contracts (form contracts presented on a “take-it-or-leave it” basis) equate with procedural unconscionability. The Court did note that the NCAAC was in a “bill stuffer,” but was not clear whether bill stuffers added oppression, surprise, or both. One might assume that closing an account, which was the only way to refuse the NCAAC amendment, makes the contract unavoidable and therefore oppressive, but it is not clear if that is what the Court assumed. It might be equally assumed that bill stuffers are usually overlooked or steeped in legalese and therefore surprising, but the Court did not specifically say so. What is clear is that the Court was not much bothered with a fine-tuned analysis and left procedural unconscionability to some probably safe, common-sense assumptions. Given the ubiquity of non-negotiable, form contracts, most businesses will face an uphill battle to argue their contracts do not present at least some degree of procedural unconscionability.

Predictable, Small Damages

The Court anchored its decision in what one may call the typical consumer class action setting, which involves allegations of relatively small damages to a relatively large group of people. In particular, the court referred to contracts “in a setting in which disputes between the contracting parties predictably involve small amounts of damages.” So what does this mean? First, it is important to note that usually unconscionability is determined from the circumstances existing at the time of contracting, not by subsequent events. The key question is when controversy arises between business and consumer, what is the “predictable” amount at issue? The Court did not address this issue in detail, but a credit card company such as Discover Bank would seem predictably to have a large number of potential disputes regarding such small amounts as “late fees,” or at most for amounts up to the balance limit on cards that for most consumers would be at or below $10,000. With the possible exception of the home, most consumer purchases or claims for damages would be similarly limited. Telecommunications companies, for example, usually face consumer claims that rarely exceed a hundred dollars. Even vehicle cases would be limited by the purchase price of the car and usually, unless allegations of fraud are to be “predicted” when dealing with car dealers [don’t laugh], diminished value would be the measure and would be a mere fraction of the purchase price.

What is “small”? Again, the Court does not set out exact parameters. However, it is clear that the basic inquiry is whether the typical claim would be of a size to attract private counsel to take the case. After all, the Court’s whole rationale is based on the notion that, in the real world, only by banding together the small claims of many, do the claims become worth an attorney’s labor and therefore provide consumers access to the machinery of the justice system.

The Court did provide one example, although not in the consumer context, where a claim would not be predictably too small to be viable on its own. The majority pointed out that employment discrimination claims under the ADEA have been reported to have median awards of $269,000, presenting this as an example of potentially viable individual claims. Past decisions regarding when consumer class actions were necessary for individuals to have viable claims also might provide some guide as to what is “small.” See Vasquez v. Superior Court (1971) 4 Cal.3d 800, 805 (claims regarding overpriced freezers and food); West Corp. v. Superior Court (2004) 116 Cal.App.4th 1167, 1180 (claims ranging from $60 – $150 per year for several years); Frank v. Eastman Kodak (W.D.N.Y. 2005)(claims of $1,000 or more); In re Copley Pharm, Inc. (D.Wyo. 1998) 1 F.Supp.2d 1407, 1418 (claims of up to $20,000). Another way to assess whether claims might be too small to be viable individually is to assess how many individual court or other actions have been filed in the past, and how many involved retained counsel.

Allegations of Cheatingand Fraud

The Court decided substantive unconscionability based largely on Cal.Civ.Code §1668 and its prohibition against contracting one’s way out of fraud. The Court did not address whether fraud in the common law sense or the much broader consumer law sense would need to be in the complaint. Nevertheless, the full text of §1668 is not limited to fraud and includes even negligent violations of law. It is hard to imagine, in any consumer case, the allegations not being sufficient.

California Law

The Discover Bank opinion leaves the basic law unchanged regarding choice-of-law issues and choice-of-law clauses. However, it does explicitly recognize a “fundamental” protection for California consumers in the right to class procedures and, therefore, gives new strength to Californians to pull themselves out of choice-of-law clauses imposing non-California law. As the Court points out, where California has a greater interest, and where a fundamental policy of California would be violated by imposing the chosen state’s laws, courts will not enforce even an express choice-of-law clause. Out-of-state businesses who wish to contract with California consumers will have to reassess their ability to provide that non-California law applies, or risk facing classwide arbitration or, alternatively, invalidation of their arbitration agreements altogether. Of course, California businesses dealing with a potential class of consumers (Californians or otherwise) will continue to have their contracts governed by California law in the usual course.

The CLRA Trump Cardand Other Bad News for NCAACs

No discussion of Discover Bank’s practical effect would be complete without discussing what the Court quite conspicuously and explicitly did not decide: the effect of the CLRA’s express right to class actions and its express “no waiver” clause. Although Mr. Boehr did not assert a CLRA cause of action, the Court went out of its way on several occasions to reaffirm and approve its own and a lower court’s decision that CLRA rights are non-waivable as a matter of express, fundamental public policy and that the right to class proceedings is one such right. Discover Bank at 158, 160, 174 (discussing Armendariz v. Foundation Health Psychcare Serv. Inc. (2000) 24 Cal.4th 83; and America Online, Inc. v. Superior Court (2001) 90 Cal.App.4th 1). The effect of this is potentially quite expansive as the CLRA covers a comprehensive array of unfair and fraudulent business practices.3

The effect of applying the CLRA’s non-waivability provision in play is two-fold. First it will end the need for any inquiry into “procedural” unconscionability. After all, you cannot waive a non-waivable right, no matter how well-disclosed and freely chosen. See Benyon v. Garden Grove Medical Group (1980) 100 Cal.App.3d 698, 713 (“[A] contractual provision which is void against public policy cannot be validated by estoppel or waiver.”). Second, as there is no dollar amount limit for CLRA causes of action and no need to show superiority of the class action mechanism for class certification,4 the right to class proceedings for consumer claims that are not “small” would also be guaranteed.

In this regard, it probably should also be noted that even beyond the CLRA, such other general contract prohibitions such as Cal.Civ.Code §3513 that states public rights cannot be waived by private agreement might have similar effect in combination with class action rights in other contexts – perhaps the new, post-Prop. 64 UCL which defendants are proclaiming now requires class actions.

Two other points bear mentioning that make Discover Bank a foreboding decision for NCAACs. First, the Court quickly dismissed the grounds that any future “new and improved” NCAACs might pass muster. For the majority, neither the potential for arbitration cost shifting, nor attorney-fee shifting solely in favor of consumers were sufficient to overcome the basic reality that small damage cases never or even usually will see the light of either the judicial or arbitral system.

Finally, the Court’s decision leaves plenty of room for expansion given the salutary and unique effects class proceedings can have in consumer cases even beyond the small-damage scenario. For example, in cases involving wide-spread fraud, failures to disclose, or latent defects, the class action may be the only way the victim class will learn of the violation of their rights at all or in a timely manner. Oftentimes the class notice is the first time consumer victims learn their rights have been violated. If the one consumer who discovers the common problem is forced to arbitrate, and the arbitrator is limited to order relief only to the parties, then the protection of state law will be effectively impeded. Such a rationale jibes well with the Discover Bank rationale, which focuses on the purposes and necessity of class actions for access to justice.


Since Discover Bank was decided, the cases on the California Supreme Court docket where NCAACs were enforced by the Courts of Appeal have since been remanded to the Courts of Appeal for reconsideration in light of its decision. All those Courts of Appeal have now reversed field and struck down the NCAACs. These are cases where no “bill stuffer” was used additional measures were taken to make individual arbitration ostensibly cost free for consumers, including attorney fee shifting in favor of plaintiffs. See, e.g., Parrish v. Cingular Wireless, LLC, 2005 Cal.App.Unpub. LEXIS 9021 (October 3, 2005); Meoli v. AT&T Wireless Serv., Inc., 2005 Cal.App.Unpub. LEXIS 8994 (September 30, 2005).

In short, most businesses, and certainly most businesses based in California, that have arbitration clauses in their consumer contracts will have to remove those clauses immediately unless they want to brave the waters of a classwide arbitration. The NCAACs are likely no longer valid. To the extent any business is constrained by California law and is thinking it will float over the floodwaters of the holding or facts of Discover Bank, it should think again before weighing anchor. Dark clouds loom on the horizon.