Use TACT: The Arbitration Alternative

November 2014LJN Product Liability Law & Strategy

In April 2014, the media ignited a firestorm of controversy over General Mills' decision to modify its online Privacy Policy and Legal Terms to include a mandatory arbitration provision. The provision required consumers who downloaded or printed coupons, "joined an online community," subscribed to an e-mail newsletter, redeemed a promotion, or participated in any "offering" to forego their right to sue the company in court and instead submit to private, binding arbitration to resolve any disputes with the company. In the face of the outcry over this policy change, the company reversed course and restored its prior legal terms, which contained no mention of arbitration.

The media's vilification of the policy change once again brings to the forefront the tension and competing interests between class action litigation and the freedom to contract to arbitrate. This tension has existed since the Federal Arbitration Act was enacted in 1925 and, much to the chagrin of class action litigation proponents, the expansive reach of mandatory arbitration has gained a strong foothold in recent years, due to the overwhelmingly pro-arbitration precedent established by the Supreme Court in its Concepcion and Italian Colors decisions, which express a clear federal policy in favor of enforcing class action waivers contained in arbitration agreements.

Public perception of mandatory arbitration provisions is unquestionably negative. Detractors of this method of dispute resolution largely deride it as an "anti-consumer" practice that allows big corporations to escape all liability by unconscionably and covertly tricking unsuspecting, unsophisticated consumers into clicking away their federally protected legal rights. The mandatory arbitration system is also criticized for establishing a climate where large groups of consumers cannot seek redress for small claims because the individualized nature of the proceedings makes it prohibitively expensive to seek relief.

Yet, an examination of the present consumer class action litigation system reveals its numerous failings, namely that the current structure often results in little or no relief to class members while providing exorbitant compensation to the attorneys involved. Literature on the subject also reveals that the vast majority of consumer class actions simply do not provide a monetary benefit to class members whose interests the system is designed to protect, especially where the members cannot be identified. If implemented properly, mandatory arbitration may actually provide a better mechanism for advancing and protecting consumer rights for legitimate small claims than class action litigation. It is critical for practitioners counseling corporations on this issue to advise their clients that they must use "TACT" (Transparency, Agreed-upon terms, Clarity about costs, and Thoroughness) when enacting arbitration policies.

FAA and the Supreme Court's Pro-Arbitration Progeny

Prior to the enactment of the Federal Arbitration Act (FAA) in 1925, arbitration agreements were met with hostility by the United States judiciary and courts generally refused to enforce such agreements. The FAA, however, ushered in a new era in which arbitration agreements are considered to be presumptively enforceable (so long as the parties have contracted fairly), thus putting agreements to arbitrate on equal footing with other contracts.

In the years following the FAA's passage, the U.S. Supreme Court has repeatedly upheld the FAA and, in the recent landmark decisions, AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (2011) and Am. Exp. Co. v. Italian Colors Rest., 133 S. Ct. 2304 (2013), the Court has further solidified its pro-arbitration stance by determining that the FAA expresses a clear federal policy in favor of enforcing class action waivers contained in arbitration agreements.

In Concepcion , the Court struck down a California common law rule that invalidated class waivers in consumer arbitration agreements (including contracts of adhesion) as unconscionable because the rule conflicted with the pro-arbitration policy of the FAA. Two years later, the Court continued its pattern of enforcing arbitration agreements according to their terms in the Italian Colors decision. In that case, the Court held that a class action waiver contained in an arbitration agreement was enforceable even though the plaintiffs showed that the waiver effectively prevented them from bringing their federal antitrust claims because litigating the claims individually would be prohibitively expensive.

The clear presumption of enforceability of arbitration clauses propounded by the Supreme Court has raised serious concerns about the use of class waivers by corporations in form contracts because such waivers have the potential to insulate corporations from virtually all liability for actions that allegedly create small harm to large groups of consumers.

Failings of the Class Action Litigation System

Class action litigation serves two primary purposes. First, as a matter of economic efficiency, it provides a mechanism for large numbers of consumers who have suffered similar small harms to aggregate their claims where the cost of litigation outweighs the potential recovery to individual consumers. Second, pursuant to the notice requirement of Federal Rule of Civil Procedure 23(b)(3) actions, the device benefits society as a whole by alerting consumers to potential, small-scale injuries that they may have suffered, and opening up a discourse about the legal relief available to these consumers.

While the individual, privatized nature of mandatory arbitration and the Supreme Court's enforcement of class action waivers in arbitration agreements appear to thwart the very important principles underlying class action litigation, existing literature on the subject reveals that, all too often, the consumer class action mechanism simply does not deliver meaningful benefits or relief to class members.

Literature on consumer class action lawsuits reveals that, in those cases that do result in settlement, the recoveries achieved for the class are minimal. See Ronald J. Levine, Class Actions: Where's the Beef? LJN's Product Liability Law and Strategy, Vol. 32, No. 1 (July 2013) (available at http://bit.ly/1vCQByq).

This is especially true in consumer class action settlements in which there are no records of the names and addresses of the consumers and where the individual payments are relatively low. It is difficult to advise a consumer public that settlement has been reached, especially where there are unregistered purchases, and even if consumers are aware of the settlement, it is questionable whether a consumer will go to the effort of filling out the claims forms.

While class action settlements often leave class members with awards of little or no value, the current structure of the system frequently results in a monetary windfall to class counsel. Although class action settlements are judicially scrutinized to ensure procedural and substantive fairness (due to the fact that class members are bound by them), the scarce publicly available data discussing how much cash relief class members receive post-settlement paints a disturbing picture: Often, attorney fees are approved without an inquiry as to the actual value of class recovery, and while plaintiffs' lawyers are well-compensated (often in the millions of dollars), only a small percentage of settlement awards actually goes to consumer class members, and only a small fraction of the class may take home any cash relief.

These findings confirm what critics of the class action litigation device have long suspected: The vast majority of consumer class actions where members cannot be identified simply do not benefit class members whose interests the system is designed to protect.

The Virtues of Consumer Arbitration

General Mills' implementation of its mandatory arbitration policy was attacked by the media as an attempt to trick consumers into forfeiting their legal rights by the mere act of interacting with the company's brands online. The method by which the company rolled out the policy detracted from the fact that, in practice, the company's mandatory arbitration policy was actually quite generous to consumers and had the potential to provide meaningful relief to consumers with small claims.

In the ensuing media storm, detractors of mandatory arbitration seized upon the opportunity to criticize the arbitration process. While it is true that arbitration reduces procedural rights such as appeals and jury trials, and immunizes large companies from public proceedings due to its private nature, the benefits of arbitration can far outweigh the downsides in the consumer context. If properly executed, arbitration may actually provide a better mechanism for advancing and protecting consumer rights for small claims than class action litigation.

In practice, the arbitration forum is an efficient, streamlined mechanism for pursuing small fee claims that has the potential to be far more advantageous to consumers than class action litigation for six distinct reasons.

First, in light of the abysmal monetary relief that is awarded to individual consumers when a consumer class action with unidentified members actually results in a settlement, consumers have a higher likelihood of garnering real, tangible benefits through arbitration.

Second, despite public perception to the contrary, the arbitration process actually does provide robust protections to consumers' due process rights. For example, the American Arbitration Association (AAA) has a "Consumer Due Process Protocol" in place that requires corporations' arbitration agreements to comply with certain notice and process requirements. If an arbitration agreement does not comply with the Consumer Due Process Protocol, the AAA will provide the company with an opportunity to revise the clause. If an arbitration containing a non-compliant arbitration clause is filed, the AAA will return the arbitration filing information to the consumer with instructions to pursue other remedies and will refuse to administer any of the company's other cases until the arbitration agreement is in compliance. JAMS has also enacted a "Policy on Consumer Arbitrations Pursuant to Pre-Dispute Clauses Minimum Standards of Procedural Fairness."

Third, arbitration is cost-effective. Many corporations will actually pay all arbitration fees for claims that fall below certain monetary thresholds. For example, General Mills, in its mandatory arbitration policy, offered to pay all fees for consumer claims totaling less than $5,000.

Fourth, arbitration provides much more autonomy to consumers. While class actions are binding on class members, oftentimes consumers have the ability to opt out of arbitration clauses and may instead pursue their claims in local small claims court, provided the claim meets the court's jurisdictional limits.

Fifth, arbitration is a much more expeditious process than class action litigation, which can often take years.

Finally, there is less red tape involved in arbitration and often it is not even necessary for attorneys to be involved.

Use 'TACT'

The backlash that General Mills endured from the media over the implementation of its mandatory arbitration policy provides a teachable moment for all practitioners who counsel large companies that are considering utilizing mandatory arbitration procedures. When enacting policies for resolving consumer fee claims, practitioners must advise their clients to use TACT in implementing all arbitration agreements:

Transparency: Broadcast the policy. State the policy clearly and visibly, and disseminate its terms far and wide.

Agreed-Upon Terms: Corporations should capture clear evidence of agreement to avoid an enforceability challenge down the line. For instance, if a corporation revises its online legal terms to include an arbitration clause, it is a best practice for consumers to agree to the clause through electronic signature.

Clarity About Costs: Corporations should make painstaking efforts to communicate their arbitration fee policies explicitly, especially if the policy will cover a consumer's arbitration costs.

Thoroughness: The agreement should: 1) include a class action waiver; 2) ensure that the arbitration clause complies with AAA's and JAMS' due process protocols; and 3) emphasize the benefits of arbitration and highlight its expeditiousness, cost-effectiveness, consumers' ability to opt out, and the higher likelihood of obtaining relief.

In addition to ensuring that any consumer arbitration agreement meets the foregoing standards, it is also prudent for practitioners to counsel their corporate clients to implement further procedural safeguards in an effort to avoid getting embroiled in class action litigation. These procedures include settling risky individual lawsuits that have the potential to develop into class actions, implementing a system to isolate and monitor unorthodox customer requests or complaints to determine if the consumer is working with class counsel to create documentation for a lawsuit, and tracking pending class actions that have been initiated against similar companies in the industry.

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Ronald J. Levine, a member of this newsletter's Board of Editors, is the Co-Chair of the Litigation Department at Herrick, Feinstein LLP. Reach him at [email protected].