Arbitration Over Free Phones: A Costly Challenge to Federal and State Arbitration Laws

Kendra Rosenberg

The United States Supreme Court heard arguments in the case of AT&T Mobility v. Concepcion on November 9, 2010.  This case brings unexpected phone charges to the forefront of a consumer rights issue–the ability to engage as a class in arbitration with a major national corporation. The briefs and arguments before the Court highlight arguments that have been bubbling up across the country between consumer rights groups advocating for the availability of class action claims and proponents of consumer’s freedom to enter into contracts, including those with arbitration agreements.

Credit: Petr Kratochvil

In this case, the plaintiffs signed two-year contracts with AT&T and received new, free phones as part of the contractual agreement. But instead of the phones being free, the Concepcions were charged $30.22 in sales tax. The Concepcions brought this lawsuit arguing first, fraudulent misrepresentation of the “free” phones.  Second, the plaintiffs dispute the validity the arbitration clause present in the contract they signed with AT&T that requires individual arbitration of all claims against the company.  The plaintiff’s contend this type of arbitration clause is unconscionable because it does not allow a class–a group of plaintiffs–to arbitrate their similar complaints against AT&T together. AT&T argues this arbitration clause is properly part of the contractual agreement between them and their consumers and that state contract law is preempted by the Federal Arbitration Act (“FAA”).

The FAA favors arbitration agreements, stating arbitrations “shall be valid, irrevocable and enforceable save upon such grounds as exist at law or in equity for the revocation of any contract.”  Meanwhile, state laws may provide greater protection to consumers though, and may invalidate this type of contractual provision.

This case arose in federal district court in the Southern District of California, where the trial judge found the contract including the class waiver provision of the arbitration agreement is unconscionable under California law.  Further, the court found the California unconscionability law is not preempted by the FAA. AT&T timely appealed. (The district court consolidated the case of AT&T Mobility v. Concepcion with Laster v. AT&T. See 2008 WL 5216255).

The Ninth Circuit also held the arbitration clause was invalid under California law and applied a three-part test in Laster v. AT & T Mobility LLC to determine whether the class action waiver in a consumer contract was unconscionable. First, the agreement was a contract of adhesion.  Second, the disputes between the contracting parties involved small amounts of damages (here the damages are $30.22 for the sales tax charged on cell phones AT & T advertised were “free).  Third, AT & T used its superior bargaining power to carry out a scheme deliberately to cheat large numbers of consumers out of individually small amounts of taxes. The Ninth Circuit held the class action waiver of arbitration “unconscionable” and thus, unenforceable under California contract law.  The Ninth Circuit further held the FAA did not preempt California unconscionability law.

The core issue before the Supreme Court is whether state law can render class action waivers contained in arbitration clauses unenforceable, or whether the Federal Arbitration Act prohibits states, California in this case, from requiring class arbitration to be available for plaintiffs.  A broad holding for AT & T may allow companies to use this type of class action waivers in standard form contract, thus insulating major corporations form class action lawsuits.  A ruling against AT & T may reinforce state’s ability to regulate waivers of class action arbitration, thus creating jurisdictional differences regarding the availability of class actions.

This issue is important because ultimately the court will determine whether states can enforce greater consumer protection policies and condition the use of arbitration clauses on the availability of class action arbitration, or if federal law preempts the state’s ability to enforce these types of conditions.

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