When the U.S. Supreme Court decided AT&T Mobility v. Concepcion (131 S. Ct. 1740 (2011)), the justices wrestled with two competing legal principles in Section 2 of the Federal Arbitration Act. (9 U.S.C. §§ 1-16.) The first is the mandate that arbitration agreements be given broad support. (See Dean Witter Reynolds, Inc. v. Byrd, 470 U.S. 213, 219-220 (1985).) The second is the issue of sovereignty: whether a state law regarding unconscionability or public policy considerations can trump the FAA, particularly with respect to small, individual claims that may only be adjudicated in a class action.

Specifically, what happens when there is an agreement not to arbitrate class claims? Is such a pact enforceable? When the high court answered that question affirmatively, it sent attorneys scrambling to consider the implications.

In the wake of AT&T Mobility, an arbitration agreement that forces employees, consumers, or others to waive the right to participate in a class action is enforceable.

The Discover Bank Rule
For more than a decade prior to the AT&T Mobility decision, California courts frequently had refused to enforce arbitration agreements on grounds of unconscionability, particularly when employment or consumer claims were at issue. One result was that consumer and wage-and-hour class actions blossomed. An impetus for this development was a California Supreme Court decision that barred enforcement of a class action waiver in a consumer arbitration agreement. (Discover Bank v. Superior Court, 36 Cal. 4th 148 (2005).) The premise of the Discover Bank ruling was simple: Small claims should be allowed to proceed as a class action; the requirement that they be arbitrated individually was unconscionable and contrary to public policy. (See 36 Cal. 4th at 162.)

But in AT&T Mobility, the U.S. Supreme Court held that the FAA preempted California's "Discover Bank rule." Although that decision affects courts and litigants all across America, the ruling is having a major impact in California.

Small claims, Big Case
The AT&T Mobility dispute arose after the cell phone company offered customers free cell phones but charged them sales tax based on the phone's retail value. The representative plaintiffs challenged this modest charge ($31 for Vincent and Liza Concepcion) and filed a putative class action claiming, among other things, that AT&T had engaged in false advertising and fraud.

The contract signed by the Concepcions provided for arbitration of disputes brought in the parties' "individual capacity and not as a plaintiff or class member in any purported class or representative proceeding." If a claim amounted to less than $10,000, AT&T was obligated to pay all arbitration costs for non-frivolous claims; the customer could choose to arbitrate in person, by telephone, or by written submission; either party could bring a claim in small claims court; arbitration would be conducted in the consumer's home county; and AT&T was prohibited from recovering its attorneys fees. The agreement further allowed the consumer to recover fees under certain circumstances, and it empowered the arbitrator to award any form of individual relief. (AT&T Mobility, 131 S. Ct. at 1744.)

Primacy of the FAA
The Federal Arbitration Act broadly governs the enforceability of arbitration provisions that involve interstate commerce. (Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395 (1967).) Though the U.S. Supreme Court had previously held that the act preempts state statutes limiting arbitration (Preston v. Ferrer, 552 U.S. 346 (2008)), the decision in AT&T Mobility further expanded the FAA's broad preemptive scope.

Writing for the five-member majority, Justice Antonin Scalia noted that Congress enacted the FAA in response to "widespread judicial hostility" to arbitration agreements. (131 S. Ct. at 1745.) The act requires courts to place arbitration agreements on equal footing with other contracts. Arbitration agreements may be declared unenforceable only to the same extent any contract could be declared unenforceable, and any state law principle that discriminates against arbitration agreements is preempted.

Section 2 of the FAA provides that an arbitration provision is "valid, irrevocable and enforceable" except on legal or equitable grounds that properly apply to all contracts. (9 U.S.C. § 2.) Generally applicable contract defenses such as fraud, duress, or unconscionability, may be applied to invalidate arbitration agreements. However, when one of those defenses is applied in a manner that disfavors arbitration, it is preempted by the FAA.

The AT&T Mobility decision is grounded on the principle that "a court may not 'rely on the uniqueness of an agreement to arbitrate as a basis for a state-law holding that enforcement would be unconscionable, for this would enable the court to effect what the state legislature cannot.' " (See 131 S. Ct. at 1747 (quoting Perry v. Thomas, 482 U.S. 483, 493 (1987)).)

California Law
In AT&T Mobility, the plaintiffs relied on a California statute that allows a court to deny enforcement of any contract found to be "unconscionable at the time it was made" and to "limit the application of any unconscionable clause." (See Cal. Civ. Code § 1670.5(a).) An unconscionability finding entails both procedural and substantive elements. Procedural unconscionability focuses on "oppression" or "surprise" due to unequal bargaining power, while substantive unconscionability focuses on "overly harsh" or "one-sided" results. (131 S. Ct. at 1746.) In Discover Bank, the state Supreme Court struck down as unconscionable a class action waiver in a consumer dispute that predictably involved small damage amounts. (Discover Bank, 36 Cal. 4th at 162.)

The U.S. Supreme Court rejected that analysis, while acknowledging that states remain free to address concerns related to adhesion contracts. The Court noted that a state such as California could require class action waiver provisions to be highlighted in the contract document. But the Court made clear that such measures cannot conflict with the FAA or frustrate its purposes. (131 S. Ct. at 1750, n. 6.)

The AT&T Mobility decision reaffirmed that the FAA embodies a "liberal federal policy favoring arbitration" (131 S. Ct. at 1745) and the "fundamental principle that arbitration is a matter of contract." (131 S. Ct. at 1746.)

But when the Court came to the Discover Bank rule, it drew a line in the sand: "When state law prohibits outright the arbitration of a particular type of claim, the analysis is straightforward: The conflicting rule is displaced by the FAA." (131 S. Ct. at 1747.)

This ruling was not written on a blank slate. Indeed, the AT&T Mobility opinion builds on two cases that the high court decided in 2010.

In Stolt-Nielsen, S.A. v. AnimalFeeds Int'l Corp. (130 S. Ct. 1758 (2010)), the Court held that a party "may not be compelled under the FAA to submit to class arbitration unless there is a contractual basis for concluding that the party agreed to do so." (130 S. Ct. at 1775.) The Court recognized that the difference between an agreement to arbitrate as an individual and one to arbitrate as part of a class is more than a procedural distinction; it is a question of whether the particular parties actually agreed to authorize class action arbitration. The contract in Stolt-Nielsen was silent on the issue, and the Court noted that consent to class arbitration could never be presumed, because such proceedings are fundamentally different than bilateral arbitration. (130 S. Ct. at 1775.)

In the second case, the Court held that issues of arbitrability and whether a given contract is unconscionable are for the arbitrator to decide, provided there is an express contractual delegation of authority. (See Rent-A-Center, W., Inc. v. Jackson, 130 S. Ct. 2772 (2010).)

Under the rule announced in Rent-A-Center, if a party challenges in court whether the arbitrator has the power to decide on the enforceability of an arbitration clause, the court's initial inquiry is limited to an analysis of the delegation provision. (130 S. Ct. at 2778.)

Taken together, the decisions in AT&T Mobility, Stolt-Nielsen, and Rent-A-Center substantially further the FAA's liberal federal policy that favors arbitration. This policy favors the arbitration of disputes regardless of whether the underlying agreement is an adhesion contract involving claims of a relatively low dollar value, as was the case in AT&T Mobility.

The Casualties
Prior to AT&T Mobility, California courts had erected a framework for analyzing claims of unconscionability that applied specifically to arbitration provisions. As the U.S. Supreme Court noted, courts in this state have "been more likely to hold contracts to arbitrate unconscionable than other contracts." (AT&T Mobility, 131 S. Ct. at 1747.)

The decision in AT&T Mobility changes all of that.

One of the first areas to feel its impact is employment litigation. A direct casualty is the Armendariz framework, which has been invoked to invalidate arbitration clauses in certain employment contracts by declaring them unconscionable and against public policy. (See Armendariz v. Found. Health Psychcare Serv's, Inc., 24 Cal. 4th 83 (2000).) To be enforceable under Armendariz, employment arbitration agreements must meet certain essential fairness requirements. Among other things, the terms must:

- not limit remedies ordinarily available to the employee;

- provide for adequate discovery;

- not require the employee to pay for the arbitrator or other arbitration costs; and

- not contain one-sided claim limitations that favor the employer.

However, the analytical framework of Armendariz is now open to challenge. Under AT&T Mobility's straightforward analysis, per se state law prohibitions on the arbitration of particular claims will not stand.

In another employment-related case, the California Supreme Court had extended the Discover Bank rule to void class action waivers in arbitration agreements covering overtime wage claims. (See Gentry v. Superior Court, 23 Cal. 4th 443 (2007).) Gentry precluded the enforcement of a class action waiver if classwide arbitration "is likely to be a significantly more effective practical means of vindicating the rights of the affected employees than individual litigation or arbitration." (Gentry, 42 Cal. 4th at 463.) However, the Gentry decision appears to conflict with the FAA and, under AT&T Mobility, it appears unlikely to survive. Prohibitions on arbitrating particular types of claims are now displaced by the act. (AT&T Mobility, 131 S. Ct. at 1740.)

Indeed, the U.S. Supreme Court continues to reinforce the premise that arbitration agreements affecting interstate commerce will be enforced under the FAA.

In Marmet Health Care Center, Inc. v. Brown (132 S. Ct. 1201, 1203 (2012)), the Court enforced an arbitration agreement and in so doing rejected the West Virginia Supreme Court's holding that the FAA did not preempt a state public policy against pre-dispute arbitration agreements in certain tort cases. Another decision is significant because it held that refusal to enforce an arbitration agreement concerning claims under a federal statute must be based on clear statutory language precluding FAA application. (See CompuCredit Corp. v. Greenwood, 132 S. Ct. 665 (2012).)

The Ninth Circuit also has weighed in, determining that California's prohibition against the arbitration of public injunctive relief claims under both California Business & Professions Code section 17200 and the California Consumer Remedies Act did not survive AT&T Mobility. (See Kilgore v. Keybank, N.A., 673 F.3d 947, 960 (9th Cir. 2012).)

PAGA and the NLRA
On the other hand, several California courts have refused to compel arbitration of wage and hour claims brought under the state's Labor Code sections 2698-2699.5, known as the Private Attorney General Act (PAGA). One court applied Gentry to find a class action waiver unenforceable, but it declined to address whether Gentry was still good law after AT&T Mobility. The court, however, went on to hold that AT&T Mobility did not apply to PAGA representative actions. (See Brown v. Ralph's Grocery Co., 197 Cal. App. 4th 489 (2011).)

Meanwhile, the National Labor Relations Board has entered the fray, concluding that an employer who requires employees to sign an arbitration agreement containing a class action waiver clause violates the National Labor Relations Act (NLRA). The board reasoned that the FAA could not override employee rights embodied in the NLRA. (D.R. Horton, 357 NLRB No. 184 (2012).) That decision is currently on appeal to the Fifth Circuit and may ultimately be tested in the U.S. Supreme Court.

In an eleventh-hour footnote, another California appellate court has weighed in, disagreeing with the Ralph's Grocery decision and the D.R. Horton ruling; it held that AT&T Mobility does indeed trump state statutes such as PAGA. (See Iskanian v. CLS Transp. Los Angeles, LLC, 2012 WL 1979266.) In another case, the court of appeal held that because a PAGA claim cannot be brought on an individual basis, such matters were not within scope of arbitrable claims. (See Reyes v. Macy's, Inc., 202 Cal. App. 4th 1119 (2011).)

It is clear that in the wake of AT&T Mobility, state and federal courts, not to mention administrative agencies such as the NLRB, will continue to grapple with these issues. The future enforceability of arbitration agreements - particularly class action waivers - will depend upon the terms of the arbitration clause itself and on the particular claims at issue. Broad per se rules that specifically preclude enforcement of arbitration agreements are likely preempted, though contracts that clearly delegate arbitrability questions to the arbitrator will stand. Those containing express class action waivers will likely stand up under AT&T Mobility, although D.R. Horton and the PAGA cases create continued uncertainty in the employment context.

In any event, the bottom line is that efforts to deny enforcement of arbitration clauses based on public policy grounds will face tough sledding. This new reality will probably lead to a resurgence of arbitration in employment and consumer cases, along with a renewed focus on drafting arbitration agreements that are consistent with AT&T Mobility and emerging case law from lower courts.

Raymond F. Lynch is a partner at San Francisco's Hanson Bridgett, where he specializes in complex labor, employment, and benefits disputes.