The Ninth Circuit Court recently set forth a ruling on an interesting case involving arbitration clauses in contracts. A couple received two complimentary cell phones from AT&T as part of a bundled-service contract but were charged $30.22 in sales tax required by California law. As part of their contract, the couple agreed to arbitration. As part of the arbitration clause AT&T agrees to pay $7500 plus fees if an arbitration award exceeds the amount last offered by AT&T before the settlement. The couple claimed they were misled and filed a class-action law suit, despite their having signed the contract agreeing to arbitration.
The ruling by the Ninth Circuit, in Laster v AT&T Mobility LLC, called the contract unconscionable and refused to enforce the clause requiring arbitration. The Court felt that such a clause, by disallowing class action, would result in little enforcement of contracts. Because the amount involved is small, the individual customer would probably not find it worth the opportunity cost of their time to go to arbitration, and thus AT&T could default on lots of small contracts for minimal amounts and not fear an arbitration settlement.
There are a number of reasons why this ruling should be overturned. First, it flies in the face of the Federal Arbitration Act of 1925, which was passed to provide certainty to contracts that have arbitration clauses. The Act requires federal courts to enforce arbitration agreements unless they violate standard contract law doctrine, such as fraud, duress, or are unconscionable. For a contract to be unconscionable, in this particular case, it must be seen as a scheme of the party in a stronger bargaining position to cheat large numbers of consumers. The standard arbitration contract doesn’t meet any of these standards.
The contract with AT&T is clear.
The consumer agrees to go to arbitration when signing the contract. The consumer clearly is in as strong a bargaining a position as AT&T. AT&T cannot force the consumer to agree to the contract. Any consumer who does not want to submit to arbitration is free to choose another carrier or to not have a cell phone at all. I, along with many of my friends, managed to spend one half of a century without a cell phone.
More importantly, invalidating contracts with arbitration agreements, even those that satisfy the conditions under Laster, creates uncertainty in contract law. It will raise the price of cell phones and numerous other goods and services that meet the same conditions, since the potential cost of class action litigation must be figured into the costs of producing the goods or services. The increased prices across numerous goods and services (which ones cannot be reasonably be known) will be borne by all consumers, whereas the benefits of not having arbitration, if they exist at all, will be limited to those who involve themselves in a successful class action, most likely no one other than trial lawyers.
If the argument is that these arbitration agreements are unconscionable because each consumer will find it not useful to go to arbitration, then the gain to each consumer that has a proper complaint will be de minimus even if a class action suit is brought. The ruling thus sets up a situation where the vast majority of consumers will face higher prices so that consumers who may freely choose not to buy a product will have the potential of a small gain should a producer defraud them.
Aside from this being an economically unsound ruling, it also allows a paternalistic government to decide that consumers may not enter into contracts that they willingly would enter into. Arbitration is a less expensive way to settle disputes than litigation and the vast majority of consumes might rather have an arbitration clause in a contract. If they didn’t, then companies that offered goods or services without arbitration contracts would be able to gain market share.
The 9th Circuit seems to be of the opinion that producers have arbitrary power and may force consumers to purchase services and sign agreements that the consumer would rather not sign. The reality is that in a market economy there is voluntary exchange. Producers must please consumers or the consumers will not buy the product. Producers must develop product warrantees, guarantees, and contracts that meet consumers’ needs or their competitors will do so. The 9th Circuit Court has no way of knowing what type of contract is preferred by all customers, and is merely substituting its opinion for what contracts should look like for what the market process of free exchange among producers and consumers has produced.