The Impact Of "Prohibitive Costs" Of Arbitration Upon The Defense Of Class Actions

Thursday, April 1, 2004 - 01:00
Nelson Levine de Luca & Hamilton, LLC
Robert T. Horst
Mark Rosenberg

The invocation of contractual arbitration provisions has long been considered an effective defense to class actions regarding a form contract. By invoking a contractual arbitration clause, defendants may obtain, at minimum, a stay of the judicial proceedings pending arbitration. See, e.g., 9 U.S.C. § 3. Furthermore, courts have dismissed an action when all of the underlying claims are arbitrable. See, e.g., Blair v. Scott Specialty Gases, 283 F.3d 595, 600 (3d Cir. 2002).

As the law evolves, many representative plaintiffs have sought to preserve class actions in the face of arbitration clauses. One argument contends that any arbitration provision requiring that a claimant pay part of the costs of arbitration is unconscionable because it limits the claimant's right of access to the arbitral forum, particularly when the costs of arbitration to each individual claimant have been shown to meet or exceed the recoveries available to the claimant. This article analyzes how arguments regarding the "prohibitive costs" of arbitration may pose a significant obstacle to the ability to invoke an arbitration clause as a defense to class actions.

The impact of a claimant's obligation to pay costs upon the enforceability of an contractual arbitration provision was addressed by the U.S. Supreme Court in Green Tree Financial Corp.-Alabama v. Randolph, 531 U.S. 79 (2000). In Randolph, the Court recognized that as "the existence of large arbitration costs could preclude a litigant ... from effectively vindicating her ... rights in the arbitral forum," a party's obligation to bear substantial arbitration costs could compel the invalidation of an arbitration agreement. Id. at 90-91. However, the Court emphasized that when "a party seeks to invalidate an arbitration agreement on the grounds that such an agreement would be prohibitively expensive, that party bears the burden of showing the likelihood of incurring such costs." Id. at 91-92.

Courts applying Randolph have held that the mere existence of language in an arbitration agreement requiring a claimant to share the costs of arbitration is ordinarily insufficient to demonstrate that these costs will be "prohibitive." See, e.g., Musnick v. King Motor Co. of Fort Lauderdale, 325 F.3d 1255, 1260 (11th Cir. 2003); Bradford v. Rockwell Semiconductor Systems, Inc., 238 F.3d 549, 556 (4th Cir. 2001); but see Ting v. AT&T, 319 F.3d 1126, 1151 (9th Cir. 2002) (discussed infra). The preferred approach is to conduct a "case-by-case analysis that focuses, among other things, upon the claimant's ability to pay the arbitration costs, the expected cost differential between arbitration and litigation in court, and whether that cost differential is so substantial as to prevent the bringing of claims." e.g., Bradford, 238 F.3d at 556.

Where courts have found the cost of arbitrating claims brought by members of a putative class to be "prohibitive," they have rendered an arbitration provision unconscionable. For example, the U.S. Court of Appeals for the Ninth Circuit recently held in Ting, supra, an arbitration provision requiring putative class members to share the costs of arbitration was unconscionable. The Court held that "parties who agree to arbitrate" are "entitled to basic procedural and remedial protections," including "the assurance that an individual 'need not 'pay either unreasonable costs or any arbitrators' fees or expenses as a condition of access to the arbitrators' forum.'" Ting, 326 F.3d at 1151 (quoting Cole v. Burns Int'l Sec. Servs., 105 F.3d 1465, 1485 (D.C. Cir. 1997)).

While few courts have echoed the Ninth Circuit's rigid view of fee-splitting provisions in arbitration clauses, some courts have refused to enforce arbitration clauses in the context of putative class actions on the grounds that the typical cost of arbitration to the class claimant would be excessive. A recent example is Morrison v. Circuit City Stores, Inc., 317 F.3d 646 (6th Cir. 2003), in which the U.S. Court of Appeals for the Sixth Circuit held that an arbitration cost of only $1,622 was "prohibitive." Id. at 669. While recognizing that "[i]n the abstract, this sum may not appear prohibitive," the Court examined the cost within the context of the underlying case of employment discrimination. Noting that the claimant must continue to pay for the "necessities of life in contemporary society despite losing her primary, and most likely only source of income," the Court held that as a claimant would be required to risk "one's scarce resources in the hopes of an uncertain benefit," it was likely that "a substantial number of similarly situated persons would be deterred from seeking to vindicate their statutory rights under these circumstances." Id. at 669-70.

While general attacks on the "prohibitive costs" of arbitration have met with some success in the class action context, the high standard of proof established by the Supreme Court in Randolph may limit their applicability. As demonstrated by the cases above, the ability to prevail on such an argument may depend upon the relative poverty of the class representative. A more effective approach has involved a comparison of the costs of arbitration with the relatively small recoveries available to class action claimants. Even minimal arbitration costs have been held to render an arbitration clause unconscionable when these costs have been found to approach or exceed the damages sought by each claimant in a class action. Courts have concluded that such a result would effectively leave each claimant without a remedy if the arbitration clause was enforced.

One of the earliest cases to reach such a holding was Patterson v. ITT Consumer Financial Corp., 18 Cal. Rptr. 2d 563 (Ct. App. 1 Dist. 1993), which concerned a putative class action regarding purportedly wrongful practices in the making and handling of loans by a finance company. The finance company filed a motion to compel arbitration based upon an arbitration clause in the loan contracts. While the claimants could obtain arbitration based solely on submitted documents without making a payment, claimants were required to make a prepayment of, at minimum, $850 in order to obtain a hearing before the arbitrator. The California Court of Appeals for the First District observed that "[t]he likely effect of these [arbitration] procedures is to deny a borrower against whom a claim has been brought any opportunity to a hearing ... unless the borrower has considerable legal expertise or the money to hire a lawyer and/or prepay substantial legal fees." Id. at 566. The Court noted that "[t]he latter is especially unlikely given the small dollar amounts at issue ... [i]n a dispute over $2,000 it would scarcely make sense to spend a minimum of $850 to obtain a participatory hearing." Id. at 566. Therefore, the Court determined that as the arbitration procedure at issue was "oppressive when applied to unsophisticated borrowers of limited means in disputes over small claims," the arbitration clause in the loan contracts was unconscionable and unenforceable. Id. at 566-67. The Patterson court's analysis was adopted by the Ohio Supreme Court in Williams v. Aetna Fin. Co., 700 N.E.2d 859 (Ohio 1998), in which the Court held an arbitration clause that was "virtually identical" to the clause under consideration in Patterson to be unconscionable.

In Leonard v. Terminix Intern. Co., L.P., 854 So.2d 529 (Ala. 2002), the Alabama Supreme Court considered whether an arbitration clause in pest control contracts operated to preclude a class action regarding the alleged violation of statutory requirements regarding the performance of such contracts. The representative plaintiffs argued that if the arbitration clause was enforced, the "small dollar value" of the plaintiffs' claim (less than $500) would make it unfeasible to submit the claim to arbitration, given the plaintiffs' obligation to pay approximately $1,150 per day in arbitration expenses, as well as the cost of retaining an attorney on an hourly basis. Id. at 535. As the plaintiffs were restricted "to a forum where the expense of pursuing their claim far exceeds the amount in controversy," the Court held that "by foreclosing the [representative plaintiffs] from an attempt to seek practical redress through a class action and restricting them to a disproportionately expensive individual arbitration," the arbitration clause was unconscionable and unenforceable. Id. at 539.

A recent Pennsylvania Superior Court ruling demonstrates that no arbitration fee may be too small to avoid a finding of unconscionability. In McNulty v. H&R Block, Inc., 843 A.2d 1267, 2004 PA Super 45, 2004 WL 351782 (Pa. Super. Ct. Feb. 26, 2004), the issue was whether a contractual arbitration provision could be invoked as a defense to a class action regarding fees charged by the tax preparation service H&R Block for the electronic filing of tax returns. The clause in question required the claimant to pay an initial $50 fee for the arbitration and to cover any costs in excess of $1,500.

Finding the arbitration clause unconscionable, the Court emphasized a previous holding that "if the costs associated with arbitration of a single claim would operate to preclude a claimant from pursuing a remedy, then the enforcement of the provision would be unconscionable." Id. at *5 (citing Lytle v. CitiFinancial Services, Inc., 810 A.2d 643, 667-68 (Pa. Super. Ct. 2002)). Observing that even the minimum $50 charge outweighed the individual damages at issue, the Court held that the case presented "a situation where the costs of arbitration, minimal though they may seem, work to preclude the individual presentation of claims." Id. Accordingly, the Court held that "the enforcement of the arbitration provision would work to deny the allegedly injured parties access to justice and is therefore unconscionable." Id.

As noted by the Leonard court, "the impracticality of pursuing a claim for a small amount of money at a cost in excess of the value of the claim is just as much an obstacle to the wealthiest member of society as it is to a pauper." Leonard, 854 So. 2d at 537. As the wealth of the representative plaintiff is not a factor, arguments based upon this "impracticality" may prove to be the most persuasive means of attacking the purportedly "prohibitive" costs of mandatory arbitration. Many consumer class cases concern individual awards that may pale in comparison to an ordinary allocation of arbitration costs to a plaintiff. In light of this practical reality, arguments regarding the economic infeasibility of pursuing individual claims through arbitration may constitute a powerful response to any attempt to invoke compulsory arbitration as a defense.

A viable response to this argument exists. By agreeing to cover or advance the entire cost of arbitration, defendants may quash arguments regarding the "prohibitive cost" of compulsory arbitration. See, e.g., Pitchford v. AmSouth Bank, 285 F. Supp. 2d 1286, 1296 (M.D. Ala. 2003). Corporate counsel may be well-served by considering whether this approach is in the best interests of their employer. While the costs of arbitration may be significant, they may be preferable to the costs of defending a large-scale class action.

Robert T. Horst is a Partner and Mark Rosenberg is an Associate at Nelson Levine de Luca & Horst.