NJ Supreme Court: Consumer Contract Arbitration Clauses are Unenforceable Unless Consumers Are Clearly Notified that Court Redress is Waived

By Edward J. Sholinsky

Arbitration clauses in consumer contracts are unenforceable in New Jersey unless they specifically state that a consumer is waiving the right to pursue statutory and constitutional remedies in court, the New Jersey Supreme Court held. The court in Atalese v. U.S. Legal Services Group, L.P., reversed decisions by the trial and intermediate appellate courts that an arbitration clause calling for binding arbitration, but not specifically waiving the right to bring an action in court, was enforceable.

The plaintiff in Atalese entered into a contract with the defendant for debt-adjustment services.  The contract contained an arbitration clause that stated that any dispute between the parties would be submitted to binding arbitration, that the parties had to agree to the arbitrator, and that the judgment would be enforceable in court.  The plaintiff brought an action in state court alleging violations of New Jersey’s Consumer Fraud Act and Truth-in-Consumer Contract, Warranty, and Notice Act.  The defendant moved to compel arbitration, and the trial court granted the motion.  The Appellate Division, in an unpublished opinion, affirmed.

The defendant argued that consumers “universally understood” that arbitration is different than litigation.  It also invoked the Federal Arbitration Act’s (FAA) policy in favor of arbitration to support its argument that the contract required arbitration. The court rejected those arguments. Relying on Section 2 of the FAA, the court reasoned that arbitration agreements could “be invalidated by generally applicable contract defenses.”

Starting with the principal that contracts require mutual assent, the court reasoned that both parties to an arbitration clause had to understand the terms to which they were agreeing. Additionally, before a party can waive a legal right by contract, under New Jersey law, she must have “full knowledge” of the right and intend to give up that right.  Also, under New Jersey law, the terms of a consumer contract must be clear to the average consumer.

Rejecting the defendant’s argument, the court stated that the “average member of the public may not know – without some explanatory comment – that arbitration is a substitute for the right to have one’s claim adjudicated in a court of law.” Thus, the defendant’s failure to include clear and unambiguous language that the consumer was waiving her right to pursue her claims in court by agreeing to arbitrate rendered the arbitration clause unenforceable.

The court stressed that there was no “magic language” required in an arbitration clause. Rather, the clause must contain “clear and unambiguous” language that alerts the parties to the distinction between resorting to arbitration and bringing a claim in court.  The court did not require that an agreement specify which statutory or constitutional rights consumers were agreeing to arbitrate. In the contract at issue, the defendant did not use plain language that was “clear and understandable to the average consumer” that she was waiving her right to bring a claim in court, even though the contract referred to binding arbitration.

The Atalese decision should prompt companies doing business in New Jersey and using arbitration clauses in consumer contracts to review those contracts.  Businesses wishing to invoke arbitration must make sure that any arbitration clause contains clear, layman’s terms that a consumer is giving up the right to bring an action in court and agreeing to arbitration, which is an alternative to a lawsuit in court.  The clause must put the consumer on notice that by agreeing to the contract that she is giving up a legal right to a jury (or bench) trial on any dispute arising between the parties.

Eleventh Circuit Affirms that Waiting Too Long to Raise an Arbitration Agreement’s Delegation Clause Waives the Right to Have the Arbitrator Decide Issues of Arbitrability

By Christopher Reese

The United States Court of Appeals for the Eleventh Circuit recently confirmed that waiting too long to raise an arbitration agreement’s delegation clause waives the right to ask the court to send threshold questions of arbitrability to the arbitrator for resolution.

In Johnson v. KeyBank National Association, David Johnson, a customer of KeyBank, filed a putative class action against KeyBank alleging that the bank violated Washington law by changing the order of posting of debit card transactions to increase the overdraft fees it charged on his account. KeyBank moved to compel arbitration and stay all proceedings, but did not mention the arbitration agreement’s delegation clause.  Johnson opposed, arguing that the arbitration agreement was unconscionable under Washington state law, and the district court agreed, denying the motion to compel arbitration because the arbitration agreement’s class action waiver effectively prohibited individual plaintiffs from filing claims due to the potentially high costs.

The Eleventh Circuit vacated the district court’s order and remanded for further consideration in light of the Supreme Court’s decision in AT&T Mobility LLC v. Concepcion.  On remand, KeyBank filed a renewed motion for arbitration, raising the arbitration agreement’s delegation clause for the first time.  On August 27, 2013, the district court granted KeyBank’s motion to compel arbitration, finding that the delegation clause required the arbitrator to resolve threshold questions of arbitrability.  Johnson appealed.

On appeal, the Eleventh Circuit began by noting that its precedent states that arbitration should not be compelled when the party seeking to compel arbitration has waived that right.  Under that precedent, waiver occurs when the party seeking arbitration substantially participates in litigation to a point inconsistent with an intent to arbitrate and the opposing party suffers prejudice in the form of incurring litigation expenses that arbitration was designed to alleviate.

Here, the Eleventh Circuit noted that KeyBank proceeded for years without raising the delegation clause, giving the impression that it believed the district court should resolve threshold questions of arbitrability.  In addition, the Court held that Johnson undoubtedly suffered prejudice as a result, incurring substantial attorney’s fees in litigating the threshold questions before the district court and on appeal.

The lesson from this case is simple: if a litigant’s arbitration agreement contains a delegation clause and the litigant prefers resolution of threshold questions of arbitrability by the arbitrator, the delegation clause should be raised at the earliest opportunity, usually in the motion to compel arbitration, to avoid any claims of waiver.

Third Circuit advises parties to use plain language when drafting arbitration agreements

By Christopher Reese

The Third Circuit recently affirmed the United States Bankruptcy Court for the District of Delaware’s denial of a motion to compel arbitration in In re Nortel Networks, Inc.  In doing so, the Third Circuit advised parties wishing to arbitrate their disputes to make that intent clear by “reducing agreements to arbitrate to plain language that can be recognized and enforced by courts examining only the text of the agreement,” and to avoid “hid[ing] their intent to [arbitrate their disputes] in the shadows of the text.”

In 2009, the multinational telecommunications firm Nortel Networks declared bankruptcy.  Nortel entities around the world filed petitions in U.S., Canadian, English, and French courts to begin insolvency proceedings.  Nortel’s bankruptcy was quite complicated, since it had “numerous subsidiaries located in multiple jurisdictions,” and “multiple Nortel entities owned the business lines and intellectual property that comprised the global Nortel brand.”  Because the value of Nortel’s assets would diminish over time, a plan to sell Nortel’s assets had to be devised quickly to maximize the return on the sale.

Nortel debtors from around the world entered into an Interim Funding Agreement, which “created a framework for Nortel debtors to sell assets without first agreeing how to allocate the proceeds of any sale among the relevant debtors.”  The Agreement required the debtors that signed it to place the proceeds of any sales of assets into escrow and to negotiate in good faith in an attempt to reach agreement on how to allocate the proceeds.  The Agreement did not contain the words “arbitrators” or “arbitration” or identify any arbitral association.

After the Agreement was approved by the necessary courts, the Nortel debtors held nine auctions, which raised approximately $7.5 billion in proceeds.  The parties then negotiated as required by the Agreement but were unable to agree on a protocol to allocate the proceeds of the auctions.  The U.S. Nortel debtors moved the Bankruptcy Court to resolve disputes about asset allocation.  Nortel debtors from other countries cross-moved to compel arbitration. The Bankruptcy Court denied the cross-motion to compel arbitration and approved a judicial allocation protocol.  An appeal to the Third Circuit followed.

The Third Circuit had little trouble affirming the Bankruptcy Court, finding that the “dispute begins and ends with the text of the Interim Funding Agreement,” “which does not reveal an intent to arbitrate disputes about the allocation of the auction funds.”  Rather, the Third Circuit explained, the language of the Agreement provided only that the debtors “would negotiate the procedure by which to divide the funds.”  Applying New York law on contract arbitration (the Agreement contained a New York choice-of-law clause), the Third Circuit refused to consider any extrinsic evidence suggesting that the parties intended to arbitrate because the Agreement was not ambiguous.

The most interesting part of the Third Circuit’s decision is its admonition that parties wishing to arbitrate disputes take care to “not hide their intent to do so in the shadows of the text.”  The Third Circuit noted that parties may agree to arbitration without using the word “arbitration” in their agreement, but also stated that “the absence of common signal words” makes it more difficult to determine that the parties intended to resolve their disputes in arbitration.  Parties wishing to arbitrate their disputes should heed the advice of the Third Circuit and ensure that their arbitration agreements indicate as clearly as possible their intent to resolve any disputes in arbitration.  Doing so will pull such intent out of the “shadows of the text” and significantly increase the likelihood that a motion to compel arbitration will be granted.

Sixth Circuit Holds That Arbitrator, Not the District Court, Must Decide if Plaintiff’s Class Claims are Barred by Waiver in Arbitration Agreements

By Christian Sheehan

On June 11, 2013, in Lowry v. JPMorgan Chase Bank, N.A., the Sixth Circuit held that an arbitrator, not the district court, must decide whether the plaintiff’s class claims were barred by a class-action waiver in the parties’ arbitration agreement. The Court explained that although questions of arbitrability are presumptively for a court to decide, the parties had clearly and unmistakably agreed that the arbitrator would resolve disputes about whether their claims were arbitrable. In addition, because the provision requiring an arbitrator to decide this threshold issue did not exclude class claims, the Court held that JPMorgan Chase’s argument that the plaintiff’s class claims were barred must be addressed in arbitration. The Court reached this conclusion despite the fact that it found the class-action waiver to be “unambiguous.” Lowry therefore is significant because it makes clear that even if an arbitration agreement contains a provision unambiguously barring class claims, if the parties agreed that the arbitrator would resolve disputes about arbitrability, the district court must submit all claims, including the seemingly barred class claims, to arbitration.

Lowry is noteworthy for the additional reason that it is the latest in a series of recent Circuit court decisions addressing the proper roles of courts and arbitrators in determining the effect of class-action waiver provisions in arbitration agreements. In In re American Express Merchants’ Litigation, 554 F.3d 300, 310-11 (2d Cir. 2009), vacated on other grounds by Am. Express Co. v. Italian Colors Rest., 130 S. Ct. 2401 (2010), and Puleo v. Chase Bank USA, N.A., 605 F.3d 172, 188 (3d Cir. 2010) (en banc), the Second and Third Circuits, respectively, held that challenges to the enforceability of such class-action waivers presented questions of arbitrability that should be resolved by a court, not an arbitrator. Lowry is not inconsistent with these decisions. Unlike in Lowry, the Third Circuit in Puleo held that the arbitration agreement did not clearly and unmistakably provide that the arbitrator would resolve questions of arbitrability. Thus, the default rule—that a court should decide arbitrability—applied. And, in American Express, neither party argued that the contract required questions of arbitrability to be decided by the arbitrator.

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