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A federal district court in New Jersey has ruled that the Federal Arbitration Act (FAA) preempts a New Jersey Supreme Court decision holding that a class waiver, if it functions as an exculpatory clause, renders an arbitration agreement unconscionable and therefore unenforceable under New Jersey law.
In Litman v. Cellco Partnership, No. 07-CV-4886, 2008 WL 4507573 (D.N.J. Sept. 29, 2008), Litman and another Verizon customer (collectively, Customers) filed a class action lawsuit alleging that Verizon, their wireless service provider, had unlawfully charged them an administrative fee totaling less than a $1 per month.
In response to the lawsuit, Verizon filed a motion to compel arbitration pursuant to an arbitration agreement in the wireless service contract. This arbitration agreement contained a class waiver barring class-wide arbitration and requiring arbitration on an individual basis. In opposing the motion, the Customers argued that the arbitration agreement was unconscionable under New Jersey law and therefore unenforceable.
Verizon apparently conceded that given the circumstances, the class waiver would render the arbitration agreement unenforceable under New Jersey law or, more specifically, under Muhammad v. County Bank of Rehoboth Beach, Delaware, 912 A.2d 88 (N.J. 2006). Verizon maintained, however, that the FAA preempts Muhammad in light of the Third Circuit Court of Appeals' decision in Gay v. CreditInform, 511 F.3d 369 (2007). Accordingly, the only issue before the Court was whether the FAA preempts Muhammad.
Based on Gay, the Court held that that the FAA preempts Muhammad and, accordingly, that the arbitration agreement and class waiver were enforceable under the FAA. In reaching this decision, the Court cited Gay for the rule that "whatever the benefits of class actions, the FAA requires piecemeal resolution when necessary to give effect to an arbitration agreement."
Moreover, in reaching its holding, the Court reasoned that even though Muhammad was ostensibly premised on a doctrine of general application, the court's application of the unconscionability doctrine was tied to the fact that an arbitration agreement was at issue. Having determined that the FAA preempts Muhammad, the Court issued an order compelling arbitration on an individual basis.
As the Court noted, other courts, such as the Ninth Circuit Court of Appeals, have found that the FAA does not preempt this application of the unconscionability doctrine, mainly on the premise that the rule would also apply to a class action waiver outside of an arbitration agreement. See, e.g., Shroyer v. New Cingular Wireless Servs., Inc., 498 F.3d 976, 987 (9th Cir. 2007).
None of these decisions has acknowledged a crucial distinction between class action lawsuits and class-wide arbitration. As the United States Supreme Court has stated, the purpose of a class action lawsuit is "to promote judicial economy by allowing for litigation of common questions of law and fact at one time." General Tel. Co. of Southwest v. Falcon, 457 U.S. 147, 161 (1982) (emphasis added). This policy consideration does not apply to arbitration because regardless of whether class-wide proceedings are available, arbitration promotes judicial economy by resolving disputes outside of the court system.
In light of this distinction, class waivers within an arbitration agreement are on different footing from standalone class waivers that are outside of an arbitration agreement. The essential difference is the relative burden on public resources. Parties to an arbitration agreement with a class waiver are preserving public resources by submitting their disputes to a privately funded system. Conversely, parties to a standalone class waiver are taxing public resources by attempting to foreclose the court system's use of procedures that have been adopted to promote judicial economy.
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