For most small to medium-sized businesses, the threat of a class action is not usually front-of-mind. However, as a business grows, the threat can increase depending on the number of employees and the nature of the work being performed. Class actions are commonly thought of as involving hundreds, if not thousands, of individuals. However, courts routinely consider much smaller groups of employees, including groups of approximately 40 individuals to be sufficient to establish a class action. To reduce the risk of a class action disrupting business operations and impacting revenue, businesses may want to consider including arbitration clauses in their employment and consumer agreements.
A judgment award for a class of plaintiffs can pose a significant threat to a company’s bottom line, and it may endanger the survival of a business. An applicable insurance policy may only cover a small portion of an award—if any amount at all. Accordingly, many businesses include arbitration clauses (also referred to herein as “clauses”) in employment and consumer agreements in an attempt to shield themselves from class action lawsuits. The success of these types of clauses in accomplishing the same largely depends upon its wording, the respective jurisdiction, and the nature of the underlying agreement.
It is important to note that arbitration clauses are not always beneficial for companies, and they may be unenforceable in certain jurisdictions, unless they are subject to the Federal Arbitration Act (9 U.S.C. §§ 1-16, et seq.) (“FAA”). To qualify under the FAA, the underlying contract needs to involve foreign or interstate commerce (parties, services, products, or materials need to cross state lines).
But what if your company’s arbitration clause does not address class actions?
If the underlying contract is subject to the FAA, you can take a deep breath (but not before consulting an attorney to determine if it qualifies). Earlier this year, in Lamps Plus, Inc. v. Varela, the Supreme Court strengthened protections for companies employing such clauses that do not specifically address class arbitration.
The Lamps Plus matter arose when a hacker convinced a Lamps Plus, Inc. employee to provide tax information of approximately 1,300 employees. All affected employees previously signed employment agreements that contained an arbitration clause. However, the clauses did not specifically address whether class arbitration was permissible.
One of the affected employees filed a lawsuit in federal court in California, seeking to certify a class action on behalf of all similarly situated employees based on the negligent disclosure of personal information. The court dismissed the lawsuit based on the arbitration clause but compelled the same on a class basis, based on the court’s finding that the clause was drafted ambiguously and could be read to contemplate class arbitration.
On appeal, the Ninth Circuit affirmed, agreeing that the clause was ambiguous on the issue of class arbitration. The court’s interpretation of the clause was based on a state law doctrine that provides all ambiguities in an agreement are construed against the drafting party (here, Lamps Plus). In so holding, the Ninth Circuit focused on the following phrase: “arbitration shall be in lieu of any and all lawsuits or other civil legal proceedings relating to [the employees’] employment.” The court found that the company’s inclusion of the words “in lieu of” in reference to “lawsuits” and “proceedings” encompasses class arbitration. In other words, a single arbitration proceeding would replace multiples of the same.
The Supreme Court overturned the Ninth Circuit, holding that (1) class arbitration is a matter of explicit consent, and (2) arbitration agreements that fall within the FAA are interpreted pursuant to the same—not state law.
Principally at issue was a conflict between state law and the FAA. The Supreme Court will normally defer to a Circuit Court’s interpretation of state law, except where the law is preempted by federal law. The contractual doctrine cited by the Ninth Circuit is solely a product of state law, even where it is employed by a federal court. The application of such doctrine directly conflicts with the foundational principle of the FAA, which provides that arbitration is a matter of consent between the parties and can only be enforced according to the terms of the agreement.
In so holding, the Court, relying upon previous Supreme Court opinions, provided that class arbitration cannot be inferred into an agreement as there are fundamental differences between class and individual arbitration. Parties normally choose arbitration due to the potential of lower costs and the efficiency of the process. Class arbitration is in direct conflict with those goals as it slows the process and increases costs.
The bottom line: if class arbitration is not explicitly addressed in an arbitration agreement, it cannot be compelled.