Legal Intelligencer: Stacked Decks and Sealed Deals: How Arbitration Tilts the Scales — Kang Haggerty News

While vigorous efforts have been made to push the courts to interpret the Federal Arbitration Act (FAA) with an increasingly broad preemptive scope, effectively overriding state laws designed to regulate arbitration, recent decisions underscore that courts are not willing to uphold arbitration agreements when fairness and justice might be compromised. Legitimate concerns surrounding arbitration are prompting more judicial scrutiny—a trend worth examining.

In the December 20, 2024 edition of The Legal Intelligencer, Edward Kang writes, “Stacked Decks and Sealed Deals: How Arbitration Tilts the Scales.“

In recent decades, the American legal landscape has seen a marked shift toward arbitration. Originally intended as an efficient and cost-effective alternative to litigation, arbitration has increasingly become a tool by which big corporations channel disputes away from public courts and into private forums. While vigorous efforts have been made to push the courts to interpret the Federal Arbitration Act (FAA) with an increasingly broad preemptive scope, effectively overriding state laws designed to regulate arbitration, recent decisions underscore that courts are not willing to uphold arbitration agreements when fairness and justice might be compromised. Legitimate concerns surrounding arbitration are prompting more judicial scrutiny—a trend worth examining.

The Alternate System of Justice

Arbitration represents a fundamental departure from the public adjudication system, namely, the right to trial by jury of one’s peers. In traditional litigation, disputes are resolved in open courtrooms, with judicial opinions forming part of the public record. The transparency of the process promotes accountability and the consistent development of legal precedent. Arbitration, however, is private: outcomes are typically confidential, and arbitrators are not bound to follow precedent.

The shift toward private arbitration has significant implications for justice. As more disputes are resolved behind closed doors, the public’s ability to monitor corporate behavior and systemic issues diminishes. This “privatization of the justice system” can thus obscure patterns of misconduct, depriving consumers, employees and the broader community of critical information. For example, widespread arbitration clauses in employment contracts can prevent employees from sharing workplace discrimination claims, shielding employers from potential reputational damage and public scrutiny. Similarly, the fine print in most service agreements compels consumers to resolve any future disputes through arbitration, effectively waiving their right to pursue claims in court. In one recent instance that drew widespread public dissatisfaction, a doctor suffered a fatal allergic reaction after dining at a Disney restaurant. After her husband filed a wrongful death suit, Disney moved to dismiss, claiming that the husband had agreed, when signing up for a one-month Disney+ trial and again when creating an account on Disney’s website to purchase tickets to the theme park, to settle any and all claims against the company through arbitration. Disney eventually withdrew the motion in the face of public outcry.

The imbalance inherent in arbitration is not accidental. Arbitration, once regarded as a low-cost, less adversarial, and efficient dispute resolution method, has morphed into a private and compulsory forum for resolving disputes between individuals and corporations, with very limited grounds for judicial review. Companies are further shielded from the financial burdens of litigation and regulatory oversight. The imbalance in the system is also seen in how much more difficult it is to regulate arbitration to protect consumers and employers than to carve out specific claims from the arbitration process on companies’ behalf. Companies often carve out certain types of claims, such as claims for injunctive relief and trade secret protection, and reserve those claims for litigation—a tendency that legal scholars say reflects a belief that arbitration is inferior to litigation for specific types of disputes. By tilting the playing field in this way, corporations are able to maximize their benefits while limiting the ability of states to protect the public interest.

An Unequal Playing Field

One of the most questionable issues with arbitration is the “repeat player advantage.” Whereas individual claimants are typically one-time participants in arbitration, large corporations are frequently involved in arbitration proceedings. This gives them a systemic advantage. Repeat players can influence the selection of arbitrators by favoring those who have issued favorable decisions, and their familiarity with the process makes them better equipped to navigate arbitration procedures. In contrast, individual claimants often enter the process unfamiliar with its nuances and with limited resources to litigate their case.

A 2015 Consumer Financial Protection Bureau (CFPB) study found that consumers in arbitration with financial services companies rarely prevail, compared to corporations. The disparity raises concerns that arbitration is not a neutral forum but one in which large entities benefit from institutional familiarity and the ability to influence outcomes over time. Research by the Economic Policy Institute (EPI) further underscores the extent of this disparity. In 2016, researchers found that employees in mandatory arbitration win only 21.4% of the time, compared to a 36.4% win rate in federal court. Additionally, the median arbitration award for employees is $36,500, only 21% of the median award in the federal courts, at $176,426.

Judicial Scrutiny

While the FAA traditionally favors enforcing arbitration agreements, courts are increasingly pushing back in cases where they perceive arbitration agreements as fundamentally unfair, unconscionable, or against public policy. Recent decisions illustrate a willingness to scrutinize arbitration agreements, particularly when there is a significant power imbalance between the parties.

For example, in Heckman v. Live Nation Entertainment, 120 F.4th 670 (9th Cir. 2024), the U.S. Court of Appeals for the Ninth Circuit affirmed the denial of a motion to compel arbitration under Ticketmaster’s terms of use, which mandated arbitration through New Era ADR’s mass arbitration rules. The court found that the delegation clause—the clause delegating to the arbitrator the authority to determine the validity of the arbitration agreement—and the arbitration agreement as a whole were unconscionable and unenforceable under California law. The court based its reasoning on several factors: given Ticketmaster’s market dominance, consumers faced a lack of meaningful choice; the agreement allowed retroactive changes and misleadingly promised individual arbitration despite a protocol that batched claims; there was no right to discovery in the mass arbitration process; only defendants had the right to appeal a decision on injunctive relief; and the procedure for selecting the arbitrator was inconsistent with California law. The court’s refusal to enforce the terms’ severability provision focused on the court’s observations that the defendants had engaged in a systematic effort to impose arbitration as an inferior forum, and that the effects of these unconscionable provisions were entirely foreseeable and intended.

Similarly, in Brooks v. AmeriHome Mortgage, 260 Cal. Rptr. 3d 428 (2020), the California Court of Appeal affirmed the granting of an employee’s motion for preliminary injunction to enjoin arbitration. In Brooks, the employee brought an action against his employer, alleging violations of the Private Attorneys General Act of 2004 (PAGA) based on wage and hour violations. The court reasoned that because PAGA action was fundamentally an action designed to protect the public, an employment agreement compelling employees to waive their right to bring a PAGA action was contrary to public policy and unenforceable as a matter of state law. The court further explained that because a PAGA action is a representative action, a single-claimant arbitration under the PAGA for individual penalties would not result in the penalties contemplated under the PAGA to punish and deter employer practices that violate the rights of employees en masse. Since the employee only alleged a single cause of action under PAGA and did not allege an individual claim for wage recovery, the court found that the claim could not be split into an arbitrable individual claim and a nonarbitrable representative claim. Consequently, the court affirmed the granting of the preliminary injunction.

These cases reflect a judicial sentiment that while arbitration is legally favored, it cannot operate as a shield for oppressive practices. The cases also signal that the courts are increasingly sensitive to issues of procedural fairness (whether the process of entering into the agreement was fair) and substantive fairness (whether the terms of the agreement are just).

Balancing Efficiency and Equity

Arbitration can be beneficial for resolving disputes when it involves two parties with equal powers and law firms with equal influence. It can provide a resolution more quickly and cheaply than litigation. However, when a dispute is between a corporation and an individual or involves a big law firm on the one hand and a solo practitioner on the other, the arbitrator might favor the big corporation or the big law firm—e.g., implicit bias.

The legal system must balance the efficiency of arbitration against the principles of fairness and transparency. As courts continue to scrutinize arbitration clauses, public trust in the arbitration process might be restored if arbitration can be a fair and accessible option rather than a mandatory and oppressive one. Counsel for litigants should also be creative in crafting claims. If the language in the agreement does not raise procedural or substantive fairness issues, anchoring claims to state laws with a public policy consideration and favorable precedent might be the most effective counter to the FAA preemption argument.

Edward T. Kang is the managing member of Kang Haggerty. He devotes the majority of his practice to business litigation and other litigation involving business entities. Contact him at ekang@kanghaggerty.com.

Reprinted with permission from the December 20, 2024 edition of “The Legal Intelligencer” © 2024 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com.