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NATIONAL HOME EQUITY MORTGAGE ASSOCIATION

Equity Update

www.nhema.org

CALIFORNIA SUPREME COURT INVALIDATES CLASS ARBITRATION PROHIBITIONS

Kirk D. Jensen

Buckley Kolar LLP

1250 24th Street NW, Ste. 700

Washington, DC 20037

(202) 349-8000

On June 27, 2005, the California Supreme Court held that consumer arbitration agreements that prohibit class arbitration are unenforceable under many circumstances. In Discover Bank v. Superior Court (commonly known as “Boehr”), the court held that the Federal Arbitration Act does not preempt state laws invalidating class arbitration prohibitions. Although the court stopped short of condemning all class arbitration prohibitions, the court’s opinion is troubling.

“Class arbitration” refers to an arbitration proceeding in which the claims of a class of claimants are resolved on a class-wide basis. Lenders have good reason to dislike class arbitration. Class arbitration proceedings present all the risk of class action litigation— including stakes that in some cases can exceed tens of millions of dollars—without the procedural safeguards of litigation.

The California court not only held that a class arbitration prohibition was unenforceable, it held that the lender could be required to arbitrate on a class-wide basis—a proceeding dramatically different than that to which the lender agreed. Perhaps even more troubling is the court’s apparent suggestion that the plaintiff could certify a nationwide class, even though the majority of courts nationwide have upheld and enforced class arbitration prohibitions (including Delaware, the state where the lender is located and under whose laws the claims were brought).

The court’s opinion is deeply flawed in a number of respects. First, it wrongly concludes that consumers cannot effectively vindicate their rights in arbitration. This conclusion is contradicted by the majority of courts and refuted by empirical evidence showing consumers fare well in arbitration. Second, it violates the Federal Arbitration Act (“FAA”) by requiring parties to submit to a proceeding radically different than that contained in the parties’ agreement. Third, it violates the FAA by attempting to impose a class arbitration requirement on all consumer agreements. Because prior California case law has held that agreements silent regarding class arbitration actually permit it, the Court’s conclusion that many express prohibitions of class arbitration are unenforceable effectively requires all arbitration agreements to allow class arbitration. Such procedural requirements directly contravene the FAA and U.S. Supreme Court opinions interpreting it. See generally Kirk D. Jensen, Can Financial Institutions Be Required to Arbitrate on a Class-Wide Basis Notwithstanding Provisions That Prohibit Class Arbitration?, 122 BANKING L.J. 328 (2005).

The California court remanded the case to the lower court to determine whether Delaware or California law applies to the arbitration agreement (with a strong suggestion that California law applies). Even if the lower court holds that Delaware law applies, the California court’s holding will cause headaches in the future. While there are ways lenders can revise their agreements to protect themselves, lenders should hope that the U.S. Supreme Court will review the case and remind the California court that it—like all courts—must abide by well-established principles of federal law.