binding arbitration clause

Challenging Binding Arbitration A New Use for the FTC By Angela Saad* Introduction When individuals encounter a problem arising from a consumer transaction they are often precluded from going to court and instead are required to engage in arbitration, because of a pre-dispute binding arbitration agreement clause in their contract. Arbitration, which requires that the consumer submit his or her dispute to a private judge and precludes the use of our civil justice system, may sometimes be favorable to consumers. Consumers, however, should be able to choose their dispute resolution forum.1 While, more often than not, consumers will be forced into binding arbitration, there may be relief available through a recent case involving the Federal Trade Commission. II. Current Consumer Protection Avenues Before the popularity of pre-dispute arbitration agreements in contracts, consumers were able to resolve commercial disputes through a variety of forums. Most consumers chose to adjudicate their claims through jury trials or small claims court. Some would engage organizations such as the Better Business Bureau to resolve commercial disputes, using alternative dispute resolution, such as 130 I. mediation or arbitration. Recently, however, due to the growing popularity of contractual mandatory pre-dispute arbitration agreements, such alternatives are rarely available. Today, most consumer contracts contain a binding arbitration clause making arbitration the only available forum when problems arise. When a contract contains a pre-dispute arbitration agreement, nearly all courts liberally interpret and enforce it.2 There is a strong national policy favoring arbitration, which leads most judges to enforce all terms of the contract including the arbitration agreement.3 This judicial attitude is based primarily on Section 2 of the Federal Arbitration Act (FAA), which provides that arbitration agreements “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.”4 Therefore, whatever the consumer’s preference regarding arbitration, the pre-dispute arbitration agreement is the exclusive forum for resolving disputes, unless the consumer can show a traditional contract defense to the validity of the arbitration provision.5 For example, an arbitration provision may be challenged on traditional contract theory arguments, such as unconscionability, Journal of Consumer & Commercial Law misrepresentation, or fraud.6 However, absent these arguments, a consumer is not excused based on his own ignorance or negligence regarding the pre-dispute arbitration clause.7 After all, there is “nothing inherently unconscionable about arbitration agreements.”8 Most Texas courts that have considered the validity of arbitration provisions have held them valid and enforceable. For example, in Universal Computer Systems, Inc. v. Dealer Solutions, LLC,9 the court enforced an arbitration provision, notwithstanding claims of procedural and substantive unconscionability and misrepresentation, as well as “contractual glitches.”10 Universal Computer demonstrates the extent to which courts support contractual pre-dispute arbitration agreements. Not every arbitration provision, however, is upheld. In Olshan v. Ayala, the court invalidated an arbitration provision finding that the prohibitive cost of arbitration could not be justified in comparison to the amount in controversy.11 However, the dissent argued that as a matter of law, a contract can only be found unconscionable in Texas at the time it was made; therefore, the cost of arbitration for the Ayala’s when they contracted should have been considered.12 While the number of cases invalidating an arbitration clause is minimal, the possibility of filing a claim based on traditional contract theory does offer a glimmer of hope for consumers. Arbitration provisions are often viewed as merely an alternative forum for consumers to resolve disputes. Consumer advocates, however, argue that a pre-dispute arbitration agreement is also a pre-determined resolution for consumers, and, therefore, a limit to their due process rights.13 Additionally, litigating in a court of law provides essential access to necessary case law – to support potential legal claims, which is not available in arbitration proceedings.14 Furthermore, limited grounds exist for appealing an arbitration outcome, leaving consumers with few alternatives other than accepting the resolution as determined by the arbiter.15 Unfortunately for consumers, “as employed in the United States, pre-dispute mandatory arbitration is designed to preclude effective redress by consumers and to substantially reduce or eliminate the beneficial effects of favorable judicial precedent and legislation.”16 The use of arbitration as an alternative forum may also have the effect of altering the enforcement scheme contemplated by the legislature in enacting consumer protection legislation. For example, the Texas Deceptive Trade Practices Act (DTPA) offers consumers legislative protection through legal recourses for unfair consumer practices.17 However, the right to bring a lawsuit under the DTPA may be limited by an arbitration provision. In Jack B. Anglin Co., Inc. v. Tipps, the Texas Supreme Court held that the Supremacy Clause in the United States Constitution trumped any applicable state law, such as the DTPA.18 Therefore, it is becoming less likely that a jury will have an opportunity to resolve a DTPA complaint.19 In light of the contractual predominance and judicial enforcement of arbitration clauses, the consumer is often left with few ways to avoid an arbitration clause. . Most consumer disputes must now be settled through arbitration. A few recent decisions, however, suggest that there may exist another avenue by which consumers may reach the courtroom – the Federal Trade Commission (FTC). For example, a recent California consent decree20 involving KB Home demonstrates a new limitation on arbitration clauses. This case, and another case involving KB Home and over 600,000 homeowners in Texas, could indicate a new wave of consumer protection from the limitations of arbitration clauses. III. Mandatory Arbitration: The KB Home Model KB Home has a long history with the FTC. In 1979, the Journal of Consumer & Commercial Law FTC filed a complaint against KB Home claiming violations of Section 5 of the Federal Trade Commission Act.21 The order prohibited KB Home from making misrepresentations of fact and using other unfair or deceptive acts or practices in the construction and sale of residential housing.22 More specifically, the order required KB Home to: 1) mirror their warranty policy after the Home Owners Warranty Corporation (HOW) warranty, 2) make timely warranty repairs, and 3) follow the HOW procedure for settlement dispute.23 While the HOW warranty stipulates that warranty disputes are to be arbitrated, it also provides that the decision is only binding on the home builder, not the homeowner. Additionally, the arbitration proceedings of the HOW warranty are free to the homeowner.24 In 1991, the Department of Justice filed a complaint in U.S. District Court alleging that KB Home violated the 1979 FTC consent agreement.25 Specifically, it alleged that KB Home violated the decree by binding homeowners to binding arbitration for warranty disputes and requiring them to pay fees and costs to initiate and conduct such dispute arbitration.26 The court entered another consent decree requiring KB Home to pay a civil penalty in the amount of $595,000 and filed a permanent injunction requiring KB Home to comply with the 1979 order.27 KB Home continued to violate the 1979 order, and in 1995 received a staff advisory opinion advising it of the continued violation. No action was taken by the FTC, however, until 2003, when a group of homeowners brought a lawsuit to counter KB Home’s mandatory warranty arbitration.28 Suit was filed in Laredo, Texas and homeowners alleged that mandatory arbitration for homeowners warranty disputes was illegal based on the FTC consent orders.29 The homeowners argued for standing to enforce the 1979 order against KB Home through a private lawsuit.30 While it was found to be against public policy to allow a private suit to enforce the FTC orders, the FTC revisited its investigation of KB Home’s actions.31 Following the private suit invoking the FTC decree, the Department of Justice filed a modified consent decree against KB Home in the U.S. District Court for the Southern District of California on August 3, 2005.32 The decree ordered that KB Home pay a 2 million dollar civil penalty to settle charges that it violated the terms of a 1979 consent order with the FTC. In the decree, the court also barred KB Home from violating the original terms of the 1979 order and demanded modification of existing home repair warranties to comply with the order.33 This decree not only required that KB Home comply with the order, but also allowed the homeowners who were required to enter arbitration proceedings to file private lawsuits against KB Home.34 On May 16, 2006, the U.S. District Court in Laredo, Texas finalized a settlement between KB Home and homeowners represented in a class action suit filed in 2003.35 The district court judge ordered KB Home to stop forcing homeowners to accept mandatory binding arbitration.36 This ruling is a victory for consumers and a substantial blow to predispute arbitration agreements. Utilizing the FTC consent order in this case allowed homeowners to adjudicate their warranty dispute in front of a jury of their peers, rather than face an expensive, mandatory, and binding arbitration proceeding. Arbitration provisions are often viewed as merely an alternative forum for consumers to resolve disputes. 131 The district court judge ordered KB Home to stop forcing homeowners to accept mandatory binding arbitration. IV. The Future of the FTC and Consumer Advocacy In the KB Home case, homeowners brought a claim to enforce the FTC’s 1979 order which relieved KB homeowners of binding arbitration and the arbitration costs involved with their warranty disputes.37 Due to an attempt by the homeowners to enforce the 1979 order in court, the FTC filed an amicus brief discussing legal theories available to consumers in relation to the FTC orders.38 A case that initially had little chance for success turned out victorious due to a fifteen year old consent decree. Attorneys representing consumers or others facing arbitration should do a little extra legwork to determine whether the defendant has been involved with the FTC, and whether there are any ongoing consent decrees. KB Home is an initial example of the use of FTC consent orders in court. Finally, it should be noted that the FTC amicus brief filed in KB Home mentioned two alternate arguments that had not been presented by the homeowners that could possibly provide additional legal theories for prospective plaintiffs. Specifically, the two issues the FTC briefly mentions are: (1) whether private contract provisions that violate a Commission order may, as a matter of contract law, be unenforceable because of such violation; and (2) whether a private party injured by a contract provision that violates a Commission order may proffer that order as evidence in support of a claim seeking either to reform the contract or to have the contract declared a nullity.39 Those terms that have been determined by the FTC to be illegal could be ruled unenforceable, reformed, or declared void. Previously, FTC consent orders have been used by plaintiffs as evidence of the violation of the consent decree in establishing the elements of its own cause of action.40 However, FTC consent orders have not been used to establish traditional contract theory elements to the full extent. For consumer advocates, these avenues should be further explored in order to fully advocate for consumer interests regarding arbitration or other matters. IV. Conclusion While not all issues pursued by the FTC relate to arbitration agreements, the use of the FTC and traditional contract theory are current avenues available to counter pre-dispute arbitration agreements. For consumer advocates, this is a small step toward consumers being able to choose their preferred dispute resolution forum and as such provides hope for the future of dispute resolution whether in the courtroom or in arbitration proceedings. *Angela Saad is currently a second year student at the University of Houston Law Center anticipated to receive her J.D. in May 2008. 1. Eric J. Mogilnicki & Kirk D. Jensen, Arbitration and Unconscionability, 19 GA. ST. U. L. REV. 761, 762-66 (2003) (citing studies demonstrating the benefits of arbitration to consumers and businesses alike). 2. J. Marie Glover, Beyond Unconscionability: Class Action Waivers And Mandatory Arbitration Agreements, 59 VAND. L. REV. 1735, 1740-42; Charles L. Knapp, Taking Contracts Private: The Quiet 132 Revolution In Contract Law, 71 FORDHAM L. REV. 761, 766; Donald Lee Rome & David M. S. Shaiken, Arbitration Carve-Out Clauses In Commercial And Consumer Secured Loan Transactions, DISP. RESOL. J., Aug.–Oct. 2006, at 43, 44-5. 3. Buckeye Check Cashing, Inc. v. Cardegna, 126 S.Ct. 1204 (2006); PacifiCare Health Systems, Inc. v. Book, 538 U.S. 401 (2003). Shearson/Am. Express, Inc. v. McMahon, 482 U.S. 220 (1987); Green Tree Financial Corp. v. Bazzle, 539 U.S. 444 (2003); Citizens Bank v. Alafabco, Inc., 539 U.S. 52 (2003); Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79 (2002). 4. 9 U.S.C. §2; See Shearson/Am. Express, Inc. v. McMahon, 482 U.S. 220, 225–27 (1987) (establishing the federal policy to favor arbitration as the purpose of the Federal Arbitration Act). 5. Richard Alderman, Pre-Dispute Mandatory Arbitration in Consumer Contracts: A Call For Reform, 38 HOUS. L. REV. 1237, 1245-46 (2001) (discussing the flaws in the current dispute resolution system and possible reforms). 6. In Section 2 of the Federal Arbitration Act, the validity, enforceability and revocability of a contract with an arbitration clause is questioned when the contract is based on “grounds as exist at law or in equity for the revocation of any contract.” This avenue is used often to avoid arbitration. (See infra note 11). However, the Supreme Court ruling, in Buckeye Check Cashing, Inc. v. Cardegna, provided that the legality of the contract and arbitration provision is to be determined through an arbitration proceeding rather than the court. Alderman, supra note 5, at 1245-46; 9 U.S.C. §2; Buckeye Check Cashing, Inc. v. Cardegna, 126 S.Ct. 1204 (2006) (holding arbiter to determine the illegality of an arbitration provision in an allegedly usurious contract, not the court). 7. Alderman, supra note 5, at 1247-49. 8. In re Palm Harbor Homes, Inc. 195 S.W.3d 672, 678 (Tex. 2006) (holding arbitration agreement for purchase of mobile home is not substantively unconscionable because the seller can choose to arbitrate and the buyer could not, nor is it procedurally unconscionable because one party has a less advantageous bargaining position). 9. Universal Computer Systems, Inc. v. Dealer Solutions, L.L.C., 183 S.W.3d 741, 752 (Tex. App.—Houston [1st Dist.] 2005, pet. filed). 10. Id. 11. Olshan Foundation Repair Co. v. Ayala, 180 S.W.3d 212, 216 (Tex. App. – San Antonio 2005, pet. filed) (holding the arbitration provision unconscionable for the extraordinary cost of arbitration). See also, Circuit City Stores, Inc. v. Adams, 279 F.3d 889 (9th Cir. 2002) (finding that an arbitration agreement was unconscionable in part because it limited the remedies available to one party); Ticknor v. Choice Hotels Int’l, Inc., 265 F.3d 931 (9th Cir. 2001) (holding the arbitration clause, which was part of a contract of adhesion, was unconscionable, and thus unenforceable and state law adhesion contract principles may be relied upon to invalidate arbitration contracts without violating Federal Arbitration Act). 12. Olshan, 180 S.W.3d at 218 (Angelini, J., dissenting). 13. Stephen J. Ware, Arbitration Clauses, Jury-Waiver Clauses, And Other Contractual Waivers Of Constitutional Rights, 67-SPG LAW & CONTEMP. PROBS. 167, 169-72; Alderman, supra note 5, at 1262-64. 14. Id. Outside of what the arbitration agreement specifically provides, arbitration participants are entitled to 1) be heard, 2) present material evidence and 3) cross-examine any witness. TEX. CIV. PRAC. & REM. CODE § 171.047. Furthermore, an arbiter is not bound to rule according to case law, but by the contract undergoing arbitration. 15. Mogilnicki, supra note 1, at 780. Journal of Consumer & Commercial Law 16. Alderman, supra note 5, at 1242 17. Stephen G. Cochran, The Texas Deceptive Trade Practices – Consumer Protection Act As a Private Remedy, 27 TEX. PRAC., CONSUMER RIGHTS AND REMEDIES § 1.29 (3d ed.) 18. Jack B. Anglin Co., Inc. v. Tipps 842 S.W.2d 266, 271 (Tex. 1992). See also Capital Income Properties v. Blackmon 843 S.W.2d 22 (Tex. 1992) (finding strong policy preference for enforcing arbitration clauses). 19. Cochran, supra note 17. 20. Modified Consent Decree, United State v. KB Home, No. 91-0872 (S.D. Cal, Aug 3, 2005). 21. Kaufman and Broad, Inc., 93 F.T.C. 235 (1979). 22. Id. at 247-62. 23. Id. at 253-54. 24. Id. at 267. 25. Press Release, Federal Trade Commission, KB Home to Pay $2 Million Penalty for Alleged Violations of FTC Order (August 3, 2005) (on file with author). 26. Id. 27. Id. 28. Id. 29. Pruitt v. Kaufman and Broad Home Corp., No. L-03-CV-21 (S.D. Tex. May 16, 2006). 30. Id. 31. Id. 32. See Modified Consent Decree, supra note 20. 33. Id. 34. Id. 35. Pruitt, No. L-03-CV-21 36. Id. 37. Id. 38. Memorandum of Law of Amicus Federal Trade Commission at 3, Pruitt v. Kaufman and Broad Home Corp., No. L-03-CV-21 (S.D. Tex. August 18, 2003). 39. Id. 40. See Biovail Corp. Int’l v. Hoechst Aktiengesellschaft, 49 F.Supp.2d 750 (D.N.J. 1999) (allowing plaintiff to rely on evidence of the defendant’s violation of the consent decree to build its own cause of action); In re Cardizem CD Antitrust Litigation, 105 F.Supp.2d 618 (E.D. Mich. 2000), aff’d on other grounds, 332 F.3d 896 (6th Cir. 2003) (holding that defendant’s conduct regarding FTC consent orders could be used as evidence to plaintiff’s claims). Journal of Consumer & Commercial Law 133