Does the Federal Arbitration Act preclude using state law principles of contract interpretation to understand commonly used language in a standard form arbitration agreement as authorizing class arbitrations?
Lamps Plus, Inc. (“Lamps Plus”) and Frank Varela (“Varela”) executed an arbitration agreement which contained a clause waiving Varela’s right to sue his employer or institute any other civil action or proceeding concerning his employment at Lamps Plus. After a data breach caused by an internet phishing incident, Varela sued Lamps Plus alleging negligence, breach of contract, and invasion of privacy. Lamps Plus moved to compel arbitration of Varela’s individual claims, but the district court decided to dismiss Varela’s claims without prejudice and to compel class arbitration of the claims. Lamps Plus appealed, arguing that, as the Federal Arbitration Act (“FAA”) requires a contractual basis showing the parties’ intent to arbitrate class actions, the court could not read in an agreement to class arbitration based on language relating to personal disputes. Further, the company argues that even if the agreement is ambiguous as to that intent, Supreme Court precedent indicates that courts must resolve such ambiguity in favor of arbitration. Varela counters that issues of jurisdiction and standing prevent the Supreme Court from deciding this case and that, even if the Court were to examine the case on the merits, California contract-law interpretive principles used by the lower court were neutral, applied properly, and, thus, permissible. The Supreme Court’s decision has implications for the employment sector and will likely influence the decision of employers to expressly exclude class actions from future arbitration agreements to maintain the efficiency and informality of arbitration.
Questions as Framed for the Court by the Parties
Whether the Federal Arbitration Act forecloses a state-law interpretation of an arbitration agreement that would authorize class arbitration based solely on general language commonly used in arbitration agreements.
Respondent Frank Varela (“Varela”) is an employee of Petitioner Lamps Plus Inc. (“Lamps Plus”). Before commencing his employment with Lamps Plus, Varela executed an arbitration agreement in which he consented to arbitrate any claims relating to his employment with Lamps Plus and also waived his right to file employment-related lawsuits or civil proceedings . The arbitration agreement also clarified that any claims that would have otherwise been available to the parties without this agreement would be arbitrable and it authorized the arbitrator to award any remedies allowed by the applicable law.
As a consequence of a phishing scam in 2016, Lamps Plus released Varela’s personal information from his W-2 tax forms. Varela’s identity was compromised as a result and a fraudulent income tax form was filed in his name. This prompted Varela to file a class action complaint in the United States District Court for the Central District of California (“district court”) against Lamps Plus and two related corporations on behalf of current and former employees of Lamps Plus and others injured by the data breach, for negligence, breach of contract, and invasion of privacy. Lamps Plus moved to compel arbitration in accordance with its arbitration agreement executed by Varela. However, Lamps Plus argued that the arbitration agreement authorized only individual arbitration of Varela’s claims and not of the entire class. Varela countered that the arbitration agreement was unconscionable, and alternatively that the language in the agreement encompassed class-wide arbitrations. The district court granted Lamps Plus’s motion to compel arbitration but found the arbitration agreement to be a contract of adhesion; consequently, the court construed the ambiguity about class arbitration against Lamps Plus because it was the drafter of the agreement. As a result, the district court allowed Varela’s claims to proceed to class-wide arbitration. The district court also granted Lamps Plus’s motion to dismiss Varela’s claims.
Lamps Plus appealed to the U.S. Court of Appeals for the Ninth Circuit (“Ninth Circuit”). The Ninth Circuit affirmed the district court’s decision, applying California law to interpret the arbitration agreement. It concluded that the most reasonable interpretation of the language in the agreement was that the parties had agreed to class-wide arbitrations. The Ninth Circuit did not consider the fact that the arbitration agreement did not expressly mention class arbitrations as fatal to the issue; rather, it read the broad language of the arbitration agreement indicating that arbitration would be “in lieu of” legal proceedings as including class arbitrations. Judge Fernandez dissented from the majority opinion on the ground that the arbitration agreement was not ambiguous. On April 30, 2018, the Supreme Court of the United States granted certiorari.
THE “CONTRACTUAL BASIS” REQUIREMENT
Petitioner Lamps Plus argues that the language of the arbitration agreement that binds itself and Varela is insufficient to compel class-action arbitration. Lamps Plus asserts that the lower court acted contrary to the primary purpose of the Federal Arbitration Act (“FAA”), which is meant to guarantee “that private agreements to arbitrate are enforced according to their terms.” Lamps Plus further contends that the lower court evaded the Stolt-Nielsen v. AnimalFeeds International Corp. holding, which requires a contractual basis showing intent to arbitrate class-action disputes. A necessary predicate to the FAA’s goal, Lamps Plus maintains, is ensuring that the arbitration is a matter of consent rather than coercion. According to Lamps Plus, reading in an agreement to arbitrate class-actions here would make arbitration a matter of coercion, not consent, and would bind countless absent parties, such as the fellow employees whose information was also compromised but who were not a party to Varela’s arbitration agreement. Though the Court in Stolt-Nielsen did not explicitly define the “contractual basis” required, Lamps Plus contends that the language relied on by the Ninth Circuit was insufficient and that the lower court’s reasoning would render Stolt-Nielsen null. Lamps Plus states that the Ninth Circuit incorrectly interpreted contractual language present in all arbitration agreements that actually contains countless personal pronouns indicating that the agreement covered only personal disputes between Lamps Plus and Varela. Further, Lamps Plus asserts that as a class action is neither a separate claim nor a remedy but rather a procedure device, it falls outside the agreement’s text which focuses on the remedies available and the claims covered. Therefore, Lamps Plus argues that there is no contractual basis upon which to infer consent to class arbitration.
Varela contends that the question put forth by Lamps Plus is a question properly decided by the Ninth Circuit applying California law. Varela focuses on certain Ninth Circuit language—that the arbitration agreement waives Varela’s right “to file a lawsuit or other civil action or proceeding”—to argue that “proceeding” could reasonably be interpreted to include class actions according to California’s reasonable layperson standard. According to Varela, the arbitration agreement’s language does not merely encompass a wide range of substantive employee claims; the language also contemplates proceedings like class actions without preempting procedures like the discovery process or the Federal Rules of Civil Procedure. Varela agrees with Lamps Plus that a class action is not a remedy, but Varela notes that Lamps Plus does not address the fact that class-action remedies are available only when a class-action proceeding is available. To exclude class-actions proceedings from the agreement would grant Varela alternative remedies—that is resulting from a class-action suit in court—which would violate the agreement, according to Varela. Varela argues that because the arbitration agreement may be reasonably interpreted to contain a contractual basis, the motion to compel must be affirmed on appeal.
STATE LAW INTERPRETIVE CANON AND THE FEDERAL ARBITRATION ACT
Lamps Plus argues that the lower court decision cannot be “salvage[d]” by asserting that the decision was in keeping was state-law contractual interpretative principles. A contract-law principle under California law provides that “ambiguous terms are construed against the drafter,” which here would mean the terms would be construed against Lamps Plus. Lamps Plus contends that multiple factors render the lower court’s reliance on this principle misplaced: first, the agreement was not ambiguous and, second, the FAA forecloses manufacturing party consent to arbitration. Lamps Plus notes that prior Supreme Court precedent supports its claim that there is an established principle under which any disputes over “the scope of arbitrable issues should be resolved in favor of arbitration,” including disputes regarding construction of contractual language. Further, according to Lamps Plus, allowing the class-action claim to proceed despite lacking party consent would create an undeniable due process claim; the absent employees would likely contest an adverse judgment resulting from a proceeding which they never joined and a contract to which they were not a party. Given the unambiguous contractual language specifying the personal disputes of the parties, the precedential history, and the potential due process violations, Lamps Plus contends that the lower court’s decision must be reversed.
Varela, in response, asserts that the state-law interpretative canon is applicable to this matter and decisively resolves the dispute in favor of compelling class-action arbitration. Varela agrees that interpreting private contracts is normally a question of state law and that the FAA requires enforcing agreements to arbitrate through that state law. Varela also acknowledges that, as the FAA aims to dissuade the traditional state-law hostility toward agreements to arbitrate, the FAA “preempts any state rule discriminating” against arbitration either on the face of the rule or through a covert manner. Here, however, Varela contends neither concern is present and that the controlling party intentions require class arbitration. Varela argues that the California contract-law principle to evaluate these controlling party intentions—where ambiguous agreements must be construed against the drafter—is a neutral and allowable state-law principle under the FAA. According to Varela, this interpretive doctrine fits within the FAA principle that arbitration is a matter of consent because the court applying the doctrine first determines ambiguity by looking only at the contract’s objective terms and may then consider subjective elements in light of interpretive rules to resolve any ambiguity. Unlike the arguments underlying the lower court decision in Stolt-Nielsen, Varela claims the lower court decision in this case was not based on policy, but instead on the intent understood from an ambiguous arbitration agreement which permitted the court to apply state-law interpretive doctrine to resolve the ambiguity. According to Varela, this generally applicable California state-law principle does not disfavor arbitration, but rather disfavors poorly drafted arbitration agreements. As the governing state-law principle passes the various tests of neutrality and applicability under the FAA, Varela argues that the result produced—that is, that there is a contractual basis for finding a class-action arbitration agreement—must be upheld on appeal.
Lamps Plus contends that there are no jurisdictional issues before the Court because this dispute arises out of an appealable order dismissing Varela’s claims. That the dismissal, according to Lamps Plus, was technically without prejudice—meaning he could sue again on the same grounds—does not change the fact that the dismissal left no part of the litigation pending before the court. Lamps Plus asserts that the lower court’s decision to compel class-arbitration was clearly adverse to the company, and that any argument otherwise is simply incorrect. Lamps Plus maintains that it is now facing a class arbitration which it never sought and actually fought against. Lamps Plus argues that the decision below was effectively a denial from which Lamps Plus can appeal to the Supreme Court because, in matters of appellate jurisdiction, the Court must give more attention to the substance of the dispute rather than the form.
In reply, Varela argues that not only does the Ninth Circuit lack jurisdiction over this appeal, but also that Lamps Plus lacks standing to even make the appeal. Section 16(b)(2) of the FAA explicitly prohibits appeals directly from interlocutory orders directing arbitration to proceed, which Varela contends is the issue at hand. The district court in this case undoubtedly directed arbitration to proceed, and Varela asserts that Lamps Plus cannot manufacture a denial no matter how artfully the appeal it writes the appeal. According to Varela, allowing appeals directly from orders granting arbitration would undermine the benefits of arbitration: rapidity and unobstructed enforcement of arbitration agreements. Further, even if the FAA did not expressly prohibit the appeal Lamps Plus sought, Varela maintains the company still lacks standing to appeal because it is not challenging the dismissal of Varela’s claims. Varela asserts that the district court’s order provided the relief that Lamps Plus sought, and the company cannot now seek to appeal a favorable decision because it did not like the particular method the lower court chose in granting the motion to compel arbitration. Varela contends that with neither appellate court jurisdiction nor standing to appeal, Lamps Plus cannot now seek reprieve from the Supreme Court.
IMPACT ON ARBITRATION AS A PREFERRED MODE OF DISPUTE RESOLUTION
The New England Legal Foundation (“NELF”), in support of Lamps Plus, contends that permitting class arbitrations based on standard form arbitration agreements that do not expressly mention such arbitrations will deter employers from choosing arbitration as a mode of dispute resolution particularly when potential claims that may arise under it could escalate into class arbitrations. NELF argues that such an unfavorable outcome does not comport with the goals of the FAA, which was enacted to promote arbitration. The Chamber of Commerce of the United States of America (“The Chamber of Commerce”), supporting Lamps Plus, asserts that interpreting a standard, boilerplate arbitration agreement as authorizing class arbitration runs afoul of the federal policy favoring arbitration. The Chamber of Commerce reasons that by imposing class arbitration upon the parties in the absence of any express agreement, both parties are deprived of the traditional advantages of bilateral arbitration such as its informality, consequently making the process slower and more expensive.
In support of Varela, contract law scholars affiliated with various American universities (“Scholars”) argue that the FAA has its foundation in state law and that interpreting the arbitration agreement pursuant to settled state law is in fact consistent with and not antithetical to the federal policy in favor of arbitration. As the American Association for Justice (“AAJ”) elaborates in support of Varela, there are concerns about the impact on principles of federalism if Lamps Plus’s argument about interpreting contract without reference to state law is accepted; it explains that such an outcome would require the Court to ignore its own precedent establishing that the FAA does not displace state law principles on interpretation of contracts, including arbitration agreements. Furthermore, Varela posits that allowing class arbitrations here will not in any way undermine the FAA because a decision in this case arises from specific language contained in the arbitration agreement entered between Lamps Plus and Varela, which distinguishes it from other arbitration agreements. Varela’s contends that Lamps Plus exaggerates the policy implications of deciding in his favor without elaborating on why adopting settled principles of contract interpretation would put the FAA at risk and without pointing to any other instance of a court interpreting an arbitration agreement to permit class arbitrations.
DUE PROCESS CONCERNS AND COSTS TO PARTIES
The Chamber of Commerce argues that the procedural complications that arise from forcing employers into class arbitrations may result in due process concerns. The Chamber of Commerce states that arbitration should be held only as a result of consent between parties and not by coercion, and that absent class members who have not consented to an arbitration have strong incentives to challenge an unfavorable award. The Chamber of Commerce further contends that such an argument is only strengthened by the absence of any contractual basis to submit the dispute to a class arbitration as opposed to bilateral arbitration. According to the Chamber of Commerce, the argument further addresses the problems that may arise when absent class members refuse to be bound by an unfavorable arbitral award because they did not participate in the proceedings, but may choose to unfairly obtain the benefits of a favorable award, thus creating a fundamentally unfair situation for defendant employers forced into these class arbitrations.
DRI – The Voice of the Defense Bar (“DRI”), supporting Lamps Plus, emphasizes that the lower costs and the procedural and administrative benefits offered by bilateral arbitration are absent in class arbitration. The Chamber of Commerce similarly states that class arbitration, unlike individual arbitration is necessarily characterized by procedural formality making the process more expensive, slower, and “more likely to generate procedural morass than final judgment.” Lamps Plus argues further that by expressing a policy preference for class arbitrations, the Ninth Circuit’s decision, if upheld, will result in employees being deprived of the higher likelihood of success from individual arbitration rather than going to court.
In contrast, Varela maintains that the due process concerns raised by Lamps Plus arise not from deciding whether an arbitration agreement permits class arbitrations, but rather from an arbitrator’s decision about what procedural protections apply to the arbitration. Varela argues that whatever implications for due process those procedural decisions might have, that is different from a decision on the preliminary question of whether the parties have given an arbitrator the mandate to conduct class arbitrations in the first instance. Further Varela emphasizes that class arbitrations have existed at least since 2003 and yet Lamps Plus fails to identify even a single instance of unfairness that gave rise to due process objections. Varela also refutes DRI and Lamps Plus’s arguments that class arbitrations are adverse to employees. He states that the Ninth Circuit’s decision was not based on any policy preference for class arbitrations but instead was grounded in an interpretation of the parties’ agreement. He further argues that Lamps Plus cites to irrelevant statistics to bolster its argument that class arbitrations deprive employees of the higher rate of success they enjoy in arbitrations rather than traditional litigation. Varela emphasizes that Lamps Plus does not cite to any comparative evidence about outcomes in individual and class arbitrations but actually makes unwarranted conclusions based on irrelevant statistics.
- John Lewis, Will SCOTUS Finally Decide What Language Authorizes Class Arbitration? Lamps Plus, Inc. v. Varela Might Just Do It, Employment Class Action Blog (May 2, 2018).
- Gilbert Samberg, Supreme Court Will Determine If Silence in an Arbitration Clause May Be Judicially Interpreted to Permit Class Arbitration, Mintz (May 4, 2018).