Supreme Court to Regulators: You Can’t Trump the Federal Arbitration ActIn a 5-4 decision along ideological lines, the Supreme Court has upheld a controversial tool used by employers to stop class action lawsuits before they start: contractual provisions requiring employees to bring individual arbitration proceedings rather than class actions in court.

In Epic Systems Corp. v. Lewis and its sister cases, the majority of the Supreme Court rejected the argument that the National Labor Relations Act (NLRA) requires employees to be able to bring class actions. Instead, Justice Gorsuch wrote for the majority, “[i]n the Federal Arbitration Act (FAA), Congress has instructed federal courts to enforce arbitration agreements according to their terms—including terms providing for individualized proceedings.” In the view of the majority, neither the FAA nor the NLRA create any exception for employment contracts.

The issue of class action waivers in employment contracts has taken on new prominence in recent years as the use of arbitration agreements has increased. Though both statutes at issue here are approaching their centennial anniversaries, there was relatively little litigation on their interplay until recent years. In 2012, the Obama-era National Labor Relations Board (NLRB) held that the NLRA invalidates any employer-imposed contracts that bar group litigation, including arbitration agreements that limit employees to individual actions. Subsequently, the Sixth, Seventh, and Ninth Circuits deferred to the NLRB’s interpretation, while the Second, Fifth, and Eighth Circuits rejected it.

Last year, the Supreme Court granted certiorari to resolve the circuit split. In each of the three cases that were consolidated, employees brought Fair Labor Standards Act (FLSA) class or collective action claims in federal court. The employees argued that the NLRA renders class action waivers illegal and that their individual arbitration agreements were therefore unenforceable. The NLRB supported the employees’ positions. But in a move that caused the court to describe the executive branch as “of two minds,” the Solicitor General argued against the NLRB’s position and in favor of the employers’ interpretation of the FAA.

In the end, Justice Gorsuch’s opinion took a decidedly textual approach, as is his habit.  The majority found that the FAA explicitly requires courts to enforce arbitration agreements according to their terms. The employees sought refuge in a savings clause that allows courts to refuse to enforce arbitration agreements where grounds “exist at law or in equity for the revocation of any contract.” The employees argued that the arbitration agreements were illegal under the NLRA, a proper ground for revocation of a contract. But the Court returned to its 2011 decision in AT&T Mobility v. Concepcion, where it found that the FAA savings clause does not apply to defenses that can apply only to arbitration. Because the employees sought to attack only the individualized nature of arbitration and that characteristic is one of arbitration’s fundamental attributes, the savings clause did not apply.

The majority also rejected an argument that the NLRA overrides the FAA’s presumption in favor of arbitration. The employees argued that Section 7 of the NLRA guarantees workers the right to take collective action. But the majority found that “Section 7 focuses on the right to organize unions and bargain collectively.” Because the statute was silent on arbitration and class actions, the Court found that the NLRA could not overcome the FAA’s strong preference for enforcing arbitration provisions. Instead, Justice Gorsuch wrote, the FAA and NLRA should be construed in harmony, with the NLRA protecting collective bargaining and the FAA protecting arbitration agreements.

The Court further noted that it would be inappropriate to apply Chevron deference to the NLRB’s interpretation of the NLRA as invalidating arbitration clauses. After applying the interpretative canons, the Court was not left with any ambiguity in the statutory language itself. The Court also noted that the NLRB’s interpretation advanced its own statutory mission at the expense of another statute in which it has no expertise. As such, courts were not required to defer to the NLRB.

Writing for the four-person dissent, Justice Ginsburg described the decision as “egregiously wrong,” lamenting that the majority “subordinates employee-protective legislation to the Arbitration Act.” Justice Ginsburg’s dissent claimed that class actions are the only way that employees can afford to litigate claims for small underpayments. Though the majority found that the NLRB’s protection for “concerted activities . . . for the purpose of mutual aid or protection” was limited by the specific bargaining-related examples that preceded it, the dissent argued that group litigation is consistent with legislative intent. In particular, Justice Ginsburg urged, the NLRB has long held that the NLRA protects employees from employer interference when they bring class actions.

The Court’s decision in this case has been closely watched and is likely to greatly affect the landscape of employment relationships. Of clearest importance, the Court’s decision allows employers to include arbitration agreements waiving class actions in employment contracts without fear of invalidation. In the wake of this decision, we expect employers’ use of such agreements to increase. The Court’s disregard of the NLRB’s purported expertise in this matter may also suggest that litigants could have success in challenging NLRB rulings on procedural, legislative and regulatory issues that are not employment-specific in the future.

But the decision also offers insight into the Court’s broader attitudes towards arbitration and class actions. In the absence of a clear congressional directive, the Court declined to make a policy decision to give employees the unfettered ability to sue their employers in a class setting. In the eyes of the Court, given the simple, clear breadth of the FAA, if any such policy choice is to be made, it must be made explicitly by Congress rather than being implied by Congress or a regulator. This philosophy suggests that had Congress not nullified the CFPB’s proposed anti-class waiver rule for arbitration clauses, the Supreme Court likely would have.

The same philosophy also suggests the answer to a question that the Court has recently decided to hear next year: whether the FAA forecloses a state-law imposition of class procedures into an arbitration agreement that does not clearly, explicitly, and unambiguously provide for any. The Court’s opinion in Epic Systems reinforces our conclusion that the Court is unlikely allow defendants to be forced into class arbitration without clear express consent.

The Supreme Court Will Soon Weigh in on Class Arbitration and Cy Pres IssuesThe U.S. Supreme Court has decided to hear two important cases next year involving important issues for class action lawyers and the clients they serve.

In Lamps Plus Inc. v. Varela, the Supreme Court will decide “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.” Recall that in Stolt-Nielsen, S.A. v. Animal Feeds International Corp., SCOTUS held in 2010 that a court could not order class arbitration unless there was a “contractual basis” for concluding that the parties have “agreed to” class arbitration, and that courts may not “presume” such consent from “mere silence on the issue of class arbitration” or “from the fact of the parties’ agreement to arbitrate” (Id. at 685, 687). Or as the Supreme Court stated in the 2013 decision in Oxford Health Plans LLC v. Sutter, “Class arbitration is a matter of consent: An arbitrator may employ class procedures only if the parties have authorized them.”

Seemingly clear enough, right? Apparently not. In the latest installment in the long series of guerilla warfare over the Federal Arbitration Act holdings of the U.S. Supreme Court, the Ninth Circuit inferred consent to arbitration from a clause that did not mention class arbitration at all. To get there, the Ninth Circuit construed phrases like “arbitration shall be in lieu of any and all lawsuits or other civil legal proceedings” and language granting the arbitrator the power to award “any remedy allowed by applicable law” to be contractual consent to class arbitration. And in remarkable contrast to the teachings of Stolt-Nielsen, the Ninth Circuit actually found support for its conclusion from the absence of any reference to class actions in the arbitration agreement. This obfuscation brings to mind the following quote:

“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean—neither more nor less.”

“The question is,” said Alice, “whether you can make words mean so many different things.”

“The question is,” said Humpty Dumpty, “which is to be master—that’s all.”

The master here is clearly the Supreme Court, unless and until Congress decides to change the FAA, and we predict the Supreme Court will not allow interpretive creativity to substitute for clear express consent to class arbitration as a prerequisite to compelling it. The high stakes combined with the absence of appellate review, the fact that due process violations in the arbitration may allow the class to avoid a loss through collateral attack while the defendant is bound when it loses without any such recourse, and the summary and informal nature of arbitration all compel that result. Judge Fenrnadez, dissenting from the Ninth Circuit majority opinion, got it exactly right when he said the Ninth Circuit’s reasoning was a “palpable evasion of Stolt-Nielsen.” Courts hostile to arbitration have lost at least five of these arbitration fights with SCOTUS in the last 10 years. This should be the sixth.

In Frank v. Paloma Gaos, the Supreme Court will decide whether a class action settlement can provide a $5 million donation to charity and $2+ million to plaintiffs’ class action lawyers but no relief to class members. The issue, in legal jargon, refers to cy pres class action settlements. Five years ago, Chief Justice John Roberts wondered whether such charitable settlements could ever be fair and consistent with Due Process. This case will answer that question, one on which the federal rules committee responsible for amendments to Rule 23 was unable to reach consensus last year.

The interesting twist in this case involves how the dispute arose. Often corporate defendants are the ones complaining about cy pres relief in contested class actions and public debate, because cy pres distribution forces defendants to hand over money not to class members but only to plaintiffs’ class action lawyers and their favorite charities. Many feel this rewards and incentivizes class litigation that should never have been filed at all. In a cy pres settlement, however, the defendant has agreed to the cy pres nature of the settlement and has waived any right to object to it. So who objected and appealed? None other than professional class action objector Ted Frank. And when he petitioned for certiorari from affirmance of the settlement over his objection, the corporate defendant, Google, actually urged the Supreme Court not to take the case. That effort was not successful. So it will now be up to Mr. Frank—who is both a class member and an experienced class action lawyer—to convince the Supreme Court to stop class action settlements that, in his words, put the interests of class members “dead last.”

The precise issue the Supreme Court will decide is when, if ever, a court can approve a class action settlement that gives money to charity in lieu of providing relief to actual class members. The lower courts in the Google case decided that it was not feasible to divide $5 million among the 129 million members of the class, which was defined as consumers who used the Google search engine between 2006 and 2014, and that cy pres distribution was therefore preferable. The objector, Mr. Frank, is pitted as Daniel against a two-headed adversary representing the interests of corporate America and the plaintiffs’ class action bar. It will be interesting to see how the Supreme Court resolves the case and what limits it places on cy pres in such a matchup.

These two cert grants continue a decade long focus by the Supreme Court on important issues in class action practice. We’ll keep you posted on the outcomes.

The Economic Loss Doctrine as a Barrier to Data Breach RecoveryWe recently commented on one hotly contested legal issue being addressed by the courts in data breach class action litigation, that of plaintiffs’ standing. Another issue that has been the subject of recent court activity in class cases is that of the economic loss doctrine: Can a data breach plaintiff in a contractual relationship with the data breach defendant recover under a negligence or other tort theory, or are its remedies confined to the contract? The issue of course does not arise in situations where the data breach plaintiff is not in contractual privity with the data breach defendant. But in other cases – in particular, cases involving compromised credit card data brought by the financial institutions that issued the cards against merchants who are part of the same payment card network – the issue is very much a live one.

In Community Bank of Trenton v. Schnuck Markets, Inc., the Seventh Circuit considered the application of the economic loss doctrine in this context. The court ultimately dismissed the suit, holding under both Illinois and Missouri law that merchants, card processors and banks voluntarily linked in a card payment system—a network of contracts that expressly allocates risk and defines remedies for data breach incidents—could not sue their card payment partners in tort.

Background

A 2012 data breach led to the compromise of over 2.4 million credit and debit cards, affecting nearly 80 percent of Schnuck’s Midwestern supermarkets. Plaintiffs subsequently brought suit, asserting common law claims under theories of negligence, contract, and other consumer protection laws. Affected customers brought a class suit, but they were not alone: Financial institutions that were exposed to the expense of issuing new cards to customers and reimbursing the costs associated with the hacker’s account fraud also sued the supermarket chain.

Schnuck, the aggrieved financial institutions, and the card processors are all linked through a system of contracts that help streamline consumer payment transactions. Within those contracts, and as part of the bargain, the agreeing parties voluntarily assume some liabilities and voluntarily limit their contractual remedies and recovery. Of note, participants must adhere to the PCI DSS—Payment Card Industry Data Security Standards. As part of that, participants agree to a sharing of the expenses of a network data breach. Based on the cost-sharing provision, Schnuck faced over $1 million in reimbursement fees, which would have then been apportioned throughout the network.

The Seventh Circuit had to determine how best to interpret and apply the economic loss doctrine, and whether Illinois or Missouri laws offered the banks additional remedies beyond those stipulated in the contract. The complaining banks brought negligence claims and alleged that they had been exposed to millions in damages, such as employee time, customer reimbursements, and transaction fees. The payment card agreements’ remedies did not cover the full amount of these losses. The Seventh Circuit, noting that the banks and Schnuck were linked through the payment system, held that the allegation of contractually uncovered losses was insufficient to allow the banks to recover beyond the amounts provided in their “network of contracts.” The banks thus could not escape the contractual limitations on their recovery by suing in tort.

The court reiterated that state courts typically decline to impart tort liability in instances where one business inflicts purely economic loss on another and their interactions are governed by contract. In making this distinction, the court then turned to the issue of duty, stating that neither Illinois nor Missouri would impose a common law data security duty upon Schnuck. The court systematically dismissed the banks remaining common law claims for similar reasons, concluding that the contracts signed by the participating institutions governed all rights and remedies as between the parties.

The banks attempted to argue that they were not in privity with Schnuck, thus making the economic loss doctrine inapplicable. The court disagreed, however, pointing again to the voluntary nature of the payment network system and the parties’ conscious choice to participate in the system—a system with written rules and procedures governing all participants— with both its benefits and allocated risks.

Looking Forward

The Seventh Circuit’s dismissal of the banks’ claims in Schnuck teaches that financial institutions, despite the obvious costs they incur on the back end of data breaches, cannot expect extra judicial help in the realm of recovery beyond the contractual terms to which they agreed in issuing payment cards. Sophisticated plaintiffs that had opportunities to negotiate and contract for their share of the risk and liability prior to data breach incidents will not likely be permitted to reapportion such risks through tort claims after a breach has occurred.

While this summary focuses primarily on the economic loss doctrine, another holding is worth noting:  Schnuck offers support for the proposition that merchants have no common law duty to protect data. It remains to be seen whether this state law holding will be confined to scenarios where merchants have expressly negotiated to allocate the risk of a breach.  In any event, however, statutory and contractual duties will often still exist, and we would not expect the pure “no duty” position to gain quick acceptance across the country, as it has far-reaching implications for all data breach cases.