(Paralegal) Binding Arbitration: Statutory Rights & Protections

Binding Arbitration: Statutory Rights & Protections

The following hypothetical legal issue was presented: A consumer, Val, has purchased a Gateway computer which, during initial set-up, displays a legal document which includes a provision that any dispute between the consumer and Gateway must be resolved by binding arbitration, a type of Alternative Dispute Resolution (ADR) that requires the two disputing parties to forgo court-based dispute resolution remedies such as litigation (including a trial by jury) in favor of a nongovernmental procedure (arbitration) (Twomey & Jennings, 2011). The consumer is further advised that if she does not choose to accept the agreement, she can return her new computer at Gateway’s expense.

Arbitration is a method by which disputes between two parties are settled by a disinterested third party (typically specified in a contract by the corporation or business which has drawn up the contract, not the consumer or client) and whose decision is considered legally binding to all parties (Twomey & Jennings, 2011). Val is wary of the binding arbitration clause and, before she clicks “I agree,” wishes to know if this is clause is valid, and what statutory rights and protections she might have in court, if any, should her new computer fail to perform as advertised, and if the terms of the contract allow her to pursue her case in court if arbitration fails to resolve her problem. The party who loses in an arbitration dispute can sometimes opt to appeal to a court, but both the initial arbitration fees and, if she decides to sue, later court costs (if she loses the case) can be financially draining to a typical consumer who may be seeking relief. “Arbitration can be a favorable option [mostly for businesses] in many instances because it does tend to save time and money as compared with a formal lawsuit. However, arbitration can severely limit your options for recovery [as a consumer], as an appeal is not usually available” (LaMance, 2011).

Since the decision of an arbitrator is generally considered binding, even if that decision seems wrong, that decision can typically only be set aside if a court later determines that there was “clear evidence of fraud, arbitrary conduct, [or] significant procedural error” (Twomey & Jennings, 2011). Val takes a risk when clicking “I agree” that the third party chosen by Gateway to preside over any arbitration procedure will be fair and objective; she is probably correct to worry that they may not be.

In Hill v. Gateway, 105 F.3d 1147 (7th Cir. 1997), the Seventh Circuit Court of Appeals held that because Gateway included a contract with an arbitration clause in each box their computers shipped in, and because the Hills failed to return their computer within the thirty day window specified in the Gateway contract, they were not entitled to relief in court and would have to abide by the arbitration terms in the contract which would cost the Hills $2,000.00 in arbitration fees (Sternlight, 1997).

[T]he Hills literally had no chance to escape the arbitration clause other than by making the heroic effort of [promptly] returning their new computer. Realistically, they had no chance to even learn of the existence of the arbitration clause before the computer was ordered, paid for, and delivered. While the Seventh Circuit implied potential buyers might learn about Gateway’s arbitration program through advertisements, the Gateway web page, or conversations with Gateway personnel, these options are illusory. Neither the advertisements nor the web page made any mention of arbitration (Sternlight, 1997).

Our consumer with the new Gateway computer, Val, has another hurdle to overcome if she lives in a state that is not aggressive about protecting consumer rights. Georgia statutes apparently only cite one caveat to the Federal Arbitration Act (FAA): “Georgia Code 9-9-2 prohibits enforcement of arbitration clauses in any contract of insurance” (Public Citizen Litigation Group, 2011); it is still possible that the U.S. Supreme Court (SCOTUS) might overturn a lower court decision based on that statute while citing the FAA if Val has the persistence and time, and if her case is important enough, to wend its way through the court system and make it that far without her suit being dismissed. SCOTUS has generally upheld the FAA when states have tried to prohibit or limit arbitration agreements in an effort to protect consumers, especially in cases involving interstate commerce (Val purchasing her new Gateway computer online and having it shipped from a different state would be considered interstate commerce), which falls under the purview of SCOTUS.

California typically favors arbitration, but also has honored business contract guidelines and statutory principles that can occasionally be more protective and supportive of consumers’ rights than are strict FAA guidelines, partially because the CAA holds that loosely-interpreted arbitration clauses can bind both parties to future arbitration legislation (which would be unfair to either party). FAA rules tend to favor corporations and businesses over consumers and, if disputes are brought before SCOTUS, split decisions tend to lean conservative and sternly reject anything perceived to be an undue restriction on corporations’ rights to participate in business and make profits. Businesses can typically bear the high cost of arbitration proceedings even when customers can not, and, more problematically, some supposedly impartial arbitration groups like National Arbitration Forum (NAF) were accused of favoring businesses’ interests—especially credit-card companies–over consumers’ rights  and disobeying California law that required disclosure of NAF’s arbitration decisions.

NAF agreed, after a lawsuit, to stop overseeing consumer arbitrations in 2009 (Lawless, 2009). “On July 17, NAF settled a lawsuit filed by Minnesota Attorney General Lori Swanson, barring them from taking on any new consumer debt-collection disputes. […] Swanson’s lawsuit alleged that the NAF worked alongside creditors and against the interests of ordinary consumers to convince credit card companies and other creditors to deprive consumers of their legal rights by inserting arbitration provisions in their customer agreements and then to appoint NAF to decide the disputes. The lawsuit also alleged that NAF had financial ties to the collection industry” (Lawyers.com, 2012).  After NAF bowed out, the American Arbitration Association (AAA) followed shortly after (possibly to avoid more lawsuits on similar grounds), leaving JAMS (formerly Judicial Arbitration and Mediation Services, Inc.) the “only nationwide alternative for consumer debt cases” (Gupta, 2009).

Before AAA followed NAF and decided not to handle consumer debt arbitration proceedings, companies with arbitration clauses were urged to drop NAF and replace them with AAA or JAMS, “the two other arbitration administrators with the ability to administer consumer and employee arbitrations on a nationwide basis […] Under Section 5 of the Federal Arbitration Act, the court must appoint an arbitrator to replace the NAF if there is no other administrator named in the arbitration agreement” (Gupta, 2009). The problem was that the arbitrators were dropping like flies, leaving only one (JAMS) with more customer credit arbitration cases than it could handle efficiently, promptly and  independently, which placed further burdens both on customers seeking relief and businesses hoping not to drag out arbitration proceedings.

The California Supreme Court has “recognized parties’ rights to opt out of the FAA in favor of the California Arbitration Act (CAA).  […] The Supreme Court’s willingness to require arbitration even where an agreement is illegal illustrates the importance of clearly stating in each agreement what the parties are agreeing to arbitrate and who will decide what. […] There is no reason for clients to agree to be bound by future, unknown arbitration rules, some of which may profoundly affect their rights. The rules of most arbitration providers acknowledge that the parties may want to agree that prior, or specific, versions of their rules will govern arbitrations [so] clients will receive precisely what they bargained for.” (Conn & Geibelson, 2007).

Val is fortunate in one regard, because her Gateway contract is not an agreement with a credit card company, and because she has not yet accepted the contract.  People typically do not purchase an expensive consumer good unless they feel they have an immediate need for it, so Val may be tempted, like most consumers, to just click “I agree” to the contract and get started using her new computer; she may choose to accept the agreement out of necessity rather than because she is comfortable with the terms in the contract.

There are some cases where consumers have sought and received relief even if they signed a contract with an arbitration clause. “In Langfitt, et al. v. Jackson, et al., 644 S.E. 2d 460 (Ga. App. March 28, 2007), the Georgia Court of Appeals reversed a trial court decision refusing to compel arbitration under a home purchase agreement mandatory arbitration clause. […] The trial court judge seemed skeptical of mandatory contractual arbitration and felt that such arbitration clauses violated the federal and Georgia state Constitutions. A jury awarded the Jacksons $70,000 in damages” (Irwin, 2012).  The plaintiffs, the Jacksons, had entered into a building contract with the defendants, Terry Langfitt and John Daniel and National Home Insurance Co. (NHIC), which included an arbitration clause. The Jacksons did not want to seek arbitration, and were initially granted damages. Unfortunately for them, an appellate court was tasked with determining whether the FAA or Georgia state laws should apply to their situation.

If the state rules applied, the defendants would have waived the right to arbitration because they failed to initial the house contract’s specific arbitration clause. Since the contract specifically stated that the FAA would govern disputes “to the exclusion of any provisions of state law,” the federal rule applied. The FAA doesn’t require that the parties specifically initial the arbitration provision, as the Georgia state law mandates. The FAA would be applicable in any event because interstate commerce was involved (Irwin, 2012).

The appellate court determined that at least one claim was not adequately addressed by the contract, but that the Jacksons would still be bound by the arbitration clause in the contract.

The FAA creates a strong national policy in favor of allowing and enforcing binding arbitration clauses in contracts: “The Act states that arbitration clauses will be enforced in all cases where there is a maritime transaction, or where a contract involves a transaction crossing state lines” (LaMance, 2012).   There are some exceptions in some states: if there is no interstate commerce involved, the FAA may not apply, in which case state law would determine the enforceability of the arbitration clause. Some factors that help determine how a contract dispute will be handled: “the State where the contract was made; the State specified in the contract; the State where arbitration is specified by the contract to take place [and] the State that has the most significant relationship to the arbitration provision” (LaMance, 2012).   Each state has different guidelines; California, for example, allows both parties to “disregard [and arbitration clause] if the parties agree to take out the clause, if the contract itself is not valid, or if a party in the arbitration agreement is joined by a third party in pending court action which arose out of the same transaction or series of related transactions.  Conversely, other States, like New York, prohibit mandatory arbitration clauses from being included in consumer contracts altogether” (LaMance, 2012).

When Vincent and Liza Concepcion of California sued AT&T for charging them $30.00 in “state taxes” for a mobile phone that had been advertised as being “free,” the case made its way to the Supreme Court. “The U.S. Court of Appeals for the 9th Circuit said the Concepcions properly invoked a California law that bars class-action waivers when a contract is particularly one-sided. The law applies when there was unequal bargaining power between the two sides in the deal and the dispute involves a small amount of money and complaint of a deliberate scheme to defraud.” Unfortunately SCOTUS did not support the Concepcions’ case.

The Supreme Court ruled […] that consumers can be bound by an arbitration clause in a cellphone deal or other contract even when state law permits a class-action lawsuit for claims arising from the deal. In a 5-4 vote, the justices divided along familiar ideological lines, with conservatives in control. […] Justice Antonin Scalia, writing for the majority, noted that the Federal Arbitration Act, which bars states from discriminating against arbitration, was passed in 1925 in response to judges’ “hostility” to such agreements. Scalia said the California law “stands as an obstacle to the accomplishment of the purposes and objectives to the FAA. If a state could block an agreement because it appeared one-sided,” Scalia said as he read portions of his opinion from the bench, “Nothing would stop states from declaring that all agreements for dispute resolution … are ‘unconscionable’” in many circumstances. (Biskupic, 2011)

Dissenting judges, led by Justice Stephen Breyer, pointed out that most consumers would find it difficult to get representation if they were prohibited from joining together to bring a class action suit, and might be tempted to drop a reasonable complaint, leaving the company free to defraud or financially abuse other customers. Further, if the only damages that could be awarded were for the bare-bones cost of the phone (“$30.22”), which the Concepcions were disputing, then the Concepcions were still out the fees they had paid for arbitration and court costs. Breyer also noted that the CAA would have been better suited to help the Concepcions than the FAA. Scalia “also disputed the contention of dissenting justices that the Concepcions and others with small-dollar grievances would end up dropping them” (Biskupric, 2011).

What should Val do? First, she should see if her state offers any consumer protections that might help her should she have a future dispute with Gateway over her computer or terms of her contract. If she lives in a state that is more proactive about protecting consumers, especially when they are in a disagreement with a large corporation with deeper pockets and more convenient access to legal representation, Val might feel more comfortable agreeing to the Gateway contract. She might consider whether or not her new computer will be shipped to her from within her own state or over state lines, if she wants to take a chance that her new computer will not have any serious problems, if she has purchased other products from Gateway and been satisfied with their customer service and the performance of those previous items, what she paid for it (thus, how expensive it would be for her if she could not get satisfaction for a dispute and was forced to replace the Gateway computer with another company’s computer), and how much she will be relying on her new computer to conduct personal and professional business, and then base her decision on whether or not she feels like taking that risk.

Some other examples of arbitration disputes, many with decisions that might be considered unfair to the consumers or individuals involved:

  • California Correctional Peace Officers Assn. v. State of California. The peace officers sought arbitration to determine their “rights under various agreements to have supervisory employees observe rank-and-file members’ negotiations with the California Department of Personnel Administration, and vice versa”. A trial court agreed with their argument, but an appellate court overturned that decision, explaining that “the presence of a potentially dispositive statutory issue is not recognized as a defense to arbitration under Code of Civil Procedure section 1281.2” (Conn & Geibelson, 2012).
  • Kleveland v. Chicago Title Ins. Co. “In Kleveland, plaintiffs purchased a title insurance policy from Chicago Title on the basis of a preliminary title report they reviewed and approved which incorporated by reference an “ALTA [American Land Title Association] HOMEOWNER’S POLICY OF TITLE INSURANCE (11/98),” which contained an arbitration clause.  However, the ALTA policy never issued.  Instead, Chicago Title issued a California Land Title Association Standard Coverage Policy (CLTA) which contained a similar arbitration clause.  When plaintiffs filed an action for breach of contract, the trial court denied defendant’s motion to compel arbitration. The Court of Appeal affirmed, holding that the preliminary title report did not incorporate by reference the policy ultimately issued, and thus plaintiff could not be compelled to arbitrate under it” (Conn & Geibelson, 2012).
  • Cronus Investments, Inc. v. Concierge Services. SCOTUS ruled that “the language of the arbitration clause in this case, calling for the application of the FAA ‘if it would be applicable,’ should not be read to preclude the application of 1281.2(c), because it does not conflict with the applicable provisions of the FAA and does not undermine or frustrate the FAA’s substantive policy favoring arbitration.”  While clearer language could have been used to identify disputes that were (and were not) subject to the FAA and the CAA, Cronus expresses a willingness to have courts make a factual determination whether the CAA or the FAA applies as a procedural matter, to be decided by the Court and not the arbitrator” (Conn & Geibelson, 2012).
  • Securities Industry Ass’n v. Lewis. “[T]he district court held preempted a Florida statute requiring that parties to securities arbitration agreements be provided the option of presenting their claims before a nonindustry arbitration panel” (Sternlight, 1997).
  • Badie v. Bank of America, 1994 WL 660730 (Cal. App. Dep’t Super. Ct. 1994). Bank of America “sent its customers an envelope stuffer announcing that all future claims against the bank must be arbitrated rather than litigated, thereby precluding such consumers from having their claims heard by a jury [and] a California state court upheld the clause” (Sternlight, 1997).
  • McCarthy v. Providential Corp., 1994 U.S. Dist. LEXIS 10122 (N.D. Cal. 1994). “Senior citizen homeowners held bound by arbitration clause contained within vast array of loan documents provided at closing” (Sternlight, 1997).
  • Sosa v. Paulos. The Utah Supreme Court held that the [arbitration] clause would be enforceable only if the evidence supported the doctor’s claim that the patient was given a copy of the agreement when she left the hospital. In so holding the court emphasized the fact that the patient had 14 days within which to revoke the clause had she decided she did not wish to be bound by its terms. Nonetheless, it is probably a very rare patient who, upon returning home from surgery, would read through all the papers she signed and take the step of revoking her agreement to arbitration” (Sternlight, 1997).
  • Cohen v. Wedbush, Noble, Cooke, Inc., 841 F.2d 282 (9th Cir. 1988). “Securities customers held bound by arbitration clause although plaintiffs claimed brokerage misled them by failing to inform them of the meaning and effect of the clause” (Sternlight, 1997).
  •  DeGaetano v. Smith Barney, Inc., 1996 WL 44226 (S.D.N.Y. 1996). “Employee held bound by arbitration provision even though she signed only a general agreement setting out “principles of employment” and was not actually provided with a copy of the arbitration agreement” (Sternlight, 1997).

Our hypothetical customer, Val, might be better off trying to remove the arbitration clause from the Gateway contract, which she is likely to find difficult or impossible, or returning the computer to Gateway at their expense within the thirty day window she has been granted by default rather than risking a future dispute costing her more in time, money and aggravation than she feels it would be worth. The problem Val is going to face next is that more and more corporations and businesses are including arbitration clauses in contracts by default, and she may have some difficulty finding a new computer that arrives with a contract that is more fair and balanced towards the end user like herself. It is a position more and more consumers are going to face, and arbitration guidelines typically favor the corporation that draws up the contracts more than the end users. It might take a lot of consumers balking at Gateway’s contract, returning their new computers at Gateway’s expense (thus forcing the company to foot the bill for return shipping fees) for Gateway to reconsider the value of protecting itself from having to make good on end user complaints with an arbitration clause.


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LaMance, K. (2011, August 9). Arbitration Fairness Act of 2009 and Mandatory Arbitration Clauses. Retrieved from http://www.legalmatch.com/law-library/article/arbitration-fairness-act-of-2009-and-mandatory-arbitration-clauses.html

LaMance, K. (2012, March 27). Enforceability of an Arbitration Clause in a Contract. Retrieved from http://www.legalmatch.com/law-library/article/enforceability-of-an-arbitration-clause-in-a-contract-for-the-purchase-or-sale-of-goods-products-or-services.html

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Biskupic, J. (2011, April 28). Supreme Court backs AT&T, limits class-action suits. Retrieved from http://www.usatoday.com/news/washington/judicial/2011-04-27-supreme-court-class-actions_n.htm

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Conn, B., & Geibelson, M. (2007) We Agreed to What?! How the Selection of an Arbitration Clause Can Impact a Client’s Legal Rights (Originally published in Business Law News, Issue 1, 2007).  Retrieved from http://www.rkmc.com/We-Agreed-to-What.htm

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Easterbrook, Circuit Judge. (2007). Hill v. Gateway 2000, Inc. 105 F.3d 1147 (7th Cir. 1997), cert den. 118 S.Ct. 47 (1997). Retrieved from http://law.scu.edu/facwebpage/neustadter/e-books/abridged/main/cases/Gateway.html

Sternlight, J.R. (1997, November). Gateway Widens Doorway to Imposing Unfair Binding Arbitration on Consumers (Originally published in The Florida Bar Journal, November, 1997. Volume LXXI, No. 10, p.8). Retrieved from http://www.floridabar.org/DIVCOM/JN/JNJournal01.nsf/Author/A96947FF647F657085256ADB005D6181

State Court of Carroll County, Georgia.  (1999). CIVIL ACTION FILE NO. 98 V 641 (Ray Marlin Crawford v. Cavalier Homes of Alabama and Green Tree Financial Servicing). Retrieved from http://www.mindspring.com/~wf1/arbitration_briefs.htm

Lawless, B. (2009, July 23). A Big Win for Consumers: NAF Leaves Arbitration Business. Retrieved from http://www.creditslips.org/creditslips/2009/07/a-big-win-for-consumers-naf-leaves-arbitration-business.html

Gupta, D. (2009, July 21). AAA Joins NAF in Quitting Arbitration of Consumer Debt Disputes. Retrieved from http://pubcit.typepad.com/clpblog/2009/07/aaa-joins-naf-in-quitting-arbitration-of-consumer-debt-disputes.html


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