Report • By Katherine V.W. Stone and Alexander J.S. Colvin • December 7, 2015
Executive summary
In the past three decades, the Supreme Court has engineered a massive shift in the civil justice system that is having dire consequences for consumers and employees. The Court has enabled large corporations to force customers and employees into arbitration to adjudicate practically all types of alleged violations of countless state and federal laws designed to protect citizens against consumer fraud, unsafe products, employment discrimination, nonpayment of wages, and other forms of corporate wrongdoing. By delegating dispute resolution to arbitration, the Court now permits corporations to write the rules that will govern their relationships with their workers and customers and design the procedures used to interpret and apply those rules when disputes arise. Moreover, the Court permits corporations to couple mandatory arbitration with a ban on class actions, thereby preventing consumers or employees from joining together to challenge systemic corporate wrongdoing. As one judge opined, these trends give corporations a “get out of jail free” card for all potential transgressions. These trends are undermining decades of progress in consumer and labor rights.
This report tracks these developments and presents the most recent research findings, summarized here:
- It is common for employees to be presented with terms of employment that include both a clause that obligates them to arbitrate all disputes they might have with their employer and one that prohibits them from pursuing their claims in a class or collective action in court.
- Employees subject to mandatory arbitration can no longer sue for violations of many important employment laws, including rights to minimum wages and overtime pay, rest breaks, protections against discrimination and unjust dismissal, privacy protection, family leave, and a host of other state and federal employment rights.
- On average, employees and consumers win less often and receive much lower damages in arbitration than they do in court.
- Employers tend to win cases more often when they appear before the same arbitrator in multiple cases, indicating that they have a repeat-player advantage over employees from regular involvement in arbitration.
Over the past 25 years, it has become increasingly commonplace for corporations to insert arbitration clauses into their contracts with customers and employees. These clauses appear to be innocuous, or even beneficial, to consumers and employees, but they pack a powerful punch. They prevent customers and employees from going to court if they have a dispute. Instead, when there is an arbitration clause, consumers and employees are required to take their complaints to a privatized, invisible, and often inferior forum in which they are less likely to prevail—and if they do, they are less likely to recover their due. Moreover, once a dispute is decided by an arbitrator, there is no effective right of appeal.
At the time of contracting, most consumers and employees do not object to having an arbitration clause in their contracts. After all, who thinks they will have a dispute with their employer or their bank? Who would risk a valuable job opportunity or an important consumer financial transaction over an obscure procedural provision? And if a dispute should arise, who wants to go to court to resolve a dispute over a faulty product or nonpayment of overtime pay? Courts are slow, excessively technical, and intimidating to most people. To hire a lawyer to handle the case would usually cost more than most disputes are worth. Yet despite the seeming benefits of arbitration, there are serious pitfalls.
As the research cited in this report shows, consumers and employees often find it more difficult to win their cases in arbitration than in court. For one thing, arbitration may not provide parties with the same extent of discovery that a court would. In certain types of cases, such as employment discrimination claims, it is practically impossible to win without the right to use extensive discovery to find out how others have been treated. In addition, while some arbitration agreements include due-process protections, others shorten statutes of limitations, alter the burdens of proof, limit the amount of time a party has to present his or her case, or otherwise impose constrictive procedural rules. In practice it is the corporation not the consumer or employee that gets to decide whether to include fairness protections in the arbitration procedure. Although a consumer or employee can try to challenge enforcement of unfair rules in court, the ability to challenge arbitration agreements has been substantially limited by the courts. Moreover, arbitrators are often reluctant to award generous damages to prevailing parties, and their awards are not appealable. On average, employees and consumers win less often and receive much lower damages in arbitration than they do in court. And in a new development, some arbitration agreements are requiring that the losing party pay all the arbitration fees, including the other side’s attorney fees. The loser-pays clauses provide a powerful deterrent to workers or consumers asserting any claims.
The trend toward increasing use of arbitration in consumer and employment relationships threatens to undermine decades of achievements in worker and consumer rights. Over the past few decades, the courts have expanded the scope of arbitration, reduced the ability of individuals to avoid arbitrating their disputes, and narrowed the possibility of obtaining judicial review. They have adopted such sweeping pro-arbitration doctrines that arbitration clauses are almost always upheld when challenged in the courts, even when individuals can show that an arbitration clause was buried in fine print or incorporated by reference to an obscure and inaccessible source. Courts also uphold clauses even when an individual can show that an arbitration system is too expensive for him or her to use. The result has been that many important employment rights can no longer be brought to a court by employees subject to mandatory arbitration. These rights include rights to minimum wages and overtime pay, rest breaks, protections against discrimination and unjust dismissal, privacy protection, family leave, and a host of other state and federal employment rights.
The most pernicious development in arbitration involves the coupling of arbitration with class-action waivers. Major corporations began to insert class-action prohibitions into arbitration clauses for consumer transactions in the late 1990s. Indeed, in 1999, the 10 major banks that issue credit cards—including American Express, Citibank, First USA, Capital One, Chase, and Discover—formed a group called “the Arbitration Coalition” to promote the use of arbitration clauses that bar class actions. This group also funded and jointly drafted amici curiae briefs to convince the Supreme Court to uphold these clauses.1 In part as a result of their efforts, courts generally permit arbitration to be coupled with prohibitions on class-action lawsuits, both for consumer and employment class actions. Thus today it is common for employees to be presented with terms of employment that include both a clause that obligates them to arbitrate all disputes they might have with their employer and one that prohibits them from pursuing their claims in a class or collective action. The legal developments have de facto stripped employees of many of the legal rights and protections that they have fought long and hard to obtain.
Arbitration clauses are frequently included in the fine print that an individual is required to click through when making an online purchase. Arbitration clauses are also often included in the company orientation and personnel materials a worker receives when beginning a new job. Because these arbitration clauses are usually buried in a sea of boilerplate, many people who are subject to them do not realize that they exist or understand their impact. These terms are called mandatory or forced arbitration because if the employee or consumer does not agree to arbitration, he or she will be denied employment or the ability to purchase the product or service. The employee or consumer has no real choice or ability to negotiate the terms of the arbitration clause. Mandatory arbitration in the consumer and employment setting is very different from arbitration clauses in contracts between two businesses or a company and a union; in those cases, the parties have voluntarily negotiated as equals and knowingly agreed to arbitrate disputes between them.
Unlike a court proceeding, there is no one form of arbitration. It is a term that describes a wide range of procedures that parties can design however they choose. In practice, however, arbitration typically takes place in a conference room, where parties are seated around a large table. Witnesses may or may not be in the room. Parties may or may not have lawyers. The arbitrator sits at the head of the table. He or she is not a judge and does not wear a judicial robe or other ceremonial garb. Rather, the arbitrator can be any person the parties have designated, although they frequently are lawyers. There is no court reporter or jury.
The arbitrator convenes the hearing and usually begins by explaining that it is an informal proceeding not subject to formal rules of evidence or procedure. Rather, he or she explains that the arbitrator’s role is to hear any evidence that either side wants to submit and then render a binding decision. Instead of excluding inadmissible evidence based on objections from lawyers, the arbitrator will generally hear all the evidence and then decide how much weight to give it in reaching a decision. Witnesses are sworn in by the arbitrator and the proceeding begins. During the hearing, the party who initiated the proceeding tells his or her story and presents any documents or witnesses that support it. The other side has an opportunity to cross-examine. Then the defending party presents its case, also subject to cross-examination. The arbitrator may also ask questions of the witnesses. After the close of the hearing, the arbitrator considers the evidence presented and issues an award. Often the award takes the form of a simple statement of who won, and the amount of the recovery, if any. Sometimes the arbitrator issues a written decision explaining the outcome. Once the arbitrator has ruled, there is no realistic possibility for appeal.
The greater flexibility and informality of arbitration compared with court proceedings means that the parties are relying much more on the neutrality, expertise, and fairness of the arbitrator in reaching a just outcome. This can work well when two equal parties come together to design an arbitration procedure and choose an arbitrator who they both trust. However, for consumers or employees who are required to enter into mandatory arbitration with a large corporation in order to buy a product or service or to get a job, removing these formal protections leaves them vulnerable to unfair procedures and unjust outcomes.
One recent case illustrates the difficulties employees now face when trying to enforce their rights under basic employment statutes. In 2008, Stephanie Sutherland was hired by Ernst & Young to work as a “staff/assistant.”2 Her work involved relatively routine, low-level clerical work, for which she was paid a fixed salary of $55,000 per year. She routinely worked 45 to 50 hours per week, but because she was classified by her employer as exempt from overtime, she did not receive any additional compensation for overtime. By the time Ms. Sutherland was terminated in 2009, she had worked 151 hours of overtime, for which she should have been paid about $1,867, had the Fair Labor Standards Act (FLSA)3 and New York state labor laws been observed. She filed a class-action lawsuit seeking to recover overtime pay for her work in excess of 40 hours a week and for other current and former nonlicensed Staff 1 and Staff 2 employees of the firm who worked overtime.
When Ms. Sutherland was hired, she was given an offer letter that also provided that “if an employment related dispute arises between you and the firm, it will be subject to mandatory mediation/arbitration under the terms of the firm’s alternative dispute-resolution program, known as the Common Ground Program, a copy of which is attached.” The arbitration agreement specified that claims arising under state and federal labor statutes, including the federal Fair Labor Standards Act, were subject to the arbitration program. It further specified that any dispute must be brought to arbitration and not to a court, and that all disputes must be brought on an individual basis.
In her lawsuit, Ms. Sutherland attempted to enforce her rights under state and federal minimum-wage and overtime laws. The federal Fair Labor Standards Act has a provision that expressly permits lawsuits for minimum-wage and overtime violations to be brought on a collective basis. Mr. Sutherland sought to use that provision, but to do so, she had to avoid the force of the arbitration clause that said she could only bring a case on an individual basis. To this end, she argued that if she had to arbitrate her claim on an individual basis, it would cost her $160,000 in attorney fees, more than $6,000 in other costs, and more than $25,000 in expert testimony. Overall, she claimed, she would have to spend nearly $200,000 to recover less than $2,000 in unpaid overtime. She argued that because she was unemployed and had substantial college debt, she could not afford to arbitrate on an individual basis, and thus should not be subject to the arbitration provision or the class-action waiver because together they operated to deprive her of rights under the FLSA.
The lower court was sympathetic to Ms. Sutherland’s arguments, and held that the class-action waiver did not apply because it would prevent her from vindicating her rights under the Fair Labor Standards Act. However, the U.S. Court of Appeals reversed, relying on the 2013 Supreme Court decision in American Express Co. v. Italian Colors, 133 U.S. 2304, an antitrust case, in which the Supreme Court held that a class-action waiver in an arbitration clause was enforceable despite the high cost of bringing an individual action. In that case, Justice Scalia, speaking for the majority, wrote that “the fact that it is not worth the expense involved in proving a statutory remedy does not constitute the elimination of the right to pursue that remedy.” On the basis of this precedent, the Court of Appeals denied Ms. Sutherland’s right to bring her dispute to a court or arbitration on a collective basis, thereby effectively eliminating her right to overtime pay under the federal statute.
This case is not an anomaly. Rather, it reflects the current law of arbitration and illustrates the difficulties that ordinary workers face when they try to enforce their statutory employment rights. Below we map out the current law of arbitration and then present data on the extent of use of arbitration and the impact of arbitration on the ability of workers and consumers to enforce their rights.
Where did the arbitration epidemic come from?
The current arbitration epidemic is a result of judicial developments that began in the 1980s, when the U.S. Supreme Court reinterpreted a little-known federal law enacted in 1925 called the Federal Arbitration Act (FAA). The FAA provides that when a dispute involves a contract that has a written arbitration clause, a court must, upon motion, stay litigation so that the dispute can go to arbitration.4 And after an arbitration proceeding is complete, the FAA gives courts extremely limited power to review arbitral awards, no matter how erroneous they might be. Under the statute, an award can only be set aside on four grounds: it was procured by fraud, the arbitrator was biased, the arbitrator refused to hear relevant evidence, or the arbitrator exceeded his or her power as set out in the parties’ arbitration agreement. Each of these has been interpreted exceptionally narrowly. There is no provision for overturning an award based on errors of fact, contract interpretation, or law.
Initially, the drafters, commentators, and the courts assumed that the FAA applied only to a narrow range of commercial disputes—those brought in a federal court pursuant to its power to decide issues arising under federal law. However, in the 1980s the U.S. Supreme Court radically expanded the scope of the statute. Today courts interpret the statute to apply to disputes of all types, whether brought in a federal or a state court. Moreover, the Supreme Court has held that the FAA overrides any state law that runs counter to the pro-arbitration policies of the FAA. It is important to recount the path by which this transformation occurred because it shows how entrenched the current interpretation has become and how overwhelming are the obstacles to change under the statute as currently interpreted. This, in turn, explains why new congressional action is necessary.
The FAA from 1925 to the mid-1980s
Under the common law as it stood in the early 20th century, arbitration agreements were not specifically enforceable, so it was easy for a reluctant party to an arbitration agreement to avoid arbitrating a dispute. To get this changed and make arbitration agreements enforceable, the New York Chamber of Commerce and the American Bar Association’s Committee on Commerce, Trade, and Commercial Law mounted a multipronged campaign to overturn the anti-arbitration policies of the common law. They drafted and successfully enacted the New York Arbitration Act of 1920. They then turned to Congress, and drafted the 1925 Federal Arbitration Act and lobbied intensely for its enactment. Their main ally in the battle for the federal statute was the Secretary of Commerce, Herbert Hoover, who saw the bill as fitting into his larger vision of promoting business self-regulation.
The stated purpose of both the New York and the federal statutes was to make written agreements to arbitrate enforceable. The key provision of the federal law, copied from the New York statute, was Section 2, which made written agreements to arbitrate in contracts involving commerce “valid, irrevocable, and enforceable, save on such grounds as exist in law or in equity for the revocation of any contract.”6 Other sections of the statute included a mandatory stay of judicial proceedings and the requirement that courts order parties to arbitrate when disputing parties have a written agreement to arbitrate. The FAA also provided for judicial enforcement of arbitration awards and specified extremely narrow grounds for a court to refuse to do so.
The drafters, legislators, and advocates of the FAA assumed that the statute applied only to business disputes. It was drafted with an eye toward trade association arbitration, not employment or consumer disputes. Indeed, the statute contains a specific exemption for “contracts of employment.” Consistent with this understanding, between 1925 and the 1980s, courts interpreted the FAA as applying to a narrow set of cases—commercial cases involving federal law that were brought in federal courts on an independent federal ground. But in the 1980s, the U.S. Supreme Court turned the FAA upside-down through a series of surprising decisions. These decisions set in motion a major overhaul of the civil justice system. It is no exaggeration to call the Supreme Court’s arbitration decisions in the 1980s the hidden revolution of the Reagan Court.
The expanding reach of the FAA after 1985
Between 1985 and 2015, there were more than two dozen Supreme Court decisions in arbitration cases, virtually all of which expanded the scope of the FAA and restricted the ability of states to maintain laws to protect consumers and employees and the ability of individuals to resist costly and unfair arbitration systems. In light of these decisions, the ability of a party to challenge an arbitration clause on the basis of state law has shrunken to a vanishing point.
First, in the 1980s, the Supreme Court adopted a presumption in favor of arbitration to use when deciding cases involving the FAA. It ruled in Moses H. Cone Memorial Hospital v. Mercury Construction Corp., 460 U.S. 1 (1983), that when deciding whether a particular dispute comes within an arbitration clause, courts should resolve all doubts in favor of arbitration. It said that such a presumption furthered the “liberal federal policy favoring arbitration agreements, notwithstanding any state substantive or procedural policies to the contrary.” This declaration of federal policy has served as a fixture of arbitration law and provided a rationale for the extraordinary expansion of the FAA that followed.
Then, in 1984, in Southland Corp. v. Keating, 465 U.S. 1 (1984), the high court rejected the view that the FAA only applied to cases in federal courts. Rather, the Court held that the FAA also applied to disputes over contracts that were brought in state courts, so long as the dispute involved interstate commerce. The Southland decision was a major expansion of the scope of the statute. Moreover, despite direct evidence in the FAA’s legislative history to the contrary, and despite language in Section 2 of the FAA preserving the role of state law to regulate arbitration, the Supreme Court majority held that the statute preempted any state laws with which it conflicted. Thereafter, any state efforts to regulate arbitration would be subject to preemption by the FAA.7
A third development of the 1980s concerned the types of disputes that were subject to the FAA. Whereas previously the FAA had been found to apply only to contractual disputes, in 1985, in Mitsubishi Motors v. Soler Chrysler-Plymouth, 473 U.S. 614 (1985), the Supreme Court held that the FAA also compelled arbitration of statutory disputes. Mitsubishi involved a business dispute in which one party alleged a violation of antitrust laws. Two years later, in Shearson/American Express v. McMahon, 482 U.S. 220 (1987), the Supreme Court expanded on its holding to conclude that a dispute involving alleged violations of the anti-racketeering RICO statute (formally called the Racketeer Influenced and Corrupt Organizations Act) and federal securities laws was also subject to an ordinary boilerplate arbitration clause.
The Southland decision on preemption and the Mitsubishi decision on the arbitration of statutory claims in the 1980s vastly expanded the scope of the FAA. In 1991, the Court further expanded the range of statutes whose provisions were subject to arbitration by holding, in Gilmer v. Interstate/Johnson Lane Corp. 500 U.S. 20 (1991), that an employee’s allegations that he had been subject to age discrimination in violation of civil rights laws had to be taken to arbitration. Thenceforth, most claims arising under federal statutes would be subject to arbitration. In the decades that followed, the Supreme Court further expanded the scope of the FAA in order to promote the liberal policy in favor of arbitration that it read into the 1925 statute.
At the same time, the Court repeatedly rebuffed attempts by states to enact legislation that would protect consumers and employees from unfair arbitration agreements. Beginning in the late 1980s and through the 1990s the Court struck down legislative efforts by states to protect consumers and employees from oppressive arbitration agreements. One case involved a 1985 Montana law requiring that arbitration agreements in consumer contracts appear on the first page of the contract in reasonable-sized type (Mont. Code Ann. § 27-5-114 (1993)). The purpose of the statute was to ensure that consumers knew that they were consenting to arbitration when they entered into a contractual relationship with a large corporation. In 1992, a Subway franchise owner and his wife in Montana sued, claiming that Subway had defrauded them by refusing to give them the preferred location they had been promised, causing their business to fail and their loan collateral—in this instance, their life savings—to be forfeited. Their franchise agreement with Subway had an arbitration clause that said all disputes must be arbitrated in Connecticut, far from Montana. To travel there and hire a Connecticut lawyer would have been exceedingly costly for the nearly bankrupt Casarottos. Moreover, the arbitration clause did not comply with the requirements of the Montana statutory notice provision: Rather than appearing prominently in the contract, it had been buried in small type. The Montana Supreme Court refused to enforce the arbitration clause, but the U.S. Supreme Court reversed, holding in Doctor’s Associates, Inc. v. Casarotto, 517 U.S. 681 (1996) that the law was restrictive of arbitration and therefore preempted.
The Supreme Court has also made it difficult for consumers or workers to avoid arbitration on the grounds that it would be prohibitively costly for them to take their cases to arbitration. In 2000, in Green Tree Financial Corp.-Ala. .v Randolph, 531 U.S. 79, an individual who borrowed money to purchase a mobile home and who was subsequently saddled with exorbitant finance charges sued, claiming that the lender had violated the Truth in Lending Act—a statute intended to protect consumer borrowers from misleading terms in loans. Her loan agreement had a clause requiring an arbitration tribunal that would have imposed costs far beyond her ability to pay. The Supreme Court nonetheless enforced the arbitration clause, despite acknowledging that the projected costs of the arbitration would probably preclude Ms. Randolph from bringing her case at all. The Court said that a party who opposes arbitration on the grounds that it is too expensive to proceed to arbitration had the burden of showing that the costs of arbitration would be prohibitive.
The Court has also further cut back on the ability of consumers and employees to avoid arbitration on the grounds that a contract is illegal, unconscionable, or otherwise not enforceable. One might think that if a contract is unenforceable, a party cannot be required to arbitrate under it because the arbitration clause is part of the unenforceable contract. That was the law until 1967. But in 1967 the Supreme Court held, in Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, that when a party claimed that a contract it had signed was induced by fraud, that party had to assert its claim in arbitration. That is, even if the entire contract (in that case, a commercial lease) was invalid, the arbitration clause survived because, the Court found, the promise to arbitrate was separable from the rest of the contract. This holding is called the “separability doctrine.”
In 2006, the Supreme Court in Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, extended the separability doctrine to illegal contracts, even though doing so meant that a party had to arbitrate an alleged violation even when the underlying contract that contained the arbitration agreement was entirely void. The only exception the Court recognized was when a party claimed that there was illegality, fraud, or some other recognized contractual defense in the arbitration clause itself.
One of the most frequently raised objections to arbitration clauses is that they are unconscionable. Unconscionability is a well-established contract-law doctrine that says that when a contract is grossly unfair in its terms and/or in the manner in which it was procured, it will not be enforced. Each state has developed its own definition of unconscionability over time. In 2010, in Rent-A-Center West v. Jackson, 561 U.S. 63, the Court expanded the separability doctrine in a way that eliminated many unconscionability challenges to arbitration clauses. In that case, the Court held that a party who claimed that the arbitration clause in his employment contract was unconscionable under his state law had to bring that claim to arbitration because the aspect of the arbitration clause he alleged was unconscionable was not the same aspect to which he objected. As Justice Stevens explained in dissent:
Prima Paint and its progeny allow a court to pluck from a potentially invalid contract a potentially valid arbitration agreement. Today the Court adds a new layer of severability—something akin to Russian nesting dolls—into the mix: Courts may now pluck from a potentially invalid arbitration agreement even narrower provisions that refer particular arbitrability disputes to an arbitrator [emphasis in original].
In addition to expanding the scope of the FAA, the Court has narrowed the standard of review of arbitral awards, thus restricting the ability of parties to appeal an arbitral decision in court. In 2008, in Hall Street Associates, L.L.C. v. Mattel, Inc., 552 U.S. 576, the Court held that parties cannot agree to have a court review the decisions of their arbitration tribunals. In that case, the parties to a commercial lease had an arbitration agreement that called for arbitration of all disputes but also specified that a court should vacate any award that was not supported by the facts or was based on an erroneous conclusion of law. Although arbitration is said to be a creature of the parties’ contract, and the parties are supposed to be able to craft arbitration systems however they like, the Supreme Court refused to enforce the parties’ agreement about the scope of review. Rather, it held that the national liberal policy favoring arbitration required limiting judicial review to the specific grounds enumerated in the FAA itself. In dicta, the Supreme Court also disparaged the long-settled principle that courts could refuse to enforce arbitration awards that were “in manifest disregard of the law.” Thus, after Hall Street, the grounds for attacking an arbitral award have become extremely narrow.