CLASS ACTION IN ARBITRATION: An Analysis of Class Action in Consumer and Investment Arbitration

Nicolás H. Varela

Introduction

A Class Action is a legal mechanism for a group of people with a common problem to act collectively against one defendant (or more than one defendant). A significant benefit for claimants who choose to litigate their claims in a class-action context is the prospect of reducing their costs of litigation, particularly attorney’s fees, by allocating such costs among all members of the class who benefit from any recovery.

Class actions are commonly used in two different types of arbitration procedures: consumer arbitration and investments arbitration.

This paper will address the many issues that arise in respect of such mechanism for these two types of proceedings. What lessons have been learned over the course of the last decade from experiences both in North America and in Argentina and what does the future possibly holds.

Class Action in Consumer Arbitration

Unlike the Argentinean system, where consumer arbitration is forbidden, in the United States arbitration clauses are increasingly being used by companies to resolve disputes and avoid court litigation, including class actions.

Sony, Netflix, eBay, PayPal, Instagram or Microsoft are just some examples of companies that had incorporated arbitration clauses and class action waivers in their contracts. These so-called “class action waivers” have been challenged on various grounds. The United States Supreme Court, in a series of decisions, has upheld their validity and effectiveness.

To begin with, the U.S court in Vasquez v. Superior Court, 4 Cal. 3d 800, 808, 94 Cal. Rptr. 796, 484 P.2d 964 (1971) argued: “Frequently numerous consumers are exposed to the same dubious practice by the same seller so that proof of the prevalence of the practice as to one consumer would provide proof for all. Individual actions by each of the defrauded consumers are often impracticable because the amount of individual recovery would be insufficient to justify bringing a separate action; thus, an unscrupulous seller retains the benefits of its wrongful conduct. A class action by consumers produces several salutary by-products, including a therapeutic effect upon those sellers who indulge in fraudulent practices, aid to legitimate business enterprises by curtailing illegitimate competition, and avoidance to the judicial process of the burden of multiple litigations involving identical claims. The benefit to the parties and the courts would, in many circumstances, be substantial”.

Some states, such as California, have determined that the use of arbitration is unfair and that the courts there will not enforce these provisions. In AT&T Mobility LLC v. Concepcion, the Supreme Court held that the Federal Arbitration Act (“FAA”) preempts state-law rules barring enforcement of an arbitration agreement if the agreement does not permit the parties to utilize class procedures in arbitration or in court.

Unlike other arbitration agreements, AT&T Mobility's arbitration agreement was designed to facilitate the pursuit of small claims in arbitration by establishing that AT&T would pay the entire cost of arbitration (unless the claim was determined to be frivolous), the arbitration would take place in the county where the consumer was located, by telephone, or through document submission, and forms for the arbitration were made available on AT&T Mobility's website. Moreover, the arbitrator was not limited to the damages it could award to a consumer, and if the consumer received an award greater than AT&T Mobility's last written settlement offer, the award would be increased to $7,500, and the consumer would be entitled to double attorney's fees. This led the United States District Court for the Southern District of California to state that arbitration under AT&T Mobility's agreement was "quick, easy to use, and prompts full or, as described by Plaintiffs, even excess payment to the customer without the need to arbitrate or litigate". However, other consumer-oriented companies do not have the same benefits.

In DIRECTV, Inc. v. Imburgia, the Supreme Court held that a state-law interpretation of an arbitration agreement does not rest upon grounds as exist for the revocation of any contract. It clarified that state law could not invalidate the arbitration agreement on the ground that it barred class procedures. The state trial court denied DirectTV’s motion, and the California Court of Appeal affirmed. The agreement, which provided that the FAA governed its terms and contained a class-waiver, provided that it was invalid if the “law of your state” would nonetheless require class arbitration. The Court of Appeal held that this reference to state law meant that the parties had agreed that California law, without regard to the FAA’s preemptive effect, would govern. Because California law required class procedures, the court held the arbitration invalid, even though that California law was preempted by Concepcion. Once action waivers contained in arbitration agreements are enforceable under the Federal Arbitration Act (FAA) and cannot be invalidated on state law grounds inapplicable to any other contract.

The position in the United States seems to have been settled, access to class action litigation can be waiver in arbitration clauses generating one of the most efficient ways to reduce potential class action litigation for companies.

Arbitration, therefore, can eliminate the possibility of initiating Class Actions that due to the cost of hiring a lawyer and filing a claim in arbitration may not make sense for a dispute involving a relatively small sum. If damages are small, class arbitrations are appropriate ways to resolve claims that are minor individually but significant in the aggregate and can be very expensive for the company being sued. Without class actions, minor frauds would not be remedied.

Arbitration clauses are nearly always drafted to require arbitration of “all disputes” relating to the contract, including its formation and entry. They consequently cover not just claims for breach of contract, but also claims that arise under consumer protection and competition statutes.

Moreover, in Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20, 31, and Green Tree Financial Corp. v. Bazzle, 539 U.S. 444 (2003) any question of whether class actions in arbitration are permissible under the FAA was implicitly put to rest by the Supreme Court. In Gilmer, the appellant employee attacked the enforceability of the arbitration requirement in the New York Stock Exchange’s rules on the grounds that it would deprive ADEA plaintiffs of the ability to proceed collectively. The Supreme Court noted that NYSE rules specifically permitted class-type arbitration proceedings, implying their permissibility under the FAA. The Court, however, held that even if collective proceedings were not available, the arbitration agreement would be enforceable. The pronouncement issue appears to have been the inability of an arbitral forum to provide class relief, not a waiver of the right by the parties. Subsequent to Gilmer, many of the major arbitration agencies have developed class action rules and procedures, making the capability issue less significant.

In Bazzle, an arbitrator had allowed the two cases in the issue to proceed as class arbitrations. The arbitrator’s rulings in favor of the classes were ultimately reviewed by the South Carolina Supreme Court, which held on that the arbitration agreements in question did not block class-wide arbitrations. In the absence of a prohibition against class arbitrations in the arbitration agreement, they were found to be permissible. The U.S. Supreme Court reversed and remanded, holding that the arbitrator, not a court, should interpret the arbitration agreements to determine whether class arbitrations were permitted by the agreements.

In Powertell, Inc. v. Bexley, the court initially had problems with the enforceability of the agreement. The arbitration language was sent as a standardized insert in the customer’s monthly bills which was found to give inadequate notice of its existence. There was no give and take bargaining over its terms. Further, in barring customers from arbitrating as a class it deprived them of the most economically feasible remedy for the kind of claim that has been asserted here. The potential claims are too small to litigate individually, but collectively they may amount to a large sum of money. The prospect of class litigation ordinarily has some deterrent effect on a manufacturer or a service provider, but that is absent here. By requiring arbitration of all claims, Powertel has precluded the possibility that a group of its customers may join together to seek relief that would be impractical for any of them to obtain alone.

Class Action Arbitration When Not Authorized by the Arbitration Agreement

In Discover Bank v. Superior Court of Los Angeles, 36 Cal. 4th 148 (Cal. 2005), pointed out that “judicially authorized class-wide arbitration in a case in which the arbitration agreement is silent on the issue” is permissible under California law. However, many courts have declined to allow arbitrations to proceed as class actions in the absence of a provision in the arbitration agreement authorizing class arbitration.

The plaintiff in Johnson v. West Suburban Bank, 225 F.3d 366 (3d Cir. 2000), the arbitration agreement involved made no specific mention of the use of class actions. Since class actions were neither barred nor authorized on the face of the arbitration agreement, the court seems to have proceeded on the basis that class arbitrations are unavailable in the absence of specific contract language allowing them. The decision did not focus on the lack of authorization but addressed policy reasons for not compelling class arbitration.

In Del E. Webb Construction v. Richardson Hospital Authority, 823 F.2d 145 (5th Cir. 1987) Quoting the Supreme Court in Dean Witter Reynolds v. Byrd, 470 U.S. 213 (1985), the court wrote: “The preeminent concern of Congress in passing the [Federal Arbitration Act] was to enforce private agreements into which parties had entered, and that concern requires that we rigorously enforce agreements to arbitrate, even if the result is “piecemeal” litigation, at least absent a countervailing policy manifested in another federal statute.”

In Elisa Maria Mostaza Claro v. Centro MóvilMilenium SL (Court of Justice of the European Communities, C-168/05, 26 October 2006) the Court analyzed the validity of an arbitration clause included in the contract. Under Spanish law, consumers were initially protected against unfair terms (Art. 45 of Law 36/1988 was worded as follows: The arbitration award may be annulled only in the following cases: 1. Where the arbitration agreement is null and void. … 5. Where the award is contrary to public policy.

As Ms. Mostaza Claro did not comply with the minimum subscription period, Móvil initiated arbitration proceedings before the AEADE (Asociación Europea de Arbitraje). The Provincial Court de Madrid stated that there was no doubt that the arbitration agreement included an unfair contractual term and was, therefore, null and void. However, as Ms. Mostaza Claro did not plead that the agreement was invalid in the context of the arbitration proceedings, and in order to interpret the national law in accordance with the Directive, the Audiencia Provincial de Madrid decided to stay the proceedings and to refer the following question to the Court for a preliminary ruling: May the protection of consumers under Council Directive 93/13/EEC … require the court hearing an action for annulment of an arbitration award to determine whether the arbitration agreement is void and to annul the award if it finds that that arbitration agreement contains an unfair term to the consumer's detriment, when that issue is raised in the action for annulment but was not raised by the consumer in the arbitration proceedings? It was ostensibly from the documents sent to the Court by the Audiencia Provincial that the latter has established that the arbitration clause contained in the contract concluded between Móvil and Ms. Mostaza Claro was unfair.

In that respect, it must be recalled that the Court may not rule on the application of general criteria used by the Community legislature in order to define the concept of the unfair term to a particular term, which must be considered in the light of the particular circumstances of the case in question.

Article 6 of the Directive which, required the Member States to ensure that consumers were not bounded by unfair terms, could not be achieved if the court seized of an action for annulment of an arbitration award was unable to determine whether that award was void solely because the consumer did not plead the invalidity of the arbitration agreement in the course of the arbitration proceedings.

The importance of consumer protection had, in particular, led the Community legislature to lay down, in Article 6(1) of the Directive, that unfair terms used in a contract concluded with a consumer by a seller or supplier ‘shall … not be binding on the consumer’. This is a mandatory provision which, taking into account the weaker position of one of the parties to the contract, aims to replace the formal balance which the latter establishes the rights and obligations of the parties with an effective balance which reestablishes equality between them.

The nature and importance of the public interest underlying the protection which the Directive confers on consumers justify, moreover, the national court being required to assess of its own motion whether a contractual term is unfair, compensating in this way for the imbalance which exists between the consumer and the seller or supplier. Having regard to the foregoing, the answer to the question referred must be that the directive must be interpreted as meaning that a national court seized of an action for annulment of an arbitration award must determine whether the arbitration agreement is void and annul that award where that agreement contains an unfair term, even though the consumer has not pleaded that invalidity in the course of the arbitration proceedings, but only in that of the action for annulment.

Although in many cases arbitration can be a procedure more efficient that court litigation, due to all the conflicts this problem arise (especially in consumer arbitration), rest to consider if the U.S legal system can learn something from Argentinean system forbidding the use of arbitration in this kind of procedures. Taking into a count that a consumer is in a worst position that the company and often accepts to waive their right to access to courts by a pre-formulated standard contract that they are not able to discuss and that allowing to waive this right, and specially the possibility to litigate through a class action it allow to the companies to behave inappropriately knowing that the average consumer would never raise a legal complaint.

Class Actions Arbitration in Investing Disputes

A little over a decade ago, following the 2003 decision of the United States Supreme Court in the case of Green Tree Financial Corp. v. Bazzle, the concept of class arbitration erupted into the international scene. In that case, the U.S. Supreme Court recognized that an arbitrator, in a domestic U.S. case, had the authority to interpret an arbitration agreement as permitting class arbitration. In the years that have passed since Bazzle , the law in the United States concerning class arbitrations has taken several twists and turns, but the idea that arbitration should be available for the resolution of class actions, in the U.S. collective or group actions has continued to animate a lively debate.

In recent years, interest in the possible use of arbitration as a means of resolving class and group claims of various kinds has been reinvigorated by the decision of the investment arbitration tribunal in the Abaclat case to assume jurisdiction in a single arbitration over the claims of 60,000 Italian bondholders with claims against Argentina.

Investor advocates argue that there is still room for improvement when it comes to arbitration of investor disputes. They have expressed concerns about the lack of diversity in the arbitrator pool and the fact that investors typically do not get explanations of the reasoning for specific arbitration decisions and awards

There has also been active discussion of debt restructuring issues in international fora and the Institute for International Finance has recently issued an annex to its Principles in light of the restructuring experience in Greece.[1]

The Argentina’s “Holdouts” case

In 2005, the Argentinean government started a process of debt restructuration of sovereign bonds that defaulted in the year 2001 at the depth of a terrible economic crisis. By 2010, 93% of bondholders had arrangements for some form of repayment, though disputes still existed with the remained holdouts.[2]

The remaining 7% of bondholders later won in the New York State Court the right to be repaid in full[3], and accordingly to the court all bonds had to be repayable on paripassu (equal) terms that prevented preferential treatment among bondholders.

The holdout bondholders, therefore, sought and won, an injunction in 2012 that prohibited Argentina from repaying the 93% of bonds that had been renegotiated, unless they simultaneously paid the 7% holdouts their full amount due as well.

Together with the agreement's rights upon future offers ("RUFO") clause, it created a deadlock in which the 93% of renegotiated bondholders could not be paid without paying the 7% holdouts, but any payment to the holdouts would potentially (according to Argentina) trigger the 93% being due repayment at full value too; a sum of around $100 billion that Argentina could not afford. The courts ruled that as Argentina had itself drafted the agreement, and chosen the terms it wished to propose, it could not now claim the terms were unreasonable or unfair, and that this could not be worked around by asserting sovereign status since the injunction did not affect sovereign assets, but simply ruled that Argentina must not give preferential treatment of any group of bondholders over any other group when making repayments.

Subsequently, though Argentina wanted to repay some creditors, the judgment prevented Argentina from doing so. The country was therefore categorized as being in selective default by Standard & Poor's and in restricted default by Fitch.

The Restructuring of Sovereign Debt

As a result of the case and by an Argentina initiative, the United Nations adopted a resolution in favor of stability of the countries in restructuration of sovereign debt. It was argued that debt is responsible for inequality and takes advantage of less developed countries. As a democratic forum where all sovereign countries have a voice (and not just developed countries) the United Nations Assembly said that Countries have a right to restructure debt and it is crucial to put an end to the power of vulture funds that fed on the lack of global legislation to take advantage of many poor countries.

The United Nations Principles for Sovereign Debt Restructuration

The General Assembly of the United Nations adopted a resolution that establishes basic principles to consider in restructuring sovereign debt. The resolution, backed by the Group of 77 plus China, won by a large majority and invites member and observer states and relevant international organizations to support and promote the basic principles for sovereign debt restructuring approaches. The principles adopted by the General Assembly are:

1. A sovereign state has the right, in the exercise of its discretion, to develop their macroeconomic policies, including the restructuring of its sovereign debt, a right that must not be frustrated or hindered by abusive measures. The restructuring should be done as a last resort since the beginning preserving the rights of creditors.

2. The principle that the sovereign debtor and all creditors must act in good faith implies their participation in constructive negotiations restructuring of sovereign debt and other process steps in order to restore debt sustainability and service debt quickly and lastingly and to obtain the support of a critical mass of creditors through constructive dialogue about the conditions of restructuring.

3. The principle of transparency should be promoted to increase the accountability of stakeholders, what can be achieved timely sharing both data and related sovereign debt renegotiation process.

4. The principle of impartiality requires that all institutions and actors involved in restructuring sovereign debt, including at regional level, in accordance with their respective mandates, are independent and refrain from exerting undue influence on the process and other stakeholders or acts that create conflicts of interest or corruption or both.

5. The principle of equal treatment imposes on States the obligation to refrain from arbitrarily discriminating against creditors unless the difference in treatment is justified according to law, is reasonable and corresponds to the characteristics of credit, guarantees equality between creditors and consideration by all creditors. Creditors are entitled to receive the same treatment in proportion to their credit and the characteristics of this. No creditor or group of creditors should be excluded a priori from the restructuring of sovereign debt.

6. The principle of sovereign immunity from jurisdiction and execution of restructuring of sovereign debt is a right of States to foreign domestic courts, and exceptions should be interpreted restrictively.

7. The principle of legitimacy implies that by establishing institutions and perform tasks related to sovereign debt restructuring operations must be respected at all levels, including requirements and the rule of law. The terms and conditions of the original contracts remain valid until they are changed by a restructuring agreement.

8. The principle of sustainability means that restructuring of sovereign debt must be made in a timely and efficient manner and create a stable situation in the debtor State debt, since the beginning preserving the rights of creditors and simultaneously promoting economic growth sustained and inclusive and sustainable development, minimizing economic and social costs, ensuring the stability of the international financial system and respecting human rights.

9. The majority restructuring involves restructuring agreements sovereign debt to be approved by a qualified majority of creditors of a State will not be affected, harmed or hindered otherwise by other States or by an unrepresentative minority of creditors, who must respect the decisions taken by the majority of creditors. States should be encouraged to include CACs in their sovereign debt issues.

Axel Kicillof, former Argentine Economy Minister said: "these basic principles are a fundamental step for anyone to suffer attacks like those now Argentina and many other countries are suffering from the vulture funds. We welcome this resolution because the United Nations is a key for us to get a better world, a world free of vultures step".

The Argentina litigation has exacerbated the collective action problem, by increasing the leverage of holdout creditors. Recent experience indicates that the contractual, market-based approach has worked reasonably well in securing creditor participation and avoiding protracted negotiations. But these episodes have also foreshadowed potential collective action problems that could hamper future restructurings.

Most of the recent debt restructurings have been conducted prior to a default and have achieved high creditor participation. Among the recent cases, all except Argentina, Ecuador, and Seychelles were preemptive restructurings.

Differential treatment of creditors has been fairly common in recent debt restructurings, reflecting creditor preferences, financial stability, market access, and trade credit considerations. For example, Seychelles offered different terms to domestic and foreign residents to protect the domestic banking sector.

Thus far, only four countries have included aggregation clauses in their sovereign bonds: Argentina, the Dominican Republic, Greece, and Uruguay. These clauses, which were first introduced in Uruguay’s bonds in 2003, provide the option to amend key terms on the basis of aggregate voting across affected bonds in cases where the amendment affects two or more series of bonds. Specifically, if the sovereign chooses to amend the bonds on an aggregated basis, two voting thresholds must be met: (i) 75 (Greece) or 85 (Argentina, Uruguay and the Dominican Republic) percent of the aggregated outstanding principal of all series to be affected and (ii) 66⅔ percent of the outstanding principal of each individual series to be affected. The latter voting threshold is lower than the typical 75 percent majority needed under CACs (which apply to a series-by-series basis). The effectiveness of such a contractual aggregation voting system is limited in two respects. First, while the required 66⅔ percent threshold for each individual series is easier to achieve than the typical 75 percent threshold, it still enables a creditor to obtain a blocking position with respect to a particular issuance (though it may be more costly to do so). In such cases, a restructuring would be precluded from going forward for that particular series, while the restructuring could still be affected by other series so long as the two-tier thresholds are met.

This limitation is potentially significant. There is merit in considering whether a more robust form of aggregation clause could be designed and successfully introduced into international sovereign bonds. Further work could be conducted to determine whether aggregated voting in collective action clauses could be made standard practice in new bond issuances, and consideration could be given to the feasibility of replacing the standard two-tier voting thresholds in the existing aggregation clauses with one voting threshold, so that blocking minorities in single bond series cannot derail an otherwise successful restructuring. These provisions would help in the long run, even though legacy debt will not be affected. In particular, removing the individual issuance voting tier would go a long way to reducing the leverage of holdouts.

The impact of the Argentine decisions is already being felt. For example, in response to the Argentine decisions, Belize explicitly stated in the February 2013 debt exchange offer as well as the legislation authorizing the terms of exchanged bonds that the paripassu clause in the restructured bonds does not require Belize to pay all items of its public debt on a ratable basis to prevent the holdout strategy employed against Argentina and to mitigate litigation risks.

Conclusion

Although arbitration is an effective way for resolution of disputes, we can see that when it comes to class action procedures there still difficulties that need to be solve.

For consumers, to keep their right to access to justice when the arbitration clauses in adhesion contracts are not just; and in investment arbitration to safeguard the right of the bondholders to a fair payment for what they have invested and, at the same time, a fair treatment to the country allowing not to be categorized in default when it reaches an agreement with the majority of the bondholders.

The basic principles of the United Nations show a clear interest for the majority of the international community to regulate the sovereign debt restructuration process and are a good start-point for protecting the international community, especially undeveloped countries.

A potential solution is the creation of a class action system for international investment disputes in arbitration or an international regulation against countries bankruptcy to reach a fear agreement with bondholders.

Nonetheless, as the Chinese philosopher, Laozi used to say: “a journey of a thousand miles begins with a single step”. We are luckily enough that already there are many steps taken; now we need to work to make new steps longer, faster and reach further.

[1] https://www.imf.org/external/np/pp/eng/2013/042613.pdf [2] J.F.Hornbeck (February 6, 2013). "Argentina’s Defaulted Sovereign Debt: Dealing with the "Holdouts"" Congressional Research Service. [3] "Argentine Funds Can’t Be Seized by Bond Holders, Judge Says". Bloomberg. March 28, 2012. Retrieved August 29, 2013.