Arguelles-Romero v. Superior Court explains rules in Gentry and Discover Bank

If you were an arbitration agreement, this is your moment in the spotlight.  In Arguelles-Romero v. Superior Court (May 13, 2010), the Court of Appeal (Second Appellate District, Division Three) granted a petition for a writ of mandate after the trial court ordered the plaintiff to submit to individual arbitration.  The trial court also ruled that a class action waiver provision in the automobile financing contract was not unconscionable.  That finding by the trial court prompted the Court of Appeal to spend a good deal of time discussing the two different tests presented in the California Supreme Court cases of Discover Bank v. Superior Court, 36 Cal. 4th 148 (2005) (Discover Bank) and Gentry v. Superior Court, 42 Cal. 4th 443 (2007) (Gentry).  The Court of Appeal held:

While we hold the trial court did not err in finding the class action waiver was not unconscionable, we also conclude that it should have also performed a discretionary analysis on whether a class action is a significantly more effective practical means of vindicating the unwaivable statutory rights at issue. We therefore grant the petition and remand with directions.

Slip op., at 2.  To provide some context, the Court stated the basic standard of review as follows:

“California law, like federal law, favors enforcement of valid arbitration agreements.” (Armendariz v. Foundation Health Psychcare Services, Inc. (2000) 24 Cal.4th 83, 97 (Armendariz).) Under both federal and California law, arbitration agreements are valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the voiding of any contract. (Id. at p. 98 & fn. 4.) Unconscionability is a recognized contract defense which can defeat an arbitration agreement. (Szetela v. Discover Bank (2002) 97 Cal.App.4th 1094, 1099.)

Slip op., at 12.

Cutting right to it, here is the first money quote:

The confusion in this case arises because plaintiffs seek to combine the doctrines set forth in Discover Bank and Gentry into a single test for unconscionability. Yet while Discover Bank is a case about unconscionability, the rule set forth in Gentry is concerned with the effect of a class action waiver on unwaivable statutory rights regardless of unconscionability. (Sanchez v. Western Pizza Enterprises, Inc., supra, 172 Cal.App.4th at p. 172.) While, in certain circumstances, a class action waiver may be both unconscionable and violate the rule of Gentry, the Supreme Court has established two separate tests which should be considered separately. We discuss the underpinnings of each case.

Slip op., at 13-14.  The Court then set about explaining the rules in Discover Bank and Gentry.  Beginning with Discover Bank, the Court said:

A key part of the court‟s legal analysis was Civil Code section 1668, which provides, “ 'All contracts which have for their object, directly or indirectly, to exempt anyone from responsibility for his own fraud, or willful injury to the person or property of another, or violation of law, whether willful or negligent, are against the policy of the law.' ” (Discover Bank, supra, 36 Cal.4th at p. 161.) In other words, the Discover Bank court was concerned with the situation where it was alleged that the defendant, by means of the procedurally unconscionable class action waiver, had essentially given itself a license to defraud numerous individuals of very small amounts of money. Believing such license to be, in effect, an improper exculpatory contract, the court concluded it was unconscionable. (Ibid.)

Slip op., at 16.  Next, the Court explained why some federal courts don't understand Discover Bank correctly:

The Discover Bank court did not set forth a three-part test for unconscionability of a class action waiver in a consumer contract, although it is clear that the presence of three elements – (1) adhesion contract; (2) the dispute predictably involves small amounts of damages; and (3) allegations that the defendant has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money – was necessary to its analysis. (Discover Bank, supra, 36 Cal.4th at pp. 162-163.) For this reason, some federal cases applying Discover Bank have concluded that it established a three-part inquiry for determining the unconscionability of a class action waiver under California law. (See e.g., Shroyer v. New Cingular Wireless Services, Inc. (9th Cir. 2007) 498 F.3d 976, 983; In re Apple & AT & TM Antitrust Litigation (N.D.Cal. 2008) 596 F.Supp.2d 1288, 1298; Stiener v. Apple Computer, Inc. (N.D. Cal. 2008) 556 F.Supp.2d 1016, 1024.) This is not strictly accurate. While it is true that the presence of the three Discover Bank factors is sufficient to establish the unconscionability of a class action waiver, the Supreme Court did not hold that class action waivers are unconscionable only when those three elements are present. (Cohen v. DIRECTV, Inc. (2006) 142 Cal.App.4th 1442, 1451.) A court is instead required to consider whether, to the extent the elements are not present, the facts might still compel the conclusion that the class action waiver is unconscionable. (Ibid.)

Slip op., at 16-17.

Gentry was then explained by the Court:

In contrast, what we will call “the rule of Gentry” is not a rule of unconscionability. Indeed, the absence of procedural unconscionability is not relevant to striking a class action waiver as violative of the rule of Gentry. (Gentry, supra, 42 Cal.4th at p. 451.)

The seeds for the rule of Gentry were planted not in Discover Bank, but in Armendariz, supra, 24 Cal.4th 83. Armendariz considered whether a plaintiff could be compelled to arbitrate discrimination claims brought under the Fair Employment and Housing Act (FEHA). The Supreme Court began with the premise that FEHA rights are unwaivable. (Armendariz, supra, 24 Cal.4th at p. 112.) The court agreed that, as a general matter, assuming the arbitral forum is adequate, an agreement to arbitrate a non-waivable statutory claim does not waive the claim, it simply submits its resolution to another forum. (Id. at pp. 98-99.) However, if the arbitral forum is not adequate, an agreement to arbitrate a non-waivable statutory claim may, in fact, improperly compel the claimant to forfeit his or her statutory rights. (Id. at pp. 99-100.) The Armendariz court then considered the minimum requirements that any arbitral forum would have to meet so that forcing a party to pursue non-waivable statutory claims in that forum would still enable the party to vindicate his or her rights. (Id. at p. 113.) These requirements included arbitrator neutrality, the provision of adequate discovery, a written decision that will permit a limited form of judicial review, and certain limitations on the costs of arbitration. (Id. at pp. 90-91.)

The question that arose in Gentry was whether the right to a class arbitration should also be included among the Armendariz protections as a necessary minimum requirement for the arbitration of a non-waivable statutory right.  The Supreme Court concluded that it should, “at least in some cases.” (Gentry, supra, 42 Cal.4th at p. 450.)

Gentry involved a class of employees who alleged that their employer had improperly characterized them as exempt and therefore did not pay them overtime. (Gentry, supra, 42 Cal.4th at p. 451.) The statutory right to recover overtime is unwaivable. (Id. at p. 455.) The Supreme Court then concluded that, in wage and hour cases, a class action waiver would frequently have an exculpatory effect and would undermine the enforcement of the statutory right to overtime pay. (Id. at p. 457.) The court identified several factors which, if present, could establish a situation in which a class action waiver would undermine the enforcement of the unwaivable statutory right. These factors included: (1) individual awards “tend to be modest” (id. at p. 457); (2) an employee suing his or her current employer is at risk of retaliation (id. at p. 459); (3) some employees may not bring individual claims because they are unaware that their legal rights have been violated (id. at p. 461); and (4) even if some individual claims are sizeable enough to provide an incentive for individual action, it may be cost effective for an employer to pay those judgments and continue to not pay overtime – only a class action can compel the employer to properly comply with the overtime law (id. at p. 462).

Slip op., at 17-19.

The Court cautioned against confusing the two decisions:

While Discover Bank and Gentry were applications of the same general principle, it is also apparent that they involved different legal theories. Discover Bank is based on unconscionability, which is a legal determination subject to de novo review, while Gentry is based on whether a class arbitration (or action) is a significantly more effective practical means of vindicating unwaivable statutory rights, which is a discretionary determination subject to abuse of discretion review.

Slip op., at 21-22.  And, the Court emphasized, "Despite the potential overlap of the two doctrines, care should be taken not to conflate them unnecessarily."  Slip op., at 22.  As the Court explained the distinctions between the two tests, it also clarified how to correctly interpret another of its own recent opinions:

In Olvera v. El Pollo Loco, Inc. (2009) 173 Cal.App.4th 447, 457, we used some of the factors from the rule of Gentry to bolster our finding of substantive unconscionability of a class action waiver. We were not, by this, implying that the presence of one of more of the Gentry factors mandates a finding of unconscionability as a matter of law. The Gentry factors are to be considered as part of an overall inquiry into whether a class arbitration is likely to be a significantly more effective practical means of vindicating the rights of the affected employees. Clearly, as the Gentry factors are relevant to the question of whether a class action is likely to be a more effective means of vindicating the employees‟ rights, they would also be relevant to the question of whether a class action waiver is substantively unconscionable as an improper exculpatory clause under Civil Code section 1668.

Slip op., at 24, n. 17.

If you need to ask why this decision is worth thorough study, you must have missed out on Stolt-Nielsen S. A. et al. v. AnimalFeeds International Corp. and this blog's discussion here.  As the Court explained in this new decision, there are two separate tests under California law that are likely to apply in consumer and wage & hour class actions to prevent the result in Stolt-Nielsen.  And if the Courts of Appeal didn't already know it, they are likely to have petitions for writs of mandate on arbitration issues coming out their ears for a few years.  But in consumer and wage & hour class actions, the results are likely to diverge from Stolt-Nielsen in most cases.