The Arbitration Fairness Act Reconsidered And Proposals for Sensible Law Reform

By Gary L. Kaplan, Esq.1
Introduction
Various consumer advocacy groups have complained of the use of arbitration in
consumer and employment disputes on grounds that arbitration favors corporate clients over
individuals, because (i) arbitrators have incentive to favor businesses that could become repeat
customers; (ii) arbitration is more costly for individuals than litigation (because parties do not
need to pay the judges); (iii) it is more difficult for individuals to obtain legal counsel for
arbitration than litigation; (iv) “secret” arbitration precludes judicial review and appeal: and (v)
individuals should not be forced to give up their rights to a jury trial by contract (where
individuals have no power to negotiate alternative terms).

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Such arguments have led to the introduction in Congress of legislation that, if
enacted, would largely preclude businesses from requiring arbitration in their standard form
agreements with consumers and employees.2 Those standard arbitration agreements have been
termed “pre-dispute” arbitration agreements to contrast them with agreements to arbitrate, in lieu
of litigation, after a dispute arises.
There are plainly many instances in which consumers have been injured by unfair
or even abusive arbitration requirement. But stories of such harms tell only part of the story.
Arbitration, like other forms of ADR, can reduce wasteful expenditures on disputes that increase
not only the cost of providing goods and services to the market but also resulting costs to
consumers of purchasing those good and service.
This paper discusses concerns raised about consumer arbitration and legislation
that has been proposed to address them. In addressing concerns about concern arbitration, this
paper attempts to provide a balanced assessment of the benefits and harms flowing from
consumer arbitration and to provide context to consider arbitration in light of the dispute
resolution alternatives presently available for addressing such concerns.
Finally, this paper proposes more moderate legislative alternatives than have been
proposed by consumer advocacy group. Pending proposals would essentially eliminate
mandatory pre-dispute arbitration agreements. By eliminating a dispute resolution alternative
that has potential to provide substantial savings, however, those proposals have the potential to
do more harm than good. Instead, I suggest a series of more moderate reforms designed to
protect consumer interest while allowing the societal benefits of efficient dispute resolution to
continue to accrue.

2 See, e.g. 110th Congress, S. 1782, The Arbitration Fairness Act of 2007. The
Senate Judiciary Committee held hearings on this bill on December 12, 2007.
Working Paper
© 2009, Gary L. Kaplan, All Rights Reserved.

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Consumer Arbitration and Fairness
In testimony before the Senate Committee on the Judiciary, the case against
arbitration in consumer disputes was made by a representative of a public interest law firm, F.
Paul Bland, Jr. Mr. Bland argued:
• “A large and rapidly growing number of corporations are requiring millions of
consumers to give up their rights to a jury trial… and instead to submit all of their
legal claims to binding mandatory arbitration.
• Most consumers have little or no choice before submitting to arbitration…
• Private arbitration companies are under great pressure to devise systems that favor
the corporate repeat players who draft the arbitration clauses… For example,
arbitrators who rule against corporation in favor of individuals are often
blackballed from serving as arbitrators in future cases.
• Many corporations tack on lots of unfair provisions to the arbitration clauses that
are not inherent to the idea of arbitration, but the further rig the system against
individuals. For example, some corporations impose “loser pays rules” to
discourage individuals from bringing claims; some corporations insert
provisions… that strip individuals of substantive statutory rights; some
corporations require people to arbitrate their claims across the country; and some
corporations use arbitration clauses to ban class actions.”3
Political arguments against arbitration often rely upon anecdotal evidence to
overstate alleged biases against individuals, while ignoring substantial deficiencies in the
supposedly preferred court procedures. For example, the notion that consumers “give up” a right
to a jury trial falsely assumes that consumers could demand a jury trial even for small consumer
disputes that would be relegated to small claims court or other limited procedures.
Further, the limited available empirical data does not demonstrate a clear pattern
of bias against individuals. In testimony before the Senate Judiciary Committee, Professor Peter
B. Rutledge explained, “[s]ome studies have found evidence of a repeat player phenomenon
3 Bland, Peter Testimony of December 12, 2007, before the Senate Judiciary
Committee on S. 1782 the Arbitration Fairness Act of 2007

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while others have found no demonstrable effect. Further, even where repeat player effect exists,
the cause is not clear. Most research suggests that the repeat player effect—if it exists—is not
due to the arbitrator’s financial incentives but, instead, to the “’learning effects’ from the repeat
player’s experiences.”4
To the extent a study purports to establish a clear bias against individuals, its
conclusions may simply reflect a poor study design. For example, in its testimony to Congress,
Public Citizens cited evidence that First USA Bank won over 99 percent of arbitrations and that
some arbitrators for the National Arbitration Forum routinely handled a large number of cases
each day. Public Citizens’ analysis, though, ignores that fact that most (or all) of the arbitrated
matters concerned nothing more than simple defaults on credit card bills.
Further, the case against arbitration ignores both the social cost of clogging the
courts with relatively simple matters that could be handled more efficiently by other means and
the social benefit of reducing the cost and inefficiency of such disputes. If corporations are
prohibited from employing efficient dispute resolution methods, there can be little doubt that the
greater cost of inefficient procedures will be passed along to consumers in the form of higher
prices for consumer goods. The net effect of such higher costs would be that consumers who
avoid disputes would be subsidizing those that do not.

4 Rutledge, Peter B., Testimony of December 12, 2007, before the Senate
Judiciary Committee on S. 1782 the Arbitration Fairness Act of 2007 (citing Lisa Bingham, Is
there a Bias in Arbitration of Nonunion Employment Disputes? An Analysis of Actual Cases and
Outcomes, 6 INT’L J. ON CONFLICT MGMT. 369, 380 (1995) and Lisa Bingham & Shimon
Sarraf, Employment Arbitration Before and After the Due Process Protocol for Mediation and
Arbitration of Statutory Disputes Arising Out of Employment: Preliminary Evidence that Self-
Regulation Makes a Difference in ALTERNATIVE DISPUTE RESOLUTION IN THE
EMPLOYMENT ARENA: PROCEEDINGS OF THE NYU 53RD ANNUAL CONFERENCE
ON LABOR 303, 323 & Table 2 (Estreicher & Sherwyn eds. 2004), with Elizabeth Hill, Due
Process At Low Cost: An Empirical Study of Employment Arbitration Under the Auspices of the
American Arbitration Association, 18 OHIO STATE J. ON DISP. RES. 777, 816 (2003)).

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If, as seems likely, most consumer disputes (excluding products liability matters)
involve payment defaults on credit agreements of one type or another, arbitration is likely to
reduce the costs of such disputes overall. For a company that regularly conducts business in all
50 states, the cost of simply identifying and complying with the highly diverse rules of state and
local courts for obtaining default judgments would be substantial.
Of course, notwithstanding an overall cost reduction, the cost to individual
consumers may be greater for arbitration than for litigation. Unfortunately, other than arguments
based upon anecdotes, there appears to be little empirical evidence that compares the cost of
litigation to the cost of arbitration for consumers.
The lack of data about the cost to consumers of arbitration, however, does not
preclude an evaluation of the fairness and economic reasonableness of the process under
traditional legal standards.

Arbitration: Unconscionability, Separability, and Right to a Jury Trial

In addition to opposing arbitration of consumer dispute on grounds that it raises
the cost of disputes for consumers, opponents argue that arbitration clauses in consumer
agreements unfairly force consumers to agree to arbitration that, in turn, deprives consumers of
constitutional rights to a jury trial and due process. In discussing arbitration, as in other areas,
arguments that focus on the risk to individual rights stand as a counterbalance to arguments
based on economic efficiency. For example, a dictatorship or society without individual rights
is likely to be far more efficient than a democracy, but few would argue that a dictatorship is
more fair or just.
The potential conflict between the rights of consumers and economic efficiency,
however, is hardly unique to arbitration. In commercial matters, the courts have routinely upheld

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one-sided agreements that require consumers to give up procedural rights. For example, the
Supreme Court has upheld contracts that impose liens on debtors, even though they deprive them
of due process, see Mitchell v. W.T. Grant Co., 416 U.S. 600 (1974), forum selection clauses that
require consumers to sue in foreign, and possibly distant, states, Carnival Cruise Lines, Inc. v.
Shute, 499 U.S. 585 (1999), and clauses that provide consent to be sued in foreign states, Burger
King Corp. v. Rudszewicz, 471 U.S. 462 (1985).5

Waiver of Jury Trials

Some courts have set a higher standard for waivers of rights to a jury trial. In
National Equipment Rental, Ltd. v. Hendrix, 565 F.2d 255 (2d Cir. 1977), the Second Circuit
held that a waiver of a right to a jury trial must be “knowing,” Contract language providing for
such a waiver, standing alone, was held to be insufficient. The Hendrix court explained:
It is elementary that the Seventh Amendment right to a jury is fundamental and
that its protection can only be relinquished knowingly and intentionally. [citations
omitted]. Indeed, a presumption exists against its waiver. [citations omitted].
There is little doubt that the provision relied on by NER fails to overcome this
presumption. The waiver clause was set deeply and inconspicuously in the
contract, and Justice Black, dissenting in National Equipment Rental, Ltd. v.
Szukhent, [375 U.S. 311, 332-3] (1964), aptly characterized the nature of NER's
form agreements: this printed form provision buried in a multitude of words is too
weak an imitation of a genuine agreement to be treated as a waiver of so
important a constitutional safeguard . . . it exhausts credulity to think that they or
any other layman reading these legalistic words would have known or even
suspected that they amounted to (such) an agreement . . .. (565 F.2d at 258.)
Since Hendrix, most courts specifically addressing the issue have adopted its test
and required a showing that a jury trial waiver was knowing, voluntary, and intelligent. For
example, the Second, Fourth, and Tenth Circuits, and many federal district courts, have held that
5 See Stephen J. Ware, “Arbitration Clauses, Jury Waiver Clauses, And Other Contractual
Waivers of Constitutional Rights,” 67 Law and Contemporary Problems 167 (Winter/Spring
2004).

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the party seeking to enforce a jury trial waiver has the burden of demonstrating that the other
party acted with the requisite state of mind. See id.; Leasing Serv. Corp. v. Crane, 804 F.2d 828
(4th Cir. 1986); Telum Inc. v. E.F. Hutton Credit Corp., 859 F.2d 835 (10th Cir. 1988), cert.
denied, 490 U.S. 1021 (1989). See, e.g., Dreiling v. Peugeot Motors of Am., Inc. 539 F. Supp.
402, 403 (D. Colo. 1982) (emphasizing that the burden of proving waiver is a "very heavy" one).
By contrast, the Sixth Circuit imposes the burden on the party objecting to the jury trial waiver.
See KMC Co. v. Irving Trust Co., 757 F.2d 752 (6th Cir. 1985) (explaining that "in the context of
an express contractual waiver the objecting party should have the burden of demonstrating that
its consent to the provision was not knowing and voluntary.")
Under Hendrix, in evaluating a waiver of jury trial, courts consider a variety of
factors, including (1) whether the jury waiver clause was conspicuous; (2) the parties' relative
bargaining power; (3) the business experience of the parties; (4) whether the contract was, in
fact, negotiated, and (5) whether the waiving party was represented by counsel. This standard is
far more exacting than the standards that have been generally applied in determining whether or
not to enforce an arbitration agreement against a consumer. See, e.g., Doctor’s Associates v.
Casarotto, 517 U.S. 681 (1996)(holding that Section 2 of the Federal Arbitration Act, which
requires courts to enforce arbitration agreements “save upon such grounds as exist at law or
equity” for the revocation of any contract, means that arbitration clauses cannot be singled out
for heightened scrutiny under state law but must instead be examined “upon the same footing as
other contracts.”)
The strict standard applied by the courts in reviewing contractual waivers of the
right to a jury trial are impossible to reconcile with either the lesser standard applied to other
waivers of procedural, jurisdictional or due process rights or with the Supreme Court’s consistent

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enforcement of arbitration agreements, even in the face of seeming unfairness to individual
parties. See, e.g., Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440 (2006)(holding that
arbitrator, not court, had jurisdiction to decide whether contract was unconscionable and
unenforceable); Doctor’s Associates, Inc. v. Casorotto, 517 U.S. 681 (1996)(holding that the
FAA preempted a Montana law that required any contract requiring arbitration to provide notice
on its first page, in underlined capital letters, that the contract is subject to arbitration).
Professor Stephen Ware argues that the most likely and preferred means of
harmonizing these inconsistent bodies of law is to reverse the trend toward heightened scrutiny
of jury trial waivers and, instead, to treat such waivers no differently than other contractual
agreements, i.e., to enforce such waivers without inquiry into the “knowing” consent of the
parties. The alternative, he argues, would be to overturn a wide range of longstanding doctrine
in cases ranging from arbitration, forum selection, property-deprivation, and the like.)6
But Professor Ware’s argument does not fully address the policy questions raised
not only by the inherent disparity in bargaining power between corporate proponents of
arbitrations and consumers, but also the disparity in such parties’ likely knowledge of arbitration
and the implications of an agreement to arbitrate any dispute. (He does, however, correctly note
that “Doctor’s Associates establishes that disclosure requirements and other mild anti-contract
law will not become part of arbitration law unless Congress amends the FAA.”7) In his view, it
is enough that consumers unknowingly waive procedural rights all the time and, he argues, to
treat arbitration and waivers of jury trials differently would make a mess of the law.
6 Stephen J. Ware, “Consumer Arbitration As Exceptional To Consumer Law,” 29
McGeorge Law Review 195 (Winter 1998).
7 Ibid. at 216.

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Before discussing policy alternatives for consumer arbitration, however, it is
necessary to address another doctrine that distinguishes arbitration agreements from all other
contractual terms—namely, the doctrine of separability.

Separability

The separability doctrine originated in the Supreme Court’s decision in Prima
Paint Corp. v. Flood & Conklin Manufacturing Co, 388 U. S. 395 (1967). In that case, Prima
Paint sought rescission of contract with Flood & Conklin based on alleged fraud and to enjoin
Flood & Conklin from proceeding with an arbitration based on an arbitration clause contained in
the allegedly fraudulent agreement. In response, Flood and Conklin sought to stay the lawsuit
pending the outcome of the arbitration. The trial court granted the stay sought by Flood and
Conklin, and the Supreme Court affirmed. In so doing, the Supreme Court created the doctrine
of “separability,” which provides that an agreement to arbitrate must be considered separately
from the contract in which it is included. Under this doctrine, based on the Court’s interpretation
of the FAA, a court is not permitted to void an arbitration clause on grounds that the contract as a
whole was fraudulently induced or otherwise invalid; it could only void an arbitration clause if
the agreement to arbitrate was itself the result of fraud or other infirmity. Specifically, the Court
held that “arbitration clauses as a matter of federal law are ‘separable’ from the contracts in
which they are embedded, and that where no claim is made that fraud was directed to the
arbitration clause itself, a broad arbitration clause will be held to encompass arbitration of the
claim that the contract itself was induced by fraud.” 388 U.S. at 402.
In Buckeye, supra, the Supreme Court reiterated and perhaps extended the
separability doctrine in holding that a state court was preempted by the FAA from deciding, as a

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matter of state consumer protection law, that a contract containing an arbitration clause was
invalid and that the enforceability of the contract was instead to be decided in arbitration.
Viewed in isolation, Prima Paint and Buckeye appear to create a bright line that
precludes a court from invaliding an arbitration clause on grounds that it is part of an invalid
contract. The bight line, however, becomes fuzzy when one considers grounds for declaring a
contract illusory, or void ab initio, as opposed to unenforceable on grounds of public policy as in
Buckeye. For example, what if a party claims the contract containing an arbitration clause was
signed under duress, by a person without authority, or with a forged signature?
Such issues are addressed, in part, in a separate line of Supreme Court cases,
which include First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 944 (1995)(holding that
the courts, rather that arbitrators, decide the question of whether the parties, in fact, agreed to
arbitrate a dispute) and Howsam v. Dean Witter Reynolds, Inc, 537 U.S. 79 (2002)(stating that “a
gateway dispute about whether the parties are bound by a given arbitration clause raises a
‘question of arbitrability’ for a court to decide.”). See also Sphere Drake Ins. Ltd. v. All
American Ins. Co., 256 F.3d 587, 590-91 (7th Cir. 2001)(holding that First Option implies that
the doctrine of separability applies only to cases based upon a “defense to enforcement” of a
contract, but not to cases asserting that “no contract came into being.”).
With respect to consumer arbitration and unconscionability, the Supreme Court
has left open a slim basis for courts to invalidate arbitration clauses. In Green Tree Financial
Corp-Alabama v. Randolph, 531 U.S. 79 (2000), the Court stated, in dicta, that an arbitration
agreement may be unenforceable if costs are so prohibitive as to preclude the vindication of
rights in arbitration and the party opposing arbitration proves “the likelihood of incurring
[prohibitive] costs.” Subsequently, however, federal courts have emphasized that in assessing

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the unconscionability of an arbitration clause, state courts may not treat arbitration clauses
differently than any other type of contract. See, e.g., Gay v. CreditInform, 2007 WL 4410362
(3d.Cir. December 19, 2007)(relying on Section 2 of the FAA, which provides for that courts
may refuse to enforce arbitration clauses only “upon such grounds as exist at law or in equity for
the revocation of any contract.). See also Perry v. Thomas, 482 U.S. 483, 493 n. 9 (1987)(“Nor
may a court rely on the uniqueness of an agree to arbitrate as a basis for a state law holding that
enforcement would be unconscionable.”)

The State of the Law of Consumer Arbitration

Notwithstanding the Supreme Court’s consistent support for enforcement of
arbitration clauses, states courts have pressed forward to limit the compulsory arbitration of
consumer disputes.
For example, in Tillman v. Commercial Credit Loans, Inc, slip. op., Case No.
360A06 (N.C. January, 25, 2008), the Supreme Court of North Carolina held that an arbitration
clause in a form loan agreement was both procedurally and substantively unconscionable, and
therefore unenforceable, because “the clause is one-sided, prohibits joinder of claims and class
actions, and exposes claimants to prohibitively high costs.” In so holding, the North Carolina
court relied on Green Tree, supra, and Bradford v. Rockwell Semi-Conductor Systems, Inc., 238
F.3d 549 (4th Cir. 2001)(stating that any inquiry into arbitration costs must be “a case-by-case
analysis that focuses… upon the claimant’s ability to pay the arbitration fees and costs, the
expected cost differential between arbitration and litigation in court, and whether that cost
differential is so substantial as to deter the bringing of claims.”) .
Likewise, numerous state courts have held that arbitration clauses that preclude
class actions are procedurally unconscionable, because they prevent potentially large numbers of

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plaintiffs with small claims from pursuing claims. See Scott v. Cingular Wireless, 161 P.3d 100,
1004 (2007)(citing cases from 16 jurisdictions finding that such clauses are procedurally
unconscionable.”)
By contrast, most federal courts have rejected such challenges to arbitration
clauses. See, e.g., Gay v. CreditInform, 2007 WL 4410362 (3d.Cir. December 19, 2007);
Jenkins v. First Am. Cash Advance of GA, LLC, 400 F.3d 868, 877 (11th Cir. 2005).
The significant number of conflicts between state and federal courts concerning
the unconscionability of consumer arbitration clauses is perhaps more importance than the
substance of the courts’ disagreements, because it highlights the present uncertain state of the
law. To the extent that arbitration of consumer disputes has the potential to create efficiencies,
the uncertainty of the law undermines that objective. Further, to the extent that it is desirable to
balance consumer interests against efficiency, legislation, rather than judicial decisions, is likely
the more sensible means of doing so.

Legislative Alternatives To Promote Fair and Efficient Resolution of

Consumer Disputes

The Arbitration Fairness Act of 2007

In 2007, both houses of Congress considered a bill entitled the “Arbitration
Fairness Act of 2007” (The “AFA”). If enacted, the AFA would (i) declare any “predispute
arbitration agreement” invalid, if it sought to require arbitration of (a) “an employment,
consumer, or franchise dispute;” or (b) “a dispute arising under any statute intended to protect
civil rights or to regulate contracts or transactions between parties of unequal bargaining power.”
As discussed below, such a sweeping elimination of broad categories of arbitration agreement

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would be an extreme response to concerns that can, and should, be handled in a less drastic
manner.
The AFA, moreover, would repeal the “separability” doctrine by proving that
“[e]xcept as otherwise provided in this chapter, the validity or enforceability of an agreement to
arbitrate shall be determined by the court, rather than the arbitrator, irrespective of whether the
party resisting arbitration challenges the arbitration agreement specifically or in conjunction
with other terms of the contract containing such agreement.” (Emphasis Added).
In setting forth an extreme response to concerns about consumer arbitration, the
AFA would, in effect, throw out the baby with the bath water. In many instances, arbitration
plainly reduces costs related to consumer disputes. By eliminating arbitration of consumer
disputes as a meaningful option, the AFA would inevitably result in wasteful litigation expense
and increased costs of consumer products. Further, the proposed ban is far more draconian than
necessary to counterbalance the disparity in bargaining power (and resources) between
consumers and business.
The extreme treatment of consumer arbitration in the AFA is demonstrated by the
“findings” set forth in its preamble to justify amending the FAA. Reasonable alternatives to the
proposed ban on pre-dispute arbitration agreement are available to respond to each of the
“findings” in support of the legislation:

1. “Few people realize, or understand the importance of the deliberately fine print
that strips them of rights; and because entire industries are adopting these clauses,
people increasingly have no choice but to accept them.”
Response: This issue is not unique to arbitration. Consumer agreements routinely require
consumers to litigate in foreign forums, to waive jury trials, to confess judgment and/or grant
liens. In the absence of a pre-dispute arbitration agreement, there will seldom be arbitration

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since one side, or the other, will have a strategic incentive to take advantage of the inefficiency
or cost of litigation. The obvious remedy for inadequate disclosure to, and knowledge of,
arbitration is to require clearer notice and explanations of the implications of arbitration, such as
its cost, confidentiality, etc.

2 “ Private arbitration companies are sometimes under great pressure to devise
systems that favor the corporate repeat players who decide whether those
companies will receive their lucrative business.”
Response: Apart from the fact that there is little empirical evidence to support this assertion, a
more sensible solution would be to penalize arbitration providers that “rig” their systems in favor
of one side or the other. For example, rather than declare arbitration itself to be an unfair and
deceptive trade practice, which it is not, it would make more sense to declare the use or
implementation of a biased arbitration mechanism to be such. In any event, the FAA already
provides that an arbitration award may be set aside “where there was evident partiality or
corruption in the arbitrators, or either of them,” Section 10(a)(2), or for decisions in excess of the
arbitrator’s authority. Section 10(a)(4).

3. “Mandatory arbitration undermines the development of public law for
civil rights and consumer rights, because there is no meaningful judicial
review of arbitrators’ decisions. With the knowledge that their rulings will
not be seriously examined by a court applying current law, arbitrators
enjoy near complete freedom to ignore the law and even their own rules.”
Response: It is doubtful that the great majority of consumer disputes raise novel questions of
law. Further, the wide discretion of arbitrators is not unique to consumer disputes. The main
protection afforded any party in arbitration is the right to select and/or veto a proposed arbitrator.

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4. “Mandatory arbitration is a poor system for protecting civil rights and consumer
rights because it is not transparent. While the American civil justice system
features publicly accountable decision makers who generally issue written
decisions that are widely available to the public, arbitration offers none of these
features.”
Response: It is hardly clear that most consumers would prefer to have their defaults made
publicly available or that most consumer disputes are addressed in “written decisions.” To the
extent that this is considered to be a valid concern, however, the solution is simply to eliminate
the confidentiality of consumer arbitration awards.

5. “Many corporations add to their arbitration clauses unfair provisions that
deliberately tilt the systems against individuals, including provisions that strip
individuals of substantive statutory rights, ban class actions, and force people to
arbitrate their claims hundreds of miles from their homes.”
Response: None of the “unfair provisions that tilt the systems against individuals” are unique to
arbitration. Courts have enforced forum selection clauses, jury waiver clauses, and prohibitions
against class actions in agreements unrelated to arbitration. To the extent such clauses are
deemed unjust, the sensible response would be to bar such clauses from any agreement relating
to resolution of disputes. As discussed below, it would be necessary to permit the courts to
implement such prohibitions.
A somewhat stronger case can be made for abolishing the separability doctrine, as
it applies to consumer actions. First, a principal benefit of arbitration is the ability of the parties
to select an arbitrator with experience in the subject matter of the dispute, as opposed to a
generalist judge. This feature of arbitration affords little if any benefit with respect to the
questions of whether a contract was induced by fraud or deception or whether it contains
unconscionable terms. To the contrary, one might reasonably expect a judge to have equal or
greater familiarity with such issues. Consequently, to the extent an arbitration hearing is delayed

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to allow for court ruling on the enforceability of the contract, the incremental cost of such delay
is likely to be minimal. Because either a judge or arbitrator would need to decide the issue in
any event, arbitration would reduce the cost of resolving this issue only if the arbitrator would
decide it more quickly with less briefing or argument by the parties.
Second, a judicial decision on the enforceability of an arbitration agreement may
often be more efficient than submission of the question to an arbitrator. Many disputes regarding
the arbitration of consumer disputes arise because of a plaintiff’s desire to pursue a class action
in court. In such cases, if arbitration is required, the plaintiff may simply opt to forego his or
claims. By contrast, if a contract and/or arbitration clause is deemed invalid, the defendant might
have a significant incentive to negotiate a prompt settlement.
Third, the separability doctrine cannot be reconciled with cases concerning jury
trial waivers. As discussed above, the dominant view is that waiver of the right to a jury trial is
subject to stricter scrutiny than other waivers of contractual rights. Under the separability
doctrine, however, a party may be deemed to have waived his or her right to litigate in court
without any judicial scrutiny of the circumstances of such waiver.
Finally, and perhaps most importantly, separability may eliminate an important
check on the arbitration process adopted in the parties’ agreement. In the absence of some
judicial review (and/or greater transparency), the potential for implementation of a biased
arbitration procedure is heightened.
It should be noted that the repeal of the separability has the potential itself to
invite costly proceedings. In California, for example, the doctrine was severely restricting in an
appellate court decision, Main v Merrill Lynch, 67 Cal App 3d 19 (1977). In Main, a brokerage
firm customer, alleged that the defendant defrauded her by misrepresenting an arbitration

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agreement and, as a result, she claimed was unaware of her obligation to arbitrate claims. The
court held that the mere allegation of fraud was enough to allow the court to hold a mini trial to
determine whether or not the plaintiffs’ arbitration clause resulted from fraud.
Cases following Main raised the prospect of costly mini-trial as a predicate to
arbitration. The cost of the mini-trial, in turn, often compels parties to give up arbitration rights
so as to avoid the costs of both a mini-trial and arbitration. If the parties chose to participate in
the mini-trial the cost of the overall proceeding—regardless of completing in litigation or in
arbitration—would be far greater than otherwise. For such reasons, the reasoning of Main was
gradually narrowed and finally eliminated in Rosenthal v Great Western Financial Securities, 14
Cal 4th 394 (1996).
As discussed below, however, it may be possible to eliminate the unintended
consequence of costly mini-trials by establishing clear rules for disclosure and consumer –
thereby eliminating or simplifying the need to review allegations of fraudulent inducement or the
like.

An Economic Approach to Consumer Arbitration

In opposing arbitration of consumer disputes, advocacy groups are quick to
identify stories of seeming unjust treatment of individuals compelled to pursue claims through
arbitration rather than litigation. Such stories fail not only to address the shortcoming and
inefficiencies of litigation as a dispute resolution mechanism, but also perhaps the most relevant
question: namely, how much are consumers willing to pay to retain full access to the courts,
rather than to submit dispute to arbitration?
The most analytically sound, although perhaps unrealistic, means of affording
consumers the right to maintain full access to the courts would be simply to require all consumer

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products and/or services companies to offer a non-arbitration or a traditional court option for
consumers, if they choose to seek arbitration of disputes. The caveat, though, is that the
companies would be permitted to charge different prices to consumers for their products or
services depending upon the selected option and provided that the differential reasonably
reflected the cost difference of insuring and/or covering the cost of the different options.
Assuming that the administrative difficulties of such a scheme could be met, it
would enable consumers to decide for themselves whether their perceived benefit of continued
access to the courts would be worth the additional expense. Further, it would avoid requiring
consumers who favor or at least accept the benefits of more efficient dispute mechanism to
subsidize those who prefer to retain access to costly court procedures.
Of course, practicality and administrative costs of the “economic” approach
render it implausible. On the other hand, the economic approach, along with critical review of
the AFA, suggests principles to inform the evaluation more practical proposals for reforming
consumer arbitration. Specifically:
• Legislative reform should consider not only consumer rights respecting dispute
resolution procedures, but also the cost and relative efficiency of alternatives.
• Protection of consumer rights should not, to the extent reasonably possible,
deprive consumers of the cost savings associated with efficient dispute resolution
procedures. Although if consumers were asked, in the absence of any economic
context, if they want to preserve their right to litigate consumer disputes, many
would answer affirmatively. That is not, however, the relevant question. Instead,
consumers need to be asked how much they would be willing to pay to maintain

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access to the courts as opposed to being provided with non-judicial, but fair,
alternatives.
• Legislative reform, to the extent possible, should avoid requiring cost-conscious
consumers to subsidize procedures desired by process-conscious consumers, i.e.,
those who desire to maintain access to the courts.
• To the extent that consumer protection laws or regulation prohibit agreements that
impose unreasonable procedural requirements or limitations on consumers, they
should apply with equal force to litigation and arbitration. On one hand,
restrictions on consumers that are permissible with respect to litigation, such as
forum selection clauses, should also be permissible with respect to arbitration. On
the other hand, parties should have incentive to adopt arbitration where, as a
decision-making and administrative process, it is more efficient than litigation,
but they should not be given incentive to adopt arbitration as means of evading
consumer protection laws. In other words, the evasion of consumer protection
regulation should not be considered an “efficiency” affecting the choice of a
dispute mechanism.

A Proposal for Reform

Rather than eliminate a potentially efficient dispute resolution mechanism, a
sensible approach to reform would be to identify the aspects of arbitration that disadvantage
consumers when compared to litigation and create mechanisms that level the playing field by
eliminating “impermissible” efficiencies, i.e., cost saving that result from disadvantaging
consumers or depriving them of legal safeguards, rather than from reducing the cost of fair
procedures to resolve disputes.
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Consumer groups and the proponents of the AFA have identified five (5)
concerns about consumer arbitration, as follows: 8
1. Lack of Consumer Awareness and Understanding of Arbitration
2. Biased Decision-Makers who favor “repeat players.”
3. Lack of Accountability and Judicial Review
4. Lack of Transparency
5. Unfair Procedural Restrictions and prohibitive costs
Each of these concerns can, and should, be fairly addressed without eliminating
arbitration as an option for efficient dispute resolution. Indeed, the American Arbitration
Association has developed a “Consumer Due Process” protocol that would extend procedural
protections to consumers that are greater than those that may be available with respect to judicial
procedures. See http://www.adr.org/sp.asp?id=22019.
With the foregoing principles in mind, reasonable legislative reform with
respect to consumer arbitration could include:

Legislative Repeal of the Separability Doctrine for Consumer Disputes

As noted above, the application of “separability” to consumer disputes does little
to reduce the overall costs of resolving consumer disputes, but may prevent even-handed
application of consumer protection laws. For example, some states have adopted laws
prohibiting enforcement of waivers of the right to file class actions on grounds that such
agreements would deprive consumers with small claims of meaningful access to the courts.
8 The preamble to proposed Act also argues that (i) the FAA was intended to apply only
to business disputes and (ii) the Supreme Court has judicially changed the meaning of the Act to
apply it to consumers. Apart from the fact the express language of the Act has no such
limitation, these assertions say nothing about whether arbitration is fair or unfair for consumer
disputes.

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While the merits of such laws can be debated, the question of whether or not such law governs a
particular consumer transaction should not depend on the dispute resolution method set forth in a
form agreement.
In addition, repeal of the separability doctrine for consumer disputes would allow
the courts to serve as gatekeepers to prevent abusive, biased, or intrinsically unfair arbitration
procedures.
Because of the risk, discussed above, that repeal of separability might result
wasteful mini-trial, this proposal should be considered only if safeguard are also adopted that, on
one hand, would reduce the likelihood of fraudulent inducement of an arbitration agreement and,
on the other, assure that the absence of fraud can be presumed.

Harmonization with Standards for Waivers of Seventh Amendment Rights

and other Consumer Protection Measures

Arbitration plainly implicates the right to a jury trial for civil actions at law under
the Seventh Amendment to the U.S. Constitution. Although numerous cases have addressed the
enforceability of express waivers of the right to a jury trial, arbitration clauses have largely been
exempted from such review.
Consumer concerns about unknowing relinquishment of Seventh Amendment
rights could be efficiently addressed by subjecting arbitration agreements to the same standards
as express waivers of jury trial rights. In other words, an arbitration agreement would be
enforced only if reflected a consumer’s knowing waiver of his or her right to a jury trial.
Coupled with revocation of the separability doctrine, such a requirement would provide
substantial incentive for delivery of adequate notice and explanations of arbitration to
consumers.

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In addition to notice protection association with a waiver of rights to a jury trial, it
may also be appropriate to adopt measures to assure the fairness and integrity of consumer
arbitration proceedings. For example, legislation should require arbitrator neutrality and provide
protections against unreasonable forum-selection clauses. Although the cost of conducting
arbitrations in all 50 states may restrict the savings from arbitration and such clauses are
enforced even with respect to litigation, it seems unfair to require, for example, a consumer in
New York to attend a hearing in California. One solution to this issue may be to permit forum
selection clauses in connection with arbitration but also to require such clauses to provide for
teleconference and/or videoconference hearings to avoid travel expenses.
Class action waivers have also been identified as unfair components of arbitration
clause. Such waivers should likely be treated in the same way as class action waivers
unconnected to arbitration and possibly in the same way as jury trial waivers. At a minimum,
notice of the waiver should be clear and conspicuous.

Restricting Arbitration Costs to Consumers to Comparable Court Costs

Leveling the field between arbitration and litigation for consumers requires
assurances that arbitration will not be selected for dispute resolution for the purpose of unfairly
restricting consumers’ access to the chosen forum. The simplest way to achieve such parity is to
require the corporate party who has selected to bear any cost increases related to that choice,
such as the cost of the arbitrator and administration of the arbitration.
The corporate party should bear the bulk of the costs of consumer arbitration not
because it is likely to have a deeper pocket than a consumer litigant, but because that is the party
likely to garner the lion’s share of savings from arbitration. Even a cursory examination of the
costs and benefits to each party demonstrates the unequal allocation of efficiencies.

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Indeed, in the absence of cost allocation rules, arbitration is likely to be a more
costly dispute resolution process than litigation. For consumers, the main cost difference
between litigation and arbitration is likely to be the fee and expenses for the arbitrator(s) and/or
case administrator. Whereas the consumer pays nothing for a judge and possibly only nominal
court costs, the arbitration expense could be substantial.
The main efficiency from arbitration of consumer disputes is likely to be
administrative savings to the consumer products or services company. By avoiding the need to
prepare to litigation in multiple jurisdictions with multiple procedures, forms, and rules, the
savings to such a company could be substantial. The other main efficiency is likely to be a
shortening of the time required for dispute resolution. Meanwhile, and in contrast to business
disputes or product liability matters, there may be less efficiency savings from discovery
limitations, expert decision-making or the like, simply because consumer disputes tend not to
involve complex technical subjects or other non-routine matters.
To the extent that arbitration is conducted more efficiently than litigation,
consumers might benefit from lower legal fees and faster decisions, but such benefits are
unlikely to outweigh the increased costs for several reasons. First, most substantial consumer
actions are litigated pursuant to a contingency arrangement with a lawyer or law firm. As a
result, any difference in the scope or duration of discovery between litigation and arbitration is
unlikely to have direct financial consequences to consumers. Although, in theory, a reduction in
the cost of discovery to the lawyers handling such contingency matters could be reflected in a
lower contingency payment, the market for contingency legal service is unlikely to be
sufficiently transparent and competitive to reflect such an effect.

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Second, and perhaps more importantly, most plaintiffs’ attorneys believe, and the
available data suggests, that juries tend to award greater damages than judges. It would be
reasonable to assume that arbitration awards would more closely follow those of judges than of
juries.
Accordingly, most of the efficiencies from arbitration of consumer
disputes are likely to inure to the benefit of the corporate party rather than consumers. If,
therefore, the corporate party is required to bear the additional costs of arbitration, it
would have incentive to adopt arbitration for its form agreement only when justified by
procedural efficiencies and not, as asserted by consumer advocates, as a ruse to impair
consumers’ access to just procedures for resolving their disputes. Further, and unlike a
consumer, the corporate party would be able to spread the additional costs and savings
over multiple disputes and pass along any costs saving to all consumers of its products or
services.

Conclusion

In sum, arbitration has the potential to allow for more efficient resolution of
consumer disputes than litigation. Unlike business arbitration, however, it also has potential for
abuse and to deprive a class of parties of fair adjudication of their claims or defenses. The goal
of any reform legislation, therefore, should be to create incentives for use of arbitration only
when it will in fact result in costs savings while protecting consumers’ basic rights by preserving
parity with litigation.
In contrast to economically rational reform, the Arbitration Fairness Act of 2007
would simply bar all consumer arbitration and likely harm most consumers by preventing the
savings that could be created with fair and efficient ADR programs.