January 4, 2012

On the Benefits of Consumer Arbitration

By Paul Kirgis

I have criticized the Supreme Court’s arbitration jurisprudence for cutting off the procedural rights of consumers and employees. See this, this, and this. Those are policy objections rooted in federalism as well as state and federal guarantees of due process and the right to a civil jury trial. I have not contended that consumer arbitration is inherently unfair, or that it necessarily produces bad outcomes for individual consumers. To the contrary, in many situations, I very much prefer to have an arbitration agreement in place when I am in the position of consumer.

Case in point: I recently replaced the windows in a small solarium on my house. These are insulated windows, so they are relatively expensive and they come with various guarantees  as to performance and lifespan. My contract with the window company includes a broad arbitration clause, providing for arbitration with AAA. I like that. I know that if something goes wrong with these windows, and my only recourse was the court system, I would end up in one of New York’s lower courts. I used to teach New York Civil Practice–few people know as well as I do what a nightmare the lower New York courts are. But if AAA arbitration is available, I know that the most I’ll have to pay is $125 and I will get at least a telephone hearing within a very short time. And I know enough about AAA to have confidence that I would get a fair hearing, and likely recover if I have a reasonable claim. I would thus have much better settlement leverage in that forum than if I had to go to court.

Two factors exist in my situation that make arbitration a good thing for me as a consumer. First, the arbitration provider in my agreement is AAA, which is a not-for-profit organization and which has an interest in promoting arbitration fairness. With the memory of the NAF debacle still fresh, I would feel much less sanguine if some less established provider had been designated.

Second, the stakes in any arbitration arising out of my window purchase are likely to be right in the arbitration “sweet spot.” Any harm I am likely to suffer would probably fall in the $1,000-$10,000 range. That’s enough to make arbitration economically viable but not enough to make litigation an attractive option.

The problem is that, in many consumer contexts, those factors are not present. Businesses have no obligation to use AAA, and most consumers lack the leverage to demand AAA. How long will it be before a NAF substitute pops up in a jurisdiction that is not as progressive as Minnesota? Further, most consumer transactions involve potential claims that fall well below my arbitration “sweet spot.” For consumer frauds committed against many people for small amounts, no individual will have sufficient financial incentive to pursue arbitration. Now that class arbitration has effectively been strangled at birth, an arbitration agreement amounts to a claim of immunity for small harms committed on a large scale. (Adam Zimmerman has a great post up at Prawfsblawg exploring whether crowd-sourced small claims litigation/arbitration could replicate the deterrent effect of class actions.)

The essential ingredient in ensuring both that arbitration is fair and that it promotes public policy is leverage. The parties need to have roughly equivalent leverage, so that arbitration is a part of a bargained-for exchange. That provides some assurance that both parties genuinely believe, from a pre-grievance perspective, that the arbitration they select is in their best overall interests. As a matter of deterrence, the presence of leverage, with the conscious choice it implies, acts as a pre-claim substitute for the class action opt-out; the people who choose arbitration are assessing their likely outcomes and concluding that an individual arbitration process will be viable. That’s deterrence at work.

In short, arbitration makes sense only when the parties have roughly equivalent leverage. And that means we are back at the original intention of Julius Cohen and the sponsors of the 1925 Federal Arbitration Act. Arbitration is wonderful thing–when it arises between rough commercial equals who knowingly and voluntarily choose it over the available judicial processes.


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  • Jean Sternlight says:

    Great points Paul. You note that individual arbitration sometimes can’t replace class actions where (1) claims are very small or (2) proof problems are great. I would also add that class actions are needed where (3) individuals may not realize they have been harmed or harmed in an illegal way or (4) individuals fear retaliation. I also agree that the social media approach, while helpful, cannot take the place of class actions for those same reasons. While some educated people might join in to protest problems relating to a several thousand dollar problem, few would join to protest a small dollar claim. Yet, unless we want to give companies license to steal a few dollars at a time from millions class actions are needed to deter such misconduct. Of course beefed up bureaucratic enforcement would be another option, but that seems currently unlikely. A forthcoming article by Myriam Gilles will also argue that state AGs should bring parens patriae suits. That too could work, if the AGs are willing and the courts cooperate.

  • Paul Kirgis says:

    Thanks for the comment, Jean. Bureaucratic enforcement may be one step closer today, now that the Consumer Financial Protection Bureau finally has a director and can start to function.

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