How the Supreme Court twisted a 1925 law to undermine the interests of citizens, employees and small business

In the last 20 years the Supreme Court has created a parallel judicial system to resolve disputes involving corporations that is effectively run by the very corporations whose behavior is under investigation.

Here is how that judicial coup against an independent judiciary occurred.

In 1925 Congress passed a simple 4-page law, the Federal Arbitration Act (FAA). Businesses that preferred a simpler and faster arbitration process in business-to-business transactions to costly and protracted court battles urged Congress to act because federal courts often refused to enforce many arbitration clauses. As one court ruling in 1904 explained, “… nothing would be easier than for the more astute party to oust the courts of their jurisdiction. By first making the contract and then declaring who should construe it, the strong could oppress the weak, and in effect so nullify the law as to secure enforcement of contracts usurious, illegal, immoral, and contrary to public policy.”

The FAA was a legislative attempt to satisfy businesses’ desire for speedy and affordable dispute resolution while also satisfying the judges’ desire for justice. Arbitration, a process in which both parties in a dispute agree to accept the ruling of an impartial third party, seemed an effective solution.

The result was a law very narrowly focused on commercial contracts voluntarily entered into by businesses of relatively equal strength. In a House floor debate Representative George Scott Graham (R-PA) summed up his colleagues’ intent, “[t]his bill simply provides for one thing, and that is to give an opportunity to enforce an agreement in commercial contracts and admiralty contracts—an agreement to arbitrate, when voluntarily placed in the document by the parties to it.”

For the next 60 years the law worked as intended. Courts consistently upheld arbitration awards between businesses but also consistently held that the FAA was procedural not substantive. Arbitration did not trump federal and state laws, and the FAA did not apply to employment or consumer contracts.

A New Conservative Supreme Court Steps In

And then the composition of the Supreme Court dramatically changed. Richard Nixon came to office declaring his intention "to nominate to the Supreme Court individuals who shared my judicial philosophy, which is basically a conservative philosophy.” During his first term promptly put four Justices on the Court. In his two terms Ronald Reagan also put four Justices on the Court.

In 1984 the Supreme Court flexed its new conservative muscles. In a case involving the right of Southland’s 7-11 franchisees to sue under the California Franchise Law the Court reinterpreted the 1925 law as a Congressional declaration of a “national policy favoring arbitration”. It further ruled that this national policy applied not only to federal courts but to state courts and was substantive as well as procedural. No matter how one-sided the balance of bargaining power once a business signed a contract with an arbitration clause it was forced to abide by the decision of arbiters even if they ignored relevant state and federal laws and even if the decision-making processed was biased against the complainant.

Dissenting Justices vainly pleaded with their colleagues not to ignore the clear will of Congress and derail more than a half-century of uncontroversial implementation of the FAA. As Sandra Day O’Connor observed, “One rarely finds a legislative history as unambiguous as the FAA's.”

In 2001 the Court, by a 5-4 vote, extended the FAA to cover employment contracts. The four dissenters beseeched their brethren not only to look at the original intent of the law but to its actual text. Section 1 of the law states, “nothing herein contained shall apply to contracts of employment of seamen, railroad employees or any other class of workers engaged in foreign or interstate commerce.” The clause was inserted at the bequest of the International Seamen’s Union and the more broadly based American Federation of Labor. “History amply supports the proposition that it was an uncontroversial provision that merely confirmed the fact that no one interested in the enactment of the FAA ever intended or expected (it) would apply to employment contracts,” noted the dissenters.

The Problems With Arbitration

Arbitration may indeed be speedier and more affordable than the judicial process but it clearly undermines the ability of workers and customers and small businesses to gain a satisfactory outcome. A path breaking 2007 report by Public Citizen found that in employment cases and medical malpractice cases, arbitration claimants received only about 20 percent of the damages they would have received in court.

As for due process, Catholic University of America law professor Peter B. Rutledge notes, “Arbitrators do not have to follow precedent. Arbitrators also are not bound by the same rules of evidence and procedure as courts. Often there is no transcript, and arbitrators are not obligated to provide detailed findings of fact and conclusion of law in their awards.”

Complainants can be forced to travel thousands of miles and put up thousands of dollars upfront to attend an arbitration proceeding.

And while it is true that aggrieved parties can ask courts to vacate (essentially to overturn) an award, Rutledge notes the grounds for vacating awards “are themselves extremely narrow, and the opportunity for judicial review of the award’s substance virtually non-existent…”

Corporations realize the disadvantages of arbitration from the complainant’s perspective. Which is why most arbitration clauses require only the weaker party (the consumer, employee, or franchisee) to arbitrate its claims, while allowing the dominant party (the corporation) to sue in court. As Public Citizen observes, “Thus, a sexual harassment victim can be forced to arbitrate a discrimination claim against a former employer while litigating identical issues in court if the employer sues to stop her from joining a competitor.”

The arbitration process is rife with conflicts of interest. Arbitration organizations, such as the American Arbitration Association (AAA) and the National Arbitration Forum (NAF), compete to provide arbitration services for companies. Company contracts often designate a specific firm to handle arbitration. Firms that rule in favor of companies and offer the cheapest price--even if that cheap price translates into arbiters deciding each case in as little as 5 minutes--win the contract.

And arbiters hired by the arbitration firm know that those who rule in favor of the company will be rehired and those who don’t won’t. As arbitrator Richard Hodge maintains, “You would have to be unconscious not to be aware that if you rule a certain way, you can compromise your future business.”

The curtain was drawn back on the seamy side of arbitration in 2008 when San Francisco city attorney Dennis Herrera sued the for-profit NAF, citing state records (California is the only state that compels companies to make arbitration decisions public) showing that of 18,075 collection arbitrations it handled consumers won just 30, or 0.2%. “Arbitrations of consumer debt matters are a sham—the sole purpose of which is to assist (NAF’s) debt collector clients in collecting money from consumers by creating an appearance that a fair and neutral arbitration has occurred and resulted in an enforceable award,” declared Herrera.

In 2009 Minnesota Attorney General Lori Swanson's also sued the NAF, alleging it was engaged in fraud, a result of its being owned by an investment group that “simultaneously took control of one of the country’s largest debt collectors and became affiliated with . . . the country’s largest debt collection arbitration company.”

Despite this dismal record, the Supreme Court continues to bestow ever-increasing authority on binding arbitration procedures.

In 2011, in still another 5-4 decision the Roberts Court overturned a California law prohibiting arbitration clauses that ban class action suits. The five conservative justices justified this bizarre decision by disingenuously arguing that a face-to-face, bilateral process was “fundamental” to arbitration.

Charles Schwab & Co quickly sent amendments that banned class action suits to over 6.8 million account holders. Schwab in particular was thrilled to be able to do so because a few years before investors had brought a class action suit against Schwab that led to a $235 million settlement.

In 2013, in a case involving small businesses suing American Express, the Roberts Court declared in remarkably dismissive language that the FAA “does not permit courts to invalidate a contractual waiver of class arbitration on the ground that the plaintiff’s cost of individually arbitrating a federal statutory claim exceeds the potential recovery.” Even if arbitration makes it impossible for the weaker party to win it still excludes judicial recourse.

The percentage of employers using forced arbitration and class action bans more than doubled from 21 percent in 2011 to almost 46 percent in 2014. Today it is all but impossible to successfully litigate a class action suit. Public Citizen identified 140 cases decided between 2011 and 2014 in which the judges cited the Supreme Court rulings as justification for dismissing a class action

Today, as F. Paul Bland, Jr, Executive Director of Public Justice notes in the new film by the Alliance for Justice, Lost in the Fine Print, between 30-40 percent of all American workers are subject to forced arbitration. As are a significant percentage of customers.

One court has likened the expanded reach of binding arbitration to the invasive species kudzu: “When introduced as a method to control soil erosion, kudzu was hailed as an asset to agriculture, but it has become a creeping monster. Arbitration was innocuous when limited to negotiated commercial contracts, but it developed sinister characteristics when it became ubiquitous.”

What Can Be Done?

Sometimes public outrage works. In April 2014, two days after the New York Times reported that General Mills planned to force consumers to give up their right to sue the company, the company retreated. “Because our terms and intentions were widely misunderstood, causing concerns among our consumers, we’ve decided to change them back to what they were.”

Congress could explicitly forbid forced arbitration. The Military Lending Act of 2006 prohibits lenders from including arbitration clauses in contracts with members of the military or their families. The Dodd-Frank Act expressly forbids the use of forced arbitration in mortgage loan agreements, and authorizes the Consumer Financial Protection Bureau (CFPB) to issue broader regulations prohibiting or limiting arbitration agreement, which it probably will do later this year (although any rule will apply only to agreements entered into more than 180 days after it goes into effect.)

Since Republicans gained control of Congress little has been done. The Arbitration Act, which would broadly void forced arbitration contracts, has languished in Congress. A bill to prohibit any school receiving federal student aid from restricting students’ ability to pursue legal claims in court likely will not come to a vote.

Even without Congressional permission, the Executive branch can act. In July 2014 President Obama signed an executive order barring employers on federal contracts from forcing workers to bring workplace discrimination, sexual assault or sexual harassment cases only through arbitration.

The Centers for Medicare & Medicaid Services has issued a rule that will require arbitration be conducted by a neutral arbitrator: residents must fully understand the agreement and agree to it voluntarily, admission to a nursing home may not be contingent on the resident signing an arbitration agreement, and an arbitration agreement may not “prohibit or discourage” the resident or their representatives from contacting federal, state or local healthcare officials.

State and regulatory agencies can play a role. Just four days after the Minnesota suit was filed, the NAF agreed not to accept new cases from credit card companies, banks, and many other firms. A broader class action suit against several large banks resulted in a settlement in which Chase, HSBC, Bank of America and Capital One announcing they would stop enforcing arbitration claims against customers in the short term. (American Express, Citibank and Discover kept their arbitration clauses and their court case is proceeding.)

Some argue that states can and should play an important role. An insightful report by David Seligman of the National Consumer Law Center identifies places where states may exercise authority to protect workers and where they have leverage.

Seligman notes that Congress expressly reserves the right of states to act in two sectors: insurance and transportation. He maintains that states have potentially powerful tools at their disposal. One is their ability to condition awarding contracts based on the existence and reach of arbitration clauses. He also argues that states responsible for enforcing the law and can argue that enforcing the law is hindered by confidentiality provisions in arbitration agreements and the lack of a written record.

Seligman also argues that a state may be able to intervene when an individual cannot and points to a recent court case in which the Supreme Court allowed the Equal Employment Opportunity Commission (EEOC) to do exactly that.

States and the President are beginning to use the tools they have to chip away at this new private judicial structure. We need to urge them to maximize their efforts and we need to publicize how much damage 5 men on the Supreme Court have done to the integrity of our judicial system.