Choice of Law Clauses in Arbitration |
Daily Journal, July, 2006
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On public-policy grounds, the California Supreme Court confirmed the right of consumers to file putative classwide arbitration, and the justices refused to enforce waivers of consolidated proceedings included in a contractual clause. Discover Bank v. Sup. Ct., 36 Cal.4th 148 (2005). In addition to the arbitration clause, a choice-of-law clause in Discover Bank identified Delaware law applicable to any credit card dispute between consumers and the bank. Unlike California law, Delaware denies parties the right to classwide arbitration and enforces class waivers. Because the Court of Appeal had not addressed the choice-of-law clause in the contract, the California Supreme Court remanded for resolution of this issue. On remand, the Court of Appeal reviewed California precedent on choice-of-law clauses in an attempt to select the applicable state law. Discover Bank v. Sup. Ct., 134 Cal.App.4th 886 (2005). Although citing Keating v. Sup. Ct., 31 Cal.3d 584 (1982) (overruled on other grounds), and Southland Corp. v. Keating, 465 U.S. 1 (1984), approving classwide arbitration in California on grounds of public policy, the California plaintiffs had pleaded only Delaware causes of action. Discover Bank, domiciled and chartered in Delaware, asserted the strong public policy of their courts in applying its law uniformly to commercial interstate transactions. The 2nd District Court of Appeal relied on California law developed in Nedlloyd Lines B.V. v. Sup. Ct., 3 Cal.4th 459 (1992). Nedlloyd applies Restatement of Laws Section 187 to resolve a choice-of-law analysis. Under Nedlloyd, a California court must determine initially whether the chosen state has a substantial relationship with the parties or the transaction, or any other reasonable basis exists for the parties' choice of law. Absent compliance with either of these tests, a California court can decline to enforce the choice-of-law clause. If either test is met, the question becomes whether the choice of law of another state conflicts with California public policy. If a fundamental conflict exists, the court must determine whether California has a "materially greater interest" in the litigation than the chosen state. Nedlloyd. The Court of Appeal, initially determining Delaware met the reasonable-basis test for its local bank, ruled that each state had a "material interest" in the outcome. Conceding that classwide arbitration waivers are unenforceable in California but enforceable in Delaware, the Court of Appeal held Delaware state law prevails. Plaintiffs having pleaded out-of-state causes of action, the court concluded California public policy could not overcome Delaware public policy, and the justices enforced the choice-of-law clause. After both courts rendered their Discover Bank decisions, the 1st District Court of Appeal reached a different result in a case with similar facts, citing the same California decisional choice-of-law precedent. Klussman v. Cross Country Bank, 134 Cal.App.4th 1283 (2005). In Klussman, the parties seeking class status were California residents and pleaded causes of action under the California Consumers Legal Remedies Act (Civil Code 1750.5), the California unfair-competition law (Business and Professions Code 17200 et seq.) and the Delaware Unfair Business Practices Act. The arbitration clause provided, inter alia, that Delaware law applies in the event of a dispute, the transaction is in interstate commerce and rules of the Federal Arbitration Act., 9 U.S.C. 1, et seq. apply to the arbitration. Citing California Supreme Court decisions in Discover Bank and Nedlloyd, the Klussman court concluded California had a greater "material interest" in the dispute. Applying California law in favor of consumer interests as reflected in the California Consumers Legal Remedies Act and the California unfair-competition law, the court denied enforcement of the choice-of-law clause. The Klussman court distinguished the 2nd District Court of Appeal opinion on grounds the Discover Bank plaintiffs had pleaded no California consumer claims. Analysis of choice-of-law clauses is also relevant in reviewing forum-selection clauses combined with an arbitration clause in a contract. In Aral v. Earthlink Inc., 134 Cal.App.4th 544 (2005), the plaintiffs alleged violation of Business and Professions Code 17200 and sought consumer class status. The judges in Aral, which was decided after the California Supreme Court decision in Discover Bank, refused to enforce a forum-selection clause mandating Georgia as the location to arbitrate disputes between the parties. The Aral court tracked the public-policy rationale of the Supreme Court decision in Discover Bank and invoked equitable grounds to hold the forum-selection clause "unreasonable as a matter of law" in compelling a dissatisfied consumer to travel long distances to resolve a minor consumer claim. Choice-of-law clauses are routine in negotiated commercial contracts, and the terms invariably presume an interstate transaction. In civil actions, California courts historically uphold these clauses on grounds the parties mutually agreed to resolve disputes by eliminating controversies among various state laws. Washington Mutual Bank v. Sup. Ct., 24 Cal.4th 906 (2001). These clauses assure conformity of substantive law among the states and are enforceable in the event a party removes to federal court. Net2Phone Inc. v. Sup. Ct., 109 Cal.App.4th (2003). For national companies doing business in several states, mutually agreed-on choice-of-law clauses identify a single jurisdiction for adjudication, regardless of the location of the dispute. In California civil actions, a clause unilaterally imposed by one party to apply laws of another state, or a clause selecting a forum outside California lacks "mutuality" of contractual terms. Olinick v. BMG Entertainment, 138 Cal.App.4th 1286 (2006). Although Olinick is a civil action, the court notes that the absence of negotiations is a factor in determining enforcement of these clauses. This rationale resonates with Carnival Cruise Lines Inc. v. Shute, 499 U.S. 585 (1991), decided by the U.S. Supreme Court, and involves an unconscionable clause subject to revocation under the California Arbitration Act. In Carnival Cruise Lines, the Supreme Court emphatically endorsed choice-of-law clauses in civil actions despite the absence of negotiations but noted that "fundamental fairness" of the clause is the ultimate test in assessing enforcement of its terms. According to the court, a choice-of-law clause cannot discourage or prevent a party from pursuing legitimate claims of a contract allegedly induced by fraud or overreaching. This language is a rhetorical variant of an unconscionable clause or an unreasonable clause under California substantive law and invokes a test distinct from a court balancing "material interests." Carnival Cruise Lines did not involve arbitration, but the Supreme Court upheld the choice-of-law clause in a federal cause of action involving a non-negotiated and unilaterally imposed contract. In a subsequent 9th Circuit case, the parties affirmatively negotiated the choice-of-law clause in an international commercial transaction, and the court cited Carnival Cruise Lines as controlling authority. E. & J. Gallo Winery v. Andina Licores S.A., 446 F.3d 984 (9th Cir. 2006). Regardless of the appropriate test for enforcing choice-of-law clauses, under U.S. Supreme Court jurisprudence involving commercial transactions in interstate commerce, the Federal Arbitration Act pre-empts any state anti-arbitration decisional or statutory law. Doctor's Associates v. Casarotto, 517 U.S. 681 (1996). Consistent with general contract law, a state court retains the right to determine whether to enforce or revoke an arbitration clause on such grounds "as exist for the revocation to any agreement." CCP 1281.2. In arbitration, a state court must apply general substantive state contract law applicable to civil actions and cannot invoke procedural rules to burden or inhibit the process. Buckeye Check Cashing Inc. v. Cardegna, 126 S.Ct. 1204 (2006). Choice-of-law clauses are procedural rules, not substantive law, and are not the means of enforcing substantive law differently from any other procedural statute. Choice-of-law clauses designate the applicable state law for arbitrable resolution of a dispute, and the Federal Arbitration Act prohibits any procedural artifice subverting arbitration. The arbitration agreements in Discover Bank and Klussman permitted arbitration on an individual basis under California law, and neither case prohibited an arbitrable forum. The California Supreme Court in its Discover Bank decision avoided a procedural label for class actions and classwide arbitration by reformulating consolidated proceedings as a means of vindicating the substantive law of fraud. Civil Code 1688. The Court of Appeal on remand in Discover Bank pointed out that this judicial transformation effectively characterized the procedural choice-of-law clause as unconscionable, a term applicable to substantive law. By characterizing a choice of law as substantive law and applicable to general contract law, the California Supreme Court insulated itself from federal pre-emption. The Klussman court also labeled classwide arbitration "more than a mere procedural right," at least in the context of consumer class actions. This rationale migrates choice-of-law clauses, generally classified as procedural law, into the substantive contract law of "unconscionability" and unenforceable. Civil Code 1670.5. The Klussman court interpretation mirrors the California Supreme Court analysis in its Discover Bank decision. Classification of law as substantive or procedural also has confronted federal courts in determining diversity jurisdiction under the venerable U.S. Supreme Court decision in Erie v Tompkins, 304 U.S. 64 (1938). The decision is important when the defendant files for removal in District Court (U.S.C.A. 1332), but the California Supreme Court in Discover Bank and the Klussman court have blurred the distinction between these two jurisprudential categories. Cases removed from state court on diversity grounds require federal courts to adhere to state substantive law, but in a case containing a contractual arbitration clause, the federal court applies Federal Arbitration Act procedural law. First Fidelity Bank FSB v. Durga Ma Corp. 386 F.3d 1306 (2004). Although Federal Arbitration Act procedural rules may not affect characterization of substantive or procedural law, the 9th Circuit held that the act does not pre-empt forum-selection clauses in arbitration if construed consistent with state general contract law. Bradley v. Harris Research Inc., 275 F.3d 884 (9th Cir. 2001). This rationale would validate the Klussman court interpretation of choice-of-law clauses and the Aral court interpretation of forum-selection clauses. To some extent, consumer claims resemble arbitration of disputes between employees and employers. In Armendariz v. Foundation Health Psychcare Services Inc., 24 Cal.4th 83 (2000), the court refused to enforce arbitration in non-negotiated employment agreements unless the employer complied with minimal standards of fairness to equalize disproportionate bargaining power among the parties. Consumers do not necessarily lack bargaining power with credit card
companies or other major commercial service providers and frequently
can exercise
a choice. Although the economic disadvantage of obtaining employment
is absent
in consumer
cases, a choice-of-law clause impeding the ability of a party to resolve
disputes under California law arguably disables a consumer from vindicating
a claim.
Gutierrez v. Autowest, 114 Cal.App.4th 77 (2003). *** |