California Supreme Court Punts on FAA Preemption

While McGill invalidated a waiver of the right to seek public injunctive relief, it did so on the narrow ground that the waiver prevented the consumer from adjudicating her statutory right to seek that remedy in any forum, not only in court. The California Supreme Court thereby attempted to reconcile its holding with Concepcion. Further, it did not reach the question of whether the invalid waiver rendered the arbitration agreement as a whole unenforceable under the severability clause. Finally, although the California Supreme Court granted review of the McGill case to consider the viability of the Broughton-Cruz rule (which is based on decisions handed down in 1999 and 2003), it side-stepped the issue. Nonetheless, McGill raises several issues that warrant review of arbitration agreements.

Summary of the Case

McGill brought a putative class action against Citibank based on Citibank’s marketing of a “credit protector” plan she had purchased and the handling of her claim under that plan. McGill sued under California’s unfair competition law (UCL), false advertising law, and the Consumer Legal Remedies Act (CLRA), and sought an injunction prohibiting Citibank from continuing to engage in its allegedly illegal and deceptive practices.

Citibank petitioned the court to enforce a mandatory arbitration agreement contained in McGill’s account agreement, which stated that it was governed by the FAA. The arbitration agreement did not expressly include or exclude claims for public injunctive relief; rather, it provided that all claims must be arbitrated and that only the rights and obligations of the named parties could be resolved in arbitration. The arbitration provision stated, in relevant part:

All Claims are subject to arbitration, no matter what legal theory they are based on or what remedy (damages, or injunctive or declaratory relief) they seek.… Claims and remedies sought as part of a class action, private attorney general or other representative action are subject to arbitration on an individual (non-class, non-representative) basis.

The parties agreed that these provisions precluded McGill from seeking public injunctive relief in any forum.

The trial court granted Citibank’s petition in part and denied it in part based on the so-called “Broughton-Cruz rule,” which provides that agreements to arbitrate claims for public injunctive relief under CLRA, UCL, or the false advertising law are not enforceable. The Court of Appeal reversed and remanded for the trial court to order all of McGill’s claims to arbitration, concluding that the FAA preempts the Broughton-Cruz rule under the U.S. Supreme Court’s holding in Concepcion. Without reaching the issue of the viability of the Broughton-Cruz rule, the California Supreme Court reversed the Court of Appeal, holding that the waiver of public injunctive relief in all forums was invalid and unenforceable under California law. The Court further found that its holding was consistent with Concepcion.

For Now, Treatment of the Broughton-Cruz Rule May Depend Upon the Forum

In crafting the Broughton-Cruz rule, under which certain statutory injunctive relief claims cannot be arbitrated, the California Supreme Court distinguished private injunctive relief, which can be subject to private arbitration, from public injunctive relief. Private injunctive relief generally rectifies an individual wrong specific to a plaintiff or group of plaintiffs and, if there is a benefit to the public, that benefit is incidental. Public injunctive relief generally benefits the public and does not directly benefit a plaintiff because the plaintiff has already been injured. The Broughton-Cruz rule stood largely intact from 1999 to 2011, when the U.S. Supreme Court held in Concepcion that the FAA preempts all state-law rules that prohibit arbitration of particular claims or that stand as an obstacle to enforcement of arbitration agreements; however, Concepcion did not specifically address the Broughton-Cruz rule.

After Concepcion, the consensus seemed to be that the FAA preempted the Broughton-Cruz rule. The only two published opinions from the California Court of Appeal on the issue both found preemption.¹ The federal courts did, too. After holding that the FAA preempted the Broughton-Cruz rule and then affirming on narrower grounds en banc in Kilgore v. KeyBank N.A., the Ninth Circuit conclusively held that the FAA preempted the Broughton-Cruz rule in Ferguson v. Corinthian Colleges Inc.

Though it was expected that McGill would settle the issue regarding whether the FAA preempts the Broughton-Cruz rule, the McGill opinion does not address the rule’s viability post-Concepcion. The California Supreme Court side-stepped the issue—finding “it is now clear the Broughton-Cruz rule is not at issue in this case” because the rule addresses agreement to arbitrate public injunctive relief, and the parties agreed this arbitration agreement excludes claims for such relief in any forum. Arguably, the Court’s reference to the circumstances under which the rule continues to apply indicates that, in the eyes of the California Supreme Court, the FAA may not preempt the rule.

Thus, if an arbitration provision requires arbitration of claims for public injunctive relief under California’s CLRA, UCL, or false advertising law, it is possible that a California court may not enforce such a provision, even if the arbitration provision is governed by the FAA. In contrast, a federal court will likely find such a waiver provision to be enforceable.

Can McGill Be Reconciled with Concepcion and Italian Colors?

The California Supreme Court in McGill found that U.S. Supreme Court decisions – including Concepcion and Italian Colors, which enforced class action waivers in arbitration agreements – actually supported its conclusion that a waiver of the right to seek public injunctive relief is unenforceable. Some background is in order.

The California Supreme Court created a judicial rule in Discover Bank that class waivers in arbitration agreements for small-dollar consumer claims were unconscionable and therefore invalid. In finding such class action waivers enforceable, Concepcion held that “[w]hen state law prohibits outright the arbitration of a particular claim, the analysis is straightforward: The conflicting rule is displaced by the FAA.” Concepcion also noted that, although Section 2 of the FAA “preserves generally applicable contract defenses, nothing in it suggests an intent to preserve state-law rules that stand as an obstacle to the accomplishment of the FAA’s objectives.”

In Italian Colors, the U.S. Supreme Court held a waiver of class arbitration is enforceable even if the plaintiff’s cost of individual arbitration exceeded the potential recovery, stating that Concepcion “all but resolve[d]” that question. Italian Colors noted that barring class proceedings did not bar the individual plaintiff from pursuing “statutory remedies.”

Nevertheless, the McGill Court found that both Concepcion and Italian Colors supported its holding. McGill’s reasoning is premised on the maxim that “a law established for a public reason cannot be contravened by private agreement,” which is codified in the California Civil Code. As a result, McGill reasoned, it is a generally applicable contract defense and helps distinguish the “substantive statutory remedy” of a public injunction from the “procedural device” of a class action. Italian Colors, it argues, distinguished between the waiver of a right to pursue “statutory remedies” and the waiver of a “procedural path” to vindicate every claim (i.e., class action waivers). It is not clear that a federal court faced with a similar issue would agree with the California Supreme Court.

Conclusion

McGill raises several important issues. First, the enforceability of a public injunctive relief waiver may depend upon the forum. But if the arbitration provision is likely to be tested in both California state and federal courts, the client may wish to closely examine such waivers for validity. Second, the matter of whether the Broughton-Cruz rule remains viable in California is unresolved. Thus, a state court could invalidate an arbitration provision that provides for arbitration of public injunctive relief claims under the UCL, CLRA, or false advertising law, notwithstanding federal law to the contrary. Third, the McGill court did not determine the enforceability of the arbitration agreement as a whole – after invalidating the public injunctive relief waiver – because it was not clear how the parties intended the severability clause to operate. McGill should prompt clients to review their arbitration agreements to avoid such potential invalidity and enforceability pitfalls.

¹ See McGill, 232 Cal. App. 4th 753 (2014), reversed and remanded, McGill, ___ Cal. 5th___, 2017 WL 1279700 (2017); see also Nelsen v. Legacy Partners Residential Inc., 207 Cal. App. 3d 1115 (2012). The Nelsen court’s treatment of the issue has been criticized as dicta and also because the Nelsen court relied on Kilgore v. KeyBank N.A., 697 F.3d 1191 (9th Cir. 2012), a Ninth Circuit opinion that was later vacated based on a rehearing en banc.