Kentucky High Court Explains Why Class Action Litigation Helps Keep Merchants Honest

A recent Supreme Court of Kentucky decision made that state the tenth where courts have struck down as unconscionable a class action waiver imposed on customers in a merchant’s form consumer agreement .

In Schnuerle v. Insight Communications, L.P., several consumers brought a class action against an internet service provider for failure to provide internet access in accordance with the terms of their contracts.  The customer agreement contained an arbitration clause and class action waiver.  The arbitration clause also had provisions requiring customers to keep confidential any settlement reached through arbitration, and permitted consumers to file claims of less than $1,500 in small claims court.

In coming to its conclusion, the court engaged in a thorough exposition of the justification for class actions and the inherent unfairness in requiring consumers to give up their right to band together against large companies that can make millions by harming many people in amounts too small to justify individual actions.  For instance, the court explained:

“The potential that an absolute ban on class action litigation may produce an improper exculpatory result is demonstrated by way of a simple example. Suppose XYZ Company inadvertently or intentionally overbilled each of its one million customers by one dollar during a particular month. As a result, it gained possession of one million dollars to which it is not entitled, and which instead belongs to its customer base. Suppose, in addition, that the company acted unethically (or incorrectly believed it had a valid defense) and refused to return the overcharges. Economic realities dictate that none of the one million overbilled customers would bring an individual claim seeking the recovery of his dollar. The time, effort, and expense involved to recover a dollar simply would not be worthwhile. Thus, while the economic loss to each individual customer would be negligible, the lack of an economically viable means to bring the company into court would effectively exculpate the company from liability, allowing it to reap unjustly a substantial economic windfall.”

In addition to an informative discussion of the principles underlying class actions, this case contains two important elements that we have not seen in many of the other recent decisions concerning arbitration clauses and class action waivers.

First, the court “severed” the arbitration clause from the class action waiver. In other words, although the court struck down the prohibition on class actions, it held that the clause requiring arbitration was enforceable. So, in essence, the court sent the parties to class arbitration.  This part of the decision is notable because it conflicts with the conclusion reached by the US Supreme Court in the Stolt-Nielsen case.  In Stolt-Nielsen, the Supreme Court held that parties cannot be compelled to submit to class arbitration unless they have agreed to it.  In so holding, the Court reversed a decision by the Second Circuit that had severed an arbitration clause and class action waiver.

Although a state court is generally free to interpret state law without interference from the Supreme Court, the Kentucky court had particularly good reason to send the case to arbitration if at all possible: Unlike “most jurisdictions, arbitration enjoys the imprimatur of [Kentucky’s] state Constitution.”

Second, the court held that the agreement’s provision allowing claims under $1,500 to proceed in small claims court did not save the class action waiver.  The court noted that the claims in this case were estimated to be approximately $40 per person—and a rational consumer likely would not take a claim of that size to small claims court even if that forum were available.

We note that provisions of this type—that permit consumers to bring individual claims in small claims court as an alternative to arbitration—have been showing up in arbitration clauses recently, and we agree with the Kentucky Supreme Court’s holding that these provisions do not cure the unfairness of a class action waiver.  No matter how fair it may seem to permit suit in a venue outside of arbitration, a contract term of this sort still denies consumers their right to band together, which may be the only way a series of small wrongs can be addressed.

Finally, the court also struck down the confidentiality provision of the arbitration clause.  That clause prohibited consumers from disclosing the result of any settlement reached with the internet service provider.  The court opined that this provision was unfair: “As a repeat participant in the arbitration proceedings, the company is able to gather a body of information relating to precedent and rulings arising from within the dispute resolution process, to which customers involved in separate proceedings would have no access.”

Overall, Schnuerle is a good decision for consumers, with the caveat that class arbitration may not provide all of the same advantages that a class action in court could offer.