Arbitration Clauses and Treble Damage Waivers In Consumer Contracts: New Jersey’s Appellate Division Splits (or Rather Severs) the Baby

September 18, 2014

The past several years have witnessed the creation of an entirely new body of law devoted to the question of whether and under what circumstances a waiver of procedural and substantive rights in a consumer contract can be enforced. The recent Appellate Division decision in Morgan v. Sanford Brown Inst.1 presents the latest chapter in this ongoing story.

Class Action Waivers

In Muhammad v. County Bank of Rehoboth Beach, Delaware,2 the New Jersey Supreme Court held that a class action waiver in the arbitration clause of a consumer contract was unconscionable and violated the public interest.3 Interpreting Muhammad to provide a defense against “all waivers of class-wide actions, not simply those that also compel arbitration,” the Third Circuit in Homa v. American Express Co.4 held that the Muhammad court’s ruling was not preempted by the Federal Arbitration Act (“FAA”).5 Two years later, however, the U.S. Supreme Court decided AT&T Mobility v. Concepcion,6 a case that the Third Circuit subsequently interpreted as overruling its Homa decision.7 In Litman v. Cellco P’ship, the Third Circuit held that Muhammad’s ban on class action waivers in arbitration clauses was indeed preempted by the FAA.8

In the state court system, the leading Appellate Division decision acknowledged the ruling in Concepcion but highlighted a footnote preserving state courts’ ability to reject arbitration clauses by “invoking traditional legal doctrines governing the formation of a contract and its interpretation.”9 The decision then proceeded to do just that, holding that the arbitration clauses at issue (containing class action waivers) were “too plagued with confusing terms and inconsistencies to put a reasonable consumer on fair notice of their intended meaning.”10 Subsequent Appellate Division decisions have followed this lead.11 The lower federal courts, on the other hand, have had little difficulty applying arbitration provisions with class action waivers in consumer contracts.12

Fee Waivers

In Delta Funding Corp. v. Harris,13 decided the same day as Muhammad, the New Jersey Supreme Court held that arbitration clauses providing that each side will bear its own attorneys’ fees and costs – thereby negating a prevailing consumer’s entitlement to a statutory fee award (such as those prescribed by the State’s Consumer Fraud Act14 or the federal Truth in Lending Act15) – are unconscionable and invalid.16 While most courts have adopted this approach,17 one federal court has held that such a provision “merely reflects the ‘American’ Rule of attorney’s fees, and it certainly does not ‘shock the court’s conscience.’”18

Treble Damage Waivers: The Morgan Decision

Over the years, courts have routinely held that the Consumer Fraud Act’s treble damage remedy is available to prevailing plaintiffs in arbitration proceedings.19 However, no court has addressed whether entitlement to such damages may be waived in an arbitration clause.20 This was the issue before the court in Morgan.

The defendant in Morgan, a provider of career training programs, required its customers to sign an Enrollment Agreement with an arbitration clause.21 In addition to a bar on attorneys’ fees, the clause provided that “[t]he arbitrator will have no authority to award consequential damages, indirect damages, treble damages or punitive damages.”22 Quoting the Supreme Court decision in Delta Funding, the Appellate Division first stated the general principle that “by agreeing to arbitrate a statutory claim, a party does not forgo the substantive rights afforded by the statute; it only submits to their resolution in an arbitral rather than a judicial forum.”23 It then went on to hold that the bar on waiving attorneys’ fees applied with equal force to a waiver of treble damages. According to the court, such a waiver is both unconscionable and unenforceable.24

Severability

While the Appellate Division invalidated the treble damage waiver in Morgan, it did not invalidate the arbitration clause in toto. Consistent with the majority of courts, it severed the offensive provisions from the contract and referred the case to arbitration.25

  1. 2014 WL 4388343 (N.J. App. Div. Sept. 8, 2014)
  2. 189 N.J. 1 (2006).
  3. Id. at 99-101.
  4. 558 F.3d 225 (3d Cir. 2009).
  5. Id. at 230.
  6. 131 S.Ct. 1740 (2011).
  7. Litman v. Cellco P’ship, 655 F.3d 225, 230 (3d Cir. 2011).
  8. Id. at 230-31. The U.S. Supreme Court subsequently reaffirmed its Concepcion holding in Am. Exp. Co. v. Italian Colors Rest., 133 S.Ct. 2304 (2013).
  9. NAACP of Camden Cty. East v. Foulke Mgt. Corp., 421 N.J. Super. 404, 427-28 (App. Div.), certif. granted, 206 N.J. 96 (2011), appeal dismissed, 213 N.J. 47 (2013). While the New Jersey Supreme Court granted leave to appeal the Appellate Division’s decision in this case, the case settled before the appeal could be heard. See id.
  10. Id. at 430-31.
  11. See, e.g., Rotonde v. Dibre Auto Grp., L.L.C., 2014 WL 3129804, at *4 (N.J. App. Div. July 9, 2014) (acknowledging that “class action waiver provisions … are not subject to a defense of per se unconscionability on public policy grounds but invalidating clauses on ground that “the reference … to ‘class action arbitration’ was potentially confusing”); GMAC v. Pittella, 2012 WL 3236072, at *4 (N.J. App. Div. 2012) (arbitration clause containing class action waiver “was not sufficiently clear and unambiguous so as to evidence plaintiff’s intention to waive any of her rights under the CFA”).
  12. See, e.g., Wolf v. Nissan Motor Acceptance Corp., 2012 WL 1079340, at *5-6 (D.N.J. Mar. 29, 2012): Brokers’ Serv. Mktg. Grp. v. Cellco P’ship, 2012 WL 1048423, at *4-5 (D.N.J. Mar. 28, 2012); Coiro v. Wachovia Bank, N.A., 2012 WL 628514, at *5 (D.N.J. Feb. 27, 2012).
  13. 189 N.J. 28 (2006).
  14. N.J. STAT. ANN. § 56:8-19.
  15. 15 U.S. CODE ANN. § 1640(a)(3).
  16. Id. at 42-43. An exception exists where a consumer brings “frivolous” or “bad faith” claims. Id. at 42 (citing N.J. STAT. ANN. § 2A:15-59.1).
  17. See, e.g., Johnson v. Wynn’s Extended Care, Inc., 2012 WL 5880310, at *4 (D.N.J. Nov. 20, 2012); Wolf, 2011 WL 2490939, at *7; Mullin v. Auto. Protect. Corp., 2008 WL 4509612, at *4 (D.N.J. Sept. 29, 2008).
  18. Coiro, 2012 WL 628514, at *5.
  19. See, e.g., Gras v. Assoc. First Capital Corp., 346 N.J. Super. 42, 53 (App. Div. 2001) (successful plaintiff can achieve all statutory CFA remedies in an arbitration forum); Jones v. The Chubb Inst., 2007 WL 2892683, at *3 (D.N.J. Sept. 28, 2007) (“plaintiffs would be entitled to any substantive rights afforded by the CFA, including treble damages”); Rinaldo v. Schaad, 2010 WL 5349009, at *7 (N.J. App. Div. Oct. 25, 2010) (“it seems unlikely that an arbitrator’s award of treble damages on a CFA claim would be overturned on the ground that the arbitrator had no jurisdiction to make such an award”); Prudential Prop. & Cas. Ins. Co. v. Greenberg, 2001 WL 34779009, at *7 (N.J. App. Div. Mar. 2, 2001) (“Fraud Act damages do not disappear because a claimant seeks arbitration”); see also N.J. STAT. ANN. 2A:23B-21(a) (arbitrator “may award punitive damages or other exemplary relief if such an award is authorized by law …”)
  20. Courts in other contexts have invalidated arbitration provisions purporting to limit punitive damages. See, e.g., Estate of Ruszala v. Brookdale Living Communities, Inc., 415 N.J. Super. 272, 299 (App. Div. 2010).
  21. 2014 WL 4388343, at *1.
  22. Id.
  23. Id. at *2.
  24. Id. at *5.
  25. As the Supreme Court explained in Muhammad, “if all the provisions of the arbitration clause are enforceable, then the court must compel arbitration according to the terms of the agreement. If, however, some or all of its provisions are not enforceable, then the court must determine whether the unenforceable provisions are severable.” 189 N.J. at 103 (quotation omitted).
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