Arbitration Clauses Can Protect Businesses From Costly Privacy Class Action Litigation

(Published in the Prism Risk Management blog, October 29, 2012. Used with permission.)

Class action litigation over alleged privacy violations appear to be a growing concern for companies that do business on the internet, including not only web-based companies like Google or Facebook, but also companies that use the internet to sell real-world products or services. For small and startup businesses, a class action lawsuit can generate huge expenses in terms of legal fees and settlements, risking a business’ very viability. The U.S. Supreme Court issued a decision in 2011 that provides businesses with a possible means of avoiding class action litigation, while still allowing consumers the ability to seek remedies for alleged injuries. This can represent savings for many businesses in both risk and actual expense.

Federal and state courts have their own rules regarding class action lawsuits. Federal law generally defines a “class” as a group of parties with common questions of law or fact that is so numerous that it would be “impracticable” to include them all as plaintiffs. A group of class representatives may appear as plaintiffs, provided their claims or defenses represent a typical claim or defense of the rest of the class.

In cases of alleged privacy violations by a company doing business on the internet, any individual consumer’s damages are likely to be very low. Attorneys may group thousands of consumers with similar claims into a class in order to file suit. The aggregate amount of damages could reach well into the millions of dollars. In the event of a settlement or award of damages, the class action attorney would receive a contingent fee, the class members would receive a nominal amount of damages, and the defendant business would pay a hefty sum. Current privacy class action lawsuits include:

- A lawsuit seeking $15 billion from Facebook for alleged web tracking;

- A lawsuit in Canada against Google alleging use of information obtained from emails for financial gain;

- A $9 million settlement from Netflix over retention of former customers’ rental history; and

- A settlement from luxury handbag maker Coach in a suit alleging misuse of debit or credit card information.

Companies often include “arbitration clauses” in their contracts with consumers, stating that the parties will submit a dispute to the arbitration process prior to seeking remedies in court. Arbitration can often be cost-effective for businesses, allowing them to defend a dispute before a neutral arbitrator or panel of arbitrators. A contract can establish whether an arbitrator’s ruling is binding on the parties or not. The Federal Arbitration Act (FAA) provides that arbitration clauses in contracts are valid to the extent they do not involve factors such as duress or fraud, and provided the terms are not “unconscionable.” Until 2011, courts had generally held that arbitration clauses that waived class action litigation were unconscionable.

In 2011, the Supreme Court ruled in a 5-4 decision in AT&T Mobility v. Concepcion that an arbitration clause that included a waiver of class action rights was enforceable. The impact of this ruling for other businesses, especially small businesses and startups, is that an arbitration clause contained in a service contract can help avoid potentially costly, even ruinous, class action litigation.

© David C. Wells 2014