Nothing's certain but death and taxes

And class actions, of course.

Laster v. T-Mobile USA, Inc., --- F.Supp.2d ----, 2005 WL 3610616 (S.D.Cal.)

In this putative class action, the plaintiffs asserted that defendants -- cellphone companies and other sellers of wireless telecommunication services -- engaged in the unfair and deceptive practice of charging consumers sales tax on the full retail value of cellphones that were advertised as "free" or at substantial discounts, in violation of California's Unfair Competition Law and False Advertising Law. Plaintiffs sought damages and injunctive relief under the Consumer Legal Remedies Act. Their state-law complaint was removed under CAFA.

Underlying facts: Cellphones are often sold as part of a bundled transaction: a free or discounted phone along with a service contract for a specified length of time. When the defendants offer the bundle, however, they generally charge sales tax of approximately 7.75% based on the full retail value of the phone. (For one representative plaintiff, this amounted to $10.31 in tax; for another it was $28.22.) Plaintiffs object that a free phone shouldn’t have any sales tax, and that the tax should be calculated on the discounted price when the phone is sold at a discount. I have to admit, this objection seems quite reasonable to me; I certainly don’t expect to be charged full-price tax on a sale item.

But this is a class action, so the legal analysis is not going to focus on the merits of the underlying claim. The contracts for the bundled phones, to which the plaintiffs agreed, included an arbitration clause that requires arbitration but bans class-wide claims in that arbitration. The Federal Arbitration Act (FAA) has a pro-arbitration policy, so the questions for the district court were whether a valid agreement to arbitrate existed and whether it encompassed the dispute at issue. But wait! Despite the federal policy favoring arbitration, state law controls issues of contract validity and enforceability. Generally applicable defenses such as fraud, duress, or unconscionability, may be applied to invalidate arbitration agreements, though the court is limited to determining whether the arbitration clause itself is unconscionable.

A contract of adhesion – a standard consumer contract imposed by the party with superior bargaining power – is unconscionable when both procedural and substantive unconscionability are present, though the amount of each required will vary with the strength of the showing on the other. Procedural unconscionability comes from oppression and surprise; oppression comes from inequality of bargaining power and an absence of meaningful choice on the weaker party’s side. Surprise comes from the extent to which the terms of the bargain are hidden in a wordy form drafted by the stronger party.

The defendants contested procedural unconscionability on the grounds that plaintiffs had meaningful choices – there were other cellphone companies on the market, including some that don’t insist on arbitration. The Ninth Circuit, however, has already rejected this very argument in Ting v. AT&T. Under Ting, take-it-or-leave-it consumer contracts are deemed to be procedurally unconscionable. The court reasoned that the T-Mobile contract at issue fell on the higher end of the unconscionability spectrum, since the arbitration provision was buried in a 52-page “Welcome Guide” that was only available to the plaintiff after she’d signed the contract. Cingular’s arbitration clause was a closer call – the plaintiff got the service agreement specifically mentioning arbitration at the time of purchase. Thus, it was on the low end of the unconscionability spectrum.

As for surprise, it’s clearly present in the T-Mobile contract. Though the Cingular service agreement talks about arbitration, it doesn’t mention the terms or the ban on class-wide claims; those elements can only be determined by reading pp. 10-12 of Cingular’s 13-page terms of service booklet, so a “modicum” of surprise is present.

Substantive unconscionability is the remaining hurdle. Plaintiffs argued that a contract by which consumers waive class action rights is subsantively unconscionable, based on the California Supreme Court’s ruling in Discover Bank v. Superior Court of Los Angeles, 30 Cal.4th 148 (Cal.2005). Defendants responded that Discover Bank didn’t hold all such arbitration provisions unconscionable, and if it did, it would be preempted by the FAA.

Discover Bank held a waiver of class-wide arbitration to be unconscionable in an adhesion contract when (1) disputes between the parties would predictably involve small damages, and (2) plaintiffs alleged a scheme by the more powerful party to cheat large numbers of consumers out of small sums. In such cases, the waiver becomes in practice an exemption from responsibility for fraud and willful injury. Applying this two-prong test, the court found substantive unconscionability. Notably, prong (2) is satisfied by plaintiffs’ allegations; they need not provide evidence at this time.

Gee, that test looks like it would invalidate class-wide arbitration waivers in most consumer contracts! Thus, the preemption argument. The FAA makes arbitration agreements enforceable except on grounds that would apply to any contract. Because the Discover Bank rule is not one of general applicability, the defendants argue, it’s preempted. The California Supreme Court found that, to the contrary, the determination that a class-wide bar is (usually?) unconscionable involves general principles of state law; it just so happens that those principles will often apply to this type of contract, as they might to any class of unconscionable contracts. The district court here agreed.

Defendants also had a motion to dismiss, so we do get some discussion of the merits of the claim. Under the newly amended unfair competition law, plaintiffs have to allege (1) actual injury (2) caused by the defendants’ false advertising. The court found that plaintiffs adequately alleged injury, but not causation. Plaintiffs claim to have been harmed by a variation on bait and switch – lured in based on promises of free phones, then induced to pay. But plaintiffs failed to allege reliance on the offer of free/discounted phones – no named plaintiff alleges seeing, reading, or in any way relying on the ads. The unfair competition claim was dismissed with leave to replead.

Plaintiffs’ Consumer Legal Remedies Act damages claim was also dismissed – with prejudice – because they failed to give defendants thirty days notice before beginning an action for damages, as required by law so that defendants can have an opportunity to fix the problem without litigation. Strict adherence to the notice requirement is necessary to further the statute’s aims.