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The Assembly Judiciary Committee today will consider a California Chamber of Commerce-opposed job killer that if passed into law would create a worse litigation environment and result in lack of job creation.
CalChamber has identified SB 33 as a job killer because it unfairly attacks the use of arbitration agreements in consumer contracts with “financial institutions” as broadly defined, is likely preempted by the Federal Arbitration Act (FAA), violates the rules of the Financial Industry Regulatory Authority (FINRA), and will have a negative impact on “financial institutions” with unnecessary and costly class action litigation that does not ultimately benefit the consumer.
SB 33’s Broad Definition of ‘Financial Institution’ Includes Securities and Insurance Brokers/Agents
Despite recent amendments, SB 33 still applies to more industries than just banks. By broadly defining “financial institution” to include any individual or entity licensed under identified sections of the Corporations Code, the bill applies to securities firms and brokers, who may be dually licensed to sell both securities and insurance products. Accordingly, insurance products are still included.
SB 33 Will Create Costly Litigation That Primarily Benefits Class Action Trial Attorneys, Not the Consumer
SB 33 precludes the enforcement of a valid arbitration agreement for claims of fraud with a financial institution. SB 33 is sponsored and supported by trial attorneys who prefer class action litigation over arbitration because the former provides a significantly higher financial recovery for trial attorneys. Recent examples of attorney fee awards in recent consumer class actions illustrate this issue:
- A case in which it was alleged LinkedIn wrongfully used members’ contact information. The case settled for $13 million; the funds were divided as follows: $1,500 for the named plaintiffs; no less than $10 per class member; and $3.25 million for attorney’s fees and costs.
- A case in which it was alleged personal identifying information of customers was compromised. The case settled for $3 million; the funds were divided as follows: $2,500 for named plaintiffs; up to $3,000 per class member for unreimbursed losses as a result of the identity theft or up to $1,000 for unreimbursed expenses as a result of the identity theft; and $652,340 for attorney’s fees.
Accordingly, by precluding the enforcement of a valid arbitration agreement, consumer attorneys, the sponsors and supporters of SB 33, can pursue more costly class action litigation where they recover higher fee awards.
SB 33 Creates Unnecessary Litigation for Impacted Industries to Establish that it is Preempted Under the FAA, as Emphasized by a Recent U.S. Supreme Court Opinion
On May 16, 2017, the U.S. Supreme Court struck down a Kentucky decision that invalidated an arbitration agreement with a nursing home that was executed by family members who had a power of attorney for the patient in Kindred Nursing Centers Ltd. Partnership v. Clark, 2017 WL 2039160. The Kentucky court determined that arbitration was such a significant issue that, in order for the agreement to be valid, the power of attorney form must specifically allow the individual to agree to arbitration on behalf of the principal or, in this case, the patient. In a 7 to 1 decision written by Justice Elena Kagan, the U.S. high court emphatically rejected the Kentucky court decision. In the opinion, the U.S. Supreme Court re-emphasized that “The FAA preempts any state rule discriminating on its face against arbitration—for example, a ‘law prohibit[ing] outright the arbitration of a particular type of claim.’”
SB 33 suffers from the same fatal flaw. On its face, SB 33 prohibits the arbitration of specific claims — i.e., those arising from a “purported contractual relationship” created fraudulently by the “unlawful use of personal identifying information” with a financial institution. As indicated in Kindred Nursing Centers, a state law that seeks to limit arbitration in this manner is preempted by the FAA. Moreover, SB 33 acknowledges that there is a valid agreement to arbitrate that has been consented to by the consumer.
The opinion in Kindred Nursing Centers also emphasizes that “[t]he Act’s key provision, once again, states that an arbitration agreement must ordinarily be treated as ‘valid, irrevocable, and enforceable.’ A rule selectively finding arbitration contracts invalid because improperly formed fares no better under the Act than a rule selectively refusing to enforce those agreements once properly made.” SB 33 acknowledges a valid agreement, but basically refuses to enforce the terms of that agreement for certain claims, which the Court just indicated on May 16, 2017, is preempted.
Forcing employers affected by SB 33 to challenge the constitutionality of this law will create further unnecessary litigation. The Kindred Nursing Centers case took approximately eight years to finally be resolved by the Supreme Court. Requiring California businesses to exhaust financial resources and time in costly litigation to establish that SB 33 is similarly preempted is unnecessary and will only harm the ability of these businesses to thrive in California.
SB 33 Preempted Under Financial Industry Regulatory Authority (FINRA) Rules
FINRA is a quasi-governmental, independent regulatory organization that was created and registered with the Securities and Exchange Commission (SEC) pursuant to the 1938 Maloney Act amendments to the Securities and Exchange Act of 1934 (Exchange Act). FINRA’s mission is to protect investors and preserve the integrity of the securities marketplace by regulating, examining, and taking enforcement action against its members, which include nearly 4,000 broker-dealer firms and nearly 650,000 individual brokers. FINRA is subject to the direct oversight of the SEC and all FINRA rules must be reviewed and approved by the SEC to ensure their consistency with the Exchange Act.
As currently drafted, SB 33 specifically includes securities brokers, dealer’s representatives, and advisors within its definition of “financial institution,” and specifically prohibits the arbitration of claims for fraud and unlawful use of personal identifying information. Specific FINRA Rules, however, require the arbitration of all claims arising out of the business activities of the brokerage firm or broker. There is no exception or exclusion under FINRA Rules for claims of fraud or unlawful use of personal identifying information. Consequently, SB 33 is in direct conflict with FINRA Rules and likely preempted.
SB 33 Will Create Further Litigation Over Ambiguous Terms and Application
SB 33 will create further litigation regarding the ambiguous terminology utilized and the uncertainty regarding how courts will interpret such ambiguity. Ambiguity, inconsistency, and confusion serve only to benefit trial attorneys and their ability to pursue more costly litigation with higher attorney fee recoveries, not consumers
Purported Contractual Relationship
SB 33 states that a respondent cannot be compelled to arbitration regarding a “purported contractual relationship.” This term is undefined and will create significant litigation over what relationships are included or excluded. California law specifically identifies the essential elements of a contract in the Civil Code. California law also specifically identifies the basis to invalidate, revoke or render a contract unenforceable under specific Civil Code Sections. Under existing law, there are only two choices: (1) a valid contract; or (2) an invalid/unenforceable contract.
SB 33 seems to create a third option of “purported contractual relationship” that was created fraudulently without the consumer’s consent and with the unlawful use of the consumer’s personal identifying information. It is completely unclear what “purported contractual relationship” means or how it differs from existing law. Existing law already invalidates contracts that are created fraudulently. This third contractual option of a “purported contractual relationship” that is “created fraudulently” will create significant confusion over how this law applies and ultimately will lead to additional litigation, leaving the courts to determine what was intended.
SB 33 Creates Confusion Between Who Is Respondent and Consumer
SB 33 proposes to amend a section of Code of Civil Procedure, which refers to “petitioners” and “respondents” of a motion to compel arbitration, meaning the parties to the litigation. Instead of applying and utilizing these same terms, SB 33 includes a “consumer” as a new party to the process, that is not necessarily the respondent or proponent. This inconsistency in terms will create confusion and litigation over its meaning. Through legislative construction, courts will have to determine the intent of why “consumer” was utilized in this section instead of “respondent.” Does SB 33 allow a “respondent” to avoid arbitration based on any contract with any consumer? Is the consumer the respondent? This inconsistent terminology adds another layer of ambiguity and concern to this bill that will create further litigation.
SB 33 Is Ambiguous as to the Determination of “Purported Contractual Relationship” Created Fraudulently by Unlawfully Using the Consumer’s Personal Identifying Information
SB 33 states that, upon a petition to compel arbitration, the court must determine whether the arbitration agreement involves a “financial institution” that is seeking to apply a written contract to arbitrate to the creation of a “purported contractual relationship” created fraudulently by the “unlawful use of consumer personal identifying information.” It is unclear how the court would make this determination. If by simply alleging these causes of action in a complaint the court may ultimately deny arbitration and send the entire case to litigation, then all arbitration agreements would be undermined. Notably, nothing in SB 33 requires a court to bifurcate claims that fall within this provision from other causes of action alleged that should be compelled to arbitration under a valid contract. Comparatively, if SB 33 requires a court to make a factual determination that a “purported contractual relationship” created fraudulently by the “unlawful use of consumer personal identifying information” exists, then SB 33 essentially turns a petition to compel arbitration into a substantive, dispositive motion on the validity of the claims asserted. At the outset of the case, the parties would have to litigate the existence of a fraudulent relationship or unlawful use of consumer personal identifying information, which undermines the very point of arbitration.
SB 33 Applies to Existing Contracts
As amended, SB 33 specifies that the provisions of the bill do not go into effect until January 1, 2018. The bill does not limit its application, however, to only those contracts created after January 1, 2018, thereby invalidating all existing consumer contracts with a financial institution that include an arbitration provision which requires the arbitration of any and all disputes arising from the relationship and is applied after January 1, 2018. This retroactive application on existing contracts will create significant costs and potential litigation for financial institutions.
SB 33 is scheduled to be considered by the Assembly Judiciary Committee today.
CalChamber is urging members to contact their Assembly representatives and committee members and ask them to oppose SB 33 as a job killer.
Staff Contact: Jennifer Barrera