Annie Kuo: Welcome to Discovery, a Ƶ podcast where we discuss the biggest legal topics with the law school’s distinguished guests and experts from around the world. I'm your new host Annie Kuo. Today we're going to explore whether class action waivers serve the interests of society or facilitate socially harmful business practices. We’re fortunate Dr. Albert H. Choi, is here on the podcast today to discuss the fine print that many of us—consumers, employees and investors—are asked to sign when we purchase cars, cell phone plans and all the things. Many companies require that we sign class action waivers as a condition for doing business with them. And the U.S. Supreme Court has endorsed this ability to block class actions through mandatory individual arbitration clauses.
Dr. Albert H. Choi is a professor at the University of Michigan who approaches legal issues through the lens of an economist. He has a J.D. from Yale where he was an Olin fellow and a Ph.D. in Economics from MIT. His research and teaching interests include corporate law, contract law, corporate finance, mergers and acquisitions and law and economics.
Hi, Albert.
Albert Choi: Hi, Annie.
AK: You spoke recently with our 1L students. And I also read with them the paper you co-wrote with Kathy Spears of Harvard, “The Economics of Class Action Waivers” in the Yale Journal on Regulation. Could you tell us about the reasons by which you two felt that scholarship on this topic was due?
AC: Yeah, as you mentioned earlier, in your very kind introduction, I sort of try to approach a lot of these legal issues using the lens of economics. And my co-author, Kathy Spears, also has a pretty serious economics training.
Our reasons for writing this paper was, should I say twofold? The first is that there has been a series of recent Supreme Court cases upholding mandatory individual arbitration clauses, basically forcing individuals to sign away their right to bring a class action. So, I mentioned at least a couple of them in the paper. One is AT&T Mobility, the other is American Express. And then there's also the Epic Systems. In my area of the corporate law, this issue has also risen to the surface, there has been a lot of litigation about federal forum, exclusive forum provisions, which is a lot like a mandatory individual arbitration. And there has also been a lot of discussion about whether or not we can impose mandatory individual arbitration against the investors. So, that's one reason why we decided to write this paper.
The second reason is that as we're kind of examining these issues, we realized that a lot of the economic thinking on this issue seemed a bit outdated. So, there was some research that was done on the class action waivers or different kinds of dispute resolution systems back in the 70s and 80s. But they were taking on, should I say much more straightforward neoclassical economics thinking. And then they came out generally positive in favor of, let's say, individuals, employees, or investors signing away their right to bring a class action. And we thought that, especially given that economics has advanced quite a lot over the past about 40 years, some updating was going to be necessary. And we began to sort of explore how more recent thinking on economics can be applied to this issue.
AK: When is litigation a, quote, social waste?
AC: That sort of kind of depends on what exactly is the purpose of litigation. From the economics perspective, we normally kind of think about the liability system, which includes the dispute resolution system, which again, includes litigation as a deterrence mechanism to deter, let's say, the companies from designing a defective product or maybe selling defective product or making this representations to the consumers, and so on. So, we can think about a setting where maybe there could be many other deterrence mechanisms that is already in place, so that the litigation may not really be necessary.
One good example might be something like a market-based mechanism. So, if let's say the firm produces a very defective or not a very good product as an example, then the consumers realize, after let's say, the initial purchase that this firm is really not selling a good product. They stopped buying from the firm. And we kind of think about that as a market-based deterrence mechanism. And if that mechanism is working relatively well, so as to incentivize the firm not to produce a defective product, then on piling on top of that, the legal system or the litigation system may be unnecessary. So, in a case like that, you can say perhaps the litigation system could potentially be quote unquote, social waste, because we already have a very good deterrence mechanism in place. So, therefore, the litigation may not be necessary.
Another great example might be like a regulation. Let's say the U.S. government—or SEC or FTC, for instance—they are into regulating, let's say, the financial markets or the anti-competitive behavior, FTC has an antitrust enforcement agency. If they're really doing a great job, of making sure that the companies do not mislead their investors or companies do not collude, then again, having on top of that sort of the private litigation system is not going to be necessary. Again, in that setting, especially given that the litigation can be very costly and we're also kind of taxing the court system in those kinds of settings, one may come to the conclusion that the private litigation system may be welfare reducing. I don't want to use the word waste too much. But should I say welfare reducing.
AK: It seems like this kind of approach to making decisions around whether or not to go through litigation is much preferred to acting out of emotion before incurring the costs of litigation and expenses. I mean, well, there's all kinds of costs, right? Not just in dollars.
Could you explain some conditions in which class action waivers can compromise product safety, facilitate anticompetitive conduct and support harmful employment practices?
AC: So, that issue sort of comes back to the questions about litigation. Usually, when we're sort of thinking of class actions, we're thinking of very large number of plaintiffs, then each plaintiff has a very small stake in litigation, so that each plaintiff does not find it worthwhile to bring an individual litigation against the company. So, imagine a situation where you potentially have a class action system—class action claim—against a company for producing a defective product. But then if you take away the right to bring a class action, then all of a sudden, no one will bring litigation because they would just find it too costly, and their stakes are too small. So, that's an example—assuming that we don't have other kinds of deterrence system. Once you take away that litigation, then the companies are not going to be liable for their defective product. And then once they're not liable for their defective product, their incentive to design a well-functioning—design and produce and sell—non-defective product to the market will be greatly diminished. And then to the extent that the consumers don't really recognize that fact. Now, the deterrence system will no longer be working. So, that's an example where the absence of a class action leads to no litigation and almost kind of leads to a liability waiver because no one will bring an individual action against a company.
Another great example is the collusive behavior among a couple of competitors. Suppose, you know, companies A and B are competing within the same town, and they're the only game in town. And imagine that they get together and then decide to charge a very high price for their products—you know, whatever, cars, computer—and then normally, the consumers can bring an antitrust action, usually on a class action basis, against companies and A and B for collusive behavior, anticompetitive behavior. But again, if companies A and B ask the consumers to sign away the right to bring a class action through a mandatory individual arbitration clause, now, again, the deterrent system will not be working. Then the companies will be able to charge a very high price, without having to worry about being sued by the consumers for being harmed by their anticompetitive behavior.
The third example—I guess, you briefly mentioned then, we briefly talked about in the paper—is employer who has a very large amount of market power wants to provide a very poor, as an example, working condition to its employees. And again, each individual employee for her stake is too small for her to bring an individual claim against the employer, by again, asking all the employees to sign away the right to bring a class action. Now, it's not going to deter the employer from providing a suboptimal, or very poor working condition to the employees so that the employer can save more money and make a larger profit. So, the general theme here that we're sort of exploring is, when exactly is the deterrence necessary through a class action? And then by signing away the right to bring a class action claim, whether or not that deterrence system is not working properly?
AK: This question might be loaded because it loads all the outcomes of your research. So, in light of recent Supreme Court cases, what is your conclusion on whether class action waiver provisions should be enforced?
AC: Yeah, I mean, that's the basic $64 billion question, right? We can try to examine this class action waivers through many different perspectives. And then one perspective we're sort of trying to provide in the paper is through the lens of economics. And then what we are basically sort of trying to argue is that what are the circumstances under which the firm's incentive—to either allow or disallow class actions—are aligned with social welfare? So, first example is that if we think that the chances of consumer misperception is rather high, so they don't know whether or not they're signing away their right to bring a class action, or they don't know the implication of signing on to a mandatory individual arbitration clause, that's going to lower the deterrence system. So, that's an example where the court needs to be a little bit more vigilant in terms of not enforcing mandatory individual arbitration clauses.
But in other settings, even in the antitrust example, and the employer employee example, that's another example, even when, let's say the consumers or the employees are fully aware of the implications of signing onto a mandatory individual arbitration clause that's an example where the firm's incentives are diametrically opposed against social welfare. So, the firms want to collude and charge a very high price. And then the consumers, when they're signing away their right to bring a class action, is kind of eliminating the deterrence system. So, at the end of the day, I don't think one can say that the mandatory individual arbitration clauses or class action waivers should always be enforced or should never be enforced. But rather, it has to be done on a more a case-by-case basis.
Now, again, we're sort of thinking about this from the economics perspective. There are a lot of other people who sort of tries to examine this issue from, let's say, the purely legal doctrinal perspective, such as looking through the Federal Arbitration Act, FAA. And then what we're sort of trying to do is to offer a different kind of perspective to think about this policy issue.
AK: It's so valuable to make legal decisions, especially on litigation, based on economics, from my point of view, not just on the legal doctrine, because time is money. Money is time and, you know, I think there is something to be said for decisions made on weighing the pros and cons to cost and expenses, not just on emotion.
AC: Although, you know, I mean, I teach law students and we usually sort of think about lawyers as engaged in legal reasoning. As an example, what's the interpretation—correct interpretation—of the statute or the Constitution? But the policy-based thinking is actually really, really important, too. And then a lot of the policy-based thinking, in many cases comes outside of the law because by simply reading through the cases, or simply reading through the statute usually does not give you this more policy-based reasoning. So, that's why we often sort of try to borrow from economics, political science or history or sociology or psychology to think a little bit more, let's say outside the box of law, and then kind of think about what exactly is the implication of adopting a certain kind of legal system.
AK: That's why that was valuable scholarship to have this policy-based nuances added to, you know, considerations around class action waivers and litigation.
AC: I certainly do hope that we're making a contribution here.
AK Yeah, well, you definitely got me thinking that, even though I didn't totally understand all the graphs that like the first or even second pass, but that's just ‘cause I'm 20 years rusty on econ. But it does have me thinking about, you know, how to weigh in some of this more rational reasoning around considerations in the legal arena.
So, let's talk about the Coronavirus. The COVID-19 pandemic introduced new dynamics in the market and that we could not foresee litigation risks. How did the pandemic create new challenges for both the practice and theory of law? And how does this throw a new layer of complexity over the question of enforceability?
AC: Yeah, that's a very difficult question. Obviously, because of the coronavirus pandemic, a lot of companies had to either cancel or not be able to honor their obligations to, you know, consumers, employees, and so on.
So, one great example might be something like Ticketmaster. So, you know, Ticketmaster sold a lot of tickets for concerts or different kinds of performances. But all of a sudden, because the pandemic, they had to cancel all these and then the customers and consumers wanted to get a full refund. And then Ticketmaster was trying to refuse to give the full refund. And then, you know, one of the ways they're trying to do so is by pointing to the mandatory individual arbitration clause and saying that if you want to bring a claim against us to get a full refund, you have to bring a lawsuit in individual arbitration, rather than bringing a class action.
So, the basics of that story is really not that different from the conventional story about, let's say, the firms in certain circumstances, trying to eliminate class actions for their own benefit. And in the process kind of undermining potential deterrence. What is, I guess more novel through the coronavirus pandemic is one, a lot of that risk was unanticipated. We didn't know, let's say circa February 2020, we didn't really realize that this was actually going to become a pandemic. And what the implication of that is that when the consumers were signing on to those contracts, or anybody was signing on to those contracts, they didn't fully anticipate something like this was going to happen. And then the other I think really strongly interesting aspect about the coronavirus pandemic is that a lot of these social good nature, social good aspects of the consequences. Because the reason, let's say, that Ticketmaster, those performances could not be held or the reason why all the sports events got canceled, the reason why airplanes could not fly was not only because of the coronavirus pandemic, but because the various kinds of government regulation because government by law can say you cannot have these mass gatherings and then you cannot have all these people flying in a confined space within an airplane.
So, I think, you know, those kinds of situations present new challenges to the class action waiver. With respect to the first, especially if we think that the consumers or employees and whoever who signed on to these mandatory individual arbitration clauses did not expect something like the Coronavirus pandemic was going to take place, then, you know, we would argue that that's kind of like a consumer misperception issue. That's really not that different from me signing onto a mandatory individual arbitration clause without knowing that I'm actually signing away the right to a class action waiver. So, of course, the story's a little bit different. But the functionality, or at least the reasoning seems fairly similar. If we kind of think about that, as similar to the consumer misperception issue, then that leads to the argument that the mandatory individual arbitration clauses should not be as vigorously enforced.
And then the other is the public health aspect, public good aspect, given that a lot of these companies are shutting down maybe because of the government regulation. And then if we were to allow, let's say, the companies to have these massive gatherings, that's actually going to cause a serious public health concern. Then again, you know, in contract law, we sometimes talk about the public policy rationale behind why certain kinds of contract clauses should or should not be enforced. So, we can think about a similar line of reasoning here, forcing the companies to, you know, hold massive gatherings is going to create a large amount of public health hazard, and then not allowing the individual consumers to recover the refund is, in some sense, sort of dovetails with it, government regulation. So, that would also perhaps argue in favor of not honoring the mandatory individual arbitration clauses.
: Albert, tell us about the context around the nascent arbitration aggregation model. How much momentum does it have? And could it eventually undermine its own viability by swinging the pendulum all the way back towards litigation?
AC: Yes, this is a really interesting innovation that is actually being done by some lawyers. So, we know that large companies are again asking their consumers to sign mandatory individual arbitration clauses. And then because all the courts are upholding those clauses, consumers cannot bring a class action. So, what some of the lawyers decided to do is to, kind of, automate the entire system. So, they know that individual consumer is not going to bring on arbitration claim against a large company, such as AT&T. But however, I'm the lawyer, let me just make it really easy for you, you submit an arbitration, quote unquote, claim to us and then we are going to file that arbitration claim on behalf of you against, let's say, a large companies such as AT&T, and then how they keep the cost down, in terms of filing these claims against large companies, is through automation. So, they actually have created this computer algorithm, that whenever someone, some individual consumer decides to submit a claim to the system, they kind of automatically generate an arbitration claim against AT&T, or large company, so that you don't have to have every single time a lawyer coming in, and then doing the system.
When thousand and thousands, of literally thousands of thousands of claims—individual arbitration claims—are being filed against a single company, that could actually translate to a huge amount of litigation costs from the company's perspective. So, I've heard, at least through the anecdotes, that some companies are willing to stay away from this altogether, when they receive this barrage of individual arbitration claims, and then move all together back to the class action system.
So, with respect to the last question, I think it is definitely possible as this arbitration aggregation model takes off more and more. I think it's going to be definitely possible for the more and more companies to stay away from the individual arbitration, but rather sort of move on to the class action system.
But it's also kind of interesting about this story is that sometimes the class action system itself is also beneficial from the defendant’s perspective as well. Because from the defendant’s perspective, the last thing they want is individuals all filing different claims against a company. So, by aggregating all the individual claims into a single claim, let's say through a class action, it also can actually help the company because now they don't have to fight all these thousands of different individual lawsuits. So, I think that's very, sort of, different from that perspective.
Now, how much momentum does it actually have? That's the question that I cannot, I don't know the answer to. And I know that at least a couple of other scholars are kind of looking at this issue more closely. And I would love to know more about this. I know that some of these are actually definitely taking off, especially in states like California, but how far they have gotten, you know, how much traction they're getting across many different areas of the law, I think that requires some additional data collection and examination.
AK: And I thought that was a very valuable part of your paper with Kathy Spears as well in acknowledging, identifying some of these unresolved issues for further research.
AK: Albert H Choi is a professor at the University of Michigan School of Law, who approaches the law from the lens of an economist. He teaches and researches on contracts; mergers and acquisitions; corporate finance and law; and law and economics. Published in over a dozen journals, Dr. Choi helps make the inaccessible understandable, so thanks for doing that for us today, Albert.
AC: Thank you so much for having me. It was a lot of fun.
