Evan Schuman's StorefrontBacktalk

Attorney Mark D. Rasch is the former head of the U.S. Justice Department’s computer crime unit and today serves as Director of Cybersecurity and Privacy Consulting at CSC in Virginia.

Retailers have won a major procedural legal victory against credit-card issuers when a federal appellate court in New York refused to force them to individually arbitrate claims against the financial institutions, despite the existence of an arbitration agreement that mandated such arbitration. The litigation creates a split among federal courts regarding the enforceability of these mandatory arbitration agreements when they conflict with other federal laws.

The merchants’ victory may by a Pyrrhic one, because consumers may use the same rules to invalidate arbitration provisions and file class-action lawsuits against the merchants themselves.

Mandatory arbitration agreements are really great when you benefit from them, and terrible when you don’t. Merchants and employers use these agreements all the time (typically in the small print on a Web site) to ensure their customers cannot file lawsuits against them and, more importantly, cannot file class-action lawsuits against them. Most famously, a purchaser of a “free” AT&T cell phone was, like tens of thousands of other cell phone purchasers, billed $60 from the telecommunications company for fees and taxes on the “free” phone.

The subscriber agreement with AT&T permitted him to initially shell out $175 to start an arbitration proceeding and get his $60 bucks back. But what lawyer would spend hundreds of hours and tens of thousands of dollars in an effort to recover $60? So the lawyer, on behalf of the consumer, filed a class-action lawsuit against AT&T on behalf of all the consumers who were billed for what they thought was a free phone.

The U.S. Supreme Court ruled that the arbitration agreement on the company’s Web site precluded such class-action lawsuits, or even class arbitrations, and that the Federal Arbitration Act trumped a California law that made such class-action waivers inherently suspect. Even if you have a right to sue, and even if you have a right to sue in class action, you can waive that right. And by buying an AT&T phone, that’s exactly what the consumer did, according to the Supremes.

Class-action waivers and arbitration agreements can be great for merchants. Imagine putting a notice at a grocery store stating that by entering the store you agree not to sue the store for negligence but instead to arbitrate any disputes. Slip and fall? No lawsuit. Find half a mouse in your food? Arbitrate.

Arbitration has a lot of advantages for companies. First, unlike in court, where you get the luck of the draw, you get a say in selecting the arbitrator. Moreover, arbitrators (unlike judges) are paid by the litigants. If you are frequently arbitrating these types of cases, then you are frequently paying the arbitrator. Arbitrators are only paid if they are selected to arbitrate, and you are not likely to select an arbitrator who consistently rules against you, right?

Next, there is almost no “discovery” in arbitration—meaning that the person seeking a remedy from the company cannot rummage through that company’s files looking for even relevant evidence. And arbitrations are generally secret. So if a company loses the arbitration, there is no precedent that another arbitrator is bound to follow. The arbitration agreement can set out the rules for the arbitration: How many arbitrators there will be, who pays the costs, what law applies to the arbitration, where the arbitration must occur, whether it must be attended in person, etc. It’s like running your own little private justice system.

Class-action waivers are even better for defendants.