Relying on the Supreme Court’s holding in Stolt-Nielsen, Second Circuit Determines that Class Arbitration Clause is Unconscionable

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Fensterstock v. Education Finance Partners, et al.

(2nd Cir. (N.Y.) July 12, 2010)


Plaintiff commenced this action asserting state law claims on behalf of himself and others similarly situated, alleging that defendants engaged in fraudulent and deceptive practices in connection with the solicitation, consolidation, and servicing of student loans.  Plaintiff alleged that defendants intentionally failed to disclose to borrowers that unless their payments were received on the precise day of the month on which they were due, defendants would alter the Amortization Schedule’s prescribed apportionment of the payment between interest and principal, diverting the entire payment to themselves as interest and preventing borrowers from paying off the principal of their loans.


Defendants moved for an order staying the action and compelling plaintiff to submit his claims to arbitration, pursuant to an arbitration clause contained in his promissory note, and to pursue them on an individual, rather than a class, basis.  The United States District Court for the Southern District of New York denied the motion, ruling that under California law, the arbitration clause of the agreement is unconscionable and therefore unenforceable.


Defendants appealed, arguing that the arbitration clause is not unconscionable under California law, or that if it is, then California law is preempted by the Federal Arbitration Act.  The United States Court of Appeals for the Second Circuit affirmed.  The court rejected defendants’ contention that the Federal Arbitration Act preempts California principles as to the conscionability of class arbitration waivers since California law places arbitration agreements with class action waivers on the exact same footing as contracts that bar class action litigation outside the context of arbitration. 


Additionally, the court applied California’s three-part test to determine whether a class action waiver in a consumer contract is unconscionable: (1) whether the agreement is a consumer contract of adhesion drafted by a party that has superior bargaining power; (2) whether the agreement occurs in a setting in which disputes between the contracting parties predictably involve small amounts of damages; and (3) whether it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money.  The court held that the record in this case satisfied this test and concluded that the promissory note’s class action and class arbitration waiver clause was unconscionable.


For a copy of the decision click here


Toni Frain and Dan Gerber