Under a proposed ordinance introduced last month, companies that do business with the City of Chicago would be banned from requiring mandatory or binding arbitration to resolve disputes with any of their customers or employees, even those beyond Chicago. For instance, a national retailer or bank holding contracts with the City of Chicago would be prohibited from using mandatory arbitration agreements from coast-to-coast, if it wished to continue doing business with the City of Chicago. The ordinance was introduced by Alderman Edward Burke, a fixture in Chicago politics, who is the longest-serving alderman in Chicago history and the powerful chairman of the City Council’s Finance Committee.

“Over the past decade, thousands of companies have begun inserting ‘mandatory arbitration’ clauses into contracts, shielding themselves from court action by consumers over alleged discrimination, elder abuse, fraud, hate crimes, medical malpractice and wrongful death,” according to a news release from Chairman Burke’s office. Under the proposed ordinance, “[n]o business entity shall be eligible to do business with the city if such business entity enters into any pre-dispute arbitration agreement with any natural person after the effective date of this ordinance that requires arbitration of an employment or consumer dispute arising from any law intended to protect civil rights.”

In practical effect, the ordinance would apply to national banks with municipal depositories as well as all entities doing business with the City of Chicago, such as automobile manufacturers, car dealers, cellphone carriers, and office supply companies. If the ordinance passes, there will likely be challenges to its constitutionality, as it may be argued to impermissibly regulate conduct outside of contractual relationships with the government.

Mandatory Arbitration: Pros and Cons

The current legislative and judicial climate favors implementation of pre-dispute arbitration agreements (PDAA) for consumer and employee disputes. A PDAA is an agreement made by parties in a contract before any issues or problems arise, and through which the parties agree that they won't be allowed to file a lawsuit in a court, but instead they will have to work with an arbitrator to resolve their dispute. Many PDAAs also contain waivers of the right of file class actions or waivers of the ability to arbitrate claims as a class of individuals. Since access to courts is generally foreclosed, these agreements are also referred to as mandatory or binding arbitration. These clauses are prevalent in a number of types of contracts including, among others, cellphone contracts, credit agreements, vehicle loans, school enrollment forms, nursing home contracts, and employment contracts in non-union workplaces.

These clauses provide employees and consumers with a private forum to resolve their claims against the company instead of the public forum—whether judicial or administrative—that is generally available for such claims. The use of PDAAs have arguments both for and against their use and social utility. In favor of their use, there are benefits to efficiency and cost savings. Against their use, there are arguments that arbitration proceedings are not transparent and not subject to open records laws.

Background for State and Local Government Regulation of Mandatory Arbitration

There has been a recent call for state and local governments to regulate the use of mandatory arbitration. This call to regulatory action comes as all branches of the federal government are focusing on arbitration. In the judicial branch, the United States Supreme Court continues to issue cases affirming the validity of arbitration. See AT&T Mobility v. Concepcion, 131 S. Ct. 1740 (2011); American Express Co. v. Italian Colors Restaurant, 133 S. Ct. 2304 (2013); DIRECTV, Inc. v. Imburgia, No. 14-462., -- S. Ct. -- (Dec. 14, 2015). In the legislative branch, Congress has made changes in federal law, like the Dodd-Frank Wall Street Reform and Consumer Protection Act’s prohibition of pre-dispute arbitration agreement in mortgage contracts. See 15 U.S.C. § 1639c(e)(1). In the executive branch, the Consumer Financial Protection Bureau (CFPB) has issued a number of reports after its investigations of consumer impacts from use of arbitration. Section 1028 of the Dodd-Frank Wall Street Reform and Consumer Protection Act provides that the CFPB can issue regulations to prohibit or restrict the use of mandatory arbitration agreements if, based on the results of a mandated study by CFPB, it finds such regulation to be “in the public interest and for the protection of consumers.” Pub. L. 111-203, 124 Stat. 1376 (2010). Industry and consumer advocates are awaiting a Notice of Proposed Rulemaking from the CFPB on the use of PDAAs, which is anticipated to be released in beginning of 2016.

Can Chicago Ordinances Trump the Federal Arbitration Act?

In general, the Federal Arbitration Act (FAA) preempts any state law that limits arbitration. More specifically, the FAA provides that arbitration clauses may be invalidated only by legal theories that may be used to invalidate any contract, including lack of capacity, lack of consideration or mutuality, duress, and unconscionability. See 9 U.S.C. § 2. State law may not impede nor act as an obstacle to enforcement of arbitration, and any such laws are preempted by the FAA.

While the FAA preempts some state laws regulating private agreements to arbitrate, it cannot prevent states from using their public enforcement and procurement powers to protect their own financial and enforcement interests. To the extent that a state or local governmental entity, acting as a market participant and not as a regulator – also referred to as acting in a proprietary versus governmental capacity – determines that companies utilizing arbitration clauses in employment or consumer contracts adversely affect that governmental entity’s procurement activities, then that state or local government can choose not to contract with those companies. In fact, there is precedent for such market participant regulation, which the federal government recently utilized. On July 31, 2014, President Obama signed the Fair Pay and Safe Workplaces Executive Order. See Exec. Order No. 13,673 (2014), available here. Under a section titled “Complaint and Dispute Transparency,” the order prohibits pre-dispute, binding arbitration agreements covering discrimination, assault, and sexual harassment claims in contracts between large federal contractors and their employees.

As long as the governmental entity acts as a “market participant,” the requirement for its vendors to not use PDAAs is not subject to federal preemption or other normal limitations on the agency’s regulatory authority. In favor of the proposed Chicago ordinance, the argument exists that a city contractor might use PDAA clauses in consumer and employment contracts to conceal from public scrutiny allegations of legal violations, which could interfere with the quality of the goods and services provided to the municipality. Unlike the public records of a court system, arbitration proceedings are not transparent to third parties outside of the dispute. Without being able to track these claims, the municipality might not be able to properly vet prospective contractors nor be able to identify ways in which it, like other grieving parties, may be harmed by or not receiving the full benefit of bargained-for services from its contractors.

However, if the agency’s purpose is intended to regulate the entities with which it does business, then it is not truly acting as a “market participant.” If the ordinance passes, then this will be one challenge to its enforcement. A court examining the ordinance will inquire whether the impact of the ordinance is on how municipal vendors conduct themselves inside business relationships with the City of Chicago, or whether the impact of the ordinance is on how these municipal vendors conduct outside of those proprietary relationships with the City of Chicago. A rule of thumb in this area of law is that a governmental agency generally acts with a regulatory purpose if it acts out of concern with a private party’s conduct outside of its relationship with the government. Here, the ordinance itself states that “[f]orced mandatory arbitration clauses are destroying a core American principle,” namely, the ability of individuals to have their day in court and joining together in class-action lawsuits. The City of Chicago could potentially ban usage of PDAAs in its own contracts, but reaching out beyond those contracts too all individuals’ access to courts might be too far a stretch. Under the well-settled unconstitutional conditions doctrine, a government may not require a person to give up a constitutional right in exchange for a discretionary benefit conferred by the government where the benefit sought has little or no relationship to the constitutional right.

Takeaway

There has been a recent call for state and local governments to regulate the use of mandatory arbitration, and as this recent proposed ordinance from the Chicago City Council shows, businesses need to orient their government relations strategies to also include municipal entities. If this proposed ordinance passes, then companies that do business with the City of Chicago would be banned from requiring mandatory or binding arbitration to resolve disputes with customers or employees. While there are constitutional arguments that could be raised against such an ordinance, it is important for affected businesses to engage the City Council and voice their concerns.