How-to guide: Practical steps to consider when drafting consumer arbitration agreements (USA)

Introduction

This guide will assist in-house counsel and private practice lawyers with drafting consumer arbitration agreements to resolve disputes between businesses and consumers. It covers the key considerations when drafting consumer arbitration agreements and the enforceability of such agreements.

The guide covers:

Overview of consumer arbitration agreements
Ensuring the consumer arbitration agreement is enforceable
Drafting considerations for consumer arbitration agreements

Arbitration agreements have long been used in commercial transactions. Now, they are increasingly being used in consumer transactions. While the agreements are generally enforceable, consumer contracts often implicate special rules regarding matters such as disclosure, or plain English requirements. These rules are not present in commercial contracts but need to be remembered in the consumer context.

This guide can be used in conjunction with the following How-to guide: How to use arbitration agreements in employment.

Section 1 – Overview of consumer arbitration agreements

1.1 What are consumer arbitration agreements and when are they used?

Arbitration is a form of alternative dispute resolution (ADR), which provides a way of settling a legal dispute outside of the court system. A key element of arbitration is that a neutral arbitrator guides the process, hears the parties’ evidence, and issues a final binding decision regarding the dispute. Arbitration may include live or recorded testimony. Arbitrators are often (but not invariably) lawyers or former judges, but the rules they apply during the arbitration (particularly evidentiary rules) do not follow the formal rules of procedure and evidence that they would in a courtroom trial.

Consumer arbitration agreements set out the types of disputes that can be referred to arbitration and commit those signing the agreement to resolve disputes via this alternative mechanism. Such an agreement can be made either before the contract is agreed, during the life of the agreement, or when a dispute arises.

Consumer arbitration agreements typically consist of a clause included in a broader, standardized legal agreement between a business providing a product or service and their customers. A wide variety of businesses – such as banks, credit card companies, health insurance providers, car dealerships and telecommunications companies – include such pre-dispute arbitration clauses in their consumer contracts. In these cases, the choice of arbitration is mandatory by contract, and the consumer may be unaware that any disputes must be resolved by arbitration because the contract offered is non-negotiable. Here, the business is in a position of power over the consumer, and the consumer will forfeit their rights to pursue claims through the court system.

A post-dispute arbitration agreement is entered into by the involved parties only after conflict arises. In such cases, the decision to proceed via an alternative dispute mechanism is made by mutual consent and represents an intentional choice. This is in contrast with pre-dispute consumer arbitration agreements, which are often overlooked by consumers (as they may not be placed conspicuously in the agreement) or seen as an unavoidable element of choosing certain products or services. Arbitration agreements entered into during the life of a contract may fall on either end of this spectrum. They may be entered into with the full knowledge of the parties, or when the business periodically updates their terms and conditions. Generally, the Federal Arbitration Act (FAA) provides that arbitration agreements are enforceable except where they are unconscionable or entered into under duress. State laws should also be considered when drafting arbitration clauses.

Regardless of when the arbitration agreement is made, during an arbitration the arbitrator will hear the parties’ evidence and then make a binding decision and award. While a court will hear an appeal from an arbitrator’s decision, the grounds for overturning such a decision are narrow, and reversal is rarely granted. It is possible, however, to agree on non-binding arbitration, which allows parties to bring a lawsuit if they are not satisfied with the arbitrator’s decision.

1.2 What are some of the perceived benefits of consumer arbitration agreements?

Consumer arbitration agreements can be an attractive alternative to litigation for the reasons listed below.

Arbitration is generally faster and less expensive than court proceedings. Court hearings can take several years, whereas arbitration hearings can be scheduled based on the availability of the parties and the appointed arbitrator.
The parties may mutually agree upon their choice of arbitrator.
The proceedings themselves are less formal from a procedural perspective. For example, evidentiary rules are not applied as rigidly as they would be in a courtroom setting, and discovery (the process of taking and answering questions and requests to produce documents) is likely reduced during an arbitration hearing.
The proceedings can also be more discreet given that they are not a matter of public record and the nature of the resolution can be kept confidential.

1.3 What are some of the perceived disadvantages of consumer arbitration agreements?

Arbitration has several disadvantages which include the ones listed below.

Selecting an arbitrator may prove to be contentious. The choice of the arbitrator will be governed by the terms of the agreement.
If the parties have agreed to binding arbitration, the arbitrator’s decision is final and will rarely be overturned on appeal. This gives finality to the decision and is not comparable with a trial decision which may be subject to further appeals. This can be difficult if one party is not totally agreeable with the final decision.
The limited scope of judicial review for arbitration awards can provide disadvantageous to the losing party.
The scope of discovery and the methods that may be employed are both limited, so the parties may enter a hearing without a clear idea of the other party’s position, or the arguments that may be employed. This lack of transparency may prove difficult longer-term too, as arbitration decisions are rarely reviewed by the courts, and it is more difficult for victims to recognize how companies have resolved similar issues for other customers.
Given the discretion afforded to the arbitrator, the decision-making process may not be as transparent as that of a court. In addition, having a jury helps prevent bias whereas the arbitrator acts as both judge and jury.

Section 2 – Ensuring the consumer arbitration agreement is enforceable

2.1 Federal law favors arbitration as an alternative dispute resolution mechanism

Congress enacted the Federal Arbitration Act (FAA) (9 USC Ch 1) in 1925 to prevent courts and state laws from refusing to enforce arbitration.

Section 2 of the FAA provides that it applies to arbitration agreements that are as follows:

in writing; and
relate to ‘any maritime transaction or a contract evidencing a transaction involving commerce.’

It further provides that arbitration agreements involving interstate or foreign commerce (within the scope of section 2), are valid, irrevocable, and enforceable. The US Supreme Court has interpreted the FAA as a ‘liberal federal policy favoring arbitration.’ Where the FAA applies, it preempts any state laws that would otherwise invalidate arbitration agreements and requires state and federal courts to enforce arbitration agreements on an equal footing with other contract provisions. See Southland Corp. v Keating, 465 US 1 (1094) at 16, where it states:

In creating a substantive rule applicable in state as well as federal courts, Congress intended [the FAA] to foreclose state legislative attempts to undercut the enforceability of arbitration agreements.

Such agreements can therefore only be invalidated upon generally applicable contract defenses, as exist at law or equity for the revocation of any contract. Examples of such defenses include fraud, duress, or unconscionability (a particular concern when drafting a consumer contract).

As a result, the Court has upheld arbitration agreements in a variety of contexts, including in disputes that involve businesses and individuals (rather than limiting this approach to situations involving conflicts amongst businesses). It has repeatedly done so with respect to employment and consumer arbitration agreements. For example, in Allied-Bruce Terminix Cos v Dobson, 513 US 265 (1995), the Court declined to apply a state statute invalidating pre-dispute arbitration agreements in a case involving an arbitration agreement in a termite prevention contract. In T&T Mobility LLC v Concepcion, 563 US 333 (2011), it went a step further and upheld a consumer arbitration agreement that required consumers to pursue any claims in individual arbitrations and explicitly prohibited them from doing so as part of a class action, ie, requiring them to waive their right to proceed collectively or as part of a group.

Similarly, in 2001, the Court held (in Circuit City Stores, Inc v Adams, 532 US 105 (2001)) that the FAA applies to most contracts of employment, subject to only narrow exceptions – ie, those involving workers who, like seamen and railroad workers, are engaged in transportation that crosses state lines. More recently, in Epic Systems Corp v Lewis, 584 US 497 (2018), the Court held that, where an employer and employee enter into a contract providing for individualized arbitration proceedings to resolve employment disputes, the employee cannot seek to litigate Fair Labor Standards Act and related state law claims through class or collective actions.

These decisions have been somewhat controversial and have prompted criticism at both state and federal levels. They have also sparked recurring efforts by Congress to attempt to limit the applicability of pre-dispute arbitration agreements. To date these efforts have not been successful although a measure that was limited to invalidating pre-dispute arbitration agreements that precluded individuals from bringing sexual harassment or sexual assault claims in court was signed into law in March 2022.

Example

In Smith v Spizzirri, 601 US (2024), decided May 16, 2024, the Supreme Court addressed the question of the authority of federal courts where an action is first brought in the federal court but is later determined to be arbitrable. Here, the court held that in these circumstances, when one party requests a stay of the court proceeding pending arbitration, Section 3 of the FAA compels the court to issue a stay. Further, the court lacks the discretion to dismiss the suit upon a motion by one of the parties. From a practical matter, should the defendant (or the arbitration provider) subsequently refuse to participate in the arbitration for whatever reason the court action has not been dismissed - only stayed. Thus, the plaintiff can go back to the same court and seek to resume litigating the case in court.

2.2 State laws may govern whether a consumer arbitration agreement is enforceable

All states and the District of Columbia have their own arbitration laws. These laws often mirror language in the FAA and also cover specific issues not addressed by the federal statute. While many of these state laws are based on the Uniform Arbitration Act (revised in 2000), they vary, so it is vital to check the specific laws of any relevant jurisdictions. This includes checking case law interpreting the statutes.

However, the FAA may ultimately preempt these state laws. Determining whether, and to what extent, it does so is no easy task. Broadly speaking, based on US Supreme Court precedent, courts have held that the FAA preempts state law (in whatever form) if the state law does not generally apply to all contracts, but instead ‘singles out’ arbitration agreements. As a result, state-level restrictions on enforcing arbitration agreements, including pre-dispute consumer arbitration agreements, have repeatedly been struck down. Furthermore, the Supreme Court determined that the FAA will preempt any state rule discriminating against arbitration, for example, ‘a law prohibit[ing] outright the arbitration of a particular type of claim.’

2.3 Rules of dispute resolution associations may determine enforceability

Various associations and organizations offer dispute resolution services in the United States. Major players include the American Arbitration Association (AAA), American College of Civil Trial Mediators, and Judicial Arbitration and Mediation Services (JAMS). These associations have developed their own rules to guide any arbitration handled by them, and some provide that the question of whether a dispute will be handled through arbitration is decided by the arbitrator. Whether or not a consumer arbitration agreement is enforceable will therefore depend not just on federal and state law, but also on the rules followed by the arbitration organization selected to resolve the dispute.

For example, arbitrators who are engaged by the AAA must adhere to the code of ethics developed by the organization together with the American Bar Association. The AAA’s rules provide the framework for the arbitration process. Specific rules – the AAA Consumer Arbitration Rules – apply for arbitration agreements between individual consumers (eg, buyers or users of products and services for personal or household use) and businesses that use standardized arbitration clauses containing mostly non-negotiable terms. Rule 4(c) of the AAA Consumer Arbitration Rules gives arbitrators the authority to determine jurisdiction pursuant to Rule 7, including ruling on his or her own jurisdiction, any objections to the validity of the arbitration agreement, or the arbitrability of any claim or counterclaim.

The organization has also developed the AAA Consumer Due Process Protocol to ensure evenhandedness in consumer dispute resolution, and will decline to administer arbitration demands based on arbitration clauses that violate its principles. In total there are 15 principles that the AAA will look for in consumer arbitration agreements. Regarding agreements to arbitrate, the Protocol provides, among others, that consumers should be given ‘clear and adequate’ notice of the arbitration provision and its consequences, as well as basic information about the differences between arbitration and court proceedings. The AAA also requires businesses to register their consumer arbitration agreements on the AAA consumer clause registry, a publicly available database of consumer arbitration clauses.

2.4 Types of claims excluded from eligibility for arbitration

Some types of claims are specifically excluded from arbitration eligibility. As mentioned above, legislative action was taken to end the forced arbitration of sexual assault and sexual harassment, and most claims that involve family law, immigration law, criminal law, or that are based on illegal activity cannot be arbitrated. While courts generally favor arbitration clauses, there are cases where courts have held that the claims were outside the scope of the arbitration agreement.

In Hearn v Comcast Cable Communications, LLC, 415 F Supp 3d 1155 (ND Ga 2019), rev’d 992 F 3d 1209 (11th Cir 2021), the parties entered into a contract for the defendant to provide cable services. The contract contained a binding arbitration clause that included a survival clause which stated that ‘the parties’ agreement to arbitrate survives termination of the agreement.’ Subsequently, the plaintiff terminated his use of the defendant’s services and later filed suit for various violations of the Fair Credit Reporting Act (FCRA), alleging that Comcast obtained his consumer report for an impermissible purpose. In response, Comcast argued that the plaintiff’s claims were covered by the arbitration agreement in the parties’ contract.

The District Court considered whether the plaintiff’s FCRA claim was within the scope of the arbitration clause and ultimately denied arbitration because the plaintiff’s claims did not arise out of the agreement. On appeal, however, the Eleventh Circuit held that FCRA claim related to the Subscriber Agreement and therefore fell within the Arbitration Provision. Comcast was able to conduct a credit check only because of its previous relationship with the plaintiff, and, more importantly, the contract contained provisions that specify duties relating to Comcast's alleged unlawful credit inquiry. The District Court was reversed.

In Bryant v Advanced MP Tech, G059215 (Cal Ct App Feb 22, 2021), the defendants hired the plaintiff as a commissioned sales manager, who signed an at-will employment and arbitration agreement on his first day at work. Three months later, the defendants fired the plaintiff. The plaintiff then asserted that the defendants had failed to pay him commissions that were due and later told prospective employers not to hire him. The plaintiff then filed a complaint against his former employer asserting several causes of action that allegedly arose during his employment, including failure to pay wages, breach of contract, and fraud. Importantly, the plaintiff also asserted two claims that allegedly arose after his employment: intentional and negligent interference with prospective economic relations.

The employer filed a motion to compel arbitration on all the claims, and the trial court granted the motion on all except for the two post-employment claims. The employer appealed. The court held that where the claims are 'rooted' in the contractual relationship between the employer and the employee, then post-employment claims may be within the scope of the arbitration clause. However, claims that are independent of the employment relationship are outside of the scope of an arbitration agreement.

In holding that the plaintiff’s claims of intentional and negligent interference with prospective economic relations were outside the scope of the parties’ arbitration agreement, the court stated, 'However broad may be the terms of a contract, it extends only to those things concerning which it appears that the parties intended to contract.'

Section 3 – Drafting considerations for consumer arbitration agreements

Drafting a consumer arbitration agreement that works best for your business will largely depend on your specific situation. However, keeping certain basics in mind can help avoid common pitfalls and, in general, a consumer-friendly arbitration agreement is more likely to be enforced. See also section 2 of How-to guide: How to use arbitration agreements in employment (USA) which provides additional guidance on drafting considerations.

3.1 Specify the scope of the agreement

It is vital to give consumers who are asked to sign arbitration agreements clear notice of what they are agreeing to. This means making clear both what it means to agree to arbitration and the scope of the arbitration agreement in terms of the kind of claims covered.

First, you should explain, in plain English, what arbitration is and what the process entails for consumers, ie, what the consumer is ‘giving up.’ The agreement should state directly that consumers agree to give up their right to go to court, that the dispute will be held in front of a neutral arbitrator instead of a judge or jury, it will be subject to different rules than a court, and there will be limited judicial review (if any) of the outcome. It can also be helpful to provide links to the websites of organizations that offer supporting resources on arbitration.

In terms of the kinds of claims covered, it is common to broadly state that the arbitration agreement applies to all disputes brought by both sides (not just to claims that the consumer brings) that ‘relate to,’ or ‘arise out of’ the contract at issue. Carve outs – exceptions to a general requirement that ‘all claims’ be arbitrated – can be similarly tricky, in that they can end up being interpreted more broadly or more strictly than anticipated. Precision when drafting is key.

In addition, be aware that certain matters may not be eligible for arbitration under federal or state law. It is beneficial, therefore, to provide that the agreement will not apply to those matters deemed ineligible under established law. This will make it clear to any court or other party reviewing the agreement after it is signed that there was no intention to deceive the consumer, or to claim the right to arbitrate where no such right exists. In addition to laws, rules promulgated by arbitration associations may require you to exclude certain claims. For example, the AAA’s rules on consumer arbitration provide that, if a party’s claim is within the jurisdiction of a small claims or conciliation court (usually, anywhere from $5,000 to $15,000), either party may take their claims to that court without first filing with the AAA. The policy theory here is that small claims courts will provide a simple, expedient, low-cost resolution tool essentially like arbitration.

3.2 Specify which arbitration rules will apply

Identify the institution that will be conducting the arbitration, explain what rules will apply, and provide a link to its rules. As noted, the AAA is a well-established and commonly used option, though be sure to review their rules (see, eg, AAA rules, AAA Consumer Arbitration Rules and JAMS rules), to confirm that you agree with any imposed limitations.

3.3 Specify by whom and where the dispute will be heard

Specify the number of arbitrators that will be involved in settling the dispute. The advantages of having a single arbitrator are speed of appointment, decision-making, greater flexibility in achieving a hearing date and cost-savings. That said, the larger the sum in dispute, the more arbitrators you may wish to appoint, and an uneven number of arbitrators is the best approach. However many you choose, you should set out clearly how they are to be selected. You may even want to consider a predetermined arbitrator but in the event they are not available be sure to set out several alternatives and options. In contracts relating to specific industries, or of a technical nature, you should expressly state the specific qualifications or experience that the arbitrator must possess.

Thinking about the physical location of the actual arbitration hearing is also important. This dictates not just the geographical location of the proceedings but may also dictate the law of the proceedings. See also section 3.5 below. The physical location of arbitration is frequently based on convenience and often aligns with governing law, but it does not have to. Courts may be skeptical of agreements that include locations that are not easily accessible and burden consumers in terms of travel required – for example, a court may find a requirement that the arbitration be conducted in the state of the business’s incorporation places an excessive burden on the consumer. One-sided clauses may be struck out and unenforceable if they are unconscionable or breach the AAA consumer clause requirements or state law. It should also be made clear whether a ‘desk arbitration’ via written submissions or participation via phone or video will be permitted.

3.4 Include consolidation and joinder clause

When entering into the same contracts with many parties (eg, when selling a standardized consumer product), it is likely that your company will encounter separate disputes involving factually similar situations. An important question to ask is how many parties there are to the contract. Having different arbitrators handling these disputes can be messy, expensive, and time-consuming, especially when they produce conflicting decisions.

To avoid this scenario, include a consolidation and joinder clause. Consolidation refers to the merging of separate disputes involving the same or interrelated contracts, ie, the consolidation of proceedings accruing on the same cause of action. Joinder refers to adding a third party to the action when the causes of action are the same. Thus, rather than having multiple proceedings, consolidating or joining them makes the process more efficient without compromising the rights of any of the parties. Be sure to check whether the rules of the arbitration organization (eg, AAA or JAMS) you have agreed to adhere to impose specific requirements regarding consolidation and joinder.

3.5 Specify which laws will govern the agreement in the event of dispute

The FAA does not contain choice-of-law rules. Parties are therefore free to decide which substantive law will apply to their arbitration proceedings. The parties typically agree on which law applies to a given matter or issue in the underlying contract for determining choice of law, and it is important to express that choice very clearly and precisely. This will determine the validity and effect of the agreement. Rather than relying on a general choice-of-law clause that applies to the entire contract, it is best to articulate that this choice also specifically applies to the arbitration agreement. If the parties’ choice is not sufficiently clear, it will fall on the arbitrator to make their own choice-of-law determination.

There are limits to which state law you can choose. For example, some states require some sort of connection to the state before a court will apply that state’s laws to an arbitration agreement (or any other form of contract). Others do not. However, it may be prudent to choose the laws of a state that has a ‘reasonable relationship’ to the transaction. Do the parties have a presence in the jurisdiction? Did the transaction arise there? Is the dispute focused on events that took place there? Within that range, some states may have laws that more strongly favor the drafter of the agreement, or impose additional requirements, such as separate consideration (ie, something of value) for the agreement to arbitrate.

3.6 Practical considerations worth noting

Efforts to address the essential elements outlined above will not matter if consumers are not aware of them. When the arbitration agreement is included in an actual, physical contract, make the arbitration agreement clause conspicuous and clearly visible. For example, place it towards the beginning of the contract or, if you keep it further down in the text, refer consumers to the later clause at the beginning. Also be sure to give the clause a clear title and call attention to where it is located.

Transactions handled online call for a different approach. If you want consumers to agree to arbitration via your website, you need to put them on notice to read the contract terms, which are likely spelled out in a separate document accessible via hyperlink. If so, make sure that both the notice and the link are visible. It is also advisable to ask consumers to actively agree to the terms of use, such as by clicking a button indicating that they do so. This is referred to as a ‘clickwrap’ approach. Arbitration agreements entered in this manner are generally held to be enforceable as they are presented directly to consumers who have consented to the hyperlinked terms.

Additional resources

American Bar Association Section of Dispute Resolution
Association for Conflict Resolution
National Academy of Arbitrators
American Arbitration Association
Judicial Arbitration and Mediation Services
American College of Civil Trial Mediators