Arbitration Clauses with Class Action Waivers: Why Don’t Your Oil and Gas Leases Have Them?

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September 19, 2018
Author: Thomas G. Ciarlone, Jr.
Organization: Kane Russell Coleman & Logan PC

The class action is among the plaintiff’s lawyer’s closest allies. It is a powerful weapon that can transform what would otherwise be a series of minor, nuisance- value claims—each far too small to pursue individually—into a juggernaut of a case. Indeed, as the Advisory Committee’s notes to the Federal Rules of Civil Procedure candidly observe, class certification can easily give rise to “ruinous liability.” Shady Grove Orthopedic Assocs., P.A. v. Allstate Ins. Co., 559 U.S. 393, 130 S. Ct. 1431, 1465 n.3 (2010) (citing Fed. R. Civ. P. 23). This is often because “the sheer magnitude of risk defendants are exposed to in a class action can provide intense pressure to settle.” Erno Kalman Abelesz v. OTP Bank, 692 F.3d 638, 653 (7th Cir. 2012) (citation and internal quotes omitted). Put another way, “because of the astronomical damages potential of many class action suits, a grant of certification may [create] enormous [incentives for] the defendant to settle, even if the suit has little merit.” McReynolds v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 672 F.3d 482, 484 (7th Cir. 2012) (emphasis added). It should come as no surprise, then, that enterprising—or, if you prefer, opportunistic—plaintiff’s lawyers sometimes exploit Rule 23 to put teeth into what are, on their merits, marginal claims. On this score, according to one legal scholar, “[o]ne can hardly deny that the class action device has significant potential for abusive practices by the class counsel.” Anna Andreeva, The Class Action Fairness Act of 2005: The Eight-Year Saga Is Finally Over, 59 U. Miami L. Rev. 385, 412 (2005).

The corporate defendant with deep pockets is right to harbor a healthy fear of class actions, and it should do everything it can to insulate itself from them. Yet our dockets are rife with class actions that might have been avoided had some simple prophylactic measures been taken in advance. While this is no less true in the oil-and-gas industry, sophisticated players in the energy sector have been slow to adopt several straightforward techniques for defusing class actions before they can even get off the ground. And make no mistake: as major shale plays like the Eagle Ford in Texas and the Bakken in North Dakota continue to grow and prosper, E&P companies will increasingly find themselves in the crosshairs of a class action bar that is constantly scanning the horizon for the next big—read, lucrative— opportunity.

Take, for example, Miller v. EnCana Oil & Gas (USA) Inc., No. 05-CV-2753, a putative class action filed in Colorado state court in 2005. There, the plaintiffs had asserted claims against EnCana for the underpayment of royalties on natural gas produced by EnCana. More specifically, the plaintiffs maintained that EnCana should not have deducted from royalty payments the expenses incurred to make gas marketable, or to deliver gas from the wellhead to the marketplace. In addition to money damages, the plaintiffs also demanded that EnCana amend its payment methodology on gas production to ensure that similar underpayments did not reoccur in the future.

Viewed in isolation, the individual class members in Miller had claims for relatively modest amounts. But once their claims were aggregated under Rule 23, the amount in controversy became enormous, and the downside exposure for EnCana if it lost at trial was of possibly “bet-the-company” proportions. So EnCana, a perfectly rational actor, did what many other class-action defendants have historically done. They settled (for a whopping $40 million) not necessarily because the plaintiffs’ claims were meritorious, but perhaps because—as distinguished from a series of smaller, individual trials—“class certification create[d] insurmountable pressure … to settle.” Castano v. American Tobacco Co., 84 F.3d 734, 746 (5th Cir. 1996). After all, as the Fifth Circuit has emphasized without mincing its words, “[t]he risk of facing an all-or-nothing verdict [often] presents too high a risk, even when the probability of an adverse judgment is low.” Id. Similarly, in Farrar v. Mobil Oil Corp., the plaintiff gas lessors sued Mobil based on allegations that it had breached express and implied contracts by subtracting a pro-rata share of gathering and transportation costs from the plaintiffs’ royalty payments. The representative plaintiffs sought to certify a class numbering over five thousand, who collectively held interests in excess of two hundred mineral leases. The trial court granted the plaintiffs’ motion for certification, and its order was promptly taken up on an interlocutory appeal. See generally Farrar v. Mobil Oil Corp., 43 Kan. App. 2d. 871 (2010).

On appeal, Mobil argued that the requirements of commonality and manageability for class treatment could not be satisfied due to variations in state law and the individual circumstances surrounding the execution of individual gas leases. The court of appeals was not to be persuaded, however. The class certification order was affirmed; the case settled; and the endgame was gigantic: a $54 million payment to the class and its lawyers. See generally Hershey v. ExxonMobil Oil Corp., 2011 U.S. DIST. LEXIS 36317 (D. Kan. 2011) (related class action compromising multiple parallel proceedings, including Farrar).

What, then, can an E&P do to enhance its odds of avoiding a similar fate? After all, choosing between an enormous settlement, now, and the prospect of a crippling verdict, after a full trial on the merits, is hardly an enviable position to be in. To avoid getting stuck between a rock and a hard place, E&Ps would be wise to pay close attention to the Supreme Court’s 2011 decision in AT&T Mobility v. Concepcion, 131 S. Ct. 1740, 1746 (U.S. 2011), and another closely-watched appeal to the high court, American Express Co. v. Italian Colors Restaurant, No. 12-133, which was argued in February of last year.

In Concepcion, the plaintiffs were AT&T wireless customers. The standardform contract that governed their wireless service required that all disputes be arbitrated, but specifically prohibited class arbitration. Undeterred, the named plaintiffs sued AT&T in federal court over a disputed a sales-tax charge. Their case was consolidated with a putative class action alleging similar claims, and AT&T moved to compel individual arbitration. The plaintiffs opposed the motion, relying on the so-called “Discover Bank rule”—a creature of California common law providing that agreements precluding class arbitration are unconscionable on their face. The trial court agreed with the plaintiffs, holding that the Discover Bank rule was not preempted by the Federal Arbitration Act (the “FAA”). On appeal, the Ninth Circuit affirmed.

AT&T petitioned for certiorari and, in a close 5-4 decision, the Supreme Court reversed, concluding that the Discovery Bank rule is, in fact, preempted by the FAA. The majority’s opinion was bottomed on the FAA’s strong presumption in favor of arbitration on the specific terms stipulated to in the agreement to arbitrate, including limits on the permissible parties to the arbitration. The Court also emphasized that—as compared to class arbitration—an individual proceeding would streamline the resolution of the dispute, which dovetails with the FAA’s policy goal of promoting efficiencies in time and cost.

Fast forward two years to Italian Colors. Right out of the gate, oral arguments did not bode well for the plaintiffs. The Court peppered plaintiffs’ counsel with questions signaling disagreement with the gravamen of their case: that antitrust suits are so expensive that, as a practical matter, American Express precludes them by forcing businesses to agree in advance to resolve all disputes in an arbitral setting—where class actions can, in turn, be banned under the auspices of Concepcion. The plaintiffs in Italian Colors were retailers who accused American Express of abusing its market influence, strong-arming them into accepting debit and credit cards with purportedly inflated merchant fees. According to the plaintiffs, it would not be economically feasible to pursue claims individually, in part because of the astronomical costs associated with retaining expert witnesses—who are standard, and arguably necessary, fixtures in any antitrust case.

But even Justice Breyer, who could have been expected to exhibit some sympathy for the plaintiffs, appeared dubious about whether they would have no choice but to hire an expert—especially when the arbitrators would themselves presumably have special expertise in the antitrust arena. “It’s just that you brought a very expensive claim,” Breyer noted matter-of-factly. “And the real problem here is the reason they can’t go into court is they can get a class action in court. And then this Court has said, you can’t get the class action in arbitration. There we have it.”

When the Supreme Court handed down its decision in Italian Colors, the majority unsurprisingly sided with American Express. Which begs the question: just how bad was the decision for the plaintiffs’ class action bar? To give you a flavor of what some legal commentators and bloggers have had to say, they have vari-ously characterized the opinion as a “virtual sentence of doom for class actions”; someone else dubbed the decision “the end of the world”; and, in the words of Paul Bland, of Trial Lawyers for Public Justice, Italian Colors is “catastrophic … an unmitigated disaster.”

So what exactly did the majority hold in Italian Colors, and, more importantly, why should it matter to you? In a nutshell, the Court determined that the FAA—the Federal Arbitration Act—will not invalidate class waivers merely because the expense of arbitrating claims on an individual basis will almost certainly outweigh the maximum possible recovery. In other words, pyrrhic victories are okay, as far the Supreme Court is concerned. Writing for the majority, Justice Scalia explained that “the antitrust laws do not guarantee an affordable procedural path to the vindication of every claim.” (Emphasis added.) Now remember, the plaintiffs in Italian Colors took a different view, citing the so-called “effective vindication doctrine”—this notion that the law does not recognize agreements to prospectively waive congressionally created rights. But Justice Scalia was not having any of this: he was adamant that the true nature of the doctrine is a “desire to prevent ‘prospective waiver of a party’s right to pursue statutory remedies.’” (Emphasis added.) And as he explained, “the fact that it is not worth the expense involved in proving a statutory remedy does not constitute the elimination of the right to pursue that remedy.” (Emphasis added.) So long as a contract provides some method— however expensive or impractical—to pursue a remedy, an arbitration clause with a class action waiver provision will survive scrutiny under the FAA. The majority even went so far as to stress that it does not matter that this sometimes means that smaller, but still meritorious, claims will “slip through the legal system,” simply because they are not financially feasible to pursue.

As a practical matter, with Italian Colors, the Supreme Court was basically telling the lower courts that it really meant business when it issued its decision in AT&T. The fact that pursuing claims individually in an arbitral setting is difficult, or costly, or burdensome, is just not enough to defeat a class action waiver. Taking Concepcion together with Italian Colors yields an obvious question for E&Ps: do your oil-and-gas leases include arbitration clauses with class action waivers? If they do not, it is probably time to update them. Incorporating this kind of clause is an easy, inexpensive way of nipping class actions in the bud. Yet the energy industry, for reasons that are not entirely clear, lags behind its peers from other segments of the business community in taking preventative steps to inoculate against class actions. Part of the problem may be traceable to the fact that, in the first instance, oil-and-gas leases are routinely obtained by land brokers who, without the benefit of in-house legal departments, are often working off of stale lease forms. And brokers, who fully expect to flip leases and resell them in short order, are not particularly concerned with the finer points of contracts involving distant litigation, much less are they sensitive to the nuances of recent Supreme Court precedent. E&Ps, however, do not have nearly the same luxury.

THOMAS G. CIARLONE, JR., a graduate of the Cornell Law School, is a partner at Burleson LLP, resident in the Firm’s San Antonio office. Tom focuses his practice on oil-and-gas-related litigation and dispute resolution. He has over a decade of experience handling a diverse range of complex commercial disputes involving Fortune 500 and other large corporate clients, including dozens of high-stakes nationwide class actions. You can reach Tom at (210) 446-6999 or by electronic mail at [email protected].

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