Financial Cryptography

Arbitration -- a community tool or a weapon?

CAcert has just approved rules for dispute resolution which, in brief, puts all before their own arbitration. (Disclosure: I was involved!)

The key in this process is the provision in the user agreement that asserts the agreement to arbitrate disputes, and the lock that matches the key is the Arbitration Act in most countries. To make it work, the Act generally says that courts must respect the intent to arbitrate. From the US:

Under the FAA, on the motion of a party, a court must stay proceedings and order the parties to arbitrate the dispute if the court finds that the parties have agreed in writing to do so. A party seeking to compel arbitration must show (1) that a valid agreement to arbitrate exists between the parties and (2) that the specific dispute falls within the scope of the agreement.

E.g., the courts will kick you back to Arbitration. But, there are some exceptions, and I took that above quote from one such, being Bragg v. Second Life, wherein Judge Robreno decided to kick out the Arbitration Clause, not the parties. As VB writes, this is a big deal. So, it is useful to check his logic, and find out if CAcert has made some of the same mistakes.

Bear in mind this is not legal writing; if you want the real story you have to read the full transcripts linked above. To stress that, I've stripped out the references, etc, so as to maintain the readability rather than the reliability.

Having said that, onwards! With some legal musing, the Court arrives at this:

Bragg claims that the arbitration agreement itself would effectively deny him access to an arbitrator, because the costs would be prohibitively expensive, a question that is more appropriately reserved for the Court to answer.

To answer the question, the Court decided to look at procedural and substantive components to the issue of unconscionability which is a get-out card generally written into Arbitration Acts, and construct a balanced view from those components. Here's a quick summary:

Contract of adhesion. The Second Life agreement is a contract of adhesion, because there is no chance to negotiate. It's a take it or leave it. Therefore, the contract meets a standard of procedural unconscionability.

"Surprise," meaning that the Arbitration intent is hidden. Again, SL has met the Court's standard of surprise, by (a) using an opaque heading and (b) not setting out the costs clearly. This is a second leg of procedural unconscionability.

"One-sidedness of the contract terms." This seems to ride on several issues:

• Does one side have a choice in forums the other does not?
• Does one side have a range in remedies, yet reduce the other party to less?
• Are fees imposed in excess of a similar action in court?

The Court asserted that "the arbitration remedy must contain a “modicum of bilaterality." It also quoted a Paypal case which is likely as close as it gets in industry similarity. In short, Paypal was able to control the entire assets within by way of freezing, restricting, take ownership, and change the TOS, whereas the the user could only (presumably) arbitrate. Linden Labs had (has?) the same power:

The TOS proclaim that “Linden has the right at any time for any reason or no reason to suspend or terminate your Account, terminate this Agreement, and/or refuse any and all current or future use of the Service without notice or liability to you.” Whether or not a customer has breached the Agreement is “determined in Linden’s sole discretion.” Linden also reserves the right to return no money at all based on mere “suspicions of fraud” or other violations of law. Finally, the TOS state that “Linden may amend this Agreement . . . at any time in its sole discretion by posting the amended Agreement [on its website].”

Ouch! Which brings us to tricky issue of costs. For some reason, Linden Labs chose the ICC for Arbitration, with three Arbitrators. The Court estimated costs at $17,250 for an action of recovery of $75,000. However, the ICC rules say that costs must be shared by the parties, and that is apparently sufficient to make Arbitration unenforceable in California law. The trick here appears to be that the existence of a fee, imposed in excess of a similar court process, creates a supports the finding of unconscionability:

California law has often been applied to declare arbitration fee-sharing schemes unenforceable. Such schemes are unconscionable where they “impose[] on some consumers costs greater than those a complainant would bear if he or she would file the same complaint in court.” ... Here, even taking Defendants characterization of the fees to be accurate, the total estimate of costs and fees would be $7,500, which would result in Bragg having to advance $3,750 at the outset of arbitration. See Dfts.’ Reply at 11. The court’s own estimates place the amount that Bragg would likely have to advance at $8,625, but they could reach as high as $13,687.50. Any of these figures are significantly greater than the costs that Bragg bears by filing his action in a state or federal court. Accordingly, the arbitration costs and fee-splitting scheme together also support a finding of unconscionability.

As well as that, the Court found that all these factors helped to suggest that Arbitration was an attempt to shield liability rather than resolve disputes:

• imposing a location for Arbitration hearings over small disputes in Carlifornia
• imposing confidentiality on Arbitration (ICC rules)
• no "business realities" reason was advanced for the one-sidedness

OK, so the court really went to town in striking down the Arbitration clause. When I read their agreement a couple of weeks ago, I came to the same conclusion, without the Court's care, and the tip-off was the choice of the ICC (a big, expensive French body?!) and three, that's THREE arbitrators. The ICC has to be expensive just from the name, and by Linden Labs choosing 3 times the price, it doesn't take a PhD in maths to realise this was a barrier not an aid.

It may be that Linden Labs have learnt their lesson, as the TOS has just been changed, which is what sparked this blog post. Benjamin of VB writes:

the new terms also create a special class of claims under $10,000 that are to be handled via non-appearance arbitration. This change is very good for users, as the new clause replaces one that required a full-blown arbitration proceeding before a three-person panel, which could easily cost more than $10,000 itself (that is essentially why the clause was declared unconscionable in the Bragg case). Non-appearance arbitration can actually be quite inexpensive, and, notably, it could even be conducted in Second Life. The arbitrator must be an established ADR provider, must have published guidelines for dispute resolution, and must be a “retired judge or attorney with legal expertise in the subject matter of the dispute.”

Two caveats: it seems to stop around the $10k mark, and I haven't looked at the new terms.

Now, to get back to CAcert and their new arbitration system. We can run the Court's ruler over CAcert's new user agreement (albeit, still in DRAFT). It's maybe a little premature as experience is new, and only one case has been heard. But let's see what we can find:

• Fees: Maybe. CAcert reserves the right to impose some costs, but none are currently applied. Something to watch.
• Contract of Adhesion: Yes. That is probably an affirmative, by the definition of such contracts and Internet business. CAcert certainly intends that the user not negotiate, and should "take it or leave it." One pleading here might be that the bound users may seek changes by either open policy processes or through Arbitration itself.
• Surprise: No. I counted 25 references to Arbitration and the Arbitrator in 5.5 pages of their draft agreement. The heading says "3.2 Arbitration as Forum of Dispute Resolution." Also, contributory factors will be that the Assurers are to be trained in this area, and CAcert's principles would rule against "surprising" the users as a tactic.
• Choice of forums: No. Both CAcert and the user go to Arbitration for any dispute.
• Range of remedies: No. Only the Arbitrator may terminate an account or impose a financial penalty. Although support members may revoke, they must then refer to Arbitration for authorisation (this is unapproved CPS writings).
• Change of TOS: No. CAcert Inc has explicitly passed the right to change the TOS across to the users themselves, by way of the policy process. While CAcert Inc retains a veto, this seems not unreasonable given the fiduciary duties.
• Costly forum: No. Hearings are mostly conducted over email, and to address a point that the Court did not address, the process seeks to reduce costs by using senior people from within the community as advisors.
• Abusing even a "Modicum of mutality:" No, as Arbitrators are chosen from senior and experienced Assurers. E.g., arbitration is before peers, and CAcert itself is bound by the ruling.

Now, with a nod to the other elements of the Court's ruling, and to the Appeals Court which needs to affirm the ruling, it should be borne in mind that this is a back-of-the-napkin calculation. Still, it's instructive. I'd say cautiously that CAcert made none of the mistakes that the Court found. Indeed, CAcert bent over backwards and tied itself in knots in order to present itself as approximately equal to the registered users.

(As I say, I had something to do with the process. Indeed, I have been hammering the desk for this policy, or any other, to be approved for more than a year now. The more excellent result of last week's conference, which I attended, is that CAcert is now firmly back on the rails.)

Posted by iang at September 25, 2007 08:46 AM | TrackBack