California’s legislative effort to allow consumers to sue financial institutions for fraud even though they have agreed to arbitrate such disputes passed the Assembly Judiciary Committee this week and is expected to pass the full Assembly later this summer.  The bill, which passed the state Senate in May, would amend California’s civil procedure rules governing arbitration to prohibit courts from granting a motion to compel arbitration made by a financial institution which seeks to apply an otherwise valid arbitration agreement to a purported contractual relationship fraudulently created by the institution with the consumer’s personal identifying information and without the consumer’s consent.

We believe that this legislative effort is an exercise in futility since the bill, if passed, will be preempted by the Federal Arbitration Act (FAA), which makes arbitration agreements “valid, irrevocable, and enforceable.”  For example, the U.S. Supreme Court has held that states are prohibited from creating categorical exceptions to the FAA that Congress did not authorize.  Thus, it reversed a decision of West Virginia’s highest court which  refused to permit arbitration of personal injury and wrongful death claims brought against nursing homes.  And, this past May, in Kindred Nursing Centers Limited Partnership v. Clark, the Court reversed the Kentucky Supreme Court’s ruling that powers of attorney must specifically authorize the representative to enter into an arbitration agreement on behalf of the grantor, holding that the state court violated the fundamental FAA principle that arbitration agreements must be placed “on an equal footing with all other contracts” and cannot be singled out for special treatment.  Notably, even Professor Jeff Sovern, who is generally supportive of anti-arbitration initiatives and arguments, has asked,  “if California enacts the law, how can it avoid being preempted under the Federal Arbitration Act, as SCOTUS has interpreted it?”

Scores of consumer advocate groups have registered support for the California bill, while a similar number of industry and trade groups have voiced opposition.