The cloud service provider's first and best line of defense: the arbitration and class action waiver clause
For the vast majority of SaaS, social media and cloud service providers, the most significant liability risk arises from the potential for individual users, who alone possess at most relatively small-value claims, to band together at the behest of some ambitious entrepreneurial plaintiffs' lawyer and sue the provider as a collective, often with millions in damages alleged. A class action waiver in the cloud provider's terms of service, as part of an enforceable arbitration clause, is a formidable shield against someone like this guy. Eliminating the possibility of class actions—that is, requiring claimants to resolve their claims individually via separate arbitrations—is the online provider's first and best line of defense.
This was not always the case. For years, US courts had ruled that adhesion terms that require consumers to forfeit the right to pursue class actions in court violated public policy and were unenforceable. In 2005, the California Supreme Court explained the rationale for this judicial hostility to class action waivers, in the decision of Discover Bank v. Superior Court: "Damages in consumer cases are often small, and because a company which wrongfully exacts a dollar from each of millions of customers will reap a handsome profit, the class action is often the only effective way to halt and redress such exploitation."
This all changed in 2011, when the US Supreme Court swatted away the Discover Bank ruling, in a surprisingly raw exercise of federal power from a conservative court majority that supposedly pays homage to the ideal of states' rights. In ATT Mobility LLC v Concepcion, the Court held, in a narrow 5-4 decision, that federal law favors a policy of arbitration as a (supposedly) cheaper and more efficient means of resolving disputes, and that this policy overrules contrary state law, including the California rule of unenforceability established by the Discover Bank case. Concepcion and its subsequent progeny of related cases have established what amounts to a federal privilege of arbitration, leading to massive proliferation of class-action waivers in binding arbitration clauses everywhere, including in totally new contexts. If you use a coupon, or walk into entrances to shops, you may have waived away your right to the courts for redress.
(Interesting sidenote: John G. Roberts, in private practice, represented Discover Bank in his unsuccessful attempt at US Supreme Court review of the California Supreme Court decision. He would later get his chance to overrule the Discover Bank decision as Chief Justice of the US Supreme Court, when he joined the late Justice Scalia's majority opinion in Concepcion.)
Because of its value in protecting online providers from liability, ensuring that the clause is enforceable is of paramount importance. Courts tend to subject such clauses to tight and exacting scrutiny, evaluating the overall reasonableness of the clause, and whether consumers, required to give up access to the courts, do so knowingly. The focus of this scrutiny is on both the fairness of the process by which users are bound by the terms (procedural), and the fairness of the clause on its own merits (substantive). The worst possible outcome would be for a court to rule that the provider's carefully crafted arbitration clause is procedurally unconscionable, or wasn't prominent or conspicuous enough for users to provide contractually binding assent to it, or was substantively unfair or oppressive—opening the floodgates to potentially crippling class action litigation.
The 2016 California Court of Appeals case of Magno v. The College Network, Inc. is instructive. In this case, the district court and the appellate court completely struck down the defendant's arbitration clause. Both courts found procedural unconscionability because the clause was not separately and conspicuously presented, was buried towards the end of the terms, and was presented on a take-it-or-leave basis. All of these factors exist in the context of online terms of service, which are classic one-sided "contracts of adhesion" in the applicable legal terminology.
The Magno courts also found that the arbitration clause at issue was substantively unconscionable because the clause required California plaintiffs to travel to Indiana, notwithstanding that the clause excluded from its scope (ie permitted) small claims court actions, as well as videoconferencing and telephonic participation.
Heeding the lessons of court decisions like Magno, the arbitration clause should be the first section of the terms of service, or at least prominently highlighted in the opening paragraph. Additionally, disclosure of the mandatory binding arbitration clause should be conspicuous in the sign-up page or overlay that displays the click-accept button. The operative language should mention arbitration; eg, "By clicking 'submit' you agree to these terms and to the binding arbitration of disputes".
To address the substantive unfairness critique, the clause should include terms that increase the possibility that in-person appearances won't be required. Another option is to allow for the possibility of a choice of cities as permissible venues, based on the location of the user. In fact, many online terms of service from prominent vendors specify that the user's home county will host the arbitration.
Other strategies exist for increasing the probability of full enforcement of such a clause. One such strategy is an opt-out, in which the end user is given the option to reject arbitration if the user mails in the user's opt-out notice by a fixed deadline. Most users will never do so, since most people never read terms of service. The case of Mohamed v. Uber Technologies, Inc. (9th Cir. 2016) offers some positive guidance in this regard. In this case, the federal appeals court for California (and other western states) held that an opt-out provision giving the user the chance to opt out of arbitration saves what might otherwise be a substantively unfair clause, despite that the opt-out clause in that case required the user to send written opt-out notices via expensive overnight mail. A word of caution, however: opt-out clauses can be gamed by clever plaintiffs' lawyers looking to form a class action, so their use should be carefully considered with advice of counsel.
Another mechanism to increase the odds of enforceability is a provision requiring the cloud provider to cover the costs of arbitration. Courts have viewed arbitration clauses containing vendor pays-provisions with favor in evaluating their validity. The consumer rules of the two most prominent arbitration organizations in the US, the American Arbitration Association and JAMS, require the business to pay the vast majority of arbitration costs anyway.
Evaluating whether and how to use such arbitration and class action waiver clauses is a job for experienced legal counsel. Cloud, online and SaaS providers should seek expert legal advice in crafting such clauses in such a way as to maximize their effectiveness as a liability shield, not only in the US but abroad.
Lawyers: you might find Redline (redline.net) to be of interest in this context. This post mirrors a Redline discussion thread (https://redli.ne/2pz5PcG) in which Redline members have posted arbitration and class action waiver clauses and redlined variations. If you are eligible, please join us in elevating our profession.