FAA Preemption: Forcing Arbitration In The States

Arbitration In The States

The Court’s standard on whether and to what extent states must enforce arbitration clauses has evolved over time. For the most of its history, the Federal Arbitration Act (FAA), a federal law governing the use of arbitration contracts, was enforced by federal courts in cases involving federal claims. Because the FAA specifically relegates jurisdiction of claims under the statute to federal district courts, state courts were not thought to have the power to compel arbitration under the FAA. Additionally, because the statute was created to facilitate the rapid dispensation of contract disputes between commercial entities of equal bargaining power when they were engaged in commerce across state lines or at sea, the notion that state statutory claims could be subject to forced arbitration under the FAA used to be unthinkable.

In the late 20th century, however, the U.S. Supreme Court embraced a wholly opposite view. Beginning in the 1980’s, the Court began forcing states to compel arbitration. Not only did the Court mandate that state courts to must enforce arbitration under the FAA, it also ruled that states legislatures are preempted from passing laws to limit the reach of arbitration clauses or to protect their citizens from the harms caused by forced arbitration. Because of the Court’s modern approach to the FAA, both state courts and state legislatures have very little power to protect citizens from being silenced by forced arbitration clauses when they have suffered unlawful violations in the marketplace and at work.

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  • The Court holds that in a diversity suit, because state law controls under the Erie Doctrine, federal courts must enforce state laws which preclude arbitration in cases where the FAA does not apply, and that the FAA does not extend to cover simple contracts of employment.

    Bernhardt v. Polygraphic Co. of America, Inc., 350 U.S. 198 (1956)

    Relevant Facts: A man was hired to work for a New York employer in New York. The employee later moved to Vermont but maintained his employment. When the company fired him, the employee brought a civil suit alleging wrongful discharge. Because the parties were now residing in different states and the value of the claim met the required threshold, the claim was removed to federal court under diversity jurisdiction. The employer then sought to enforce an arbitration clause in the employment contract under the Federal Arbitration Act (FAA).


    Question Before The Court: Whether a federal court must order arbitration of an employment contract under the FAA when the parties in the case have a diversity suit and state law would preclude arbitration.


    The Opinion: The U.S. Supreme Court first looked to the text of the FAA to determine whether the statute applied and observed that the part of §3 of the FAA that provides for a stay of the trial of an action until arbitration has been had does not apply to all arbitration contracts. On the contrary, for §3 to apply, the contracts at issue must fall within the scope of §§1 and 2 of the FAA; that is, it only applies to contracts relating to maritime transactions or those involving interstate or foreign commerce. The Court determined the employment contract at issue here did not involve either of those classes of contract, and, thus, the FAA did not apply.


    The Court then turned to the question of whether the Vermont state statute disfavoring arbitration applied, noting that, “The differences between arbitration and judicial determination of a controversy substantially affect the cause of action arising under state law, and make the Erie Doctrine applicable. If, in this case, arbitration could not be compelled in the Vermont state courts, it should not be compelled in the Federal District Court.”


    The Court disagreed with the appellate court’s conclusion that “arbitration is merely a form of trial, to be adopted in the action itself, in place of the trial at common law.” The majority explained, “We deal here with a right to recover that owes its existence to one of the States, not to the United States. The federal court enforces the state-created right by rules of procedure which it has acquired from the Federal Government and which therefore are not identical with those of the state courts. Yet, in spite of that difference in procedure, the federal court enforcing a state-created right in a diversity case is . . . in substance ‘only another court of the State.’ The federal court therefore may not ‘substantially affect the enforcement of the right as given by the State.’ Id.


    The Court continued, “If the federal court allows arbitration where the state court would disallow it, the outcome of litigation might depend on the courthouse where suit is brought. For the remedy by arbitration, whatever its merits or shortcomings, substantially affects the cause of action created by the State. The nature of the tribunal where suits are tried is an important part of the parcel of rights behind a cause of action. The change from a court of law to an arbitration panel may make a radical difference in ultimate result. Arbitration carries no right to trial by jury that is guaranteed both by the Seventh Amendment and by Ch. 1, Art. 12th, of the Vermont Constitution. Arbitrators do not have the benefit of judicial instruction on the law; they need not give their reasons for their results; the record of their proceedings is not as complete as it is in a court trial; and judicial review of an award is more limited than judicial review of a trial.”


    “The nub of the policy that underlies Erie R. Co. v. Tompkins is that for the same transaction the accident of a suit by a nonresident litigant in a federal court instead of in a State court a block away should not lead to a substantially different result. There would in our judgment be a resultant discrimination if the parties suing on a Vermont cause of action in the federal court were remitted to arbitration, while those suing in the Vermont court could not be.”

  • In promulgating a new “severability doctrine” the Court changes the standard for assessing the enforceability of an arbitration clause.

    Prima Paint Corp. v. Flood Conklin Mfg. Co., 388 U.S. 395 (1967)

    Relevant Facts: Two companies entered into a contract. One sued the other for breach of contract and fraudulent representation. In the lower courts, the defending company successfully sought to compel arbitration under a broad arbitration clause in the agreement.


    Question Before The Court: Whether arbitration clauses are severable from the contracts that contain them.


    The Opinion: The Court found that, because the Federal Arbitration Act (FAA) specifies the manner in which federal courts are to treat questions relating to arbitration clauses, in considering whether to compel arbitration under the FAA, “a federal court may not consider a claim of fraud in the inducement of the contract generally . . . but may consider only the issues relating to the making and performance of the agreement to arbitrate.”


    The Court distinguished this case from the Bernhardt decision, providing that in Berhardt the Court held that the stay provisions of §3 “apply only to two kinds of contracts specified in §§1 and 2 of the Act, namely those in admiralty or evidencing transactions in ‘commerce’.” Here, the matter involved a New Jersey paint business engaging in the manufacturing and sale of paint in Maryland, squarely within the scope of the FAA.


    With that framework in mind, the Court held that, under the FAA, arbitration clauses are severable from the contracts that contain them. In the Court’s view, §4 of the FAA requires courts to order arbitration once it is satisfied that the “making of the agreement to arbitrate . . . is not at issue.” The Bernhardt Court focused on the jurisdictional ability of a federal court to enforce an arbitration clause a la the Erie Doctrine, but the Court here traced the FAA to Congress’ exercise of its Commerce Clause power.


    Since the challenge in this case was to the formation of the contract, at large, rather than specifically to the arbitration clause contained within, and because there was no evidence that the parties intended to prevent this type of claim from being submitted to arbitration, the Court ruled that the FAA demanded the claim proceed in arbitration. After this ruling, courts are required to look at challenges to arbitration clauses separately from challenges to the contracts that contain them. If a person challenges a contract at large, unless a specific challenge to the arbitration clause itself is launched, the court will compel arbitration, regardless of the possible unenforceability of the larger contract.

  • The Court holds that, absent a countervailing federal statute, states may protect their workers by prohibiting the enforceability of arbitration provisions in employment contracts as a matter of public policy.

    Merrill Lynch, Pierce, Fenner, & Smith, Inc. v. Ware, 414 U.S. 117 (1973)

    Relevant Facts: A broker for the firm, Merrill Lynch, Pierce, Fenner, & Smith, Inc. (“Merrill Lynch”) was hired to sell securities. To get the job, the broker signed a NYSE broker-dealer contract that contained an arbitration clause. Upon quitting the firm to work for a competitor, Merrill Lynch refused to pay the broker vested monies due under the profit-sharing plan included in his compensation package. The broker sued under relevant state labor law, which guaranteed workers’ access to a judicial forum. Merrill Lynch moved to stay the proceedings and compel arbitration under the FAA based on the NYSE application’s arbitration clause. In particular, Merrill Lynch argued that its fiduciary obligations to investors under the Securities and Exchange Act justified the enforcement of the forced arbitration clause. The state court didn’t buy it, and held the arbitration provision was unenforceable as a matter of public policy.


    Question Before The Court: Whether a state law precluding compulsory arbitration of an employment claim applied by a state court is preempted under federal law.


    The Opinion: The Court held that arbitration could not be compelled because there was no evidence that the state’s policy interfered with any federal regulatory scheme. The Court reasoned, “It is unclear why muffling a grievance in the cloakroom of arbitration would prevent lessoning of confidence of the market,” as the defense had argued. In standing up for the state’s right to enforce its labor laws through judicial proceedings, the Court explained “there is nothing in the [Federal Arbitration] Act . . . that specifies arbitration as the favored means of resolving employer disputes.”


    Instead, the Court recognized the state legislature’s right “to protect the worker from the exploitative employer who would demand that a prospective employee sign away in advance his right to resort to the judicial system for redress of an employment grievance.” This view is the polar opposite of where workers and states’ stand today. Ironically, the Court here describes forced arbitration in the workplace exactly as millions of workers now experience it.

  • The Court declares that the Federal Arbitration Act created a “body of federal substantive law” such that “any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration.”

    Moses H. Cone Memorial Hospital v. Mercury Constr. Co., 460 U.S. 1 (1983)

    Relevant Facts: A hospital contracted with a building contractor and an architect to renovate its facilities. While the contract involving the building contractor included an arbitration clause, the contract with the architect did not. After a complicated dispute concerning the cost of the project arose, multiple legal actions were filed in both state and federal court, including motions to compel arbitration.


    Question Before The Court: Whether state courts have the requisite jurisdiction to grant motions to compel arbitration under the Federal Arbitration Act (FAA); how far the nation’s federal policy favoring arbitration extends; and whether federal courts may defer to state courts when both are adjudicating parallel claims regarding the enforceability of an arbitration provision.


    The Opinion: The Court focused on the FAA’s “statutory policy of rapid and unobstructed enforcement of arbitration agreements” and professed that §2 of the FAA “is a congressional declaration of a liberal federal policy favoring arbitration agreements, notwithstanding any state substantive or procedural policies to the contrary. The effect of the section is to create a body of federal substantive law of arbitrability, applicable to any arbitration agreement within the coverage of the Act. . .. The [FAA] established that, as a matter of federal law, any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration, whether the problem at hand is the construction of the contract language itself, or an allegation of waiver, delay, or a like defense to arbitrability.”


    The Court was unmoved by the argument that, should the hospital be compelled to arbitrate its dispute with the building contractor, but not the architect against whom there was also pending litigation under the same facts, then it would have to resolve the two disputes in separate forums. To that point, the Court lamented that such misfortune “occurs because [the FAA] requires piecemeal resolution when necessary to give effect to an arbitration agreement. Under the [FAA], an arbitration agreement must be enforced notwithstanding the presence of other persons who are parties to the underlying dispute but not to the arbitration agreement.”


    The Court expressed concern regarding the state’s ability to adequately protect the building contractor’s right to arbitration under the contract, observing “state courts, as much as federal courts, are obliged to grant stays of litigation under §3 of the [FAA]. It is less clear . . . whether the same is true of an order to compel arbitration under §4 of the Act.” The Court declined to go so far as establishing state courts had the jurisdiction to do so. Still, the Court mused that, “if the state court stayed litigation pending arbitration but declined to compel the [objecting party] to arbitrate, [the party seeking to enforce the arbitration clause] would have no sure way to proceed with its claims except to return to federal court to obtain a §4 order.”


    Over a series of footnotes, the Court explained, but did not resolve, an important issue arising from a conflict between federal subject matter jurisdiction and a state court’s ability to rule on FAA cases. The Court observed that the FAA “is something of an anomaly in the field of federal court jurisdiction. It creates a body of federal substantive law establishing and regulating the duty to honor an agreement to arbitrate, yet it does not create any independent federal question jurisdiction under §28 USC 1331 or otherwise. §4 provides for an order compelling arbitration only when the federal district court would have jurisdiction over a suit on the underlying dispute; hence, there must be diversity of citizenship or some other independent basis for federal jurisdiction before the order can issue. § 3 likewise limits the federal courts to the extent that a federal court cannot stay a suit pending before it unless there is such a suit in existence.”


    At the time this case was decided, based on the discrepancy, many courts had interpreted the FAA to allow state courts to grant stays of proceedings under §3. Yet, a problem arose when a plaintiff would bring a wholly state level claim against another citizen of the same state before a state court. In that situation, assuming the state court granted the Motion to Stay the claim, because the FAA does not create any independent federal question jurisdiction under the Federal Rules of Civil Procedure, there is no way for a party seeking to compel arbitration to access the federal court to file the requisite Motion to Compel Arbitration. Although it failed to do so here, in the first case of the Supreme Court’s 1984 term, Southland Corp. v. Keating, the Court directly addressed and resolved this issue.

  • In a landmark opinion, the Court held that the FAA preempts certain state laws and ruled that state courts must order arbitration under the FAA unless an exception applies.

    Southland Corp. v. Keating, 465 U.S. 1 (1984)

    Relevant Facts: A group of franchisees came together as a class and sued Southland Corp., a franchisor of 7-Eleven convenience stores, in state court alleging fraud, misrepresentation, breach of contract, and violations of state franchise disclosure laws. Southland sought to compel arbitration based on an arbitration clause embedded in its franchise agreement, and was successful on all but the state franchise law claims. The state appellate court reversed in part, holding that to disallow the claims to proceed in arbitration would be in direct conflict with the FAA. The state supreme court disagreed with the appeals court and reversed, holding the state laws at issue specifically required judicial enforcement and refusal to compel arbitration on those claims did not conflict with the FAA.


    Question Before The Court: Whether the state franchise statute conflicted with the FAA to the extent that it was preempted under the U.S. Constitution’s Supremacy Clause, and whether state courts have the requisite subject matter jurisdiction to grant motions to compel arbitration.


    The Opinion: The Court reviewed this case, in part, to resolve a divide between enforcement of the arbitration clauses in state versus federal courts. The Court held that “[i]n enacting §2 of the FAA, Congress declared a national federal policy favoring arbitration and withdrew the power of states to require a judicial forum for the resolution of claims which the contracting parties agreed to resolve by arbitration. . .. The purpose of the Act was to assure those who desired arbitration and whose contract related to interstate commerce that their expectations would not be undermined by federal judges.” The Court’s views here were based on the supposition that parties to a contract were sophisticated businessmen that had thoughtfully negotiated all the terms of their contract. It was on that premise that the Court determined Congress’ intent in passing the FAA was to “place arbitration agreements upon the same footing as other contracts.”


    The Court declared that “Congress has mandated the enforcement of arbitration agreements,” and there are “only two limitations on the enforceability of arbitration provisions governed by the FAA: they must be part of a written maritime contract or contract ‘evidencing a transaction in commerce,’ and such clauses may be revoked [under the § 2 “savings clause”] upon ‘such grounds as exist at law or in equity for the revocation of any contract.’” The majority found that the savings clause did not apply in this case because that clause is limited in its application only to “any general contract defense” that would serve to revoke all contracts anywhere (like fraud or undue influence), and does not include contract defenses that are only available under a particular state’s law. The Court expressed concern that upholding the state supreme court’s interpretation of the law would encourage and reward forum-shopping, and held that the state’s franchise disclosure law was preempted by the FAA under the Supremacy Clause.


    The majority rejected the dissent’s argument that “the FAA was never meant to encroach upon individual states,” and that Congress only intended the FAA to serve as a procedural statute applicable solely in federal courts. After declaring that Congress called upon its Commerce Clause powers in enacting the FAA—a view that is suspect in itself—the Court provided, “We are unwilling to attribute to Congress the intent, in drawing upon on the comprehensive powers of the Commerce Clause, to create a right to enforce an arbitration contract and yet make the right dependent for its enforcement dependent upon the particular forum in which it is asserted. . . . In creating a substantive rule applicable in state as well as federal courts, Congress intended to foreclose state legislative attempts to undercut the enforceability of arbitration agreements.” To reach this outcome, the Court also ignored how limited the Commerce Clause power was in 1925, the year the FAA was enacted.


    Justice Sandra Day O’Connor, in her dissent, argued that Congress relied on its Article II power over the jurisdiction of the federal judiciary in passing the FAA, not the Commerce Clause. Her observation was not new, but was a view shared by both the majority and minority in Prima Paint, as well. Citing the legislative history, Justice O’Connor provided, “The FAA rests upon the constitutional provision by which Congress is authorized to established and control inferior Federal Courts.” The legislative history also supports the view that the FAA was never intended to reach the states. The ABA Committee that drafted the legislation provided, “So far as the present law declares simply the policy of recognizing and enforcing arbitration agreements in federal courts, it does not encroach upon the province of the individual states.” Joint Hearings on S. 1005 and H.R. 646 before the Subcommittee of the Committees on the Judiciary, 68th Cong., 1st Sess., 17 (1924).


    Finally, the Court’s finding that the drafters didn’t intend for the FAA to be limited to federal courts is simply not supported by the plain meaning of the text. §4 of the statute expressly limits the power to issue orders to compel arbitration to “any United States District Court which, save for such agreement, would have jurisdiction under Title 28, in a civil action or in admiralty of the subject matter of a suit arising out of the controversy between the parties.” Under the Federal Rules of Civil Procedure, such jurisdiction only arises when there is a federal question at issue or the parties have so-called “diversity jurisdiction” (where the parties reside in different states and the amount of the claim at issue exceeds a statutory minimum). Under these jurisdictional requirements, state courts can never have the requisite jurisdiction to grant a motion to compel arbitration under the FAA and, absent diversity or ancillary jurisdiction, state claims should never be forced into arbitration under the Act.

  • The Supreme Court divests federal district courts of discretion in ordering certain claims into arbitration, yet concedes that “arbitration cannot provide an adequate substitute for a judicial proceeding in protecting the federal statutory and constitutional rights that §1983 [of the Civil Rights Act] is designed to safeguard.”

    Dean Witter Reynolds, Inc. v. Byrd, 470 U.S. 213 (1985)

    Relevant Facts: A retired dentist invested his life savings in the stock market, only to lose the majority of his money. He subsequently sued the investment company in federal court, alleging violations of the Securities Exchange Act (SEA) and various state statutes. Although state law claims had never before been forced into arbitration, the company argued that since the federal claims were arbitrable under the terms of the contract, then the pendant state claims were too. However, the company also sought to stay arbitration pending the resolution of the non-arbitrable SEA allegations. The district court denied the motion, and the Court of Appeals affirmed.


    Question Before The Court: Whether, when a complaint raises both federal and state claims, a federal district court may deny a motion to compel arbitration of the state law claims despite the parties’ agreement to arbitrate their disputes; and whether district courts should decide arbitrable pendant claims when a non-arbitrable federal claim is before them due to the possible collateral estoppel effect that may arise in a subsequent federal proceeding were an arbitration of the pendant claims to occur.


    The Opinion: In deciding this case, the Court resolved a circuit split on the issue of how to apply the process of compelling arbitration described in §§3 and 4 of the Federal Arbitration Act (FAA). Prior to this case, when faced with the question, some circuits applied the doctrine of intertwining, which provided that where “arbitrable and non-arbitrable claims arise out of the same transaction, and are sufficiently intertwined factually and legally, the District [court] may deny arbitration.” Other circuits held that “the FAA divests the District courts of any discretion regarding arbitration in cases containing both arbitrable and non-arbitrable claims, and instead requires that the court compel arbitration of arbitrable claims when asked to do so.”


    The Supreme Court in this case chose the latter interpretation when it held that “even where the result would be the possible inefficient maintenance of separate proceedings in different forums . . . [b]y its terms, the [FAA] leaves no place for the exercise of discretion by a District court, but instead mandates that District courts shall direct the parties to proceed to arbitrate on issues as to which an arbitration agreement has been signed.” The Court reiterated “the preeminent concern of Congress in passing the Act was to enforce private agreements unto which parties had entered, and that concern requires that we rigorously enforce agreements to arbitrate, even if the result is piecemeal litigation, at least absent a countervailing policy manifested in another federal statute. By compelling arbitration of state law claims, a district court successfully protects the contracts of the parties and their rights under the FAA.”


    Despite ruling that courts must order arbitration of pendant state claims bound to non-arbitrable federal actions, Justice Thurgood Marshall, writing for the majority, made a point of observing that “arbitration cannot provide an adequate substitute for a judicial proceeding in protecting the federal statutory and constitutional rights that §1983 [of the Civil Rights Act] is designed to safeguard.”


    Prior to this case, the Supreme Court had never ruled that state law claims were arbitrable under the FAA. It’s worth noting that Justice Marshall rooted his finding they were arbitrable in Congress’ Article III power to restrain the jurisdiction of the courts, and not in the Commerce Clause. With this decision, federal district courts have no discretion to refuse to compel arbitration of state statutory claims if they are deemed to fall within the scope of actions covered within a broadly-written arbitration clause, even if it is presented in a consumer contract of adhesion between an individual and large corporation. By forcing arbitration “on issues as to which an arbitration agreement has been signed,” the Court opened the door for all types of statutory claims to be deemed de facto arbitrable— a move they fully committed to in Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, 473 U.S. 614 (1985), a case they heard oral arguments for just two weeks after issuing the opinion in this case.

  • The Court ruled that a state labor law guaranteeing workers access to a public judicial forum to adjudicate their claims was preempted by the FAA.

    Perry v. Thomas, 482 U.S. 483 (1987)

    Relevant Facts: An employee who had worked for a securities broker in California sued for unpaid commissions in violation of state law. Based on an arbitration provision found in a Uniform Application for Securities Industry Registration form that all broker-employees are required to complete, the employer moved to compel arbitration. The state court refused to grant the motion, citing Merrill Lynch, Pierce, Fenner & Smith v. Ware, which held wage violations under that statute were non-arbitrable.


    Question Before The Court: Whether a state labor statute that expressly guarantees employees a private right of action is preempted by the FAA, and, thereby, claims brought under that statute may be forced into arbitration.


    The Opinion: In light of its more recent pro-arbitration decisions, the U.S. Supreme Court declined to apply the reasoning of the Ware Court. Instead, the Court focused on whether the state labor code section guaranteeing employees a private right of action for the collection of wages “without regard to the existence of any private agreement to arbitrate,” was preempted by the Federal Arbitration Act. Citing our nation’s “federal policy favoring arbitration agreements” and a handful of its most recent arbitration cases, the Court held that the state labor protections were in “unmistakable conflict” with the FAA, and so, “under the Supremacy Clause, the state statute must give way.”


    The Court, in a footnote, spoke to the root of the issue, providing, “In instances such as these, the text of §2 provides the touchstone for choosing between state law principles and the principles of federal common law envisioned by the passage of that statute: an agreement to arbitrate is valid, irrevocable, and enforceable, as a matter of federal law, ‘save upon such grounds as exist at law or in equity for the revocation of any contract.’


    Thus, state law, whether of legislative or judicial origin, is applicable if that law arose to govern issues concerning the validity, revocability, and enforceability of contracts generally. A state law principle that takes its meaning precisely from the fact that a contract to arbitrate is at issue does not comport with this requirement of §2. A court may not, then, in assessing the rights of litigants to enforce an arbitration agreement, construe that agreement in a manner different from that in which it otherwise construes non-arbitration agreements under state law. Nor may a court rely on the uniqueness of an agreement to arbitrate as a basis for a state law holding that enforcement would be unconscionable, for this would enable the court to effect what we hold the legislature today cannot.”

  • The Court acknowledges that states may give courts authority to consolidate arbitral proceedings to reduce the risk of contradictory judgments.

    Volt Info. Sciences v. Stanford Univ., 489 U.S. 468 (1989)

    Relevant Facts: A construction contract between parties included an arbitration clause containing a choice-of-law provision that required the contract to be governed by the law of “the place where the Project is located.” A dispute arose in relation to a California-based project and the appellant made a formal demand for arbitration. In response, the appellee filed an action in California state court seeking indemnity from two other parties involved in the dispute who were not subject to the contract. The state court denied the motion to compel arbitration, citing a state law that permitted a stay pending resolution of related litigation between a party bound to an arbitration clause and third parties who are not bound by it.


    Question Before The Court: Whether the state law at issue was preempted by the Federal Arbitration Act (FAA) and whether, given the national policy favoring arbitration, the application of the choice-of-law provision in this case was properly applied.


    The Opinion: The U.S. Supreme Court focused on the terms of the arbitration clause in rendering its decision. The Court observed that the FAA confers a right to obtain an order directing that “arbitration proceed in the manner provided for in [the parties’] agreement, and that “parties are free to structure their arbitration agreements as they see fit.” Thus, an arbitration clause’s terms can include the rules by which the claim is arbitrated, such as those found in a choice-of-law provision. The Court reasoned that when parties, as here, agree to arbitrate according to a particular state’s laws, and that state’s laws require a stay of arbitral proceedings, then staying those proceedings is giving the arbitration clause effect, as required by the FAA.


    On the matter of preemption, the Court re-affirmed its position that states “cannot pass laws that require a judicial forum for the resolution of claims which the contracting parties agreed to resolve by arbitration.” To determine whether a state law conflicts with the FAA to the point of being preempted, one must ask whether the state law stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress in passing the FAA. The Court then identified three purposes and objectives of the FAA: to place arbitration agreements on the same footing as other contracts, but not more so; to enforce agreements into which parties had entered; and to encourage the expeditious resolution of disputes.


    Although not germane to its central decision here, in a footnote the Court addressed the problem of contradictory judgments arising from forced arbitration, which modernly remains an inevitable biproduct of enforcing class, collective and joint action bans in forced arbitration: “[T]he FAA itself contains no provision designed to deal with the special practical problems that arise in multiparty contractual disputes when some or all of the contracts at issue include agreements to arbitrate. California has taken the lead in fashioning a legislative response to this problem, by giving courts authority to consolidate or stay arbitral proceedings in these situations in order to minimize the potential for contradictory judgments.”

  • The Court rules that the FAA is applicable to wholly intrastate consumer claims.

    Allied-Bruce Terminix Cos., Inc. et al v. Dobson, 513 U.S. 265 (1995)

    Relevant Facts: A homeowner contracted with an exterminator to inspect and protect his home from termites. The contract included both a lifetime guarantee and an arbitration clause. The homeowner decided he wanted to sell his house, so he had the company come out to inspect and give the green light on being pest-free, which they did. The homeowner sold the house to a buyer. Shortly thereafter, the buyer discovered termites everywhere. The buyer sued the homeowner and extermination company. The company moved to compel the buyer’s suit into arbitration because of the forced arbitration clause in the contract with homeowner. The company’s motion to compel arbitration was denied at both the district court and appellate court levels.


    Question Before The Court: Whether the FAA, which the Court has held is rooted in Congress’ Commerce Clause power, applies to wholly intrastate consumer contracts.


    The Opinion: The petitioner directly called on the Court to overturn Southland. Instead, the Court doubled down on and went further than Southland in holding that states are not free to apply anti-arbitration law or policy. The majority reasoned that §2 of the FAA should be applied using the modern understanding of the limits of Congress’ Commerce Clause power, and not as the legislature understood the power to exist at the time the FAA was passed in 1925. The Court then expressly prohibited states from limiting the enforcement of arbitration clauses, declaring, “States may regulate contracts, including arbitration clauses, under general contract law principles and they may invalidate an arbitration clause ‘upon such grounds as exist at law or inequity for the revocation of any contract.’ What States may not do is decide that a contract is fair enough to enforce all its basic terms (price, service, credit), but not fair enough to enforce its arbitration clause. The Act makes any such state policy unlawful, for that kind of policy would place arbitration clauses on an unequal ‘footing,’ directly contrary to the Act’s language and Congress’ intent.”


    With this case, the Court moved fully into enforcing forced arbitration clauses in adhesive consumer contracts. Relying on its modern commerce clause analysis, the Court held that if the transaction involved interstate commerce in fact, even if the parties did not contemplate an interstate commerce connection, then the FAA will apply to the contract. Even though the contract here was for extermination services on a stationary home, because the company used materials they obtained in interstate commerce to conduct those services, the tangential relationship to interstate commerce was enough in the Court’s view to render the contract subject to the FAA.


    In his dissent Justice Clarence Thomas excoriated the majority’s opinion, arguing, among other things, that the FAA does not apply to states at all, that the FAA itself in no way supports this outcome, and that the Court is now just making up new FAA rules as they go along, independent of congressional intent or legislative text.

  • The Court vastly expands the reach of the FAA beyond the commercial context to include almost all contracts of employment.

    Circuit City Stores, Inc. v. Adams, 523 U.S. 105 (2001)

    Relevant Facts: A man filled out a job application to work at a big-box electronics retailer, and was hired. The fine print at the bottom of the company’s job application contained a forced arbitration clause. Two years later, the employee pursued a discrimination claim under state law. Citing the FAA, the company invoked the forced arbitration clause to move the claim out of court.


    Question Before The Court: Whether the reach of the FAA extends beyond commercial contracts to include most contracts of employment.


    The Opinion: §1 of the FAA excludes from the Act’s coverage “contracts of employment of seamen, railroad employees, or any class of workers engaged in foreign or interstate commerce.” Applying a general rule of statutory construction, the Court held that, rather than exclude employment contracts from the FAA, “the better interpretation is to construe the statute . . . to confine the exemption to transportation workers.” To hold that the clause exempted all workers from the FAA, in the Court’s opinion, would be to render the specific reference to seamen and railroad workers superfluous. As a result, according to the Court, most non-transportation employment contracts containing an arbitration clause are subject to the FAA.


    The Court rejected the argument that applying the FAA to most employment contracts would infringe on the traditional role played by states to regulate the employment relationship, including the passage of “state employment laws which restrict or limit the ability of employees and employers to enter into arbitration agreements.” Instead, the Court re-iterated its position in Southland that “Congress intended the FAA to apply in state courts and to preempt state antiarbitration laws to the contrary. . . The Court should not chip away at Southland by indirection, especially by adoption of the variable interpretation theory advanced by the respondents in the instant case [which argued for interpreting the statute in light of the extent of the legislature’s commerce clause power at the time of the law’s passage].”


    With this case, the Court opened the floodgates on forced arbitration clauses in employment contracts. It is worth noting that the employer in this case raised the argument that the job application did not actually constitute an employment contract in its petition for certiorari, but the Court declined to rule on that point. The opinion in this case, then, is implicitly premised on the fact that the arbitration clause in the job application constituted a valid and enforceable contract.


    After this ruling, with extremely limited exception, employers became free to require pre-dispute arbitration agreements—forced arbitration clauses—as a condition of employment, and they have done so with rapidity. Through job applications, employee handbooks, and other adhesive employment documents, over 60 million workers are now bound by forced arbitration clauses.

  • The Court declares that arbitration is fundamentally bilateral in nature and rules that the FAA precludes states from barring enforcement of class waivers in arbitration clauses, even for unrelated law enforcement or public policy reasons.

    AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011)

    Relevant Facts: Consumers who responded to an advertisement for a free phone were subsequently charged a fee on their bill, so they sued AT&T for fraud. Their action was joined with others in a nationwide class proceeding. The defense invoked a forced arbitration clause in the consumer contract to force the class action out of the judicial forum and into individual arbitration. A question arose as to availability of class proceedings for the claims because the arbitration clause at issue contained a class action ban. If enforced, pursuit of valid claims would have been financially untenable because each individual claim was only valued at approximately $30 apiece – far less than the cost of legal proceedings. The district court acknowledged that fact and found the class action ban unconscionable under state law. The appeals court affirmed and held that the state law on which the ruling was based was not preempted by the FAA.


    Question Before The Court: Whether the FAA preempts a state law holding that class action bans in forced arbitration agreements are unconscionable.


    The Opinion: The Court began by addressing the application of the state law of unconscionability, saying, “When state law prohibits outright the arbitration of a particular type of claim, the analysis is straightforward. The conflicting rule is replaced by the FAA. But the inquiry becomes more complex when a doctrine normally thought to be generally applicable, such as duress or unconscionability, is alleged to have been applied in a fashion that disfavors arbitration.” The Court continued, “[a]lthough the §2 savings clause preserves generally applicable contract defenses, nothing in it suggests an intent to preserve state law rules that stand as an obstacle to the accomplishment of the FAA’s objectives.” The Court then ruled that the FAA preempts states from barring enforcement of class waivers in arbitration clauses, even for public policy reasons that have nothing to do with arbitration.


    Focusing on the use of the class action ban to require individual proceedings, the Court provided, “Arbitration is a matter of contract and the FAA requires courts to honor the expectations of the parties. But [if] what parties have agreed to . . . is not arbitration as envisioned by the FAA and lacks its benefits . . . [it] may not be required by state law.” Rooting its reasoning in concern for defendants to appeal large adverse judgments from class arbitral proceedings, the Court declared that arbitration is poorly suited to the higher stakes of class litigation, finding that “the overarching purpose of the FAA is to ensure the enforcement of private arbitration agreements according to their terms so as to facilitate streamlined proceedings. Requiring the availability of classwide arbitration interferes with fundamental attributes of arbitration and thus creates a scheme inconsistent with the FAA.”


    The Court then swatted away the argument that “class proceedings are necessary to prosecute small-dollar claims that might otherwise slip through the legal system” by quipping that “States cannot require a procedure that is inconsistent with the FAA, even if it is desirable for unrelated reasons.”


    With this case the Court unambiguously elevated the importance of enforcing a contractual term to arbitrate above almost any other concern. Justice Thomas, in his concurrence, observed that based on the majority’s holding, to win on an FAA §2 savings clause argument now would require “a party successfully assert[] a defense concerning the formation of the agreement to arbitrate, such as fraud, duress, or mutual mistake. . . Contract defenses unrelated to the making of the agreement—such as public policy—could not be the basis for declining to enforce an arbitration clause.”

  • The Court reaffirms that states cannot pass laws that directly or indirectly “disfavor” arbitration.

    Kindred Nursing Centers Ltd. P’Ship v. Clark, 137 U.S. 1421 (2017)

    Relevant Facts: Beverly Wellner and Janis Clark, two individuals who did not know each other, used their respective powers of attorney to move their family members into a nursing and rehabilitation facility owned by Kindred Nursing Centers Limited Partnership (“Kindred”). Completing the relocation required signing a lot of paperwork, among which included an arbitration clause requiring all disputes with Kindred be resolved in arbitration. Within a year, each of the loved ones had died while in the care of Kindred. Wellner and Clark separately sued, each alleging wrongful death. Kindred moved to dismiss under the arbitration clauses. Because the state constitution declared the rights of access to the courts and trial by jury to be “sacred” and “inviolate” the state courts held the arbitration agreements were invalid under the state constitution.


    Question Before The Court: Whether the state’s clear-statement rule, which permitted an agent to enter an arbitration agreement waiving the right to adjudication by a judge or jury of behalf of her principal only if expressly provided that authority in their power of attorney, is preempted by the Federal Arbitration Act (FAA).


    The Opinion: The Court identified that the FAA “establishes an equal treatment principle: A court may invalidate an arbitration agreement based on ‘generally applicable contract defenses’ like fraud or unconscionability, but not on legal rules that ‘apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue.’ The FAA thus preempts any state rule discriminating on its face against arbitration . . . And not only that: The Act also displaces any rule that covertly accomplishes the same objective by disfavoring contracts that (oh so coincidentally) have the defining features of arbitration agreements.”


    Here, the Court found that the state supreme court did “exactly what Concepcion barred: adopt a legal rule hinging on the primary characteristic of an arbitration agreement—namely, a waiver of the right to go to court and receive a jury trial.” Because the clear-statement rule singled out arbitration for disfavored treatment, the Court held that it violated the FAA.


    The Court emphatically rejected the argument that the state’s clear-statement rule “affects only contract formation because it bars agents without explicit authority from entering into arbitration agreements,” and that the FAA did not apply because “states have free rein to decide . . . whether such contracts are validly entered in the first instance.” Citing both the FAA’s text requiring arbitration contracts to be held “valid, irrevocable, and enforceable” and the Court’s existing case law on the formation of arbitration agreements, the Court held that, “A rule selectively finding arbitration contracts invalid because improperly formed fares no better under the Act than a rule selectively refusing to enforce those agreements once properly made.”


    With this ruling, the Court appears to be warning states that it will not permit any legislation that gives the slightest whiff of disfavoring arbitration, even if the potentially adverse effect on arbitration is merely incidental. Moreover, the Court is indicating that states are just as tightly restricted in writing laws governing the formation of arbitration contracts as they are in legislating their enforceability.

  • The Court ruled that the FAA forecloses courts from applying neutral state law principles in the face of ambiguous contract language if doing so would result in allowing arbitration to proceed on a class-wide basis.

    Lamps Plus, Inc. v. Varela, No. 17-988 (U.S. Apr. 24, 2019)

    Relevant Facts: An employee of Lamps Plus fell prey to a phishing scheme and accidentally released the tax information of thousands of the company’s workers. After Frank Varela discovered a fraudulent tax return had been filed in his name, he filed a putative class action lawsuit in federal court against Lamps Plus on behalf of the employees whose information was compromised. Lamps Plus responded by filing a motion to compel individual arbitration. The District Court granted the order to compel arbitration, but denied the company’s effort to break the class. Under the state law doctrine contra proferentem, ambiguous language in a contract should be interpreted in a favor of the non-drafting party. Because the language in the arbitration clause drafted by Lamps Plus was ambiguous, the court allowed class arbitration proceedings to move forward. The appellate court affirmed.


    Question Before The Court: Whether the Federal Arbitration Act bars courts from applying a neutral principle of state contract interpretation to an ambiguous contract term when doing so would result in the authorization of class arbitration proceedings.


    The Opinion: Under California law, the doctrine of contra proferentem provides that ambiguous contract terms should be interpreted against the drafter. Because the arbitration provision at issue here was ambiguous, the Ninth Circuit interpreted it in a way most favorable to the non-drafting employee required to accept it, allowing class arbitration to move forward. Relying on precedent from only the last decade, the U.S. Supreme Court reversed, holding that an arbitration contract must expressly authorize class arbitration in order for parties to access the arbitral forum collectively. In the Court’s view, the “traditional individualized arbitration contemplated by the FAA”—and the benefits the Court has assigned to it—are undermined by class arbitration. For that reason, the Court held that “ambiguity does not provide a sufficient basis to conclude that parties to an arbitration provision agreed to ‘sacrifice the principal advantage of arbitration.’


    Additionally, the Court addressed the appellate court’s use of contra proferentem, and ruled that the FAA’s predilection for individual arbitration prevents courts from applying a state’s general contract principles to ambiguous contract terms if doing so would result in the authorization of class arbitration. The Court explained, “The FAA provides the default rule for resolving certain ambiguities in arbitration agreements. . .. Courts may not infer from an ambiguous agreement that parties have consented to arbitrate on a classwide basis. The doctrine of contra proferentem cannot substitute for the requisite ‘contractual basis’ for concluding that the parties agreed to class arbitration.”


    All four justices in the minority authored separate dissents. Justice Breyer focused on jurisdictional issues. Justice Ginsburg lambasted the majority’s woeful straying from the legislative purpose of the FAA at the expense of employees and consumers. “Piling Pelion on Ossa,” she wrote, “the Court has hobbled the capacity of employees and consumers to band together in a judicial or arbitral forum.” Justice Kagan, too, excoriated the majority’s blatant anti-class action judicial activism that lay at the heart of their decision to render the state’s “plain-vanilla rule of contract interpretation” inapplicable to arbitration contracts.


    In her dissent, Justice Sotomayor expressed her dismay as to the effect the majority’s rule would have on states, providing, “This Court normally acts with great solicitude when it comes to possible preemption of state law, but the majority today invades California’s contract law without pausing to address whether its incursion is necessary. Such haste is as ill advised as the new federal common law of arbitration contracts it has begotten.”

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