Litigation vs. Arbitration

The New Jersey Supreme Court refused to allow a respondent to benefit from its refusal to pay arbitration fees in Roach v. BM Motoring, LLC, 2017 WL 931430 (NJ March 9, 2017).

First, Ms. Jackson filed a demand for arbitration against a New Jersey car dealership with the AAA.  The parties’ arbitration agreement required the dealership to “advance both party’s [sic] filing, service, administration, arbitrator, hearing or other fees, subject to reimbursement by decision of the arbitrator.”  Nevertheless, the dealership refused to pay any filing fees or even respond to the claim and the AAA dismissed the case for non-payment.  (Sing it: “Sorry Ms. Jackson, I am for real…”)  Another buyer, Ms. Roach, also had her claim dismissed due to the dealership’s failure to comply with the AAA rules.

Ms. Jackson and Ms. Roach then filed a putative class action in New Jersey state court.  The dealership had the nerve to move for dismissal, due to the arbitration clause. The trial court granted the dealership’s motion, and the high court reversed.

The NJ Supreme Court had no patience for the dealership’s arguments.  It first disposed of the dealership’s argument that the consumers were wrong to take their arbitration demand to the AAA.  The agreement provided that “arbitration shall be conducted in accordance with the rules of the” AAA.  The court noted that Rule R-2 of the AAA’s Commercial Rules provides that parties who agree to use the AAA rules also consent to AAA administration, and the plaintiff’s choice of forum is granted deference.

Second, the court found the dealership materially breached the arbitration agreement by failing to pay AAA fees and respond to the arbitration demands, and as a result, the dealership could no longer compel arbitration.  Otherwise “the result would be a ‘perverse incentive scheme’–a company could ignore an arbitration demand, and if the claimant did not abandon the claim, later compel arbitration.”  (internal quotes from a Ninth Circuit decision on the topic).

What’s the lesson?  As my contracts professor liked to say: “Don’t try to game it.” 


As long as we’re on the subject of state courts, I will share that Georgia’s high court enforced an arbitration agreement in the context of an allegation of wrongful death at a nursing home.  United Health Services of Georgia, Inc. v. Norton, 2017 WL 875035 (Ga. March 6, 2017).  That’s not the direction that many state courts have taken recently.

 

 

Within the U.S. Government, the CFPB has gotten most of the attention for trying to regulate consumer arbitration.  But this month, the Centers for Medicare & Medicaid Services (CMS) are bumping the CFPB out of the arbitration regulation spotlight.  In particular, the CMS issued a rule that will prohibit the use of pre-dispute arbitration agreements in most long term care facilities.

On its blog, the CMS explains the change this way:

The rule makes important changes to strengthen the rights of residents and families in the event that a dispute arises with a facility. Historically, many facilities require residents to agree to binding arbitration clauses when they are admitted to these facilities. These clauses require the resident to settle any dispute that may arise using arbitration rather than the court system. Effective November 28, 2016, our final rule will prohibit the use of pre-dispute binding arbitration agreements. This means that facilities may not require residents to sign pre-dispute arbitration agreements as a condition of admission to that long-term care facility.

The rule applies to all long-term care facilities that participate in the Medicare or Medicaid programs.  The prohibition is in keeping with the recommendation of the American Bar Association.

The rule is also in keeping with the decisions of many state courts, which have largely refused to enforce arbitration agreements in nursing home admission documents.  For example, the Supreme Court of Florida last month found that an admission document signed by the resident’s son did not bind the resident, and therefore claims of negligence and statutory violations could proceed in court.  Mendez v. Hampton Court Nursing Ctr., __ So. 3d __, 2016 WL 5239873 (Fl. Sept. 22, 2016).  The highest courts in Pennsylvania, Alabama, South Carolina, Kentucky, and Oklahoma have also refused to enforce arbitration agreements in recent years, for a variety of reasons.

It will be interesting to see whether CMS’ regulation of arbitration draws the same type of challenge that CFPB’s regulation of arbitration has drawn.

The 9th Circuit recently allowed a claimant to proceed in court after her arbitration had been terminated due to her  failure to pay half the arbitration fees. Tillman v. Tillman, __ F.3d __, 2016 WL 3343785 (9th Cir. June 15, 2016).

The case involved a client’s malpractice claim against her lawyers, which was stayed by the federal court after the lawyers compelled it into arbitration. At some point in arbitration, the client was unable to pay the $18,562.50 the AAA required to continue with the claim.  The law firm refused to pay the client’s share of the fees, and the arbitrator terminated the arbitration as a result of nonpayment.

The law firm then asked the federal court to lift its stay and dismiss the malpractice complaint for failure to prosecute. The court reviewed evidence and confirmed the client was unable to pay the AAA fee, but dismissed her case.

On appeal, the Ninth Circuit first focused its attention on the text of Section 3 of the FAA. Section 3 requires courts to stay court proceedings “until such arbitration has been had in accordance with the terms of the agreement.”  It found that the client’s arbitration “ha[d] been had in accordance with the terms of the agreement”, as the AAA rules allowed the arbitrator to terminate the proceeding for nonpayment.  So, lifting the stay was appropriate.

However, the Ninth Circuit found the district court erred when it dismissed the client’s claim. It found nothing in the FAA or binding precedent that required dismissal of the litigation.  Therefore, it enforced a district court’s usual obligation to decide cases properly before it.

The court was not blind to the potential policy ramifications of its decision, though.  It commented:

“Our decision that Tillman’s case may proceed does not mean that parties may refuse to arbitrate by choosing not to pay for arbitration.  If Tillman had refused to pay for arbitration despite having the capacity to do so, the district court probably could still have sought to compel arbitration under [Section 4 of the FAA].”

So, poor litigants may avoid arbitration by failing to pay the arbitration fees, but wealthy litigants cannot? That seems to be the outcome here (and last year in the 10th Cir. ).  Any respondent in arbitration who wants to avoid this odd result should agree to pay both parties’ fees, and then ask the arbitrator(s) to take that into account in the resulting award.

What is “arbitration”? Although courts often use and apply the word, rarely do they stop to define it.  While the FAA concerns agreements to “settle by arbitration a controversy,” the FAA does not define “arbitration,” leaving the question to the courts. Lacking definitive guidance from the U.S. Supreme Court, two lines of cases have developed among the U.S. Courts of Appeals.

The split can be traced back to AMF Inc. v. Brunswick Corp., where bowling lane companies agreed to submit disputes about advertising to a third party to determine whether the claims in the ads were supported. 621 F. Supp. 456 (E.D.N.Y. 1985). After ads from Brunswick claimed “high tech” superiority over AMF’s wooden lanes, the court set out to resolve whether the process detailed in the agreement was “arbitration.” The key language from the case is that the “essence of arbitration” is “to have third parties decide disputes.” The court concluded that the parties had agreed to arbitrate because at least one controversy — the factual issue of whether the advertising claim was supported — would be “settled.” “Arbitration” need not end all controversy between the parties, and with the factual dispute resolved it was “highly likely” that the litigation based on that factual dispute would also be resolved.

Will it resolve the dispute?

The first line of case law stemming from AMF emphasizes the likelihood of parties to resolve their disputes through a given dispute resolution process. The Third, Ninth, Fourth, Tenth, and Second Circuits take this view, each with their own twist. In Harrison v. Nissan Motor Corp. in U.S.A., the Third Circuit narrowed the AMF holding slightly, reviewing an arbitration provision that expired after 40 days and holding that the process agreed to was not arbitration because the parties did not agree to see the dispute “through to completion.” 111 F.3d 343 (3d Cir. 1997).

The Ninth Circuit expanded Harrison’s definition in Wolsey, Ltd. v. Foodmaker, Inc., 144 F.3d 1205 (9th Cir. 1998), holding that an agreement that did not “explicitly permit one of the parties to seek recourse to the courts” was still arbitration, even though it was non-binding. The Fourth Circuit stretched Harrison’s definition even further in United States v. Bankers Ins. Co., holding that an agreement that permitted a federal agency to unilaterally reject a third party’s determination qualified as arbitration. 245 F.3d 315 (4th Cir. 2001). The court reasoned that because the agency would presumably approve an arbitration award it found favorable, the dispute resolution process would not be a “futile exercise.”

Seemingly rejecting the more expansive views of the Ninth and Fourth Circuits, the Tenth Circuit held that an agreement to accept a series of appraisals to resolve a purchase price dispute was not an agreement to arbitrate in Salt Lake Tribune Publ’g Co., LLC v. Mgmt. Planning, Inc., 390 F.3d 684 (10th Cir. 2004). Relying heavily on Harrison, the court found that the appraisal at issue would only fix the purchase price under certain circumstances, and therefore would “not necessarily settle a dispute” between the parties. The Second Circuit took a similar approach in Bakoss v. Certain Underwriters at Lloyds of London Issuing Certificate No. 0510135, emphasizing precedent requiring a binding resolution for arbitration, and holding that a doctor’s “final and binding” evaluation of a disability diagnosis met the definition. 707 F.3d 140 (2d Cir. 2013).

Does it look like “classic” arbitration?

The second line of AMF-derived cases focuses less on a dispute resolution process’s likelihood of settling disputes, and instead looks for a set of procedural features indicative of “classical arbitration.” In Fit Tech, Inc. v. Bally Total Fitness Holding Corp., the First Circuit identified several “common incidents of arbitration,” including a binding resolution, an independent adjudicator, substantive standards, and an opportunity for each side to present its case. 374 F.3d 1 (1st Cir. 2004). Finding that the parties’ dispute resolution process had all of these features, at least with respect to some of their disputes, the court held that it qualified as arbitration.

The Eleventh Circuit identified the circuit split on the definition of arbitration, but did not see a real disagreement. Advanced Bodycare Sols., LLC v. Thione Int’l, Inc., 524 F.3d 1235 (11th Cir. 2008). The court concluded that submitting a dispute to a third party for a binding decision is “quintessential classic arbitration,” and identified four factors used to decide whether a dispute resolution method is arbitration, expanding on the “common incidents of arbitration.”

The Sixth Circuit provided the most comprehensive definition of arbitration of all the AMF-derived appellate cases in Evanston Ins. Co. v. Cogswell Properties, LLC, 683 F.3d 684 (6th Cir. 2012). In building its definition of arbitration, the court cited Fit Tech factors in support of the proposition that the definition of arbitration depends on “how closely it resembles classic arbitration.” The court observed that a central feature of classic arbitration is a third party empowered to render a decision settling the dispute between parties, mirroring the reconciliation approach taken in Advanced Bodycare. Citing Harrison, the court also observed that arbitration requires parties to submit to the process “through to completion.”

Why does this matter? 

Many contracts provide that some third party will decide a dispute between the parties.  For example, a third party appraiser will determine if a change in rent is fair, or a CPA will determine the buy-out price for a departing shareholder.  But, if those provisions are treated as arbitration by the court, that means they can be strictly enforced pursuant to Section 2 of the FAA, and it means the third party’s decision is entitled to great deference, pursuant to Section 10 of the FAA.  That may not have been what the parties intended when they were drafting.

________________________________

Additional reading:

Definitional Avoidance: Arbitration’s Common-Law Meaning and the Federal Arbitration Act by Niall Mackay Roberts provides an in-depth look at the evolving definition of arbitration among the courts over time

The Committee on International Commercial Disputes examines the definition of arbitration and a host of other issues in the expert determination context in its 2013 report, Purchase Price Adjustment Clauses And Expert Determinations: Legal Issues, Practical Problems And Suggested Improvements.

_______________________________

ArbitrationNation thanks Justin Sharp, a law student at Northwestern University School of Law, for researching and drafting this post.  And asks you to consider nominating the blog for the ABA’s Blawg 100 list, by following this link (the URL is www.arbitrationnation.com)!  Last request. 

Continuing last week’s theme of “States Gone Wild,” here are three more oddball summer decisions from state supreme courts. All of them find interesting paths around federal case law (IMHO).

Georgia Says Class Complaint Is Deemed Arbitration Opt Out For All Class Members

In Bickerstaff v. SunTrust Bank, 2016 WL 3693778 (Ga. July 8, 2016), the issue was whether a class action challenging overdraft fees could proceed in court. The class complaint was filed in July of 2010, and in August of 2010 (in response to a court ruling), the bank amended its deposit agreement to allow customers to opt out of arbitration. In part, the amended arbitration agreement stated:

To reject this arbitration agreement provision, you must send the Bank written notice of your decision … by the later of October 1, 2010 or within forty-five (45) days of the opening of your Account. Such notice must include a statement that you wish to reject the arbitration agreement … along with your name, address, account name, account number and your signature … This is the sole and only method by which you can reject this arbitration agreement provision.

Just after October 1, the bank moved to compel arbitration. The issue of whether the complaint could serve as the formal rejection of the arbitration provision ended up before the Supreme Court of Georgia. That court unanimously held that “the filing of Bickerstaff’s complaint, thereby signaling his rejection of the arbitration agreement, tolled the time in which the putative class members were required to notify SunTrust of their intent to reject arbitration.”

In its analysis, the court leaned heavily on Georgia cases in the class action context, finding that class representatives may satisfy statutory or contractual preconditions on behalf of those class members who remain in the class after it is certified. “[T]he satisfaction of a precondition for suit by the class plaintiff typically avoids the necessity for each class member to satisfy the precondition individually.” Curiously absent from the decision was any discussion of Stolt-Nielsen, or Section 2 of the FAA (requiring strict enforcement of valid arbitration agreements), or the preemption rulings in Concepcion and DirecTV.

[Thanks to a reader for sending me this case before Westlaw did.]

Split South Carolina Court Reasons Its Way Around Rent-A-Center

Our next state court ruling at least acknowledges the relevant federal precedent. In Smith v. D.R. Horton, Inc., 2016 WL 3660720 (S.C. July 6, 2016), the issue was whether a husband and wife had to arbitrate their construction defect claims against their builder. Section 14 of the parties’ agreement was entitled “warranties and dispute resolution,” and made up of ten subparagraphs covering topics from whether the builder could remove existing trees, to the private warranty it provided, to the requirement to arbitrate disputes. The arbitration agreement was in 14(g), with its own subheading “mandatory binding arbitration.” The builder moved to compel arbitration and the homeowners argued that clauses within Section 14 made the arbitration agreement unconscionable.

The builder relied on the severability doctrine, first set forth in Prima Paint but reiterated in Buckeye Check Cashing and Rent-A-Center, which holds that courts may only decide disputes about the validity of the arbitration agreement itself, all other challenges to the contract must be determined by the arbitrator. The builder defined the arbitration agreement as 14(g), which the homeowners did not challenge, while the homeowners defined the arbitration agreement as all of Section 14. The court agreed with the homeowners, relying largely on the title of Section 14, and the fact that the subparagraphs had “cross-references to one another, intertwining the subparagraphs so as to constitute a single provision.”

Having defined the arbitration agreement to include all of Section 14, the court went on to find the arbitration agreement unconscionable due to its disclaiming implied warranty claims and prohibiting monetary damages. (As Section 14 had no severability clause, the court refused to analyze whether the unconscionable portions could be stricken.) Two justices dissented, noting that “the majority has not followed controlling precedent of the United States Supreme Court.” (That should help the cert petition…)

[NOTE TO DRAFTERS: Move your arbitration agreement into a separate paragraph with its own heading right now! Give it its own severability clause. Then you can keep reading.]

North Dakota Forgets To Read The Footnotes

Not to be left out of the “buck SCOTUS” summer trend, North Dakota issued a decision finding that a district court did not err in compelling arbitration of the formation of the parties’ contract. 26th Street Hospitality, LLP v. REAL Builders, Inc., 2016 WL 3022054 (N.D. May 26, 2016). One party to the contract argued the contract was invalid because it was executed without the knowledge and authority of the Partnership, as proper consent had not been received pursuant to the company’s charter documents. Nevertheless, the district court compelled arbitration, without deciding the formation of the contract. The North Dakota Supreme Court unanimously found the district court did not err in refusing to decide formation before ordering arbitration, relying on Rent-A-Center’s discussion of severability.   What it did not discuss, however, is 1) the first footnote in Buckeye Check Cashing which specifically states that the severability doctrine does not apply when the issue is “whether any agreement between the alleged obligor and obligee was ever concluded,” or 2) the fact that a majority of federal courts have concluded formation is an issue for courts, not arbitrators.

As long as we’re talking state courts…

Two state supreme courts have new decisions on waiver. The Texas Supreme Court found a company did not waive its right to arbitrate claims with individual customers in RSL Funding, LLC v. Pippins, 2016 WL 3568134 (Tex. 2016). Importantly, the Texas court said that for Party A to waive its right to arbitrate with Party B, the court will only analyze Party A’s litigation conduct with respect to Party B after a dispute arises. In this case, the majority of the company’s litigation conduct at issue was directed at third parties before a dispute arose with the individual customers.

The Supreme Court of South Carolina found a nursing home waived its right to arbitrate wrongful death claims in Johnson v. Heritage Healthcare of Estill, 2016 WL 3022394 (S.C. May 25, 2016). The nursing home had litigated over the estate’s right to records and conducted discovery before moving to compel arbitration.

_____________________________

Phew!  Long post.  Is ArbitrationNation your primary source for analysis of state court arbitration decisions? For the latest advice on drafting arbitration clauses? Or just a home for your arbitration geekdom? If so, please consider nominating the blog for the ABA’s Blawg 100 list, by following this link.

Before I can sum up 2015 in arbitration (next post!), I need to report on some new cases coming out of the federal and state appellate courts in recent weeks.  Two are just good reminders of basic arbitration law, but the third addresses an interesting question of double recovery.

Our first “reminder” case comes from New York’s highest court.  In Cusimano v. Schnurr, 2015 WL 8787554 (N.Y. Dec. 16, 2015), that court held that the Federal Arbitration Act applies, even to intrafamily transactions among New York residents (sing: “it’s a family affaaaair…”), and even when defendants argue their family business is “passive” and has no impact on interstate commerce.  The court basically said family shmamily, look at the type of business you have and what it owns.  “The idea that the intrafamilial nature of the agreements has some bearing on whether the FAA is applicable finds no support in the caselaw.”  Instead, the fact that the family business owned commercial properties inside and outside New York was key.  (But, the plaintiffs waived their right to arbitrate by litigating aggressively for a year.)

The second “reminder” comes from the Eleventh Circuit and relates to appeal timing.  In the Wise Alloys case, 2015 WL 8119326 (11th Cir. Dec. 8, 2015), that court held that the defendant did not appeal the district court order compelling arbitration within the allowed deadline.  (The court had fun with this one, quoting Carole King to say “it’s too late…”)  Critically, the entire complaint related to the union’s effort to compel the defendant company to arbitration.  The district court compelled arbitration in June of 2012, but the company did not appeal until after the arbitration was complete and the award had been confirmed in late 2014 (well beyond the 30-day deadline in the federal rules).  The lesson from this case is that while Section 16 of the FAA commands that “interlocutory” orders compelling arbitration are not immediately appealable, not all orders compelling arbitration are interlocutory: if the only relief a complaint seeks is an order compelling arbitration, then the order granting that relief is final and immediately appealable.

The most interesting outcome in this group comes from the Ninth Circuit (with Judge Shira Scheindlin from SDNY sitting by designation on the opposite coast).  In Uthe Technology Corp. v. Aetrium, Inc., 2015 8538090 (9th Cir. Nov. 19, 2015), the plaintiff had already been awarded millions of dollars against related defendants in an arbitration and then brought a RICO claim for treble damages in U.S. federal court for the same conspiracy.  The question was whether that RICO claim was precluded by the “one satisfaction” rule that avoids double recovery.  (P.s. That arbitration lasted two decades.  Score one for litigation.)   The Ninth Circuit found the RICO claims were not precluded, largely because the arbitration claim was against a different set of defendants, and RICO provides remedies that were not available to Uthe in the arbitration, and the arbitration award specifically noted that it was made without prejudice to Uthe’s right to bring further claims in federal court.  The 9th Circuit did note that any damages in the RICO case must be offset by the sums paid as a result of the arbitral award

Arbitration is having its 15 minutes of fame.  Thanks to a series in the New York Times, my inbox is full of links to the articles, questions about the information, and fascinating commentary.  [Next time I am in Oakland, I am totally having the “Scalia” cocktail at Italian Colors.]  With the far-reaching audience of the NYT, the policy questions surrounding waivers of class arbitration are no longer just a conversation among in-house counsel, advocates, and law professors, but reached the general water cooler set.  For anyone passionate about arbitration law, it’s like Christmas morning.  Jumping past the merits of the policy questions for a moment, what could happen if the public demands that its representatives take action?

One possibility is that there may be more cases like McLeod v. General Mills, Inc., Case No. 15-494 (D. Minn., October 23, 2015).  In that case, the Chief Judge of the District of Minnesota found that an employee collective action could go forward in court, despite a valid arbitration agreement that demanded individual actions.  Why?  Because language in the Older Workers Benefit Protection Act of 1990 (OWBPA) provides that any worker challenging the validity of a waiver of ADEA (Age Discrimination in Employment Act) rights “shall have the burden of proving in a court of competent jurisdiction that a waiver was knowing and voluntary.”  The court found that the statute’s use of “shall” along with “court” was sufficient to trump the earlier and more general requirement that courts enforce arbitration agreements (in the FAA).  [Some of the workers in the case are just 42, and 44 years old.  Could I really be that close to the definition of an “older worker”??]

Unless there is a wholesale rewriting of the FAA, which seems unlikely, any action to ensure the availability of class and collective actions in court will likely take place one industry or one specific statute at a time.   The CFPB may require that consumers of financial products can bring class actions in court.  And members of Congress may start inserting language like the text of the OWBPA into other statutes designed to protect certain classes of employees and consumers.  Although, in my experience, the most likely outcome is that arbitration’s 15 minutes will pass, and it will go back to something talked about only by lawyers, judges and professors, and nothing will change until the current SCOTUS majority becomes the minority.

Richard Cordray, Director of the Consumer Financial Protection Bureau, has positioned himself as the Boogeyman that financial companies fear this Halloween season.  Earlier this month, the CFPB outlined the proposals under consideration for regulating arbitration in the consumer financial industry.  The proposals address the availability of class actions — as was widely expected — but also express concern about individual financial arbitrations and suggest those will be monitored.  [I am late to the party on this topic.  But I had to consider it carefully over butterbeer in Orlando…]

To set the table, the CFPB describes its take-aways from the arbitration study it published in March.  In particular, the study led to two concerns:

  • “[T]he Bureau is concerned that arbitration agreements effectively prohibit class proceedings, including litigation, and that they prevent many consumers from obtaining remedies when they are harmed by their providers of consumer financial products or services” and
  • “The Bureau is concerned [] that pre-dispute arbitration agreements that require arbitration of individual claims may have in the recent past led to harms to many consumers and is further concerned that these types of harms may recur.”  “The Bureau is concerned that there is a potential for significant consumer harm if arbitration agreements were to be administered in biased or unfair ways.”  [Here CFPB cited the NAF example.]

Each of those concerns inspired a particular proposal for regulating consumer financial arbitration.  The proposal for addressing the concern about class proceedings is that any arbitration agreement included with consumer financial agreements must state that it is inapplicable to cases filed in court on behalf of a class “unless and until class certification is denied or the class claims are dismissed.”

The proposal for addressing the concern about potential bias in individual arbitrations is “to shed sunlight” on those proceedings by collecting consumer financial claims filed with private arbitration administrators (and potentially publishing them), and publishing the resulting arbitration awards (with redactions for privacy).  CFPB notes that FINRA already publishes all awards and the AAA publishes employment awards, so there is some precedent.

Opponents of the proposals take the position that the data in the CFPB study does not support these proposed regulations and that they will lead to higher prices for consumers as companies pass along their increased costs of defending class actions. There has also been a suggestion that these regulations by the CFPB go beyond the authority granted in the Dodd-Frank Act or are otherwise improperly broad.  On the other hand, consumer advocates urge the CFPB to go farther and ban pre-dispute arbitration agreement in all consumer financial transactions.

The proposals will now be the subject of a small business advisory review panel, and then after formal rules are proposed there will be a notice and comment period, so final regulation is not likely until late 2016.  However, I personally am interested to see whether the conversation over these proposals catches the public’s attention to the extent that it becomes a topic in the presidential election.  If so, it is possible that there could be even more changes in store for arbitration.

 

Let’s say your client gets sued in court, the parties have an arbitration agreement, and you want to compel arbitration right away and not mess around with any other court proceedings. You already know you can make a motion to compel instead of an Answer, but you are stuck on this: what do you call the motion?

Let’s face it, neither the federal or state rules of civil procedure line up perfectly with the FAA (for example, Rule 12 does not list “motion to compel arbitration” as a potential responsive pleading). Today’s post is designed to help you figure out what subsection of Rule 12 to identify when you make your motion to compel arbitration straight out of the box. In short, not all federal appellate courts have spoken on this issue, and the ones that have are divided on whether a motion to compel arbitration should be made under Federal Rule 12(b)(1), 12(b)(3), or 12(b)(6).

Federal courts in six circuits have treated motions to compel arbitration as motions to dismiss for lack of subject matter jurisdiction under Rule 12(b)(1). A district court in the Eleventh Circuit is the only court to expressly state that motions to compel arbitration should be brought under Rule 12(b)(1). MRI Scan Ctr., L.L.C. v. Nat’l Imaging Assocs., Inc., No. 13–60051–CIV, 2013 WL 1899689, at *2 (S.D. Fla. May 7, 2013). However, in the Second, Sixth, Eighth, Ninth, and Federal Circuits litigants have been permitted to bring motions to compel under the 12(b)(1) standard. See, e.g., Geographic Expeditions, Inc. v. Estate of Lhotka, 599 F.3d. 1102, 1106–07 (9th Cir. 2010); U.S. ex rel. Lighting & Power Servs., Inc. v. Inferface Constr. Corp., 553 F.3d 1150, 1152 (8th Cir. 2009); Harris v. United States, 841 F.2d 1097, 1099 (Fed. Cir. 1988); Multiband Corp. v. Block, No. 11–15006, 2012 WL 1843261, at *5 (E.D. Mich. May 21, 2012); Orange Cnty. Choppers, Inc. v. Goen Techs. Corp., 374 F. Supp. 2d 372, 373 (S.D.N.Y. 2005).

Other circuits take a different position asserting that motions to compel arbitration should be brought under Rule 12(b)(3) for improper venue. The Fourth and Seventh Circuits adopt this approach. These circuits reason that because arbitration clauses are a type of forum selection clause and therefore concern venue, motions to compel arbitration should be brought under Rule 12(b)(3). Gratsy v. Colo. Technical Univ., 599 Fed. App’x 596, 597 (7th Cir. 2015); Hayes v. Delbert Servs. Corp., No. 3:14:–cv–258, 2015 WL 269483, at *4 n.1 (E.D. Va. Jan. 21, 2015).

Only one circuit adopts Rule 12(b)(6) — failure to state a claim upon which relief can be granted — as the proper subpart for a motion to compel arbitration. The Third Circuit explicitly rejects the practice of bringing motions to compel arbitration under 12(b)(3) and requires that motions to compel arbitration should be made under Rule 12(b)(6). Palko v. Airborne Express, Inc., 372 F.3d 588, 597–98 (3rd Cir. 2004); Lomax v. Meracord L.L.C., No. 13–1945 (SRC), 2013 WL 5674249, at *6 n.3 (D.N.J. Oct. 16, 2013).

The First, Fifth, Tenth, and D.C. Circuits have yet to address the issue.

The following chart summarizes the federal appellate courts’ treatment of motions to compel arbitration:

  12(b)(1)   Subject Matter Jurisdiction 12(b)(3) Improper Venue 12(b)(6)   Failure to State a Claim Unanswered
1st Circuit Unanswered
2nd Circuit Permitted
3rd Circuit Express
4th Circuit Express
5th Circuit Unanswered
6th Circuit Permitted
7th Circuit Express
8th Circuit Permitted
9th Circuit Permitted
10th Circuit Unanswered
11th Circuit Express
Fed. Circuit Permitted
D.C. Circuit Unanswered

ArbitrationNation thanks Mary-Kaitlin Rigney, a student at American University Washington College of Law, for researching and drafting this post.

Usually, when faced with a respondent who refuses to pay its share of the arbitration fees, a claimant simply pays both sides’ fees, so that the arbitration can proceed.  A new case out of the Tenth Circuit answers the question: what happens if it does not pay both sides’ fees?  Pre-Paid Legal Services, Inc. v. Cahill, __ F.3d__, 2015 WL 3372136 (10th Cir. May 26, 2015).  Somewhat surprisingly, the answer is that the claimant can choose to litigate its case in court, where there are no fees.

Pre-Paid Legal Services sued its former employee for allegedly taking its trade secrets to a new employer.  Pre-Paid brought that suit in state court.  The employee removed to federal court and moved to stay the case pending arbitration.  The district court agreed.  The day after the district court’s order, Pre-Paid started a AAA arbitration against the ex-employee.  Pre-Paid paid its share of the arbitration fees, but the ex-employee never paid its share.  “Pre-Paid declined to pay [the employee’s] share of the fees.”  (Maybe it wanted to be a test case??)  After many warnings, the AAA terminated the arbitration for non-payment of fees.  Because the employee refused to pay its share of the fees, and Pre-Paid would not pay its share either, Pre-Paid’s claims were never heard on the merits in arbitration.

So, Pre-Paid went back to federal court, asking the district court to lift the stay and allow litigation to proceed.  The ex-employee opposed the motion based on Section 3 of the FAA.  He argued that the language of Section 3 only allows a stay to be lifted after an arbitration is heard on the merits.  The statute says that if suit is brought on an arbitrable issue, the court:

shall on application of one of the parties stay the trial of the action until such arbitration has been had in accordance with the terms of the agreement, providing the applicant for the stay is not in default in proceeding with such arbitration.

Both the district court and the Tenth Circuit disagreed with the ex-employee.  They refused to allow him to create a loophole whereby a defendant/respondent could avoid ever getting to the merits of a claim against him by simply refusing to pay his share of arbitration fees.

The Tenth Circuit analyzed two key phrases in the statutory language quoted above.  First, it found that “arbitration has been had in accordance with the terms of the agreement” does not necessarily mean a full hearing on the merits.  Instead, where the parties incorporate the rules of the AAA in their arbitration agreement, and those rules allow the AAA to terminate an arbitration for non-payment, even a terminated arbitration did happen “in accordance with the terms of the agreement.”

Second, the Tenth Circuit identified an alternative basis for lifting the stay: the ex-employee was “in default in proceeding” with the arbitration.  The ex-employee’s failure to pay constituted a default under Section 3, especially since he made no attempt to show he was unable to pay or ask the arbitrators for any relief from the payment obligation.

What is the result of this decision?  Pre-Paid will “resume with litigation” in the federal district court, almost three years after it initially filed its court case against the ex-employee.  What else?  Defendants everywhere are on notice that non-payment is not a “get out of litigation free” card.

—————————–

Another interesting tidbit: Judge Posner, writing for a panel of the Seventh Circuit, recently expressed his displeasure with the “strong federal policy” in favor of arbitration.  “It’s not clear that arbitration, which can be expensive because of the high fees charged by some arbitrators and which fails to create precedents to guide the resolution of future disputes, should be preferred to litigation.”  Andermann v. Sprint Spectrum L.P., No. 14-3478 (7th Cir. May 11, 2015).