By Liz Kramer and Patrick Burns (http://www.valuesolveadr.org/patrick.html ), Guest Blogger

If an arbitration agreement calls for the dispute to be administered by an ADR provider that will not or cannot accept the case, or calls for the application of non-existent rules, it may not be enforceable.  That issue seems to be increasingly prevalent in consumer arbitrations today, which frequently call for the application of rules or arbitral fora that are unavailable. 

Consumer arbitration in the United States changed drastically in 2009.  In July of that year, the National Arbitration Forum (NAF) was essentially put out of the consumer arbitration business by the Minnesota State Attorney General’s Office.  Soon thereafter, the American Arbitration Association (AAA) ceased administering almost all consumer cases.  

Yet the resulting void of administrated consumer arbitration programs did not change the fact that many existing contracts still called for arbitration via those primary providers’ programs.  Nor does it appear to have stopped businesses from naming those same two ADR administrators in their subsequently-revised contracts.

The result is that after a dispute arises, both consumers and businesses are faced with an arbitration provision that calls for something impossible –arbitration administered by an ADR provider that refuses to accept the dispute or under rules that do not exist.  If the parties cannot agree to proceed in a replacement forum or under replacement rules, they must decide whether to roll the dice with the courts.  The trend among courts to date appears to be that they will not compel arbitration (under any rules or in any forum) if the arbitration agreement calls for arbitration before an administrator that refuses to hear the dispute. 

For example, a Pennsylvania state court recently refused to enforce an arbitration agreement between orthopedists and their patients when it called for non-existing rules.  The agreement in question called for the application of “‘Health Care Claims Arbitration Rules of the American Arbitration Association,” yet there are no rules with that title from the AAA.  In fact, the only health care rules available from the AAA do not govern disputes between doctors and patients.  The AAA’s health care rules only apply to “business-to-business” disputes (such as reimbursement disputes between health care providers and insurance payors).  The orthopedists argued that the agreement to arbitrate should still be enforced, just in another forum and under different rules, but the court found that the specific rules and forum were essential terms of the agreement.  Because those essential terms failed, the arbitration agreement was not enforceable.  (The decision is not reported; its title is Luderer v. Nazarian, and it was issued on Sept. 12 by the Philadelphia Common Pleas Court.)

 Similarly, in February of this year, the Supreme Court of Illinois held that the selection of the NAF in a consumer contract was “integral to the parties’ agreement to arbitrate,” such that when the NAF stopped conducting consumer arbitrations, the arbitration agreement was unenforceable.  Carr v. Gateway, Inc., 944 N.E.2d 327 (Ill. 2011).  However, the authors are aware of a Minnesota state court judge who resolved this problem by ordering the parties to select a new forum for arbitration when the one specified in the arbitration agreement was no longer available.   

 ENDNOTE:

 

 

The Eleventh Circuit has ruled that the plaintiff’s act of amending its complaint may allow a defendant to resurrect its previously-waived right to arbitrate.  “[I]n limited circumstances, fairness dictates that a waiver of arbitration be nullified by the filing of an amended complaint.”  Krinsk v. Suntrust Banks, Inc., __ F.3d ___, 2011 WL 3902998, at *5 (11th Cir. Sept. 7, 2011). 

In Krinsk, the defendant had participated in the court case for nine months without enforcing its right to arbitrate the putative class action claims.  The defendant’s actions included: filing a Rule 12 motion to dismiss without mentioning arbitration; expressly opposing arbitration of the claims in a case management report; agreeing to a discovery plan; and opposing class certification without ever asserting its intent to arbitrate.  

In response to the court’s ruling on the motion to dismiss, the plaintiff amended the complaint and expanded the definition of the putative class from one that covered hundreds of members to one that potentially covered tens of thousands of members.  At that point, the defendant “raised its right to arbitration for the first time since the litigation began,” and moved to compel arbitration.  The district court denied the defendant’s motion to compel arbitration, concluding it had waived that right. 

The Eleventh Circuit vacated the district court’s decision.  Despite having little authority in the arbitration realm to cite in support of its decision, the circuit court concluded that when an amended complaint “unexpectedly changes the scope or theory of the plaintiff’s claims,” the defendant may revive its right to compel arbitration.  The court supported its decision by referring repeatedly to “fairness” considerations and to the strong federal policy in favor of enforcing arbitration agreements. 

This may prove to be an important decision for parties who, intentionally or inadvertently, waived their right to arbitrate and want to resurrect it at a later point.  If there is an argument that a pleading has unexpectedly changed the scope or theory of the case, this case may provide authority for a belated assertion of the right to arbitrate.

A recent decision from the Western District of Oklahoma reminds all litigators that you may be able to get preliminary injunctive relief from the courts, despite having a valid arbitration agreement.  Although this seems to fly in the face of the courts’ general arbitration refrain (stolen from M.C. Hammer: “[We] Can’t Touch This”), courts rationalize their decision by noting that they must preserve the status quo so that the arbitration hearing may be meaningful.

 In Wells Fargo Bank v. Maynahonah, 2011 WL 3876519 (W.D.Okla. Sept. 2, 2011), the district court granted first a TRO and then a preliminary injunction, prohibiting decision-making bodies of the Apache Tribe of Oklahoma from “proceeding with any hearing, issuing any order, making any determination, or taking any official action” with respect to issues that Wells Fargo claimed were arbitrable.  While the Tribe did not challenge the validity of the arbitration agreements at issue, it had taken various actions that seriously undermined those arbitration agreements, and it planned to adjudicate issues in tribal administrative proceedings that fell within the scope of the arbitration agreement.  The Court analyzed the usual factors for injunctive relief and found: Wells Fargo had demonstrated the risk of irreparable harm (through the potential loss of its right to arbitrate and the resources it would have to spend in the tribal adjudication); the balance of interests favored Wells Fargo because of the strong federal policy favoring arbitration; the public interest favored “safeguarding an arbitration agreement made by the Tribe”; and Wells Fargo was likely to succeed in showing that the Tribe was proceeding improperly.

If you have a valid arbitration agreement in your case, but need emergency relief, a two-step analysis is required to determine whether that relief is available from the courts. 

1.         Step One: Analyze The Language of the Arbitration Provision.

            If the arbitration agreement carves out requests for injunctive relief from the scope of arbitrable controversies, you have a strong basis to seek court relief.  Even a carve-out, however, does not necessarily guarantee success with the courts if there are disputes about the scope or applicability of the carve out. 

            Note that your arbitration agreement may also provide for emergency relief from the arbitrator.  If your arbitration agreement calls for administration with the AAA, check to see if that agreement incorporates the AAA rules for emergency protection.  (Those rules are titled “O-1” through “O-8”.)  If those rules are incorporated, they provide for temporary restraining orders and preliminary injunctions using procedures very similar to those applicable in state and federal courts.  However, the AAA may not react as quickly to a claimant’s request for emergency relief as a court is able to react.  (The AAA first has to appoint a case administrator and an emergency arbitrator, for example, and will not act until all fees are paid.)

2.         Step Two: Analyze the Governing Case Law.

            If your arbitration agreement does not explicitly provide for any special emergency procedures, or you think those emergency procedures still may be too slow, the next step is to see whether the case law in your federal circuit still allows you to seek relief in court.  While the FAA does not specifically address whether courts have authority to issue injunctions, most federal circuits are willing to grant emergency relief for the limited purpose of maintaining the status quo for the arbitrator, as long as the usual tests for injunctive relief are met.  E.g., Performance Unlimited, Inc., v. Questar Publishers, inc., 52 F.3d 1373, 1380 (6th Cir. 1995); Merrill Lynch, Pierce, Fenner & Smith v. Salvano, 999 F.2d 211, 214 (7th Cir. 1993); Ortho Pharmaceutical Corp. v. Amgen, Inc., 882 F.2d 806, 812 (3d Cir. 1989); Teradyne, Inc. v. Mostek Corp., 797 F.2d 43, 47 (1st Cir. 1986); Jameson v. Pine Hill Development, LLC, No. 07-0111, 2007 WL 623807, at *2 (S.D. Ala. Feb. 23, 2007) (citing decisions on both sides of issue).

            However, other federal circuits require evidence that the parties intended to give the courts authority to grant temporary relief.  The governing rules the parties selected for their arbitration can be sufficient evidence of the parties’ intent.  For example, in Toyo Tire Holdings of Ams. Inc. v. Continental Tire N. Am., Inc., 609 F.3d 975, 980 (9th Cir. 2010), the Ninth Circuit clarified that a court may grant injunctive relief when the governing arbitration rules provide for such relief and it is necessary to preserve the status quo pending the arbitration hearing.

In April, the Supreme Court struck down a common law rule in California that declared most consumer arbitration agreements void if they prohibit classwide arbitration of claims, holding that it was preempted by the Federal Arbitration Act.  AT&T Mobility, LLC v. Concepcion, 131S. Ct. 1740 ( 2011).  In the last few weeks, two federal circuit courts have followed suit and declared similar common law rules in New Jersey and Florida are also preempted.

The Concepcion Holding

Concepcion is a 5-4 decision written by Justice Scalia, in which the Supreme Court continued its recent trend of fighting back state court attempts to use their common law to void arbitration clauses .  The putative class action in Concepcion alleged false advertising claims in cell phone promotions.  The lawsuit was in court because each class member’s contract with AT&T prohibited class-wide arbitration.  The district court denied AT&T’s motion to compel individual arbitrations.  It ruled that the AT&T arbitration provisions were unconscionable under a 2005 decision from the California Supreme Court called Discover Bank, which applied California law to conclude that most “collective-arbitration waivers” in consumer arbitration provisions are unconscionable.  The Ninth Circuit affirmed.

The Supreme Court concluded that Discover Bank applied California’s unconscionability doctrine in a way that impermissibly “interferes” with arbitration and was therefore preempted.  The Court went on to explain that allowing consumers to demand classwide arbitration, when the parties did not consent to arbitrating on a classwide basis, is inconsistent with the FAA because it would make arbitration more formal, more expensive, slower to reach a decision on the merits, and involves increased risk to defendants (because the potential judgments can be large and there is little opportunity to appeal).  The majority wrote “we find it hard to believe that defendants would bet the company with no effective means of review.” 

The Concepcion decision, with its strenuous dissent arguing that the Discover Bank rule was applicable to all contracts, shows increasing concern by the Court about 1) how state courts are interpreting their “general” contract doctrines in ways that may be unique to arbitration, and 2) whether the strict enforcement of arbitration agreements is in keeping with the purpose of the FAA and the nation’s overall system of justice.

Eleventh and Third Circuits Follow Suit

In early August, the Eleventh Circuit applied Concepcion to compel individual arbitration of actions against a wireless service provider.  In Cruz v. Cingular Wireless, LLC, 2011 WL 3505016 (11th Cir. Aug 11, 2011), the class of plaintiffs argued that the prohibition on class actions in their arbitration agreements violated Florida public policy and was therefore unenforceable.  Plaintiffs argued that the class action prohibition effectively defeated the remedial purpose of Florida’s unfair trade practices act (because many claims would be too small to merit litigating individually) .  The Eleventh Circuit held that even if that interpretation of Florida law were correct, it would be preempted by FAA under Concepcion.

 In late August, the Third Circuit issued a similar decision.  In Litman v. Cellco Partnership, 2011 WL 3689015 (3d Cir. Aug. 24, 2011), the Third Circuit held that New Jersey common law, which found a class arbitration waiver unconscionable, was preempted by the FAA.  (Of course, the court didn’t have much choice, given that the U.S. Supreme Court had vacated the Third Circuit’s earlier opinion to the contrary and remanded the case for reconsideration in light of Concepcion…)

Look for this trend to continue over the next year, with more and more courts finding the FAA preempts particular state common law decisions that found class arbitration waivers unenforceable under state law principles.

Just over a year has passed since the U.S. Supreme Court applied the severability doctrine in Rent-A-Center, West Inc.  v. Jackson, 130 S. Ct. 2772 (2010), in such a way that Justice Stevens and three others dissented, raising the specter of “infinite layers of severability” and a parade of arbitrability horribles.  A review of the case law applying Rent-A-Center in the past year suggests that the parade of horribles has not fully come to pass.  Courts have limited their application of Rent-A-Center to cases where the parties’ arbitration agreement authorized the arbitrator to decide claims that the arbitration agreement was invalid.

Rent-A-Center Refresher

First, a refresher on the Rent-A-Center case.  In it, a litigant argued that his stand-alone arbitration agreement was unconscionable and therefore invalid.  However, the agreement  contained a provision authorizing the arbitrator to decide questions of validity (the “delegation provision”).  The Supreme Court enforced the delegation provision and sent the decision regarding validity to the arbitrator.  The Court ruled that for the employee to have his unconscionability claims heard in court, he needed to allege that the delegation provision itself was invalid, citing the Prima Paint doctrine.

The dissent balked, claiming that the majority was taking the severability doctrine from Prima Paint too far.  It worried that courts would interpret the Rent-A-Center decision to make it virtually impossible for a litigant to have a court review the enforceability of an arbitration agreement:   

Before today, however, if respondent instead raised a challenge specific to “the validity of the agreement to arbitrate”— for example, that the agreement to arbitrate was void under state law—the challenge would have gone to the court. That is what Buckeye says. But the Court now declares that Prima Paint’s pleading rule requires more: A party must lodge a challenge with even greater specificity than what would have satisfied the Prima Paint Court. A claim that an entire arbitration agreement is invalid will not go to the court unless the party challenges the particular sentences that delegate such claims to the arbitrator, on some contract ground that is particular and unique to those sentences.
It would seem the Court reads Prima Paint to require, as a matter of course, infinite layers of severability: We must always pluck from an arbitration agreement the specific delegation mechanism that would—but for present judicial review—commend the matter to arbitration, even if this delegation clause is but one sentence within one paragraph within a standalone agreement. And, most importantly, the party must identify this one sentence and lodge a specific challenge to its validity. Otherwise, he will be bound to pursue his validity claim in arbitration.
Id. at 2787 (internal citations omitted).

The dissent raises at least two concerns.  First, whether litigants whose arbitration agreement(s) contain a similar delegation provision will ever be able to obtain a court hearing on issues of the validity of the arbitration agreement.  And second, whether courts will apply the same level of severability outside the delegation context.  For example, whether a litigant arguing that her arbitration agreement is unconscionable must argue that the particular sentence saying “any and all disputes arising out of this agreement shall be heard in arbitration” is unconscionable, instead of arguing that the other sentences describing the arbitral processes are unconscionable.

One Year of Application

In reviewing a full year of state and federal case law applying the Rent-A-Center decision (thank goodness for excellent summer associates!), we found no case applying its hard-line approach to an arbitration agreement without a delegation provision.  At least to date, then, courts applying Rent-A-Center have generally heeded that particular concern from the dissenting Justices.  Litigants without a delegation provision are unlikely to have to parse their arguments relating to the enforceability of the arbitration agreement as finely as they would have to if their arbitration agreement contained a delegation provision.

However, it is certainly true that Rent-A-Center has made it nearly impossible for litigants with a delegation provision in their arbitration clause to have a court hear their allegations that the arbitration agreement as a whole is invalid.  Numerous federal and state courts have sent those types of claims to arbitration in the past year, relying on the Rent-A-Center decision.  The only litigant who avoided that fate was one who wisely alleged that the delegation provision itself was invalid.  Howard v. Rent-A-Center, Inc., No. 1:10-CV-103, 2010 WL 3009515, at *1 (E.D. Tenn. July 28, 2010).  The victory was short-lived, however—while the Court agreed it was authorized to decide the gateway issue of the validity of the delegation clause, it quickly concluded the delegation clause was valid and “allowing arbitrators [t]o] determine their own jurisdiction is neither contrary to the public policy nor unconscionable.”  Id. at *5.

 

A party with an arbitration agreement can waive its right to arbitrate by acting inconsistently with that right, usually by “invoking the litigation machinery” before demanding arbitration.  However, the federal circuits are split over whether a party asserting a waiver of arbitration must also show it was prejudiced by the other party’s use of that litigation machinery.  The Eighth Circuit generally sides with the circuits that require a showing of prejudice, but carved out an exception for the construction industry in a new case, Erdman Co. v. Phoenix Land & Acquisition, ___ F.3d ___, 2011 WL 3568929 (8th Cir. Aug. 16, 2011).

Reasoning that construction contracts tend to be standardized and “efficient resolution is of great importance” to parties in construction disputes, the court found “it makes little sense to litigate endlessly over the details of prejudice.”  Instead, it held, the “federal policy favoring arbitration does not require a showing of prejudice in this situation, unlike many others.” 

Arguments may now proceed about whether this lower bar for proving waiver should apply:

  • only to the specific facts of this case–where the same party who drafted the contract with the arbitration agreement was the one who chose to file its complaint in court, then made a subsequent motion and participated in a Rule 26(f) conference without ever mentioning a right to arbitration; or
  • to all construction cases; or
  • to all industries where contracts are standardized and efficient resolution is important, which could be almost every industry. 

 

What is an arbitrator to do after concluding that the parties’ entire agreement — the same agreement that authorized the arbitration proceeding — is invalid?  That is the question that the California Court of Appeal addressed this week.  The California court ruled that the arbitrator was authorized to reach a decision on the merits of the construction dispute even after it concluded that the parties’ agreement was illegal, and therefore the arbitration award should be confirmed.  Templo Calvario Spanish Assembly of God v. Gardner Constr. Corp., __ Cal. Rptr. 3d ___, 2011 WL 3586481 (Cal. Ct. App. Aug. 16, 2011). 

The construction dispute in Templo Calvario was between a church and an unlicensed contractor.  Although the contractor had initially balked at arbitrating the dispute (despite the contract’s arbitration clause), the opinion says that it later “agreed to submit the matter to arbitration.”  The arbitrator applied California’s strict licensure statutes and ruled that the contractor had to disgorge all the money the church had paid the contractor.  The church moved to confirm the award.  The district court vacated the award, reasoning that the contractor’s unlicensed status voided the parties’ contract, including its arbitration provision, and “the arbitrator was without authority to render a decision.”  The appellate court reversed, finding that under California law, contracts with unlicensed contractors are not “automatically illegal and void.”  For example, if a contractor was licensed while it performed the work at issue, and had only been unlicensed when it signed the contract, that may not void the construction contract.  [Based on the factual description, it seems the court could have confirmed the arbitration award on a less controversial basis.  The court could have held that the contractor’s post-dispute agreement to arbitrate authorized the arbitrator to decide the issues, so that any invalidity of the parties’ original contract was immaterial.]

The arbitrator in Templo Calvario is not the first to have decided the merits of a dispute even after concluding that the entire contract was invalid.  E.g., Elem Indian Colony of Pomo Indians v. Pacific Dev. Ptnrs. X, LLC, 2010 WL 2035331 (N.D. Cal. May 19, 2010); Ultimate Experience, USA v. Raging Waters Grp., 2005 WL 2995259 (Cal. Ct. App. Nov. 9, 2005).  At least one court, however, has refused to confirm an award reached by an arbitrator who had already concluded the entire agreement was unenforceable.  Niven v. G.F.B. Enterprises, LLC, 849 So. 2d 1093, 1094 (Fl. Ct. App. 2003).  In it, the appellate court found “the trial court erred by confirming an arbitration award based on an agreement that never existed.”  Id.

In short, the arbitrator and the parties should proceed with caution if the entire contract containing the arbitration agreement is declared invalid.  No one wants to waste resources on an arbitration proceeding that a court may later determine was unauthorized.

West Virginia’s highest court acknowledged just weeks ago that a state statute, which nullified any nursing home resident’s waiver of his or her right to a court action, is preempted by the FAA.  Brown v. Genesis Healthcare Corp., et al, __ S.E.2d ___, 2011 WL 2611327 (W. Va. June 29, 2011).  More interesting, however, was a second holding from the Supreme Court of Appeals of West Virginia.  After criticizing the U.S. Supreme Court’s interpretation of the FAA, the West Virginia court held that West Virginia will not enforce arbitration clauses “in a nursing home admission agreement adopted prior to an occurrence of negligence that results in a personal injury or wrongful death,” because it concludes they are unconscionable.

While many state courts have applied their general unconscionability doctrines in an attempt to get around the Supreme Court’s arbitration case law, West Virginia’s is a new approach.  Instead of simply applying the state’s test for unconscionability to the particular facts of a case, West Virginia’s Supreme Court of Appeals looked at three cases involving wrongful death suits at nursing homes and analyzed facts that are common to the whole nursing home industry.  (Not surprisingly, there were amicus briefs from multiple health care associations.)

The Genesis Healthcare decision implied that Congress did not intend the FAA to apply to personal injury or wrongful death suits involving a pre-injury arbitration contract.  It cited no support for that proposition apart from a Tennessee decision finding that arbitration agreements between patients and health care providers raise issues of procedural unconscionability and a statement that “[m]any groups now only arbitrate personal injury and wrongful death claims where the agreement was signed after negligence occurred, and the parameters of the liability and damages could be clearly understood by the parties”

Stay tuned to see if this new avenue of unconscionability gains traction in other states, or if the health care defendants seek certiorari from the U.S. Supreme Court.  And if they did, would Genesis Healthcare stand up any better than the California unconscionability rules at issue in AT&T Mobility v. Concepcion?

The AAA just reported that 143,349 cases were filed with it in 2010.  JAMS reports that approximately 10,000 cases are filed with it each year.

There were 190,543 new civil cases filed with all the U.S. District Courts in 2010.

In short, two of the largest ADR providers are currently handling almost as many civil cases as the nation’s federal courts.

Another point of comparison: the National Arbitration Forum had over 62,000 cases filed with it in two areas (domain name disputes and New Jersey personal injury cases), and Arbitration Forums, Inc. says it handles 500,000 insurance cases a year.  In contrast, there were less than 200,000 civil cases filed in the State of Minnesota in 2010 (and only 42,136 if you exclude things like conciliation court matters and unlawful detainers).

If you needed any more convincing about why the statutes and case law governing arbitration are important to our nation’s overall system of justice, that should do it.

SOURCES:

http://www.adr.org/sp.asp?id=39888

http://www.jamsadr.com/aboutus_overview/

http://www.uscourts.gov/uscourts/Statistics/JudicialBusiness/2010/judicialbusinespdfversion.pdf

https://www.arbfile.org/webapp/

http://www.state.nj.us/dobi/pipinfo/aicrapg.htm#dispute