What happens when state courts disagree with SCOTUS’s interpretation of the Federal Arbitration Act?  They resist, and they have a thousand different ways of doing so.  The Mississippi Supreme Court demonstrated one way to resist recently in Pedigo v. Robertson, Rent-A-Center, Inc., 2017 WL 4838243 (Miss. Oct. 26, 2017). (I neglected to mention the state appellate courts as important actors in last week’s post about what we may see now that the CFPB rule is dead.)

In Pedigo, the plaintiff entered into a Rental Purchase Agreement (RPA) from Rent-A-Center.  (Yes.  The same Rent-A-Center of delegation clause fame.)  Within about four months, he stopped making payments.  At that point, Rent-A-Center found out that plaintiff had sold the television to a pawn shop shortly after purchasing it.  Rent-A-Center then filed a complaint with the police, and the plaintiff was arrested and incarcerated.

After the plaintiff was released from jail, he filed a civil action against Rent-A-Center, alleging the police report was false.  Rent-A-Center moved to compel arbitration.  The trial court judge compelled arbitration.

On appeal, the high court found that plaintiff’s claims of malicious prosecution were outside the scope of the parties’ arbitration agreement.  The RPA itself prohibited the sale or pawning of the leased goods.  The arbitration agreement in the RPA stated that covered claims “shall be interpreted as broadly as the law allows and mean[] any dispute or controversy between you and RAC….based on any legal theory…”  The only claims not covered were those for injunctive or declaratory relief, or those seeking less than $5,000 in damages.  However, because “the agreement fails to contemplate that a lessor/signatory might pawn collateral and subsequently be indicted and jailed” the court did not require the plaintiff to arbitrate his claims.

Why do I call this “resistance”?  Because there are many cases saying that as part of the federal policy favoring arbitration, courts presume that claims are within the scope of a valid arbitration agreement.  The coin is weighted towards “heads.”  And here, the agreement explicitly prohibited pawning the TV, and the arbitration clause was about as broad as it could be.  Yet the court refused to compel arbitration.  The implication of this court ruling seems to be that if a specific claim is not enumerated in an arbitration clause in Mississippi (to show it was contemplated), the claim is not arbitrable.  And that just does not fit within the federal precedent.

You know what state is not currently resisting?  Missouri.  The Supreme Court of Missouri faithfully followed the instructions SCOTUS gave in Rent-A-Center, and enforced a delegation clause over the votes of two dissenting justices.  In Pinkerton v. Fahnestock, 2017 WL 4930289 (Mo. Oct. 31, 2017), the Missouri high court found that the parties’ incorporation of the AAA rules was a clear and unequivocal delegation clause.  It also found that the great majority of the plaintiff’s challenges were not specific to the delegation provision (they applied to the arbitration agreement as a whole) and so could not be considered; the only specific challenge was plaintiff’s argument that it is unconscionable to delegate arbitrability to “a person with a direct financial interest in the outcome.”  The court dismissed that out of hand, citing Rent-A-Center.  Because the plaintiff had made no successful challenge to the delegation clause, the Missouri high court enforced it, sending the issue of the arbitration agreement’s validity to the arbitrator.

A recent report showed that less than half of arbitration agreements in the consumer financial arena include delegation clauses in their arbitration agreements.  Two recent decisions from state high courts suggest that is a wise decision because courts do not like to enforce delegation clauses. (Reminder: a delegation clause gives the arbitrator explicit authority to decide issues of substantive arbitrability that would otherwise be decided by a court, like the enforceability and scope of the arbitration clause.)

In Schumacher Homes of Circleville v. Spencer, __ S.E.2d.___, 2015 WL 1880234 (W.Va. 2015), the highest court in West Virginia refused to enforce the parties’ delegation clause.  The construction contract contained an arbitration agreement, which stated that “The arbitrator(s) shall determine all issues regarding the arbitrability of the dispute.” When the homeowners sued over construction defects, the builder moved to compel arbitration. The trial court denied the motion, finding the arbitration clause unconscionable. On appeal, the builder focused on the delegation clause, arguing that the trial court erred in not sending the unconscionability issue to the arbitrator.

The West Virginia Supreme Court of Appeals called the rule in Rent-A-Center, that delegation clauses must be enforced unless the plaintiff alleges the clause itself is unenforceable, “absurd” and an “ivory-tower interpretation of the FAA.”  Yet, it also recognized the rule is binding on state courts, so it found a different basis to object to the delegation clause. Noting that delegation clauses must be “clear and unmistakable,” the court found that “arbitrability” is an ambiguous term, so the delegation clause here did not clearly delegate the question of unconscionability to the arbitrator. (It did not help that the builder first raised the delegation clause orally after the issues were briefed in the trial court.) One justice dissented from the opinion, calling it “blatant ‘judicial hostility’ toward arbitration” and noting that the court “has been notoriously chastised by” SCOTUS for singling out arbitration agreements for hostile treatment.

[Editor’s note: The decision in Circleville reiterates the need for this blog to exist and continue educating people about arbitration law. The opinion starts by explaining that the SCOTUS decisions construing the FAA “create an eye-glazing conceptual framework” that is “a tad oversubtle for sensible application” and that “the rules derived from these decisions are difficult for lawyers and judges—and nearly impossible for people of ordinary knowledge—to comprehend.” That’s why I’m here, folks! To stop your eyes from glazing over and help lawyers and judges and “ordinary” people understand the FAA. Okay, back to our regular program.]

The Supreme Court of Kentucky did something similar in Dixon v. Daymar Colleges Group, LLC, __S.W.3d__, 2015 WL 1544450 (Ky. 2015). The single-page student enrollment agreement at issue in that case had an arbitration agreement on its back side, with a clause saying “all determinations as to the scope or enforceability of this arbitration provision shall be determined by the arbitrator, and not by the court.” After the students brought suit, the college moved to compel arbitration. The trial court denied the motion, finding the arbitration agreement was unconscionable. The Court of Appeals reversed, finding no unconscionability.

The state supreme court applied the FAA, but found a way out of Rent-a-Center by reframing the issue as not one over the enforceability of the delegation clause, but instead whether the parties formed an arbitration agreement at all. Because the students argued that their signature was only on the front side of the agreement, and they were fraudulently induced to sign the agreement, the court defined this as a formation dispute that belonged in the courts. Applying Kentucky’s Statute of Frauds, the court held that the signatures had to be at the end of the document and because they were not, the parties were not bound by the arbitration agreement that appeared after the students’ signature.

In drafting arbitration agreements, we must take it as a given that there will be state courts that are hostile to arbitration and eager to find ways not to enforce an arbitration agreement. That is likely exactly the sentiment that led drafters to invent delegation clauses in the first place – hoping that if the very validity of the arbitration agreement could be decided by the arbitrator, there was a higher chance of the arbitration agreement’s survival. However, if the delegation clause is not likely to be enforced anyway, it bears reconsidering its insertion. Reading these two opinions, it strikes me that the argument over enforcing the delegation clause, which involves arguing over Rent-A-Center, may instead remind some judges exactly why they dislike federal arbitration case law so much and give them extra incentive to throw out the arbitration agreement.

 

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.