There are only four ways to avoid an arbitration agreement.  You can prove: 1)  it was never formed; 2) it was formed, but is invalid under state law; 3) the current dispute is outside the scope of it; or 4) the other party waived their right to arbitrate (through litigation conduct).  Today’s post is about the third method.  Because of the federal presumption in favor of arbitrability, which applies when courts are determining whether the parties’ dispute falls within the scope of the clause, it is not the most common way to evade an arbitration agreement.   Yet, I collected four recent decisions in which courts find the parties’ dispute is not covered by their arbitration agreement.

In Anderson v. Deere & Co., 2018 WL 5262778 (Mont. Oct. 23, 2018), the Montana Supreme Court found that a fight between John Deere Company and the former owner of one of its dealerships was not arbitrable.  The Dealer Agreement had an arbitration clause obligating the Dealer, and its guarantors, officers, and shareholders, to arbitrate “any dispute” “between Dealer and Company.”  The plaintiff signed the Dealer Agreement as managing partner of the Dealer and as guarantor.  Later, the plaintiff sold his interest in the Dealer and sued Deere for tortious interference.  The trial court denied the motion to compel and the supreme court affirmed.  It focused on the language saying arbitrable disputes were those “between Dealer and Company,” and found that because the plaintiff alleged defendant committed torts against him personally, not as part of “Dealer,” there was no obligation to arbitrate.  One judge wrote a special concurrence, disagreeing with the majority’s finding on scope.

In Perez v. DirecTV, 2018 WL 5115531 (9th Cir. Oct. 19, 2018), the 9th Circuit found the named plaintiff in a putative class action did not have to arbitrate her claims for violations of the Communications Act.  DirecTV’s Customer Agreement with the plaintiff specifically exempted disputes “involving a violation of the Communications Act”.  That sounds fairly straightforward, but one member of the panel dissented, finding the exception was ambiguous and therefore should have been resolved in favor of arbitration.

In Pictet Overseas Inc. v. Helvetia Trust, 2018 WL 4560685 (11th Cir. Sept. 24, 2018), the 11th Circuit affirmed a district court’s conclusion that the plaintiff’s claims were not arbitrable.  The dispute was between investment trusts whose funds had been stolen, on one hand, and the owners and affiliates of a Swiss Bank on the other.  The trusts started a FINRA arbitration, but the Swiss Bank objected that the claims did not belong in FINRA arbitration.  FINRA Rule 12200 requires FINRA members and associated persons to arbitrate when the dispute “arises in connection with the business activities of the member or the associated person.”  There was no dispute that the Swiss Bank was a FINRA member, but the court had to interpret the meaning of “business activities of ..the associated person.”  The court concluded that “only disputes arising out of business activities of an associated person as an associated person are covered” by the rule and must be arbitrated.  One judge concurred specially, to give further examples of why the rule could not be read the way the trusts advocated.

Finally, in Grand Summit Hotel Condominium United Owners’ Assoc. v. L.B.O. Holding, Inc., 2018 WL 4440370 (N.H. Sept. 18, 2018), the New Hampshire Supreme Court affirmed the lower court’s decision that the claims of condo owners against their property manager were not arbitrable.  The parties’ arbitration agreement provided for decision  by an independent public accountant of disputes over “actual costs” — pass-through costs of operation and maintenance — or management fees.  The court “assume[d] without deciding that the provision is an arbitration clause and that the presumption in favor of arbitrability applies.”  Even so, the court found that the disputes provision was narrow and because the owners did not dispute the Actual Costs, but instead sought damages caused by the manager’s misconduct (in failing to engage anyone to winterize the cooling tower), they were not obligated to arbitrate their claims.

Is this the new arbitration resistance??  Some kind of “scope-a-dope,” in which courts that don’t take kindly to arbitration can hold up their hands and say “I accepted that the arbitration agreement was formed, and that it was valid, but under state contract law, I interpret this claim as outside the scope.”  That is a hard type of case to preempt under federal law, especially if it’s done without announcing a “rule” of contract interpretation.

Two cases recently fit in one of my favorite categories: those awards that get “un-vacated.”  These cases went through arbitration, had that arbitration award vacated by a district court, only to have the award later resurrected by an appellate court.  In today’s edition, the whiplash happens in both state and federal court.

In Caffey v. Lees, 2018 WL 327260 (R.I. Jan. 9, 2018), Lees was the winner after bringing a personal injury case in arbitration. He was awarded nearly $200,000.  Caffey moved to vacate the award, arguing every possible basis under the Rhode Island arbitration statute.  The trial court granted the motion to vacate, based on the initial failure of Lees’ counsel to disclose a document from its expert.  Not just any document, of course, but an early assessment that contradicted the expert’s eventual opinion about causation.  The trial court found that omission meant the award was procured by “undue means.”

On appeal, the Supreme Court of Rhode Island noted it had not addressed “undue means” since 1858.  It looked to more recent definitions from federal circuit courts of the phrase — noting that proving undue means involves proving “nefarious intent or bad faith” or “immoral” conduct.   It found that standard was not met in this case, since the losing party had the critical document well before it submitted its final brief to the arbitrator.  Indeed, the issue of the untimely disclosure was placed before the arbitrator, and the expert explained the discrepancy.  Because the expert had a plausible explanation, the court could not agree that Lees’ counsel obtained the award through underhanded or conniving means.  The Supreme Court reinstated the award.

A case in the Ninth Circuit followed the same path.  In Sanchez v. Elizondo, 2018 WL 297352 (9th Cir. Jan. 5, 2018), an investor won a $75,000 award in a FINRA arbitration.  The district court granted the broker’s motion to vacate based on an argument that the arbitrator exceeded his powers.  In particular, the arbitrator allowed the arbitration to proceed with a single arbitrator, even after the claimant had submitted a pre-hearing brief increasing its damage request to just over the FINRA line that requires a three-arbitrator panel.  (The FINRA rules provide that claims over $100,000 must be heard by three arbitrators.  The claimant had initially requested exactly $100,000, so was assigned the single arbitrator, but then sought $125,000 in the pre-hearing brief, without amending the claim.)

The Ninth Circuit reinstated the award.  After first establishing that it had appellate jurisdiction, it considered the arbitrator’s powers.  Importantly, the court affirmed that arbitrators have discretion on matters of substance as well as matters of procedure.  In this case, FINRA rules explicitly gave the arbitrator power to interpret the FINRA Code and rules. Furthermore, the arbitrator asked the parties to address the issue of the increased damage amount, considered their arguments, and interpreted the rule to reference the amount initially claimed in the demand, instead of any amount later sought in the arbitration.  Because the arbitrator had power to interpret the rule and did so, the court found he did not exceed his powers.

These don’t seem like hard cases to me.  Given the standard for vacating awards, these arbitration awards should have been straightforward to confirm.  The fact that they weren’t suggests either that the speed of development under the FAA is difficult for advocates and judges to keep up with, or that there may be some judicial hostility toward arbitration coloring the application of the standard for vacatur.

The Fifth Circuit recently refused to vacate an arbitration award, despite the loser’s arguments that: the arbitrators decided claims outside the scope of the arbitration agreement; and the winner’s expert used incorrect damage numbers in his testimony. Morgan Keegan & Co., Inc. v. Garrett, 2012 WL 5209985 (5th Cir. Oct. 23, 2012). 

At issue in Garrett were 18 investors’ claims of securities fraud.  Each investor’s Client Agreement with Morgan Keenan contained an arbitration clause, and after the dispute arose, the parties executed a FINRA Submission Agreement, agreeing to submit the investors’ claims and any related cross claims or answers, to the FINRA arbitrators.  Despite those agreements, Morgan Keenan made a motion late in the arbitration process to dismiss the arbitration because the claims were not within the scope of the FINRA arbitration rules (because they were allegedly derivative and/or some of the investors were not “customers”).  The arbitrators denied the motion. 

With almost no reasoning, the district court vacated the arbitration award, finding the arbitrators had “exceeded their power” by deciding derivative claims and claims of non-customers.  The Fifth Circuit reversed that decision.  It relied heavily on the two broad arbitration agreements between the parties, as well as the extraordinary deference granted to arbitrators, repeating the mantra that courts may not vacate arbitration awards “simply because [they] disagree[] with the arbitrator’s legal reasoning.”  (The emphasis on deference is a bit disingenuous, given the Fifth Circuit’s recent refusal to grant deference to an arbitrator’s rationale for allowing class arbitration.)

With respect to the expert, he had testified regarding the investors’ losses attributable to the fraud.  One week later, in an arbitration brought by a different group of investors relating to the same fraud by the same defendant, the expert used different figures.  He explained that one of his staff had made an error, and he did not realize it until after the Garrett arbitration.  (The opinion does not indicate the magnitude of the error, nor whether it increased or lowered the investors’ damages.  It does say, however, that there is no evidence suggesting the error was intentional.) 

Morgan Keegan also moved to vacate the arbitration award on this second basis, characterising the award as being “procured by fraud” within the meaning of Section 10 of the FAA.  The district court granted the motion to vacate the award, but the Fifth Circuit reversed.  It found that Morgan Keegan had not proven that the “fraud was not discoverable by due diligence before or during the arbitration hearing.”  Because Morgan Keegan knew about the error before the award was issued, and because Morgan Keegan could have discovered the error on its own before or during the hearing, the Fifth Circuit found it had not proven its own due diligence.  The Fifth Circuit reversed the district court’s vacatur, and remanded with instructions to confirm the arbitration award.

I think this case turns on the fact that Morgan Keegan was not a sympathetic party.  The fact that it waited until just before the arbitration hearing (when it may have realized the chips were stacked against it) to argue that the claims should be dismissed, and the fact that it did nothing to raise the expert’s revised calculations before the arbitration award was issued (let alone find those errors on its own), gave the odor of sour grapes to this entire arbitration appeal.

In an opinion that runs less than three pages, the Eighth Circuit ruled that a managing broker-dealer is not obligated under the FINRA rules to arbitrate with a group of investors who purchased securities from another party.  Berthel Fisher & Co. Fin. Servs., Inc. v. Larmon, __ F.3d. __, 2012 WL 4477433 (8th Cir. Oct. 1, 2012).  The Eighth Circuit found that because the managing broker-dealer provided its services to other broker-dealers, who in turn offered the securities directly to the investors,  the investors were not “customers” of the managing broker dealer within the meaning of Rule 12200 of the FINRA Code.

Rule 12200 of FINRA requires its members (including the managing broker-dealer here, Berthel) to arbitrate disputes with customers if the dispute arises in connection with “the business activities of the member or the associated persons.”  The parties agreed that their dispute was connected to Berthel’s business activities, so the entire appeal related to whether the investors were Berthel’s “customers” within the meaning of the FINRA Code.  The Eighth Circuit held the investors were not customers because: they had no direct contact with Berthel; and Berthel’s services were provided to the issuing company and to the group of broker-dealers that sold directly to investors.  “Simply put, there is no “relationship” between Berthel and the Investors as required…”

An interesting note about this decision is that the Eighth Circuit never mentioned a recent case from the Second Circuit, also interpreting who is a “customer” entitled to arbitrate under Rule 12200 of the FINRA Code.  That fact is more striking given that the case, UBS Fin. Servs., Inc. v. W. Va. Univ. Hosps., Inc., 660 F.3d 643 (2d Cir. 2011), was one of only two cases cited by the Berthel Appellants as “apposite authority” in their brief’s statement of the issues.  In that case, UBS argued unsuccessfully that because a hospital system that used UBS as an underwiter to issue municipal bonds was not an investor, but an issuer of securities, the term “customer” did not apply to it.  However, the Second Circuit in UBS rejected a number of narrow definitions of customer, before holding that the hospital system was a customer of UBS within the meaning of FINRA Rule 12200 because the hospital system purchased auction services from UBS

Given that the Second Circuit recently interpreted the word “customer” in FINRA Rule 12200 broadly, while the Eighth Circuit interpreted it rather narrowly in Berthel, this seems like an area of law that will likely see more litigation before the circuit courts of appeal come to some common understanding (or SCOTUS steps in).

A few months ago I posted about actions that FINRA and the NLRB were taking in support of allowing class arbitration, and those agencies have recently taken additional actions that help consumers or employees with relatively low dollar claims.

The NLRB brought a complaint against 24 Hour Fitness USA, Inc.  The complaint alleges that 24 Hour Fitness’s requirement that all of its employees waive their rights to any type of collective or class action suits — whether in arbitration or litigation — “violates protections guaranteed by the National Labor Relations Act.”   The complaint cites seven instances where classes of employees were claiming wage and hour violations and 24 Hour Fitness moved to compel those plaintiffs to individual arbitrations. 

FINRA also recently approved a change in its arbitration rules.  In recognition that $25,00 is no longer the cutoff for “smallish” claims, FINRA raised the dollar limit for its simplified and streamlined arbitration from $25,000 to $50,000.  Cases under $50,000 can now be heard by one arbitrator on written submissions with expedited discovery.   This should help securities customers with lower damages afford to prosecute their claims.

A reasonable person may have thought that the Supreme Court effectively killed off class arbitrations with its decisions in Stolt-Nielsen and Concepcion, but at least two government agencies have recently made decisions that ensure financial consumers and employees can bring classwide claims in some arbitrations.

FINRA, the Financial Industry Regulatory Authority, regulates all securities firms doing business in the United States.  It also administers the largest dispute resolution forum for investors and investment firms.  FINRA has enacted rules that prohibit investment firms from including class action waivers in their agreements with customers.    Not only does it have those rules, but it is enforcing them.  Just last week, FINRA brought an enforcement action against Charles Schwab for “violating FINRA rules by requiring its customers to waive their rights to bring class actions against the firm.”

In January, the NLRB, National Labor Relations Board, “ruled that it is a violation of federal labor law to require employees to sign arbitration agreements that prevent them from joining together to pursue employment-related legal claims in any forum, whether in arbitration or in court.”   In its decision, the NLRB acknowledged that it was confronted for the first time with a conflict between federal precedent interpreting the Federal Arbitration Act and precedent interpreting the National Labor Relations Act.  The NLRB’s outcome, it found, was an “appropriate accomodation of the policies underlying the two statutes.” 

It appears the executive branch is ready to take on the judicial branch over the issue of class arbitration.

The Second Circuit just held that a federal court has the power to enjoin an ongoing arbitration.  In re Am. Express Fin. Advisors Sec. Litig., ___ F.3d ___, 2011 WL 5222784  (2nd Cir. 2011).  While many litigants would no doubt like a federal court to enjoin their arbitrations — especially when arbitrators refuse to dismiss frivolous claims — application of this case’s holding is limited to a very unique set of facts. 

In the American Express case, a couple filed a FINRA arbitration against Ameriprise, alleging multiple claims relating to Ameriprise’s management of their assets.  Ameriprise notified the arbitrators that the couple was part of a class action that had been settled, and because they had never opted out of the class, they were bound by the settlement agreement’s release of their claims.  The arbitrators did not blink and ordered that the arbitration should proceed full speed ahead. 

Ameriprise then took the unusual step of asking the Southern District of New York, which retained jurisdiction of any disputes over the class action settlement, to enjoin the arbitration.  And the district court took the unusual step of granting that injunction and ordering the couple to dismiss their arbitration claims.

The Second Circuit affirmed much of the trial court’s decision.  The court framed the dispute between the parties as one of arbitrability, and therefore appropriate for the court (not an arbitrator) to decide.  That was because “the Class Settlement revoked Ameriprise’s consent to arbitrate certain claims. The question therefore is not whether those claims had been settled, thus precluding arbitration, but whether there was a surviving agreement, following the settlement, to arbitrate those claims at all.”  Furthermore, the Second Circuit placed emphasis on the fact that the trial court had specifically retained jurisdiction over all matters relating to the Class Settlement.  

Interestingly, neither party had briefed or argued the court’s power to enjoin an arbitration, a power that  the FAA does not specifically grant to federal courts.  Having considered the issue sua sponte, the Second Circuit concluded that the district court possessed “the authority to order the cessation of an arbitration by parties within its jurisdiction where such authority is necessary in order for a court to enforce the terms of the parties’ own agreement.”  

Can this decision be used by parties in future arbitrations who may be frustrated by an arbitration panel’s refusal to dismiss claims that are time-barred or otherwise subject to a strong legal defense?  Probably only if the legal defense can be said to call into question the validity of the agreement to arbitrate.  And even then I imagine courts would be skittish.