This post is aimed at drafters of arbitration clauses. Because if you don’t insert an administrator for your arbitration, and don’t anticipate that the administrator may just stop providing services, your arbitration clause is dead in the water. At least, that’s the holding of two new state court cases.

In A-1 Premium Acceptance, Inc. v. Hunter, 2018 WL 4998256 (Mo. Oct. 16, 2018), the Supreme Court of Missouri affirmed the lower court’s decision to deny a defendant’s motion to compel arbitration. The reason was that the arbitration agreement within the 2006 loan documents provided “any claim or dispute related to this agreement…shall be resolved by binding arbitration by the National Arbitration Forum [NAF], under the Code of Procedure then in effect.” As regular readers are aware, the NAF stopped administering consumer arbitration in 2009. Although many courts have enforced arbitration agreements, despite their inclusion of NAF, Missouri did not. It found that the language of this clause showed that the parties intended to arbitrate before the NAF and only the NAF. Therefore, the court refused to use Section 5 of the FAA to appoint a replacement administrator.

In Flanzman v. Jenny Craig, Inc., Docket No. A-2580-17T1 (N.J. Super. Ct. App. Div. Oct. 17, 2018), New Jersey’s appellate division was faced with a slightly different problem: the parties’ arbitration clause did not provide what rules would govern the arbitration nor which entity would administer it.  As a result, the court found the arbitration clause was never formed, because the employee could not give informed assent. It reasoned:

Selecting an arbitral institution informs the parties, at a minimum, about that institution’s arbitration rules and procedures.  Without knowing this basic information, parties to an arbitration agreement will be unfamiliar with the rights that replaced judicial adjudication.  That is, the parties will not reach a “meeting of the minds.”

While clarifying that no magic words were required, the New Jersey court noted that if the parties don’t identify an “arbitral institution (such as AAA or JAMS)” they should at least identify the process for selecting a forum.  Otherwise, arbitration agreements will not be enforced under New Jersey law. (Unlike Missouri, the New Jersey court did not discuss Section 5 of the FAA and the statutory authority for courts to appoint arbitrators.)

The Supreme Court of Hawai’i concluded last week that it is fundamentally unfair to allow one party to an arbitration agreement to unilaterally select the arbitral forum. Nishimura v. Gentry Homes, Ltd., __ P.3d__, 2014 WL 5503393 (Haw. Oct. 31, 2014).  The parties can either jointly agree to a forum, or the court will select it for them.

A putative class of homeowners sued their builder, alleging the homes lacked “adequate high wind protection.” The builder moved to compel arbitration. The arbitration agreement called for binding arbitration of all disputes relating to the design or construction of the home. It also stated the “arbitration shall be conducted by Construction Arbitration Services, Inc., or such other reputable arbitration service that [the warranty service corporation] shall select, at its sole discretion…” Because Construction Arbitration Services, Inc., was no longer administering construction arbitrations, the agreement allowed the builder and its warranty service to unilaterally chose the entity that would administer the arbitration.

The Hawaii high court refused to allow the builder such one-sided power. It adopted the Sixth Circuit’s “fundamental fairness” test to determine “whether an arbitrator-selection provision is enforceable.” Applying that test, the court affirmed the lower court’s finding that the sole discretion in the arbitration agreement is fundamentally unfair. (The court also clarified that a party challenging the arbitration agreement’s arbitrator selection process does not need to wait until the arbitration is over and does not need to prove actual bias.) The court therefore severed the arbitrator-selection sentence from the agreement, and affirmed the lower court’s order requiring the parties to try and agree on an arbitration service or else the court would fill in the gap.

I am not sure why the Sixth Circuit, and then Hawaii, would establish a separate test for invalidating an arbitrator selection provision, instead of just applying a routine unconscionability analysis. Creating a special test for arbitrator selection seems to invite a preemption argument.

Finally, a post script from last week’s post (noting that a wife was not bound to her husband’s arbitration agreement on a golf cart purchase). This week, a case went the other way, finding a wife was bound to her husband’s arbitration agreement. In Everett v. Paul Davis Restoration, Inc., __ F.3d __, 2014 WL 5573300 (7th Cir. Nov. 3, 2014), the court found that the wife had received many direct benefits from the franchise agreement signed only by her husband and therefore was bound by its arbitration agreement. (For example, she was a half owner of the company that ran the franchise and benefitted from “trading upon the name, goodwill, reputation and other direct contractual benefits of the franchise agreement.”) It also did not help that the husband-wife team colluded to avoid the restrictive covenant in the franchise agreement.

In a 2-1 decision, the Third Circuit held last week that the arbitration agreement in a personal computer purchase was valid, despite its mandate of a defunct arbitral forum.  Its decision, Khan v. Dell Inc., ___ F.3d ___, 2012 WL 163899 (3d Cir. Jan. 20, 2012), is in line with the decision of the South Dakota Supreme Court in late December, and suggests a trend toward upholding arbitration agreements that call for an impossible forum or arbitrator.

The plaintiff, Khan, purchased a Dell computer in 2004 and signed a contract including this arbitration language: “Any claim, dispute, or controversy…shall be resolved exclusively and finally by binding arbitration administered by the National Arbitration Forum (NAF) under its Code of Procedure.”  NAF’s Code of Procedure provided that it “shall be administered only by the National Arbitration Forum.”  After Kahn sued Dell for defective design, Dell moved to compel arbitration.  The district court denied the motion, based on the fact that the NAF no longer administers consumer arbitrations and the court’s conclusion that the NAF was “integral” to the arbitration agreement.

 The Third Circuit reversed the district court.  It first restated the applicable standard in a way that make it harder for Khan to meet, writing that for an impossible forum to invalidate an arbitration agreement  “the parties must have unambiguously expressed their intent not to arbitrate their disputes in the event that the designated arbitral forum is unavailable.”   The court then went out of its way to find ambiguity in the arbitration agreement.  For example, it found that it was ambiguous whether “exclusively” modified only the phrase “binding arbitration” or the entire phrase “binding arbitration administered by the [NAF]” and it found that the incorporation of the NAF rules still leaves ambiguous “what should happen in the event that the NAF is unavailable.”  In support of ambiguity, the Third Circuit cited cases that have interpreted similar NAF language and come to conflicting conclusions.  

After finding ambiguity in the agreement, the court concluded “we must resolve this ambiguity in favor of arbitration.”  The court then found Section 5 of the FAA was applicable and required the district court to appoint a substitute arbitrator.

The dissent found no ambiguity in the arbitration agreement between Khan and Dell.  It found “the selection of the NAF as arbitrator was an integral part” of the arbitration agreement.  It also cited to facts from an amicus brief from the National Association of Consumer Advocates, detailing the allegations of fraud against the NAF that led to the demise of NAF’s administration of consumer claims, suggesting that Dell should not be rewarded for requiring a biased arbitration forum in its consumer contracts. 

The Third Circuit is the highest federal court to date to address this exact issue — whether to enforce an arbitration agreement that calls for administration by the defunct NAF — and its decision makes it much more difficult for consumers with similar arbitration agreeements to convince trial courts to allow them to litigate their claims in court.