In a recent opinion, the Fourth Circuit cited waiver as its basis to refuse to compel arbitration, but the result seems animated by a sense that the arbitration agreements were unenforceable.  Degidio v. Crazy Horse Saloon & Restaurant, Inc., __ F.3d __, 2018 WL 456905 (4th Cir. Jan. 18, 2018).

The case involved a putative collective and class action case by “exotic dancers” at a club in South Carolina, alleging they were wrongly classified as independent contractors and thereby denied minimum wages and other statutory protections.  The complaint was filed against the club in August of 2013.  [I can’t call it a saloon.  We aren’t in the wild west.]  At that point, it is undisputed that none of the potential plaintiffs had arbitration agreements with the club.

The club participated in discovery for a year.  In November and December 2014, the club obtained arbitration agreements with some of its dancers “as a condition of performing.”  In December of 2014, the club moved for summary judgment on the merits, arguing the dancers were properly classified as independent contractors.  Then in January of 2015, the club brought a motion to compel arbitration against plaintiffs who had signed arbitration agreements.  The district court denied the motion, raising concerns about the enforceability of the arbitration agreements.  The club brought a new summary judgment motion on the merits in October of 2015.  When that was denied, the club sought additional discovery on the merits, attempted to certify questions to the South Carolina Supreme Court, and then moved to compel arbitration against nine plaintiffs who had opted into the litigation after its last motion.  That motion was also denied.

The Fourth Circuit set the stage for its discussion by noting that litigants may waive their rights to arbitration by “substantially utilizing the litigation machinery.”  Without citing any further case law about waiver, the opinion proceeded to review the significant extent of the club’s use of “litigation machinery” (summarized above).  The court was particularly upset at the apparent gamesmanship:

The only possible purpose of the arbitration agreements, then, was to give [the club] an option to revisit the case in the event that the district court issued an unfavorable opinion [on summary judgment].  In other words, Crazy Horse did not seek to use arbitration as an efficient alternative to litigation; it instead used arbitration as an insurance policy in an attempt to give itself a second opportunity to evade liability.

In response to the club’s argument that it could not have moved to compel arbitration until the entertainers who had actually signed the agreements opted into the case, the court suggested that it should have informed the district court of its intentions so that the court did not waste judicial resources.  In addition, the court did not want to “give defendants a perverse incentive to wait as long as possible to compel arbitration.”

At the close of this waiver discussion, the court veers into what seems to be the heart of the matter: its conclusion that the arbitration agreements were “misleading” and “sham agreements.”  The arbitration agreements told the dancers that they only reason they could keep tips and set their own schedules was because they were independent contractors, and that would change if they joined the Degidio lawsuit.  The court noted that information was false.  Furthermore, the court was upset that the agreements were presented to plaintiffs “in a furtive manner,” evading the district court’s ability to supervise contact between the potential plaintiffs and counsel.  “The setting here was ripe for duress.”  However, the court does not undertake any analysis of unconscionability or other bases to find the agreements unenforceable under South Carolina law.  It just affirms the decision to deny the motion to compel arbitration.

I find this a puzzling case.  Normally, parties are allowed to agree to arbitrate a dispute that has already begun.  And litigation conduct before that agreement can’t count as a waiver.  Furthermore, parties don’t usually tell the judge about motions that they don’t yet have a basis to bring.  So, unless FLSA cases are really so different, this seems like a case that should have been analyzed on the validity of the arbitration agreements.  It is decidedly underhanded to convince people to sign arbitration agreements by misrepresenting the law.  Maybe South Carolina unconscionability doctrines are very difficult?

Today we take a close look at that rare creature: an opinion finding sufficient basis under the FAA to vacate an arbitration award. In Tenaska Energy Inc. v. Ponderosa Pine Energy, LLC, __S.W.3d __, 2014 WL 2139215 (Tex. May 23, 2014), the Supreme Court of Texas found an arbitrator had shown “evident partiality” due to his misleading “partial” disclosures of his contacts with the law firm representing the claimant.

The underlying dispute was over whether Tenaska had breached representations and warranties to Ponderosa in a power plant purchase agreement. The purchase agreement required that any disputes be arbitrated before a panel of three arbitrators, with each party choosing one neutral arbitrator and the two party-appointed arbitrators selecting the third. Ponderosa, represented by Nixon Peabody, demanded arbitration and chose Samuel Stern as its arbitrator. Stern, along with the third arbitrator, awarded Ponderosa $125 million.

Tenaska moved to vacate the award, arguing that Stern had shown evident partiality. After “extensive discovery” on the issue of Stern’s contacts with Nixon Peabody, the trial court agreed and vacated the award. The intermediate appellate court reversed the trial court, finding that Tenaska had waived its right to argue evident partiality by not objecting to Stern’s appointment after receiving his limited disclosures. The Texas Supreme Court reinstated the district court’s order vacating the arbitration award.

Upon his appointment, Stern  disclosed that Nixon Peabody had designated him as an arbitrator in three other disputes, that he was a director of a litigation services company, LexSite, based in India, and that he had met with Nixon Peabody lawyers about outsourcing some of their discovery tasks to LexSite. However, he said the firm had done no business with LexSite and “it is not clear that Nixon-Peabody would ever have any business to give LexSite.”

The court found it material that Stern did not disclose the following facts: Stern owned shares of LexSite, was being paid $6,000 per month by LexSite to actively solicit business from U.S. law firms, had communicated multiple times with the individual lawyers representing Ponderosa on this very matter about Nixon Peabody using LexSite, and allowed Ponderosa’s counsel to edit his arbitration disclosures. The court held that “[t]aken together, this undisclosed information might cause a reasonable person to view Stern as being partial toward [Nixon Peabody’s] client, Ponderosa, to gain their favor in securing business for LexSite from Nixon Peabody.” Because the court found that the Tenaska did not have to prove “actual bias,” the fact that a reasonable, objective person could conclude Stern was partial was sufficient to vacate the award. [In a nod to Stern, the court “reiterate[d] that [its] holding should not be read as indicating that Stern was actually biased.”]

Furthermore, the court found that Tenaska did not waive its right to vacate the award by accepting Stern’s appointment after he disclosed his relationship to LexSite and his meeting with Nixon Peabody. The court concluded that because material information was withheld from Tenaska, it did not waive its partiality challenge. “To hold otherwise ‘would put a premium on concealment’ in a context where the Supreme Court has long required full disclosure.”

This case has important practical implications for arbitrators and counsel alike: if you choose an arbitrator who you believe will be a strong voice in your client’s corner, do not put that appointment at risk by making partial disclosures.

Legally, I find it interesting that even though the Texas Supreme Court acknowledged that the FAA governed, it rested its analysis largely on its own precedent decided under its state arbitration act. The court did not discuss, for example, the Fifth Circuit decision from just two years ago, finding a party had waived its claim of partiality under the FAA when it received partial disclosures from an arbitrator and took no further action. The Fifth Circuit found the disclosures at issue in that case “ were sufficient to put [the party] on notice of a potential conflict” and the party had a duty to reasonably investigate. That holding appears at odds with the Texas Supreme Court’s Tenaska decision, even though both courts are applying the FAA.