One of the most confounding doctrines in federal arbitration jurisprudence is the severability doctrine.  The U.S. Supreme Court has held, since Prima Paint in 1967, that courts must enforce arbitration clauses within contracts, even if the entire contract is invalid or unenforceable.  (Most non-arbitration geeks don’t believe me when I tell them that’s the law.)  The only time a court can address the argument for invalidity is if the litigant directs it specifically at the arbitration clause.  For example, an argument that the elves’ contract with Santa is invalid because it’s illegal to pay them in candy canes is an argument about the contract as a whole, and would get sent to arbitration if the elves’ contract had a valid arbitration clause.  On the other hand, an argument that the arbitration clause in the elves’ contract with Santa is unconscionable because it calls for arbitration in the South Pole with Mrs. Claus as the arbitrator *is* specific to the arbitration clause, and should be decided by the court.  Unless, of course, the arbitration clause clearly and unmistakably delegated questions of validity to an arbitrator…

Two courts recently had an opportunity to remind litigants of the severability doctrine.  In Rogers v. Swepi LP, 2018 WL 6444014 (6th Cir. Dec. 10, 2018), the Sixth Circuit reversed a district court judge who failed to apply the severability doctrine.  In Rogers, a putative class of landowners brought suit against Shell for claims arising out of lease agreements.  Shell responded by moving to compel arbitration.  The landowners argued that the arbitration clause within the lease agreement (as well as the whole “second phase” of the lease) was only triggered upon payment of a bonus.  The court found this was an attack on more than just the arbitration clause, and therefore application of the severability doctrine called for the issue of arbitrability to be decided by an arbitrator.  (However, whether class arbitration was permissible should be decided by the court on remand.)

Similarly, the Supreme Court of Montana sent a dispute over arbitrability to an arbitrator in Peeler v. Rocky Mountain Log Homes Canada, Inc., 2018 WL 6498693 (Mont. Dec 11, 2018).   In Peeler, an owner sued both the design professional and contractor over claims relating to construction of a custom log home.  Only the contractor’s agreement had an arbitration clause, but the complaint alleged the design firm was an affiliated entity that should be treated the same as the contractor.  So the contractor and design firm moved to compel arbitration.  The homeowner argued that the arbitration agreement was permissive, not mandatory, and that the defendants had waived their right to arbitrate by waiting to assert it until after he filed suit.  Those arguments did not prevail at the trial court or the appellate court.  The Montana Supreme Court noted that the defendants did not waive their right to arbitrate, and because the owner did not challenge the validity or enforceability of the arbitration agreement, his arguments should be heard by an arbitrator.  Finally, the court found that the design firm could compel arbitration as a matter of equitable estoppel.

Speaking of construction cases, the Supreme Court of Nevada continues its campaign to remind all construction litigators that the FEDERAL Arbitration Act governs even local disputes between homeowners and contractors.  Since its Ballasteros decision in February of this year, it has issued two more decisions reiterating that holding: Lanier, 2018 WL 6264809 (Nev. Nov. 28, 2018), and Greystone Nevada, 2018 WL 6264756 (Ne. Nov. 28, 2018).  As evidence of interstate commerce, Lanier points to three things: the builder was incorporated in Delaware while the homeowners were Nevada residents, the large number of subcontractors and material suppliers who worked on the home made it likely that at least some of them are engaged in interstate commerce, and “in the aggregate, the general practice of developing, buying, and selling homes substantially affects interstate commerce.”  All of this mattered because trial court judges were relying on Nevada anti-arbitration rules to refuse to compel arbitration.  Those rules are preempted if the dispute is governed by the FAA.

Continuing last week’s theme of “States Gone Wild,” here are three more oddball summer decisions from state supreme courts. All of them find interesting paths around federal case law (IMHO).

Georgia Says Class Complaint Is Deemed Arbitration Opt Out For All Class Members

In Bickerstaff v. SunTrust Bank, 2016 WL 3693778 (Ga. July 8, 2016), the issue was whether a class action challenging overdraft fees could proceed in court. The class complaint was filed in July of 2010, and in August of 2010 (in response to a court ruling), the bank amended its deposit agreement to allow customers to opt out of arbitration. In part, the amended arbitration agreement stated:

To reject this arbitration agreement provision, you must send the Bank written notice of your decision … by the later of October 1, 2010 or within forty-five (45) days of the opening of your Account. Such notice must include a statement that you wish to reject the arbitration agreement … along with your name, address, account name, account number and your signature … This is the sole and only method by which you can reject this arbitration agreement provision.

Just after October 1, the bank moved to compel arbitration. The issue of whether the complaint could serve as the formal rejection of the arbitration provision ended up before the Supreme Court of Georgia. That court unanimously held that “the filing of Bickerstaff’s complaint, thereby signaling his rejection of the arbitration agreement, tolled the time in which the putative class members were required to notify SunTrust of their intent to reject arbitration.”

In its analysis, the court leaned heavily on Georgia cases in the class action context, finding that class representatives may satisfy statutory or contractual preconditions on behalf of those class members who remain in the class after it is certified. “[T]he satisfaction of a precondition for suit by the class plaintiff typically avoids the necessity for each class member to satisfy the precondition individually.” Curiously absent from the decision was any discussion of Stolt-Nielsen, or Section 2 of the FAA (requiring strict enforcement of valid arbitration agreements), or the preemption rulings in Concepcion and DirecTV.

[Thanks to a reader for sending me this case before Westlaw did.]

Split South Carolina Court Reasons Its Way Around Rent-A-Center

Our next state court ruling at least acknowledges the relevant federal precedent. In Smith v. D.R. Horton, Inc., 2016 WL 3660720 (S.C. July 6, 2016), the issue was whether a husband and wife had to arbitrate their construction defect claims against their builder. Section 14 of the parties’ agreement was entitled “warranties and dispute resolution,” and made up of ten subparagraphs covering topics from whether the builder could remove existing trees, to the private warranty it provided, to the requirement to arbitrate disputes. The arbitration agreement was in 14(g), with its own subheading “mandatory binding arbitration.” The builder moved to compel arbitration and the homeowners argued that clauses within Section 14 made the arbitration agreement unconscionable.

The builder relied on the severability doctrine, first set forth in Prima Paint but reiterated in Buckeye Check Cashing and Rent-A-Center, which holds that courts may only decide disputes about the validity of the arbitration agreement itself, all other challenges to the contract must be determined by the arbitrator. The builder defined the arbitration agreement as 14(g), which the homeowners did not challenge, while the homeowners defined the arbitration agreement as all of Section 14. The court agreed with the homeowners, relying largely on the title of Section 14, and the fact that the subparagraphs had “cross-references to one another, intertwining the subparagraphs so as to constitute a single provision.”

Having defined the arbitration agreement to include all of Section 14, the court went on to find the arbitration agreement unconscionable due to its disclaiming implied warranty claims and prohibiting monetary damages. (As Section 14 had no severability clause, the court refused to analyze whether the unconscionable portions could be stricken.) Two justices dissented, noting that “the majority has not followed controlling precedent of the United States Supreme Court.” (That should help the cert petition…)

[NOTE TO DRAFTERS: Move your arbitration agreement into a separate paragraph with its own heading right now! Give it its own severability clause. Then you can keep reading.]

North Dakota Forgets To Read The Footnotes

Not to be left out of the “buck SCOTUS” summer trend, North Dakota issued a decision finding that a district court did not err in compelling arbitration of the formation of the parties’ contract. 26th Street Hospitality, LLP v. REAL Builders, Inc., 2016 WL 3022054 (N.D. May 26, 2016). One party to the contract argued the contract was invalid because it was executed without the knowledge and authority of the Partnership, as proper consent had not been received pursuant to the company’s charter documents. Nevertheless, the district court compelled arbitration, without deciding the formation of the contract. The North Dakota Supreme Court unanimously found the district court did not err in refusing to decide formation before ordering arbitration, relying on Rent-A-Center’s discussion of severability.   What it did not discuss, however, is 1) the first footnote in Buckeye Check Cashing which specifically states that the severability doctrine does not apply when the issue is “whether any agreement between the alleged obligor and obligee was ever concluded,” or 2) the fact that a majority of federal courts have concluded formation is an issue for courts, not arbitrators.

As long as we’re talking state courts…

Two state supreme courts have new decisions on waiver. The Texas Supreme Court found a company did not waive its right to arbitrate claims with individual customers in RSL Funding, LLC v. Pippins, 2016 WL 3568134 (Tex. 2016). Importantly, the Texas court said that for Party A to waive its right to arbitrate with Party B, the court will only analyze Party A’s litigation conduct with respect to Party B after a dispute arises. In this case, the majority of the company’s litigation conduct at issue was directed at third parties before a dispute arose with the individual customers.

The Supreme Court of South Carolina found a nursing home waived its right to arbitrate wrongful death claims in Johnson v. Heritage Healthcare of Estill, 2016 WL 3022394 (S.C. May 25, 2016). The nursing home had litigated over the estate’s right to records and conducted discovery before moving to compel arbitration.

_____________________________

Phew!  Long post.  Is ArbitrationNation your primary source for analysis of state court arbitration decisions? For the latest advice on drafting arbitration clauses? Or just a home for your arbitration geekdom? If so, please consider nominating the blog for the ABA’s Blawg 100 list, by following this link.

Lots of interesting arbitration law has been made already in 2016, so here is a roundup from the first four weeks of the year. As a teaser, courts have breathed life into the effective vindication doctrine, found arbitrators cannot determine the availability of class actions, and found state laws not preempted.  More surprisingly, state courts are following SCOTUS’s interpretations of the FAA.

Effective Vindication Lives On

Although I thought Italian Colors was an “effective elimination” of the effective vindication doctrine, the Tenth Circuit affirmed its use as a defense to a motion to compel arbitration this month in Nesbitt v. FCNH, Inc., 2016 WL 53816 (10th Cir. Jan. 5, 2016).  [Side note to WestLaw: can there really have been 53,816 cases by January 5th of the year??  Or do I misunderstand the numbering system?]  In that case, class action plaintiffs in a Fair Labor Standards Act case defeated a motion to compel individual arbitrations by asserting that under the AAA Commercial Rules, each plaintiff would have to pay between $2,300 and $12,500 in arbitrator fees and could not recover attorneys’ fees.  The appellate court affirmed.

Incorporation of AAA Rules Can “Unmistakably” Delegate Some Gateway Issues, But Maybe Not the Availability of Class Actions

The Third Circuit drew what seems to me a questionable distinction between parties’ ability to delegate some substantive issues of arbitrability from others. Despite acknowledging that federal courts of appeals have universally found that when parties agree to be bound by the AAA rules, they delegate substantive arbitrability to arbitrators, the Third Circuit found that does not extend to the availability of class arbitration. Chesapeake Appalachia, LLC v. Scout Petroleum, LLC, 2016 WL 53806 (3d Cir. Jan. 5, 2015).  Recall that in general, courts are presumed to have authority to determine whether an arbitration exists, whether it is valid, and whether it covers the scope of the parties’ dispute.  But, under First Options of Chicago, a SCOTUS opinion, parties can delegate even those issues to arbitrators as long as their intent to do so is “clear and unmistakable.”  In Chesapeake Appalachia, the court repeats its pronouncement from Opalinski that the “availability of classwide arbitration” is one of those substantive questions of arbitrability that courts presumptively decide, unless parties clearly and unmistakably state otherwise.  And then it further protects courts’ ability to make that determination by holding that the parties’ incorporation of AAA rules, which explicitly allow arbitrators to determine their own jurisdiction and contain supplementary rules about class arbitration, is not sufficient to delegate the availability of classwide arbitration to arbitrators.  Drawing on statements from Sutter, the court leaned on the “great” procedural differences between bilateral and class-action arbitration to support its distinction.

Waiver of the Right to Arbitrate is an Issue Presumptively for Courts

Maybe Bryan Garner can come up with a new term for “waiving” the right to arbitrate, so that it is not the same verb as waiving the substantive claim being arbitrated. If so, that would alleviate the problem that the Supreme Court of Nevada addressed in Principal Investments, Inc. v. Harrison, 2016 WL 166011 (Nev. Jan. 14, 2016).  That court wrestled with the issue of whether a court or an arbitrator should decide if a party has waived its right to arbitrate by participating in litigation.  In other words, is that type of waiver a substantive question of arbitrability (like whether there is a valid arbitration agreement) that is presumptively for courts, or a procedural question of arbitrability that is presumptively for arbitrators?  Adding to the confusion is language from Howsam and BG Group characterizing “waiver” as an issue presumptively for arbitrators.  After canvassing other courts and finding the majority have concluded that waiver-by-litigation is presumptively for courts, the Nevada Supreme Court followed the herd.

Missouri Enforces Prima Paint’s Severability Doctrine

As I have picked on Missouri for bucking federal arbitration law, I owe it to the Show-Me State to point out that it recently (but reluctantly) followed federal precedent on severability. In Ellis v. JF Enterprises, LLC, 2016 143281 (Mo. Jan. 12, 2016), the Supreme Court of Missouri recognized that under federal precedent, a plaintiff cannot avoid an arbitration agreement by asserting the contract as a whole is void, it must point to a deficiency with the arbitration clause specifically.  As a result, the court held that “no matter what logic or fairness” undergirded the plaintiff’s argument that her auto sale was invalid, she had to arbitrate that claim.

Kentucky’s Precedent on Wrongful Death Actions is not Preempted by FAA

In Richmond Health Facilities v. Nichols, 2016 WL 192004 (6th Cir. Jan. 15, 2016), the Sixth Circuit analyzed Kentucky’s state law rule, which holds that wrongful-death claims belong only to beneficiaries, and therefore any arbitration agreement signed by a decedent cannot bind a beneficiary bringing a wrongful death claim.  The Sixth Circuit found that state law rule does not stand as an obstacle to the FAA, because it does not categorically prohibit arbitration of wrongful death claims, so was not preempted.

Lots of Action on Attorneys’ Fees

The Supreme Court of Utah held that an arbitrator cannot award attorneys’ fees incurred in confirming the arbitration award, under the Uniform Arbitration Act. Westgate Resorts, Ltd. V. Adel, 2016 WL 67717 (Utah Jan. 5, 2016).

Massachusetts’ highest court also found an arbitrator is not authorized to award attorneys’ fees due to one party’s assertion of frivolous defenses (unless the parties specifically granted the arbitrator that authority). Beacon Towers Condominium Trust v. Alex, 2015 WL 9646024 (Mass. January 7, 2016).

Similarly, the Second Circuit held that a federal district court erred in awarding attorneys’ fees and costs to the party that successfully confirmed its arbitration award. Zurich Am. Ins. Co. v. Team Tankers (2d Cir. Jan. 28, 2016).  As part of its contractual analysis, the court repeated that parties may not contract around Section Ten of the FAA.  In other words, it would not read the parties’ contract as precluding an attempt to vacate the award.

PHEW. I have now alleviated the guilt that has been weighing on me for not blogging about these cases yet.  Hope February brings a more reasonable stream of opinions!

2015 has been a dry spell in arbitration decisions from the U.S. Supreme Court, but 2016 promises to be much more interesting.  In addition to the California case being heard next week, SCOTUS just granted certiorari in another California-based arbitration decision.  This one, MHN Government Services, Inc. v. Zaborowski, will review an unpublished 2-1 decision of the Ninth Circuit that affirmed a district court’s refusal to compel arbitration.  The beautifully succinct question presented is “whether California’s arbitration-only severability rule is preempted by the FAA.”

In Zaborowski, counselors who provide services to members of the military alleged that MHN improperly classified them as independent contractors instead of employees, thereby violating federal and state labor laws.  (The district court opinion is at 936 F. Supp. 2d 1145.)  The relevant agreement had an arbitration clause which the counselors argued was unconscionable under California law.  The court summarized the provisions that the plaintiffs objected to as including: “MHN shall choose three arbitrators, and the [counselor] shall choose one amongst them; each party may depose one individual and any opposing expert witness; arbitration must be initiated within six months of the claim’s occurrence; the arbitrator may not modify or refuse to enforce any agreements; the parties may not be awarded punitive damages; and the prevailing party or substantially prevailing party’s costs are borne by the other party.”  963 F. Supp. 2d at 1150.  The district court found procedural unconscionability and determined that many of the provisions raised by plaintiffs were substantively unconscionable.

Critically, the district court refused to sever those provisions it found substantively unconscionable.  It concluded, citing primarily to a California Supreme Court decision from 2000, that the arbitration agreement was “so permeated with unconscionability that it is not severable.”  A majority of the appellate panel affirmed that conclusion, noting that while they may have made a different decision in the first instance, the district court did not abuse its discretion.  Judge Gould dissented only with respect to the severability question, opining “Concepcion and its progeny should create a presumption in favor of severance when an arbitration agreement contains a relatively small number of unconscionable provisions that can be meaningfully severed and after severing the unconscionable provisions, the arbitration agreement can still be enforced.”  601 Fed. Appx. 461.

The petition for certiorari was bold and attention-grabbing.  It states: “California courts routinely display the flagrant hostility to arbitration that the FAA was designed to end. The Ninth Circuit routinely allows this to occur. And the severability issue presented here arises literally every time a court finds one or more provisions of an arbitration agreement to be invalid under California law.”  In response, the plaintiffs argue that “California’s severance doctrine derives from statutes that apply to all contracts and from cases dealing with contracts of various sorts—not just arbitration agreements.”  (They also note that a dozen judges have refused to enforce MHN’s arbitration agreement and lean on the discretion of district courts.)

Will this case be Concepcion part II, focused on when state contract rules of interpretation should be deemed obstacles to arbitration?  Or will it be narrowly focused on appropriate rules of severability?

Also, could there be more arbitration cases this term?  My fingers are crossed.

 

 

 

You hear more about Lena Dunham than you expect, given the audience for “Girls”, right?  (Read this article for more.)  The same is true, or should be true, for the contract defense of illusoriness.  After decades of disuse, it is popping up more and more often as a defense to the enforcement of arbitration clauses (like in New Mexico and the Fifth Circuit), and therefore qualifies as the “it girl” of arbitration law.  Just last week, the Sixth Circuit issued a new decision, affirming the district court’s denial of a motion to compel arbitration based on its conclusion that the arbitration agreement was illusory.

In Day v. Fortune Hi-Tech Marketing, Inc., 2013 WL 4859781 (6th Cir. Sept. 12, 2013), a number of independent sales representatives sued Fortune, alleging it was running an illegal pyramid scheme.  The parties’ agreement had an arbitration clause.  It also had a separate clause saying that Fortune could modify the agreement at any time, effective upon notice. Fortune moved to compel arbitration, and the district court denied the motion.  The district court concluded the arbitration clause was unenforceable because Fortune had the ability to modify the contract at any time, making its promises illusory and meaning the agreement lacked consideration under Kentucky law.  On appeal, the Sixth Circuit affirmed that ruling.

Relying on Kentucky state court cases from 1912, 1938, and 1949, the Sixth Circuit held that “because the contract lacked consideration, the entire contract, including the arbitration clause, is void and unenforceable.”  The problem, as the district court found, is that “in this case, in effect, [Fortune] promised to do certain things unless it decided not to, and that is by definition illusory.”   The court noted that Fortune could have made its contract enforceable by ensuring that unilateral changes were not effective until a notice period (30 days?) had passed.

The problem that I see with the reasoning in this case is it does not confront the severability doctrine (that began with Prima Paint and extends to Rent-a-Center).  That line of Supreme Court case law holds that in deciding the validity of an arbitration agreement, courts may not consider arguments that attack the validity of the contract as a whole, and instead courts are limited to arguments that identify something invalid in the arbitration agreement itself.  In this case, the invalidity came from the unilateral modification clause, which was outside the arbitration agreement.  The Sixth Circuit did not discuss that argument, so maybe no one argued it.  Alternatively, the Sixth Circuit may have concluded the illusoriness sufficiently affected the arbitration clause (it did say “Defendant could modify the arbitration clause to suit its purposes at any time”) to satisfy the severability doctrine, but that analysis is not set forth.  (To be fair, this case is not set for publication.)

Is illusoriness an up and coming argument for invalidating arbitration agreements?  Yes.  Should drafting parties reduce their risk by ensuring that unilateral modifications are not effective for a certain period of time?  Yes.  Does the party hoping to avoid arbitration need to construct an argument that the illusoriness is specific to the arbitration agreement itself?  That answer should also be yes.

To date, courts have largely limited the impact of the Rent-A-Center decision to arbitration agreements with explicit delegation clauses. But, what if Rent-A-Center applied to every single arbitration agreement that mentioned the AAA rules?  That is a very real possibility, and one which would send almost all arbitrability disputes to arbitrators.

The ­Rent-A-Center decision used “delegation clause” to mean any aspect of an arbitration agreement that authorizes an arbitrator to decide questions about the validity of the arbitration agreement.  Rent-A-Center held that unless a party could allege a fatal flaw in the delegation clause itself, the arbitrator should decide the arbitrability question.  Courts have applied that ruling to explicit delegation clauses like this one: “Any issue concerning … the formation, applicability, interpretation or enforceability of [the arbitration agreement] . . . will be resolved by the arbitrators.”  Rai v. Ernst & Young, LLP, 2010 WL 3518056, at *1 (E.D.Mich. Sept. 8, 2010).  However, not many courts have yet had to struggle with what really constitutes a delegation clause?  Must it be so explicit?

In the 20 years before Rent-A-Center, many federal circuits reached a related decision: that an adoption of the AAA rules clearly and unmistakably demonstrates the intent of the parties to delegate the question of arbitrability to the arbitrator.  That is because the various AAA rules themselves state that the arbitrator has the power to rule on any questions of arbitrability ( the same rule should hold for any forum whose rules delegate that same power).  At least the First, Second, Eighth, Ninth, Eleventh, and Federal Circuits agree in that holding (with only the Third and Tenth Circuits disagreeing).  SCOTUS has never addressed whether adopting the AAA rules clearly and unmistakably delegates arbitrability to the arbitrator. (See case cites at end.)

The question is – how long will it take for these two lines of cases to meld into an airtight zipper that excludes 99% of arbitrability challenges from courts?   Here is how the argument would go: 1) the arbitration agreement at issue calls for application of AAA rules; 2)  federal courts have concluded that the adoption of AAA rules is an unmistakable delegation of arbitrability to the arbitrator; 3) therefore, the sentence mentioning the AAA rules is a “delegation clause”; and 4) Rent-A-Center applies, such that the anti-arbitration party must specifically challenge that delegation clause in order to have the court hear the challenge.

Of course, it may be just that sort of result  — a nearly wholesale denial of the court venue to litigants who challenge their larger arbitration agreement — that will create a five-Justice majority in favor of a less harsh severability doctrine.

———————————————————————–

ENDNOTE

Cases holding that the parties’ agreement to arbitrate under AAA rules constitutes a clear and unmistakable delegation of arbitrability to the arbitrator:  Fadal Machining Centers, L.L.C. v. Compumachine, Inc., 2011 W.L. 6254979, *2 (9th Cir. 2011); Fallo v. High-Tech Institute, 559 F.3d 874, 878 (8th Cir. 2009); Terminix Intern. Co., L.P. v. Palmer Ranch Ltd. Partnership, 432 F.3d 1327, 1332 (11th Cir. 2005); Contec Corp. v. Remote Solution, Co., Ltd., 398 F.3d 205, 208 (2d Cir. 2005); Qualcomm Inc. v. Nokia Corp., 466 F.3d 1366, 1372-73 (Fed. Cir. 2001); Apollo Computer, Inc. v. Berg, 886 F.2d 469, 473 (1st Cir. 1989) (relating to ICC, not AAA rules).

Two Circuits have declined to follow the majority.   In Quilloin v. Tenet Health System Philadelphia, Inc., 673 F.3d 221, 225-26, 230 (3d Cir. 2012), the Third Circuit held that the parties “did not agree to arbitrate the issue of arbitrability,” despite agreeing to abide by the procedural arbitration rules of the AAA in their arbitration agreement.  Similarly, in Riley Mfg. Co., Inc. v. Anchor Glass Container Corp., 157 F.3d 775, 780 (10th Cir. 1998), the court held that, although the arbitration agreement in question required submitting to the rules of the AAA, the court could properly resolve the issue of arbitrability.

 

Do you remember the moment when you first encountered the concept of arbitrating arbitrability?  Just the phrase is mind-bending!  It took me a while to wrap my head around the idea that parties could separately agree to arbitrate the question of whether they really had to arbitrate.   Well, here’s a similar mind-bender: how does state law regarding severability clauses intersect with the federal doctrine of severability?  This is an issue that courts (like the Florida courts in the previous post) are increasingly having to address.  (I am using “severability clause” to refer to a contractual provision stating that if any clause(s) are  found invalid, the invalid clauses should be severed and the remainder of the agreement enforced.)

44 years ago, the Court declared that arbitration provisions are severable from contracts that contain them and the enforceability of the arbitration agreement must be considered separately.  See Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 402-03 (1967); see also Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, 445-46 (2006) (“[A]as a matter of substantive federal arbitration law, an arbitration provision is severable from the remainder of the contract.”)  What none of the Supreme Court cases has yet had to address is what happens if there is a severability clause in the very arbitration agreement itself and one of the parties argues that an aspect of the arbitration agreement is unenforceable. 

Like the Shotts and Gessa cases from the Florida Supreme Court, most courts will consider state law arguments that an invalid clause or provision within a larger arbitration agreement may be severed if there is a severability clause within the arbitration agreement.   See Jackson v. Cintas Corp., 425 F.3d 1313, 1317 (11th Cir. 2005) (using a severability clause within the arbitration agreement to sever the illegal provision within the arbitration agreement);  Anders v. Hometown Mortgage Services, Inc., 346 F.3d 1024, 1032 (11th Cir.2003)(finding objectionable provisions of arbitration agreement severable based on severability language within arbitration agreement); Brady v. Williams Capital Group, 64 A.D.3d 127, 137-38 (N.Y. App. Div. 2009)(excising the unconscionable fee language from the parties’ arbitration agreement based on severability clause in arbitration agreement).

This is an important drafting point.  If the drafting party wants an ironclad arbitration agreement,  it may want to insert a severability clause that is specific to that arbitration agreement (or specific to the paragraphs of the contract that form the arbitration agreement).

The Supreme Court of Florida has moxie.  It issued two new decisions the day before Thanksgiving which go out of their way to sidestep and distinguish the U.S. Supreme Court’s decision in Rent-A-Center, West v. Jackson, 130 S. Ct. 2772 (2010), in order to find that nursing home residents may not be compelled to arbitrate under an arbitration agreement that undermines their statutory rights.  Shotts v. OP Winter Haven, Inc., __ So. 3d __, 2011 WL 5864830 (Fla. Nov. 23, 2011); Gessa v. Manor Care of Fla., Inc., __ So. 3d. __, 2011 WL 5864823 (Fla. Nov. 23, 2011).  Florida’s current action feels especially bold as it comes just five years after the U.S. Supreme Court reversed a different attempt by the Florida Supreme Court to distinguish federal arbitration precedent.  See Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440 (2006) (reversing the Florida Supreme Court and holding that, pursuant to Prima Paint, arguments about a contract’s legality may only be heard by courts if they are specifically directed at the parties’ arbitration agreement).

The new cases, Shotts and Gessa, both involve negligence claims against nursing homes.  In both, the nursing homes moved to compel arbitration of the claims based on stand-alone arbitration contracts, signed along with many other agreements at the time the nursing home residents entered the facilities.  In each contract, the nursing home’s liability was limited — either by precluding punitive damages or also limiting “noneconomic damages” to $250,000.  Because Florida’s Nursing Home Resident’s Rights Act provides for punitive damages and contains no cap on pain and suffering damages, the Florida Supreme Court found the limitations of liability in the arbitration contracts “undermine specific statutory remedies created by the Legislature” and are unenforceable.  In doing so, Florida followed West Virginia’s lead in curtailing the enforcement of arbitration agreements in nursing home agreements.

That substantive conclusion is less surprising than the fact that the Florida Supreme Court found it could address the enforceability of the arbitration contract at all.  Just last year, the U.S. Supreme Court looked at a stand-alone arbitration contract in the Rent-A-Center case, and found that attacks to that arbitration contract as a whole must be heard by an arbitrator.  The Supreme Court found there were multiple agreements to arbitrate different issues within the single arbitration contract and that Rent-A-Center was only trying to enforce one of those multiple agreements (the one that held the arbitrator would decide any dispute about the validity of the arbitration contract — called the “delegation provision”).   Because there was no allegation that the delegation provision was invalid, the Supreme Court enforced that delegation provision and sent all the remaining complaints about the unconscionability of the arbitration contract to the arbitrator.  Rent-A-Center, West v. Jackson, 130 S. Ct. 2772, 2779 (2010)

Shotts and Gessa limit Rent-A-Center’s application to arbitration agreements containing delegation provisions.  Furthermore, the decisions conclude that the stand-alone arbitration contracts in Shotts and Gessa constitute single arbitration agreements, while Rent-A-Center involved multiple arbitration agreements within one arbitration contract.  Shotts at *22.  With that analytical move, the Florida court was able to consider the nursing home residents’ complaints levied at the arbitration contract as a whole — “it is for the court, not the arbitrator, to decide whether an arbitration agreement violates public policy.”  Shotts at *7.

A third interesting piece of the Shotts decision is that the arbitration contract had a “severability clause” within it.  (“In the event that any portion of this Agreement will be determined to be invalid or unenforceable, the remainder of this agreement will be deemed to continue to be binding.”)  Despite that language, the Florida Supreme Court refused to sever the aspects of the agreement that it found violate Florida’s public policy.  The court applied Florida state contract law on severability and concluded that one of the unenforceable parts of the provision (the application of American Health Lawyers Association rules) “goes to the very essence of the agreement,” and therefore could not be severed.

These decisions are interesting because they continue the recent trend of courts carving particular types of cases out of arbitration (like complaints about care by nursing homes) and because they continue the trend of limiting the Rent-A-Center decision to arbitration contracts with clear delegation provisions.  Stay tuned to see if the Supreme Court grants cert in either of these cases.

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.