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?

Lest anyone think that the preemption doctrine in arbitration has gone dormant, today’s cases should set the record straight.  Courts have recently found the FAA preempted state rules in Pennsylvania, South Carolina, and Alabama.

The Pennsylvania Supreme Court found that one of its rules of civil procedure was preempted by the FAA in Taylor v Extendicare Health Facilities, Inc., __ A.3d ___, 2016 WL 5630669 (Penn. Sept. 28, 2016).  The case involved claims regarding whether a nursing home properly cared for a patient.  The patient had signed an arbitration agreement, and under Pennsylvania law, that meant the “survival claim” on her behalf had to be arbitrated, but her heirs’ wrongful death claims were not subject to arbitration.  However, a rule of state civil procedure required that survival actions be consolidated with wrongful death actions for trial. Relying on that rule, the trial court and intermediate appellate court refused to enforce the arbitration agreement.  After clarifying its feelings about the current state of FAA case law (the court comments that the FAA has implicitly altered the Constitution and created a “preemption juggernaut” with Concepcion), the court acknowledged that it is “bound by the Supreme Court’s directive to favor enforcement over efficiency.”  Therefore, the survival action can proceed in arbitration.

Similarly, the South Carolina Supreme Court reversed two lower courts that had refused to compel arbitration of claims in Parsons v. John Wieland Homes & Neighborhoods of the Carolinas, Inc., __ S.E.2d __, 2016 WL 441112 (S.C. Aug. 17, 2016).  Those courts had relied on the “outrageous tort exception” in South Carolina common law, which allowed “parties whose claims arose out of an opponent’s ‘outrageous’ tortious conduct to avoid arbitration.”   Though a majority of the court did not agree to totally overrule the doctrine, it did decide that it was preempted using the analysis of DirecTV.

The Alabama Supreme Court found one of its insurance regulations preempted by the FAA in African Methodist Episcopal Church v. Smith, __ So. 3d __, 2016 WL 4417268 (Ala. Aug. 19, 2016).  In that case, plaintiffs argued that the arbitration agreement in their group life insurance policy was unenforceable because the company had not included the disclosures required by the Alabama Department of Insurance.  The court found “[a]ny state requirement that an arbitration provision in an insurance contract be specially disclosed . . . is unenforceable; federal law prohibits arbitration provisions from being singled out for such special treatment.”

If you stuck with me this far, here are two bonus cases for you.  Although the FAA is usually the winner in a preemption war, there are times another federal statute overrides the FAA.  For example, the Supreme Court of Arizona held that the Medicare Act preempts the FAA.  United Behavioral Health v. Maricopa Integrated Heath Sys., 2016 WL 4474155 (Ariz. Aug. 25, 2016) (holding that the “administrative appeals process provided under the Medicare Act preempts arbitration of Medicare-related coverage disputes between private healthcare administrators and providers”).  However, the Eleventh Circuit found that the Uniformed Services Employment and Reemployment Rights Act (USERRA) did not preempt the FAA.  Bodine v. Cook’s Pest Control, Inc., 2016 WL 4056031 (11th Cir. July 29, 2016).  Instead, the court found the two statutes could be harmonized, by modifying the aspects of an arbitration agreement that offended USERRA.

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.

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The Supreme Court of South Carolina just ruled that contracts for the sale of residential property are not interstate commerce, and therefore are outside the reach of the Federal Arbitration Act.  Bradley v. Brentwood Homes, Inc., __ S.E.2d __, 2012 WL 2847616 (S.C. July 11, 2012).  That is a surprising result in my view, given that the FAA applies to all agreements that involve or affect interstate commerce, Allied-Bruce Terminix Cos. v. Dobson, 513 U.S. 265, 271-72 (1995), and the Supreme Court has been largely unreceptive to states’ attempts to carve out certain types of arbitration contracts (like those in nursing home contracts). 

In Bradley, the plaintiff bought a “completed dwelling” in Myrtle Beach from defendant.  Two years later, the plaintiff sued in state court, alleging construction defects.  The parties engaged in six months of discovery before the defendant asserted its right to arbitrate and moved to compel arbitration.  The district court denied the motion, not on the basis of waiver (which would have been much simpler), but by finding that the arbitration agreement was unenforceable.  It held the arbitration agreement was unenforceable under South Carolina’s Uniform Arbitration Act, because it did not comply with technical requirements of that statute, and also held that the agreement did not involve interstate commerce and therefore was not covered by the Federal Arbitration Act (which would likely have made the agreement enforceable, as the FAA does not have the same technical requirements about font size, etc). 

The facts related to interstate commerce are these: 

  • the agreement stated that the defendant was “not acting as a contractor” for the plaintiff;
  • the defendant did, however, construct the home using subcontractors, materials and suppliers from outside South Carolina;
  • the defendant provided a warranty from a national company; and
  • the plaintiff used an out of state bank to finance the transaction.

Despite those last three facts, the South Carolina court held that the FAA did not apply to this arbitration clause.  The analysis relied heavily on the court’s assessment that real estate contracts are unique; it begins with a “discussion of the historical intrastate character of real estate transactions.”  To support the exceptional nature of real estate contracts, it cited a state court case from South Carolina and federal district court cases from Puerto Rico and Kentucky.  The court held that none of the facts cited by the defendant (out-of-state banks, warranty programs, subcontractors, supplies) “negate the intrastate nature of the sale and purchase of residential real estate.”  The court was careful to narrow its ruling, however, noting that if the agreement had been for the construction of the home, instead of for the completed dwelling, its arbitration clause would have been governed by the FAA. 

Because the conventional wisdom is that the vast majority of arbitration agreements are covered by the FAA, this decision provides rare support to parties who want to keep their claims in court, despite an arbitration agreement that could be unenforceable under state law grounds.