Defenses Using Contract Terms & The “Savings” Clause

Once a worker is bound by a forced arbitration clause, there is little they can do to escape it. In recent years, the U.S. Supreme Court has rejected many of the defenses that workers previously relied on to protect themselves from being silenced in forced arbitration. For decades, it was understood that the Federal Arbitration Act (FAA) was only intended to govern commercial contracts between companies engaged in business across state lines or at sea. If you were an individual asserting rights given to you by state or federal statute, or had a contract that wasn’t based on international commerce, you could argue that the FAA didn’t apply. A court could then find an arbitration provision in a contract you were otherwise bound by was unenforceable.

In the 1980’s things began to change. The Court held that the FAA can be used to compel claims asserting federal and state statutory rights into arbitration. Moreover, it limited the discretion of both federal and state courts to find arbitration clauses unenforceable – even where the contracts are adhesive, as is the case with consumer and employment contracts.  When asserting rights rooted in federal law, the Court now takes the approach that to successfully overcome the forced arbitration of statutory rights, the person resisting forced arbitration must demonstrate that Congress, in passing the law, enshrined a “contrary congressional command” to preserve citizens’ ability to enforce their rights in a public court of law. If a citizen wants to assert rights under state law, the Court will deny the state statute effect if it finds doing so would “disfavor arbitration.”   

Gone are the days when the Court would consider the fairness of enforcing contracts obtained through coercive means, including those where one party has substantially more bargaining power, or arbitration terms are buried in the fine print of a pre-printed form. Applying the principal that an arbitration contract must be enforced “according to its terms,” the Court has rejected arguments that an arbitration clause should not be enforced when presented on a take-it-or-leave-it basis, or where one party has no choice but accept if they want to get or keep a job.

Perhaps the biggest blow to workers fighting forced arbitration has come from the Court’s unwillingness to apply the FAA’s built-in “savings clause”, which was designed to prevent unscrupulous arbitration contracts from taking effect. Section 2 of the FAA provides that “an agreement in writing to submit to arbitration an existing controversy arising out of such a contract, transaction, or refusal, shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” 

In recent years, the Court has consistently rejected defenses challenging forced arbitration provisions rooted in the “savings clause.” In 2011, citing this nation’s “liberal federal policy favoring arbitration,” the Court held that no law disfavoring arbitration could be used to overcome an arbitration clause, even if that state law was passed for wholly independent public policy reasons.  This flies in the face of the very purpose of the savings clause, as most generally applicable defenses, including unconscionability, duress, and illegality, are matters of state law and have grown from a foundation of public policy.

Nearly every avenue workers and consumers used to have to avail themselves of our public justice system when harmed by corporate wrongdoing has been cut off by the Supreme Court’s “arbitration-at-all-costs” approach.  Corporations have seized this opportunity and now routinely place forced arbitration clauses into the fine print of their terms of service, job applications, employee handbooks, and elsewhere. Corporations know that, by doing so, they are essentially writing themselves a ticket to “get out of court free”—regardless of the harm they cause to consumers and employees.

Beginning in 1963, this timeline shares how the Court, through its increasingly pro-arbitration decisions, has cut off workers’ access to the courts, and consequently, their access to justice when they have been harmed in the workplace.

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  • The Court rules that where a party alleges both a contract and its arbitration clause were obtained by fraud, the question of the arbitration clause’s enforceability is for a court to decide.

    Moseley v. Electronic & Missile Facilities., 374 U.S. 167 (1963)
     

    Relevant Facts: A plumbing and heating contractor subcontracted with a primary contractor under a contract with the U.S. Department of Defense. The subcontract included an arbitration clause which provided for arbitration in New York. The plaintiff-subcontractor initiated a statutory claim under the Miller Act in Georgia, where the work under the subcontract was performed, alleging fraud in the inducement of both the contract and the arbitration agreement.

     

    Question Before The Court: Whether a court or an arbitrator should determine the enforceability of an arbitration clause.

     

    The Opinion: The Court found that where the petitioner alleged both the contract and the arbitration agreement were obtained by fraud, “[u]nder either the Miller Act or the [Federal Arbitration Act] (FAA), it seems clear that the issue of fraud should first be adjudicated [in a judicial forum] before the rights of the parties under the subcontract can be determined. . .. Only after that issue is resolved can the Court “decide the question of arbitrability of disputes under [a federal law].” The Court sent the case back to the district court, where the arbitration clause would be held unenforceable if that court found fraud.

     

    The concurring opinion emphasized that the question of fraud in the procurement of an arbitration agreement is a judicial one: “To allow this question to be decided by arbitrators would be to that extent to enforce the arbitration agreement even though steeped in the grossest kind of fraud.”

  • In assessing the enforceability of an arbitration provision in a contract allegedly obtained through fraud, the Court promulgates the “severability doctrine,” changing the standard for assessing the enforceability of all arbitration clauses.

    Prima Paint Corp. v. Flood Conklin Mfg. Co., 388 U.S. 395 (1967)
     

    Relevant Facts: Two companies entered into a contract. One sued the other for breach of contract and fraudulent representation. In the lower courts, the defending company successfully sought to compel arbitration under a broad arbitration clause in the agreement.

     

    Question Before The Court: Whether arbitration clauses are severable from the contracts that contain them.

     

    The Opinion: The Court found that, since the Federal Arbitration Act (FAA) specifies the manner in which federal courts are to treat questions relating to arbitration clauses, in considering whether to compel arbitration under the FAA, “a federal court may not consider a claim of fraud in the inducement of the contract generally . . . but may consider only the issues relating to the making and performance of the agreement to arbitrate.”

     

    With that framework in mind, the Court held that arbitration clauses are severable from the contracts that contain them. In the Court’s view, Section 4 of the FAA requires courts to order arbitration once it is satisfied that the “making of the agreement to arbitrate . . . is not at issue.” Since the challenge in this case was to the formation of the contract, at large, rather than specifically to the arbitration clause contained within, and because there was no evidence that the parties intended to prevent this type of claim from being submitted to arbitration, the Court ruled that the FAA demanded the claim proceed in arbitration.

     

    With the Prima Paint ruling, courts must look at challenges to arbitration clauses separately from challenges to the contracts that contain them. If a person challenges a contract at large, unless a specific challenge to the arbitration clause itself is launched, the court will compel arbitration, regardless of the possible unenforceability of the larger contract.

  • The Court observes that the right to a particular court’s jurisdiction and other procedural protections are waivable via a valid forum-selection clause.

    The Bremen v. Zapata Off-Shore Co., 407 U.S. 1 (1972)
     

    Relevant Facts: A contract between two companies contained a forum-selection clause requiring any litigation to proceed in London. Later, the plaintiff filed suit in admiralty in the United States. The defendant moved for dismissal under the forum-selection clause.

     

    Question Before The Court: Whether a choice-of-forum clause in a contract requiring all controversies to be adjudicated in an international foreign jurisdiction are enforceable.

     

    The Opinion: At the time of this case, many courts at the federal and state level declined to enforce forum-selection clauses as a matter of public policy. With this case, the U.S. Supreme Court took the opposite approach, finding that parties are free to waive their rights to particular jurisdictions (amongst other procedural safeguards), and held that the forum-selection clause, which was the result of “an arm’s length negotiation by experienced and sophisticated businessmen,” should be binding on parties unless they can meet the heavy burden of showing that its enforcement is “unreasonable, unfair, and unjust.” Disregarding concerns about the ability for parties to receive equal and just treatment in alternative forums, the Court here asserted, “The argument that such clauses are improper because they tend to ‘oust’ a court of jurisdiction is hardly more than a vestigial legal fiction. . .. It reflects something of a provincial attitude regarding the fairness of other tribunals.”

     

    Although this case did not involve the Federal Arbitration Act, the Court has subsequently maintained that arbitration clauses are “mere forum-selection clauses” and has enforced them based on the (frequently incorrect) assumption that they were freely negotiated by parties of equal bargaining power. See, e.g., Mitsubishi Motors v. Soler Chrysler-Plymouth, 473 U.S. 614 (finding a strong presumption in favor of freely negotiated contractual choice-of-forum provisions). Furthermore, the Court’s embrace of non-judicial forums here, and its downplaying of the potential harms to plaintiffs in those forums, paved the way to an exponential increase of dispute resolution in forums other than a court of law, including forced arbitration.

  • The Court declares that the Federal Arbitration Act created a “body of federal substantive law” such that “any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration.”

    Moses H. Cone Mem. Hosp. v. Mercury Const. Co., 460 U.S. 1 (1983)
     

    Relevant Facts: A hospital contracted with a building contractor and an architect to renovate its facilities. While the contract involving the building contractor included an arbitration clause, the contract with the architect did not. After a complicated dispute concerning the cost of the project arose, multiple legal actions were filed in both state and federal court, including motions to compel arbitration.

     

    Question Before The Court: Whether state courts have the requisite jurisdiction to grant motions to compel arbitration under the Federal Arbitration Act (FAA); how far the nation’s federal policy favoring arbitration extends; and whether federal courts may defer to state courts when both are adjudicating parallel claims regarding the enforceability of an arbitration provision.

     

    The Opinion: The Court focused on the FAA’s “statutory policy of rapid and unobstructed enforcement of arbitration agreements” and professed that Section 2 of the FAA “is a congressional declaration of a liberal federal policy favoring arbitration agreements, notwithstanding any state substantive or procedural policies to the contrary. The effect of the section is to create a body of federal substantive law of arbitrability, applicable to any arbitration agreement within the coverage of the Act. . .. The [FAA] established that, as a matter of federal law, any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration, whether the problem at hand is the construction of the contract language itself, or an allegation of waiver, delay, or a like defense to arbitrability.”

     

    The Court was unmoved by the argument that, should the hospital be compelled to arbitrate its dispute with the building contractor, but not the architect against whom there was also pending litigation under the same facts, then it would have to resolve the two disputes in separate forums. To that point, the Court lamented that such “misfortune” occurs because [the FAA] requires piecemeal resolution when necessary to give effect to an arbitration agreement. Under the [FAA], an arbitration agreement must be enforced notwithstanding the presence of other persons who are parties to the underlying dispute but not to the arbitration agreement.” In a footnote, the Court hinted at the idea of delegating the question of arbitrability to arbitrators, providing, “Some issues that might be thought relevant to arbitrability are themselves arbitrable – further speeding the procedure under Sections 3 and 4.”

  • The Court holds that the FAA preempts certain state laws and rules that state courts must order arbitration under the FAA unless an exception applies.

    Southland Corp. v. Keating, 465 U.S. 1 (1984)
     

    Relevant Facts: A group of franchisees came together as a class and sued Southland Corp., a franchisor of 7-Eleven convenience stores, in state court alleging fraud, misrepresentation, breach of contract, and violations of state franchise disclosure laws. Southland sought to compel arbitration based on an arbitration clause embedded in its franchise agreement, and was successful on all but the state franchise law claims. The state appellate court reversed in part, holding that to disallow the claims to proceed in arbitration would be in direct conflict with the FAA. The state supreme court disagreed with the appeals court and reversed, holding the state laws at issue specifically required judicial enforcement and refusal to compel arbitration on those claims did not conflict with the FAA.

     

    Question Before The Court: Whether a state franchise statute conflicted with the FAA to the extent that it was preempted under the Supremacy Clause of the United States Constitution, and whether state courts have the requisite subject matter jurisdiction to grant motions to compel arbitration.

     

    The Opinion: The Court reviewed this case, in part, to resolve a divide between enforcement of the arbitration clauses in state versus federal courts. The Court held that “[i]n enacting Section 2 of the FAA, Congress declared a national federal policy favoring arbitration and withdrew the power of states to require a judicial forum for the resolution of claims which the contracting parties agreed to resolve by arbitration. . .. the purpose of the Act was to assure those who desired arbitration and whose contract related to interstate commerce that their expectations would not be undermined by federal judges.”

     

    The Court’s views here were based on the supposition that parties to a contract were sophisticated businessmen that had thoughtfully negotiated all the terms of their contract. It was on that premise that the Court determined Congress’ intent in passing the FAA was to “place arbitration agreements upon the same footing as other contracts.”

     

    The Court declared that “Congress has mandated the enforcement of arbitration agreements,” and there are “only two limitations on the enforceability of arbitration provisions governed by the FAA: they must be part of a written maritime contract or contract ‘evidencing a transaction in commerce,’ and such clauses may be revoked [under the Section 2 “savings clause”] upon ‘such grounds as exist at law or in equity for the revocation of any contract.’” The majority found that the savings clause did not apply in this case as it is limited in its application only to “any general contract defense” that would serve to revoke all contracts anywhere (like fraud or undue influence). The savings clause does not include contract defenses that are only available under a particular state’s law. The Court expressed concern that upholding the state supreme court’s interpretation of the law would encourage and reward forum-shopping, and held that the state’s franchise disclosure law was preempted by the FAA under the Supremacy Clause.

     

    The Court reasoned that “[s]ince the overwhelming proportion of civil litigation in this country is in the state courts, Congress could not have intended to limit the [FAA] to disputes subject only to federal court jurisdiction.” The Court in order to give the FAA its full effect, held that state courts do have the requisite jurisdiction to grant Motions to Compel Arbitration under Section 4 of the FAA and must do so unless the savings clause in Section 2 applies. This monumental assertion opened the door to all kinds of statutory claims being forced into arbitration. As Justice Stevens observed in his dissent, “the FAA was never meant to encroach upon individual states.” Yet, because the majority was “unwilling to attribute to Congress the intent . . . to create a right to enforce an arbitration contract and yet make the right dependent for its enforcement on the particular forum in which it is asserted” the effect of this ruling was to require state court judges to enforce arbitration clauses under the FAA at the expense their own state’s employee and consumer protections.

     

    Justice Sandra Day O’Connor, in a separate dissent, focused on the majority’s emphatic resolution that specific performance should somehow be exclusive remedy for breaches of arbitration clauses—a declaration that modernly props up forced arbitration as much as anything. Justice O’Connor rightly observed that in 1925, “common law jurisdictions that enforced arbitration agreements did so in at least three different ways—through actions for damages, actions for specific enforcement, or by enforcing sanctions imposed by trade and commercial associations on members who violated arbitration agreements. In 1925, a forum allowing any one of these remedies would have been thought to recognize the ‘validity’ and ‘enforceability’ of arbitration clauses.” Were courts still permitted to award damages when a party objects to arbitration as an alternative to ordering all claims into secret, privately-paid proceedings, America’s arbitration landscape would look very different today.

  • To support its new position that parties can be compelled to arbitrate nearly all disputes, regardless of whether the claims are contractual or statutory in nature, the Court promulgates the “effective vindication doctrine.”

    Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, 473 U.S. 614 (1985)
     

    Relevant Facts: An auto dealership sued Mitsubishi Motors under the Sherman Act, a federal anti-trust law. Mitsubishi moved to compel arbitration under an arbitration clause in the contract. Neither party disputed that the arbitration agreement was valid, but the question of arbitrability arose because the contract also contained a choice-of-law clause which provided that the arbitration would occur in Japan. The dealership argued that because the Sherman Act is designed to protect businesses like theirs, the federal anti-trust act required a court, not an arbitrator, to enforce it and, as such, the Sherman Act claims were non-arbitrable.

     

    Question Before The Court: Whether claims alleging violations of federal statutes are “arbitrable” under the Federal Arbitration Act.

     

    The Opinion: In a monumental decision, the Court held for the first time that federal statutory claims may be compelled into arbitration, despite the fact that arbitrators hold only the power to enforce contracts, not the law at large. The Court declared, “The ‘liberal federal policy favoring arbitration agreements’ manifested by [the FAA] is at bottom a policy guaranteeing the enforcement of private contractual arrangements: the Act simply creates a body of federal substantive law establishing and regulating a duty to honor an agreement to arbitrate. . .. There is no reason to depart from these guidelines where a party bound by an arbitration agreement raises claims founded on statutory claims.”

     

    The Court continued, “By agreeing to arbitrate a statutory claim, a party does not forgo the substantive rights afforded by the statute; it only submits their resolution in an arbitral, rather than a judicial forum. It trades the procedures and opportunity for review of the courtroom for the simplicity, informality, and expedition of arbitration. We must assume that if Congress intended the substantive protection afforded by a given statute to include protection against waiver of the right to a judicial forum, that intention will be deducible from a text or legislative history.”

     

    Indeed, the Court determined that even “the potential complexity” of the antitrust claim at issue “should not suffice to ward off arbitration.” Casting arbitration clauses as “a specialized kind of forum-selection clause that posits not only the sitis of suit but also the procedure to be used in resolving the dispute,” the Court showed little concern for the potential obstacles to civil law enforcement such a restricted forum might present. “The Bremen [inter alia] established a strong presumption in favor of enforcement of freely negotiated contractual choice-of-forum provisions. . . . That presumption is reinforced by the emphatic federal policy in favor of arbitral dispute resolution.”

     

    Ultimately, the Court established that determining the arbitrability of a federal statutory claim only requires a two-step inquiry: first, ascertain whether the parties’ agreement to arbitrate reached the statutory issue; then, upon finding it did, consider whether legal constraints external to the parties’ agreement foreclosed arbitration of those claims. Citing The Bremen, the Court allowed that “[a] party resisting arbitration may attack directly the validity of the agreement to arbitrate. Moreover, the party may attempt to make a showing that would warrant setting aside the forum-selection clause – that the agreement was affected by fraud, undue influence, or overweening bargaining power, that enforcement would be unreasonable and unjust, or that proceedings in the contractual forum will be so gravely difficult and inconvenient that the resisting party will for all practical purposes be deprived of his day in court. But, absent such a showing . . . there is no basis for assuming the forum inadequate or its selection unfair. . . And so long as the prospective litigant effectively may vindicate its statutory cause of action in the arbitral forum, the statute will continue to serve both its remedial and deterrent function.”

     

    With this decision, all statutory claims – federal and state – are now presumed arbitrable, with a high bar for challenging arbitration of any statutory claims. Practically speaking, once this decision came down, big, powerful companies started drafting contracts of adhesion that include extremely broad language requiring all statutory claims against them to be resolved solely in binding arbitration – a move that essentially allows them to avoid the American judicial system with the stroke of a pen.

  • The Court rules that a state labor law guaranteeing workers access to a public judicial forum to adjudicate wage theft claims is preempted by the FAA.

    Perry v. Thomas, 482 U.S. 483 (1987)
     

    Relevant Facts: An employee who had worked for a securities broker in California sued for unpaid commissions in violation of state law. Based on an arbitration provision found in a Uniform Application for Securities Industry Registration form that all broker-employees are required to complete, the employer moved to compel arbitration. The state court refused to grant the motion, citing Merrill Lynch, Pierce, Fenner & Smith v. Ware, which held wage violations under the state statute were non-arbitrable.

     

    Question Before The Court: Whether a state labor statute that expressly guarantees employees a private right of action is preempted by the FAA, and, thereby, claims brought under that statute may be forced into arbitration.

     

    The Opinion: In light of its more recent pro-arbitration decisions, the U.S. Supreme Court declined to apply the reasoning of the Ware Court. Instead, the Court focused on whether the state labor code section guaranteeing employees a private right of action for the collection of wages “without regard to the existence of any private agreement to arbitrate,” was preempted by the Federal Arbitration Act. Citing our nation’s “federal policy favoring arbitration agreements”, and a handful of its most recent arbitration cases, the Court held that the state labor protections were in “unmistakable conflict” with the FAA, and so, “under the Supremacy Clause, the state statute must give way.”

     

    The Court, in a footnote, spoke to the root of the issue, providing “In instances such as these, the text of §2 provides the touchstone for choosing between state law principles and the principles of federal common law envisioned by the passage of that statute: an agreement to arbitrate is valid, irrevocable, and enforceable, as a matter of federal law, ‘save upon such grounds as exist at law or in equity for the revocation of any contract.’ Thus, state law, whether of legislative or judicial origin, is applicable if that law arose to govern issues concerning the validity, revocability, and enforceability of contracts generally. A state law principle that takes its meaning precisely from the fact that a contract to arbitrate is at issue does not comport with this requirement of §2. A court may not, then, in assessing the rights of litigants to enforce an arbitration agreement, construe that agreement in a manner different from that in which it otherwise construes non-arbitration agreements under state law. Nor may a court rely on the uniqueness of an agreement to arbitrate as a basis for a state law holding that enforcement would be unconscionable, for this would enable the court to effect what we hold the legislature today cannot.”

  • The Court emphasizes that arbitration clauses should be enforced “according to their terms.”

    Volt Inf. Sciences v. Stanford Univ., 489 U.S. 468 (1989)
     

    Relevant Facts: A construction contract between parties included an arbitration clause containing a choice-of-law provision requiring the contract to be governed by the law of “the place where the Project is located.” A dispute arose in relation to a California-based project and the appellant made a formal demand for arbitration. In response, the appellee filed an action in California state court seeking indemnity from two other parties involved in the dispute who were not subject to the contract. The state court denied the motion to compel arbitration, citing a state law that permitted a stay pending resolution of related litigation between a party bound to an arbitration clause and third parties who are not bound by it.

     

    Question Before The Court: Whether the state law at issue was preempted by the Federal Arbitration Act (FAA), and whether, given this nation’s policy favoring arbitration, the application of the choice-of-law provision in this case was properly applied.

     

    The Opinion: The U.S. Supreme Court focused on the terms of the arbitration clause in rendering its decision. The Court observed that, “There is no federal policy favoring arbitration under a set of procedural rules; the federal policy is simply to ensure the enforceability, according to their terms, of private agreements to arbitrate.” The FAA confers a right to obtain an order directing that “arbitration proceed in the manner provided for in [the parties] agreement”, and that “parties are free to structure their arbitration agreements as they see fit.” Thus, an arbitration clause’s terms can include the rules by which the claim is arbitrated, such as those found in a choice-of-law provision. The Court reasoned that when parties, as here, agree to arbitrate according to a particular state’s laws, and that state’s laws require a stay of arbitral proceedings, then staying those proceedings is giving the arbitration clause effect, as required by the FAA.

     

    On the matter of preemption, the Court re-affirmed its position that states “cannot pass laws that require a judicial forum for the resolution of claims which the contracting parties agreed to resolve by arbitration.” To determine whether a state law conflicts with the FAA to the point of preemption, one must ask whether the state law stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress in passing the FAA. The Court then identified three purposes and objectives of the FAA: to place arbitration agreements on the same footing as other contracts, but not more so; to enforce agreements into which parties had entered; and to encourage the expeditious resolution of disputes.

  • The Court holds that the rules governing an arbitration proceeding should be derived from the text of the contract and the intent of the parties. It further held that ambiguous contracts should be interpreted against the drafter, but that ambiguities in the scope of arbitrable issues should be decided in favor of arbitration.

    Mastrobuono v. Shearson Lehman Hutton, 514 U.S. 52 (1995)
     

    Relevant Facts: A married couple sued their investment firm in federal court, alleging that their securities trading account had been mishandled by the firm’s brokers. The customer agreement contained both an arbitration clause and a choice-of-law provision. The choice-of-law provision required proceedings in New York, according to New York law, which would have protected certain substantive rights in arbitration. The arbitration clause provided for the arbitration to be conducted pursuant to the rules of the National Association of Securities Dealers (NASD). After being compelled into arbitration, the couple was awarded both compensatory and punitive damages. Under New York law, the arbitrator would not have been empowered to award punitive damages. The brokerage firm moved to vacate the award of punitive damages under the theory that the New York choice of law provision should govern. The district court granted the motion, and the court of appeals affirmed.

     

    Question Before The Court: Whether a dispute should be resolved using the rules provided by a choice-of-law provision in a contract when that same contract also includes an arbitration clause specifying that alternative rules govern the agreement.

     

    The Opinion: The Court held that where there is a conflict between a choice-of-law provision and an arbitration agreement in a contract regarding the particular rules to govern arbitration, courts must look to the intent of the parties and the text of the agreement. Where there are ambiguities as to the scope of an arbitration clause, they should be resolved in favor of arbitration. The Court called on two standard rules of contract interpretation. First, ambiguous language should be read against the drafter. Second, a document should be read to give effect to all its provisions and to render them consistent with each other.

     

    With this opinion, the Court built on prior rulings that limited the ability of states to reign in the application of forced arbitration within their jurisdictions. The Court doubled down on the idea that arbitration contracts are to be enforced according to their terms, and any ambiguity is to be decided in favor of arbitration. In its 2019 decision, Lamps Plus Inc. v. Varela, the Court revisited its decision here and determined that reading an ambiguous contract against the drafter violates the FAA if doing so would render an arbitration clause unenforceable.

  • The Court reaffirms that a challenge to the validity of a contract as a whole, but which fails to specifically challenge an arbitration clause within that contract, must be ordered into arbitration. This occurs even where the objecting party asserts an illegality defense claiming the entire contract is unlawful.

    Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440 (2006)
     

    Relevant Facts: Victims of a predatory “payday” lending trap sued the lender, a check cashing company. The documents they signed as part of the predatory loan included a forced arbitration clause. The plaintiffs filed a class action suit, alleging usurious interest rates, among other things, which made the contract illegal on its face. The check cashing company invoked the arbitration provision.

     

    Question Before The Court: Whether a court or an arbitrator should consider the claim that a contract containing an arbitration provision is void for illegality.

     

    The Opinion: The Court reiterated that challenges to the validity of arbitration agreements under the “savings clause” may be divided into two types. One type challenges specifically the validity of the agreement to arbitrate. “The other challenges the contract as a whole, either on a ground that directly affects the entire agreement (e.g., the agreement was fraudulently induced), or on the ground that the illegality of one of the contract’s provisions renders the whole contract invalid. The consumer’s claim here was of the second type, and the crux of his complaint was that the contract as a whole—including its arbitration provision—was rendered invalid by the excessive finance charge.”

     

    The Court denied Mr. Cardegna’s assertion, relying on precedent to reach its holding: “First, as a matter of substantive federal arbitration law, an arbitration provision is severable from the remainder of the contract. Second, unless the challenge is to the arbitration clause itself, the issue of the contract’s validity is considered by the arbitrator in the first instance. Third, this arbitration law applies in state as well as federal courts. The parties have not requested, and we do not undertake, reconsideration of those holdings. Applying them to this case, we conclude that because respondents challenge the agreement, but not specifically its arbitration provisions, those provisions are enforceable apart from the remainder of the contract.”

     

    Reflecting on their holding in Southland, which arose in state court, the Court recalled, “We did not ask whether the several challenges made there—fraud, misrepresentation, breach of contract, breach of fiduciary duty, and violation of the California Franchise Investment Law—would render the contract void or voidable. We simply rejected the proposition that the enforceability of the arbitration agreement turned on the state legislature’s judgment concerning the forum for enforcement of the state-law cause of action. So also here, we cannot accept the Florida Supreme Court’s conclusion that enforceability of the arbitration agreement should turn on Florida public policy and contract law.”

     

    “It is true,” the Court continued, “that the Prima Paint rule permits a court to enforce an arbitration agreement in a contract that the arbitrator later finds to be void. But it is equally true that [the consumers’] approach permits a court to deny effect to an arbitration provision in a contract that the court later finds to be perfectly enforceable. Prima Paint resolved this conundrum—and resolved it in favor of the separate enforceability of arbitration provisions. We reaffirm today that, regardless of whether the challenge is brought in federal or state court, a challenge to the validity of the contract as a whole, and not specifically to the arbitration clause, must go to the arbitrator.”

  • The Court holds that when an arbitration provision contains a delegation clause a party specifically challenging forced arbitration on the grounds of unconscionability must also bring a separate specific challenge to the delegation provision in order to have their objections heard by a court, not an arbitrator.

    Rent-A-Center, West, Inc., v. Jackson, 561 U.S. 63 (2010)
     

    Relevant Facts: After a retail salesman filed an employment discrimination claim against his former employer, the company moved to compel arbitration under a forced arbitration clause upon which the worker’s employment had been conditioned. The employee specifically challenged the forced arbitration clause on the grounds of unconscionability, but the forced arbitration clause contained a delegation provision which provided that questions of the clause’s enforceability would be decided by an arbitrator. The district court granted the motion to compel and, because of the delegation provision, ordered the unconscionability question into arbitration. The appeals court reversed in part, holding that when a challenger asserts that he cannot meaningfully assent to the agreement, the threshold question of unconscionability is for the court to decide.

     

    Question Before The Court: Whether an arbitrator or a judge shall determine the enforceability of a forced arbitration clause when the agreement includes a delegation provision.

     

    The Opinion: The Court acknowledged that there are two ways to challenge an arbitration clause under § 2 of the FAA; a party can either specifically challenge the validity of the agreement to arbitrate, or they can challenge the contract as a whole. The Court held that unless it is expressly and specifically challenged, a delegation provision must be enforced. “If a party challenges the validity under § 2 of the precise agreement to arbitrate at issue, the federal court must consider the challenge before ordering compliance with the agreement under § 4. That is no less true when the precise agreement to arbitrate is itself part of a larger arbitration agreement.” In other words, challenging the contract as a whole will not suffice to get the issue of the enforceability of an arbitration agreement with a delegation provision before a judge.

     

    The Court cited its severability rule from Prima Paint in holding that “the delegation provision is an agreement to arbitrate threshold issues concerning the arbitration agreement. We have recognized that parties can agree to arbitrate ‘gateway’ questions of ‘arbitrability,’ such as whether the parties have agreed to arbitrate or whether their agreement covers a particular controversy. . .. [Delegation provisions are] simply an additional, antecedent arbitration agreement the party seeking arbitration asks the federal court to enforce, and the FAA operates on this additional arbitration agreement just as it does any other. . . Application of the severability rule does not depend on the substance of the remainder of the contract. Section 2 operates on the specific ‘written provision’ to ‘settle by arbitration a controversy’ that the party seeks to enforce. Accordingly, unless [a party] challenged the delegation provision specifically, we must treat it as valid . . . and must enforce it, . . . leaving any challenge to the validity of the Agreement as a whole to the Arbitrator.”

     

    The primary effect of this case was summarized in Justice Stevens’ dissent: “A claim that an entire arbitration agreement is invalid will not go to the court unless a party challenges the particular sentences that delegate such claims to the arbitrator, on some contract ground that is unique and particular to the sentences.” In so deciding, the Court gave effect to contracts even when the validity of those very contracts is in question. Justice Stevens addressed this problem, saying, inter alia, “I do not think an agreement to arbitrate can ever manifest a clear and unmistakable intent to arbitrate its own validity.”

     

    Arguably, one could go much further in questioning why the FAA is applied to the delegation provision at all. The FAA only applies to “written provision[s] . . . evidencing a transaction involving commerce.” While an arbitration clause may be a part of, but severed from, an underlying contract in interstate commerce—which is the means by which the FAA applies to them—the same cannot be said for a delegation provision. The contract that contains a delegation provision is the arbitration contract. In Mitsubishi Motors the Court went to great lengths to characterize arbitration contracts as “mere forum-selection clauses.” Even under the broadest interpretation of the Commerce Clause, forum-selection clauses have never been interpreted as contracts in interstate commerce. Because delegation provisions are severed from arbitration agreements which, again, are not contracts in interstate commerce in and of themselves, it’s questionable that the FAA should apply to matters of their enforceability.

  • The Court declares that arbitration is fundamentally bilateral in nature and rules that the FAA precludes states from barring enforcement of class waivers in arbitration clauses, even for unrelated law enforcement or public policy reasons.

    AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011)
     

    Relevant Facts: Consumers who responded to an advertisement for a free phone were subsequently charged a fee on their bill, and sued AT&T for fraud. Their action was joined with others in a nationwide class proceeding. The defense invoked a forced arbitration clause in the consumer contract to force the class action out of the judicial forum and into individual arbitration. The arbitration clause at issue contained a class action ban. If enforced, pursuit of valid claims would have been financially untenable because each individual claim was only valued at approximately $30 apiece—far less than the cost of legal proceedings. The district court acknowledged that fact and found the class action ban unconscionable under state law. The appeals court affirmed and held that the state law on which the ruling was based was not preempted by the FAA.

     

    Question Before The Court: Whether the FAA preempts a state law holding that class action bans in forced arbitration agreements are unconscionable.

     

    The Opinion: The Court began by addressing the application of the state law of unconscionability, saying, “When state law prohibits outright the arbitration of a particular type of claim, the analysis is straightforward. The conflicting rule is replaced by the FAA. But the inquiry becomes more complex when a doctrine normally thought to be generally applicable, such as duress or unconscionability, is alleged to have been applied in a fashion that disfavors arbitration.” The Court continued, “[a]lthough the Section 2 savings clause preserves generally applicable contract defenses, nothing in it suggests an intent to preserve state law rules that stand as an obstacle to the accomplishment of the FAA’s objectives.” The Court then ruled that the FAA preempts states from barring enforcement of class waivers in arbitration clauses, even for public policy reasons that have nothing to do with arbitration.

     

    Focusing on the use of the class action ban to require individual proceedings, the Court provided, “Arbitration is a matter of contract and the FAA requires courts to honor the expectations of the parties. But [if] what parties have agreed to . . . is not arbitration as envisioned by the FAA and lacks its benefits . . . [it] may not be required by state law.” Rooting its reasoning in concern for defendants to appeal large adverse judgments from class arbitral proceedings, the Court declared that arbitration is poorly suited to the higher stakes of class litigation, finding that “the overarching purpose of the FAA is to ensure the enforcement of private arbitration agreements according to their terms so as to facilitate streamlined proceedings. Requiring the availability of class wide arbitration interferes with fundamental attributes of arbitration and thus creates a scheme inconsistent with the FAA.”

     

    The Court then swatted away the argument that “class proceedings are necessary to prosecute small-dollar claims that might otherwise slip through the legal system” by quipping that “States cannot require a procedure that is inconsistent with the FAA, even if it is desirable for unrelated reasons.”

     

    With this case the Court unambiguously elevated the importance of arbitration provisions above almost any other concern. Justice Thomas, in his concurrence, observed that based on the majority’s holding, to win on an FAA Section 2 savings clause argument now would require “a party successfully assert[] a defense concerning the formation of the agreement to arbitrate, such as fraud, duress, or mutual mistake. . . Contract defenses unrelated to the making of the agreement—such as public policy—could not be the basis for declining to enforce an arbitration clause.”

  • The Court rules that the National Labor Relations Act does not give employees a right to collective legal action, and that the FAA requires courts to enforce class, collective, and joint action bans in forced arbitration clauses in employment contracts.

    Epic Systems, Corp. v. Lewis, 138 S. Ct. 1612 (2018)
     

    Relevant Facts: In granting certiorari, the U.S. Supreme Court consolidated three different cases with similar facts. All involved claims by workers for unpaid wages by a more-powerful employer. In each instance, when the workers tried to band together to enforce their right to their unpaid wages, the employer invoked of a class ban in the company’s forced arbitration provision. The class ban required the workers to arbitrate all claims on an individual basis, which, due to the expense involved, inter alia, would have effectively ended the workers’ lawsuits before they ever reached the merits. To retain their right to go to court, the employees argued that the National Labor Relations Act (NLRA) protects their right to act collectively for their “mutual aid or protection.” The class ban in the company forced arbitration clause, the employees argued, violated that NLRA guarantee, so was unlawful and unenforceable.

     

    Question Before The Court: Whether arbitration agreements with individual employees that bar them from pursuing work-related claims on a joint basis in any forum are illegal because they limit the employees’ right under the NLRA and NLGA to engage in “concerted activities” in pursuit of their “mutual aid or protection,” and are therefore illegal and unenforceable under the Federal Arbitration Act’s (FAA) “savings clause.”

     

    The Opinion: The U.S. Supreme Court held that the FAA requires collective action bans to be enforced. In so finding, the Court determined that the NLRA did not apply in the case before it because, in its view, the NLRA was designed to serve as a mechanism for workers to organize a union in their workplace, but that workers’ right to act collectively for “mutual benefit or protection” does not extend to collective legal action. The Court reasoned that, since the NLRA didn’t protect a right to collective legal action, class bans in forced arbitration clauses limiting workers’ ability to band together against a more-powerful employer are not illegal, and, by extension, the FAA’s “savings clause” did not apply. It further asserted that even were the illegality defense available, it still could not be applied because doing so would impermissibly “disfavor arbitration”—an act the Court ruled in Concepcion would violate the FAA. The Court then reiterated its position in Concepcion that courts cannot render arbitration contracts unenforceable for public policy reasons.

     

    In reaching its holding, the majority expressed open disdain toward the employees’ effort to retain their right to band together. It portrayed the illegality defense asserted by the workers as an attempt to “attack the individualized nature of the arbitration proceedings,” and claimed that the employees’ demand to enforce their rights collectively was really intended to “interfere with one of arbitration’s fundamental attributes.” In making this point, the Court ignored the fact that the attributes it was holding up as sacrosanct had only been used to characterize arbitration proceedings for less than a decade and were wholly a product of the Court’s own recent decisions—observations that Justice Ruth Bader Ginsberg pointed out in her scathing dissent.

     

    The full repercussions of this opinion have yet to be felt. Time will tell what this case will mean for workers who seek avail themselves of the “mutual aid or protection clause” of the NLRA in the future; and the winnowing of the FAA “savings clause” in this opinion creates doubt as to how an employee may use the provision to defend against forced arbitration moving forward.

  • The Court ruled that the FAA forecloses courts from applying neutral state law defenses in the face of ambiguous contract language if doing so would result in allowing arbitration to proceed on a class-wide basis.

    Lamps Plus, Inc. v. Varela, No. 17-988 (U.S. Apr. 24, 2019)
     

    Relevant Facts: An employee of Lamps Plus fell prey to a phishing scheme and accidentally released the tax information of thousands of the company’s workers. After Frank Varela discovered a fraudulent tax return had been filed in his name, he filed a putative class action lawsuit in federal court against Lamps Plus on behalf of the employees whose information was compromised. Lamps Plus responded by filing a motion to compel individual arbitration. The District Court granted the order to compel arbitration, but denied the company’s effort to break the class. Under the state law doctrine contra proferentem, ambiguous language in a contract should be interpreted in a favor of the non-drafting party. Because the language in the arbitration clause drafted by Lamps Plus was ambiguous, the court allowed class arbitration proceedings to move forward. The appellate court affirmed.

     

    Question Before The Court: Whether the Federal Arbitration Act bars courts from applying a neutral principle of state contract interpretation to an ambiguous contract term when doing so would result in the authorization of class arbitration proceedings.

     

    The Opinion: Under California law, the doctrine of contra proferentem provides that ambiguous contract terms should be interpreted against the drafter. Because the arbitration provision at issue here was ambiguous, the Ninth Circuit interpreted it in a way most favorable to the non-drafting employee required to accept it, allowing class arbitration to move forward.

     

    Relying on precedent from only the last decade, the U.S. Supreme Court reversed, holding that an arbitration contract must expressly authorize class arbitration in order for parties to access the arbitral forum collectively. In the Court’s view, the “traditional individualized arbitration contemplated by the FAA”—and the benefits the Court has assigned to it—are undermined by class arbitration. For that reason, the Court held that “ambiguity does not provide a sufficient basis to conclude that parties to an arbitration provision agreed to ‘sacrifice the principal advantage of arbitration.’

     

    Additionally, the Court addressed the appellate court’s use of contra proferentem, and ruled that the FAA’s predilection for individual arbitration prevents courts from applying a state’s general contract principles to ambiguous contract terms if doing so would result in the authorization of class arbitration. The Court explained, “The FAA provides the default rule for resolving certain ambiguities in arbitration agreements. . .. Courts may not infer from an ambiguous agreement that parties have consented to arbitrate on a classwide basis. The doctrine of contra proferentem cannot substitute for the requisite ‘contractual basis’ for concluding that the parties agreed to class arbitration.”

     

    All four justices in the minority authored separate dissents. Justice Breyer focused on jurisdictional issues. Justice Ginsburg lambasted the majority’s woeful straying from the legislative purpose of the FAA at the expense of employees and consumers. “Piling Pelion on Ossa,” she wrote, “the Court has hobbled the capacity of employees and consumers to band together in a judicial or arbitral forum.” Justice Kagan, too, excoriated the majority’s blatant anti-class action judicial activism that lay at the heart of their decision to render the state’s “plain-vanilla rule of contract interpretation” inapplicable to arbitration contracts.

     

    In her dissent, Justice Sotomayor expressed her dismay as to the effect the majority’s rule would have on states, providing, “This Court normally acts with great solicitude when it comes to possible preemption of state law, but the majority today invades California’s contract law without pausing to address whether its incursion is necessary. Such haste is as ill-advised as the new federal common law of arbitration contracts it has begotten.”

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