In a landmark opinion, the Court held that the FAA preempts certain state laws and ruled that state courts must order arbitration under the FAA unless an exception applies.

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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 the state franchise statute conflicted with the FAA to the extent that it was preempted under the U.S. Constitution’s Supremacy Clause, 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 §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 § 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 because that clause is limited in its application only to “any general contract defense” that would serve to revoke all contracts anywhere (like fraud or undue influence), and 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 majority rejected the dissent’s argument that “the FAA was never meant to encroach upon individual states,” and that Congress only intended the FAA to serve as a procedural statute applicable solely in federal courts. After declaring that Congress called upon its Commerce Clause powers in enacting the FAA—a view that is suspect in itself—the Court provided, “We are unwilling to attribute to Congress the intent, in drawing upon on the comprehensive powers of the Commerce Clause, to create a right to enforce an arbitration contract and yet make the right dependent for its enforcement dependent upon the particular forum in which it is asserted. . . . In creating a substantive rule applicable in state as well as federal courts, Congress intended to foreclose state legislative attempts to undercut the enforceability of arbitration agreements.” To reach this outcome, the Court also ignored how limited the Commerce Clause power was in 1925, the year the FAA was enacted.

 

Justice Sandra Day O’Connor, in her dissent, argued that Congress relied on its Article II power over the jurisdiction of the federal judiciary in passing the FAA, not the Commerce Clause. Her observation was not new, but was a view shared by both the majority and minority in Prima Paint, as well. Citing the legislative history, Justice O’Connor provided, “The FAA rests upon the constitutional provision by which Congress is authorized to established and control inferior Federal Courts.” The legislative history also supports the view that the FAA was never intended to reach the states. The ABA Committee that drafted the legislation provided, “So far as the present law declares simply the policy of recognizing and enforcing arbitration agreements in federal courts, it does not encroach upon the province of the individual states.” Joint Hearings on S. 1005 and H.R. 646 before the Subcommittee of the Committees on the Judiciary, 68th Cong., 1st Sess., 17 (1924).

 

Finally, the Court’s finding that the drafters didn’t intend for the FAA to be limited to federal courts is simply not supported by the plain meaning of the text. §4 of the statute expressly limits the power to issue orders to compel arbitration to “any United States District Court which, save for such agreement, would have jurisdiction under Title 28, in a civil action or in admiralty of the subject matter of a suit arising out of the controversy between the parties.” Under the Federal Rules of Civil Procedure, such jurisdiction only arises when there is a federal question at issue or the parties have so-called “diversity jurisdiction” (where the parties reside in different states and the amount of the claim at issue exceeds a statutory minimum). Under these jurisdictional requirements, state courts can never have the requisite jurisdiction to grant a motion to compel arbitration under the FAA and, absent diversity or ancillary jurisdiction, state claims should never be forced into arbitration under the Act.

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