The Court holds that in a diversity suit, because state law controls under the Erie Doctrine, federal courts must enforce state laws which preclude arbitration in cases where the FAA does not apply, and that the FAA does not extend to cover simple contracts of employment.

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Bernhardt v. Polygraphic Co. of America, Inc., 350 U.S. 198 (1956)
 

Relevant Facts: A man was hired to work for a New York employer in New York. The employee later moved to Vermont but maintained his employment. When the company fired him, the employee brought a civil suit alleging wrongful discharge. Because the parties were now residing in different states and the value of the claim met the required threshold, the claim was removed to federal court under diversity jurisdiction. The employer then sought to enforce an arbitration clause in the employment contract under the Federal Arbitration Act (FAA).

 

Question Before The Court: Whether a federal court must order arbitration of an employment contract under the FAA when the parties in the case have a diversity suit and state law would preclude arbitration.

 

The Opinion: The U.S. Supreme Court first looked to the text of the FAA to determine whether the statute applied and observed that the part of §3 of the FAA that provides for a stay of the trial of an action until arbitration has been had does not apply to all arbitration contracts. On the contrary, for §3 to apply, the contracts at issue must fall within the scope of §§1 and 2 of the FAA; that is, it only applies to contracts relating to maritime transactions or those involving interstate or foreign commerce. The Court determined the employment contract at issue here did not involve either of those classes of contract, and, thus, the FAA did not apply.

 

The Court then turned to the question of whether the Vermont state statute disfavoring arbitration applied, noting that, “The differences between arbitration and judicial determination of a controversy substantially affect the cause of action arising under state law, and make the Erie Doctrine applicable. If, in this case, arbitration could not be compelled in the Vermont state courts, it should not be compelled in the Federal District Court.”

 

The Court disagreed with the appellate court’s conclusion that “arbitration is merely a form of trial, to be adopted in the action itself, in place of the trial at common law.” The majority explained, “We deal here with a right to recover that owes its existence to one of the States, not to the United States. The federal court enforces the state-created right by rules of procedure which it has acquired from the Federal Government and which therefore are not identical with those of the state courts. Yet, in spite of that difference in procedure, the federal court enforcing a state-created right in a diversity case is . . . in substance ‘only another court of the State.’ The federal court therefore may not ‘substantially affect the enforcement of the right as given by the State.’ Id.

 

The Court continued, “If the federal court allows arbitration where the state court would disallow it, the outcome of litigation might depend on the courthouse where suit is brought. For the remedy by arbitration, whatever its merits or shortcomings, substantially affects the cause of action created by the State. The nature of the tribunal where suits are tried is an important part of the parcel of rights behind a cause of action. The change from a court of law to an arbitration panel may make a radical difference in ultimate result. Arbitration carries no right to trial by jury that is guaranteed both by the Seventh Amendment and by Ch. 1, Art. 12th, of the Vermont Constitution. Arbitrators do not have the benefit of judicial instruction on the law; they need not give their reasons for their results; the record of their proceedings is not as complete as it is in a court trial; and judicial review of an award is more limited than judicial review of a trial.”

 

“The nub of the policy that underlies Erie R. Co. v. Tompkins is that for the same transaction the accident of a suit by a nonresident litigant in a federal court instead of in a State court a block away should not lead to a substantially different result. There would in our judgment be a resultant discrimination if the parties suing on a Vermont cause of action in the federal court were remitted to arbitration, while those suing in the Vermont court could not be.”

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