GPSolo Magazine - March 2005

Practice Management

FAA Preemption: Does It Wipe Out State Contract Law?

How much state contract law is wiped out by the Federal Arbitration Act? Based on the U.S. Supreme Court’s 1984 decision in Southland Corp. v. Keating, the federal courts have used the FAA as a departure point to develop a body of preemptive federal common law that severely restricts state attempts to regulate predispute arbitration clauses in adhesion contracts.

The FAA has been construed to bind state courts and preempt those state laws that target arbitration agreements for special barriers to enforcement, whereas “generally applicable contract defenses” and rules that “arose to govern . . . contracts generally” may be applied to arbitration agreements “without contravening [FAA] §2.” Or so we thought.

Proponents of compelled arbitration have launched two new arguments to push preemption even further. They argue that the FAA specifies that arbitration clauses must be enforced “as written,” irrespective of how they are written. Any state law, either judge-made or statutory, that is designed to protect the weaker contracting party from overreaching is preempted by the FAA if its effect would be to vary any aspect of the written arbitration clause.

Alternatively, these proponents argue that the FAA preempts all but “general” state contract law, whereas state laws that regulate specific categories of contracts—consumer protection laws, for example—are not “general” contract law. These arguments threaten to expand the wrong-headed doctrine of FAA preemption to a previously unimagined extent.

The new assault on state contract law. In Green Tree Financial Corp. v. Bazzle, the defendants argued that an arbitration agreement that was purportedly written to exclude class actions must, as a matter of judge-made FAA law, be enforced in exactly those terms—arbitration without a class action. The “enforce as written” rule misconstrues the FAA. The FAA permits drafting parties to control only one particular aspect of dispute resolution—the choice of arbitration or court. It expresses no “federal policy” in favor of oppressive venue clauses, waiver of class action remedies, waiver of damages remedies, or other unconscionable terms, even if such terms can be grafted onto an arbitration agreement.

The law of contract guarantees no one an absolute right to have a private written agreement enforced exactly “as written.” All contracts are subject to background state contract law, which will provide, as a matter of public policy, that certain terms cannot be enforced as written.

The recognized purpose of the FAA is to place arbitration agreements “upon the same footing as other contracts,” and “make arbitration agreements as enforceable as other contracts but not more so.” This precludes the idea that the FAA can serve as a special national exemption from state contract law that applies to arbitration agreements but no other contracts.

The Court has held that “state law, whether of legislative or judicial origin” is saved from preemption if it “arose to govern issues concerning the validity, revocability, and enforceability of contracts generally. . . .” Unfortunately, the concept of “generally applicable contract law” has recently confused some courts.

In Bradley v. Harris Research, the Ninth Circuit held that a California statute barring unfair venue provisions in franchise agreements was preempted by the FAA. The court acknowledged that the state venue statute did not “single out” arbitration and would have applied irrespective of the presence of an arbitration agreement.

But the court nevertheless concluded that “general” contract law means a law that applies to every contract, whereas the California statute “applies only to forum selection clauses and only to franchise agreements; it therefore does not apply to ‘any contract.’”

Like the purported federal “enforce as written” rule, Bradley’s application of the “general/specific” distinction would turn arbitration agreements into blanket exemptions from consumer protection and other statutes aimed at preventing contractual overreaching.

Why it’s high time to overrule Southland. A federal statute preempts state law only if intended to have that effect by Congress. The FAA was originally intended as a procedural rule for the federal courts, and not as substantive law binding on the states.

Nothing in the statute says the FAA applies in state court or preempts state law. The House Report states that enforcement of arbitration agreements “is a question of procedure to be determined by the law [of the] court in which the proceeding is brought and not one of substantive law

Contracts are an area of traditional state regulation that federal courts should be “reluctant to federalize.” Yet, under Southland, FAA preemption has run amok. Last year alone, state laws were held preempted under Southland in at least 16 cases. At least 30 states have one or more statutes containing anti-waiver provisions of the kind held preempted in Southland. Many states have tried to regulate arbitration agreements by creating specific exceptions to a general state rule of specific enforcement of arbitration agreements, but Southland preempts these laws.

“If a case can be decided on either of two grounds, one involving a constitutional question, the other a question of statutory construction or general law, the Court will decide only the latter.” As a corollary principle, “where an otherwise acceptable construction of a statute would raise serious constitutional problems, the Court will construe the statute to avoid such problems unless such construction is plainly contrary to the intent of Congress.” The Court has failed to apply this principle in the Southland line of cases. The FAA, at bottom, governs procedure. The choice of arbitration over litigation does nothing more than “trade . . . the procedures and opportunity for review of the courtroom for the simplicity, informality, and expedition” of arbitral procedures. By holding that the FAA binds state courts, the Southland doctrine permits a federal restructuring of state dispute resolution procedures by supplanting such processes as a jury trial, discovery, and plenary appellate review.

What exactly is the federal interest in restructuring state dispute resolution procedures for state law claims? The FAA evinces a congressional intent to bring private contractual arbitration agreements into general contract law, not lift them out of it into a category of special federal concern. In marked contrast, collective bargaining agreements, although private contracts in form, have long been regarded as contracts carrying national public policy implications, due to the history of labor strife.

The absence of substantive federal policy underlying the FAA explains why the FAA does not even create federal question jurisdiction. It has become commonplace to answer the “federal interest” question by waving the flag of the so-called “national policy favoring arbitration,” but that is nothing more than a circular argument that fails to explain why Congress would, or constitutionally could, impose such a policy on the states.

Southland thus violates the principle of constitutional avoidance by adopting a construction of the FAA that raises serious constitutional doubts when an alternative construction—holding that the FAA does not bind state courts or preempt state law—is highly plausible and consistent with the intent of Congress.

The “enforce as written rule” and the “general law” arguments are dead wrong. But for that matter so is FAA preemption itself. Southland and the doctrine of FAA preemption are an anomaly in the Rehnquist court’s current “federalism revival” and should be overruled once and for all.

David S. Schwartz is an assistant professor of law at the University of Wisconsin Law School. He can be reached at dsschwartz@wisc.edu.

For More Information about the Section of Dispute Resolution

- This article is an abridged and edited version of one that originally appeared on page 23 of Dispute Resolution Magazine, Spring 2004 (10:3).

- For more information or to obtain a copy of the periodical in which the full article appears, please call the ABA Service Center at 800/285-2221.

- Website: www.abanet.org/dispute/.

- Periodicals: Dispute Resolution Magazine, quarterly magazine; Just Resolutions, newsletter published three times per year.

 

 

 

 

 

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