On December 8, 2020, the Supreme Court heard oral argument in the case Henry Schein, Inc. v. Archer & White Sales, Inc., No. 19-963, which is now on its second trip to the Court. The case presents the question of whether “a provision in an arbitration agreement that exempts certain claims from arbitration negates an otherwise clear and unmistakable delegation of questions of arbitrability to an arbitrator.” Throughout the briefing and in argument, the exemption is colloquially referred to as the “carve-out.” While the parties’ main battle is over the interpretation of the operative arbitration clause, there is a collateral issue of significance that may or may not be decided by the Court: Respondent’s contention that incorporation by reference of institutional arbitration rules, such as those of the American Arbitration Association (“AAA”), does not constitute clear and unmistakable evidence of the parties’ intent to arbitrate arbitrability.
Editor's Note: After this article was submitted for publication the Supreme Court issued a per curium order dismissing the writ of certiorari as “improvidently granted.” The dismissal leaves intact the Fifth Circuit decision as well as the unanimous circuit case law holding that the incorporation of institutional arbitration rules evidences clear and unmistakable intent to delegate arbitrability to the arbitrator. The dismissal notwithstanding, the Schein case remains a cautionary tale regarding contract drafting and unresolved questions surrounding delegation.
Who Decides Arbitrability?
The determination of “arbitrability” – i.e., whether the parties have submitted a particular dispute to arbitration – traditionally is seen as an issue for the courts to decide. More recently, however, the Supreme Court has stressed that the question of who decides arbitrability “turns upon what the parties agreed about that matter.” Determining the parties’ agreement generally involves the application of ordinary state-law principles governing the formation of contracts with one exception: “Courts should not assume that the parties agreed to arbitrate arbitrability unless there is ‘clea[r] and unmistakabl[e]’ evidence that they did so.” If there is a clear and unmistakable delegation of arbitrability to the arbitrator, a court may not decide the issue.
While the Supreme Court has not definitively ruled on the question, the federal courts of appeal have uniformly held that an arbitration clause that incorporates by reference the AAA rules (or similarly worded arbitral rules) constitutes clear and unmistakable evidence that the parties agreed to arbitrate arbitrability. The rationale underlying these decisions is straightforward. Under long-settled principles of contract law, parties can incorporate outside documents, such as the AAA rules, into their contract. Because those rules provide that the arbitrator has the power to rule on his or her jurisdiction as well as the scope of the arbitration agreement, incorporating these rules is an agreement to arbitrate arbitrability.
Schein, Act I: The Wholly Groundless Exception Deemed Wholly Groundless
The Schein case involves an antitrust suit brought in a Texas federal court by Archer & White Sales, Inc. (“Archer”) seeking both money damages and injunctive relief. Henry Schein, Inc. and its affiliated defendants (collectively, “Schein”) moved to compel arbitration based on the following arbitration clause in a dealer agreement:
This Agreement shall be governed by the laws of the State of North Carolina. Any dispute arising under or related to this Agreement (except for actions seeking injunctive relief and disputes related to trademarks, trade secrets, or other intellectual property of Pelton & Crane), shall be resolved by binding arbitration in accordance with the arbitration rules of the American Arbitration Association [(AAA)]. The place of arbitration shall be in Charlotte, North Carolina.
Following a hearing, a magistrate judge compelled arbitration because: (1) the claim did not seek “only” injunctive relief and monetary damages were the predominant relief sought, and (2) the incorporated AAA rules “very clearly state that the question of the arbitrability of a dispute is referred to the arbitrator under the AAA rules.”
The district court, however, vacated the magistrate judge’s ruling on two grounds. First, the Court found that the parties did not clearly and unmistakably agree to arbitrate the arbitrability of actions seeking injunctive relief because the pleaded action fell squarely within the terms of the express carve-out from arbitration. Second, the court found that, even if a delegation had occurred, recent Fifth Circuit jurisprudence permitted it to determine arbitrability when a party’s argument in favor of arbitration was “wholly groundless.” The Court found Schein’s arguments in favor of arbitration to be wholly without merit based on the plain language of the arbitration clause.
The Fifth Circuit affirmed the district court. The Court acknowledged that the parties’ express incorporation of the AAA rules “present[ed] clear and unmistakable evidence that the parties agreed to arbitrate arbitrability.” After noting that the interplay between this delegation and the exception was “at best ambiguous,” the Court determined that it need not decide the delegation issue because the Fifth Circuit’s adoption of the “wholly groundless” exception provided it “a narrow escape valve.” Because the arbitration clause expressly excluded actions involving injunctive relief, the Court affirmed the district court based on the arguments in favor of arbitration being “wholly groundless.”
The Supreme Court, in a unanimous decision, reversed the court of appeals on two grounds. First, there was no support for a “wholly groundless” exception in the language of the Federal Arbitration Act. Rather, the Courts were required to interpret the Act as written, and the Act in turn required that Courts interpret the parties’ contract as written:
When the parties’ contract delegates the arbitrability question to an arbitrator, a court may not override the contract. In those circumstances, a court possesses no power to decide the arbitrability issue. That is true even if the court thinks that the argument that the arbitration agreement applies to a particular dispute is wholly groundless.
Second, the “wholly groundless” exception was inconsistent with the Court’s prior jurisprudence holding that a court may not rule on the merits of a claim assigned by a contract to an arbitrator even if the Court believes the claim is frivolous: “Just as a court may not decide a merits question that the parties have delegated to an arbitrator, a court may not decide an arbitrability question that the parties have delegated to an arbitrator.” Because the court of appeals had not addressed the delegation issue, the case was remanded for further proceedings.
Schein, Act II: Deciding Who Decides Arbitrability
On remand, the Fifth Circuit again affirmed the district court. The Court noted the parties’ agreement that a valid arbitration clause existed and precedent establishing that incorporation of the AAA rules constituted clear and unmistakable evidence of the parties agreement to arbitrate arbitrability. Notwithstanding, the Court found that the placement of the carve-out in the clause was dispositive: “The plain language incorporates the AAA rules – and therefore delegates arbitrability – for all disputes except those under the carve-out. Given that carve-out, we cannot say that the Dealer Agreement evinces a ‘clear and unmistakable’ intent to delegate arbitrability.”
The Supreme Court granted Schein’s petition for certiorari, but denied a cross-petition by Archer. Archer maintained that if the Court granted Schein’s petition, the Court should also decide the “logically antecedent” question of whether merely choosing a set of arbitration rules constitutes “clear and unmistakable” evidence that the parties agreed to allow an arbitrator to decide arbitrability.
Before the Court, the parties have arrived at vastly different views on the application of the “clear and unmistakable” evidence rule. Not surprisingly, both parties have argued that their view of the arbitration clause presents the simplest, most commonsensical reading of its text.
At its core, Schein’s argument is that a “clear and un-mistakable” delegation of arbitrability resulted from the incorporation of the AAA rules, and thus, the Court lacked authority to decide arbitrability. Schein reasons that the delegation is an antecedent agreement that is subject to the rules governing arbitration agreements generally, and one of those rules is the presumption that any doubts regarding the scope of an arbitration agreement be resolved in favor of arbitration. Given that presumption, the fact that the carve-out is silent regarding who decides arbitrability does not restrict the delegation effected by the incorporation of the AAA rules. In Schein’s view, the court of appeals conflated the questions “who decides arbitrability” and “whether the dispute is arbitrable,” thereby gutting the delegation. In doing so, the Court created a scenario in which responsibility for deciding arbitrability is divided between a court and an arbitrator, leaving open the question of who decides which arbitrability decisions are for the court and which are for the arbitrator.
Archer argues that that no delegation occurred, either as a matter of law or fact. First, Archer contends that the “clear and unmistakable” evidence rule is not satisfied because the agreement does not contain an explicit delegation. Second, notwithstanding the denial of certiorari (and twelve contrary court of appeals decisions), Archer contends that the “mere incorporation” of the AAA rules is insufficient to show by clear and unmistakable evidence that the parties intended to delegate arbitrability to an arbitrator. Finally, Archer maintains that even if a delegation exists, it was never triggered under the plain language of the agreement. Here, Archer argues that because its action seeks injunctive relief, the carve-out applies, the claim is not subject to arbitration under the AAA rules, and thus no delegation of arbitrability under the AAA rules ever occurred.
Both views of the clause have faults. As the Chief Justice pointed out, the Schein view of the clause has the arbitrator deciding whether a claim falls within the carve-out when the parties expressly stated they did not want arbitrators dealing with actions seeking injunctive relief. The Archer view, on the other hand, would divide responsibility for arbitrability determinations between the arbitrator and the court, adding a new question to the mix, namely, who decides who makes the arbitrability decision.
Conclusion
There are several takeaways from the Schein case even as the Supreme Court ruling remains pending. First is the importance of carefully reviewing dispute resolution clauses in contracts. The Schein parties have now spent approximately eight years fighting over arbitrability. Whatever the outcome in the Supreme Court, the Schein case demonstrates the critical importance of precisely reciting the parties’ mutual intent regarding the dispute resolution process. To paraphrase Archer’s counsel, parties need to express their intentions in simple, explicit sentences.
Second, the case (or, perhaps more accurately, the carve-out) highlights the tension between the presumption that any doubts as to the scope of arbitral issues should be resolved in favor of arbitration and the principle that courts should not assume that the parties agreed to arbitrate arbitrability unless there is clear and unmistakable evidence that they did so. This conflict is muddied by yet another principle: that arbitration agreements are to be construed like any other contract – i.e., what effect is to be given the delegation worked by incorporating arbitration rules.
Finally, it is not clear whether the Court will decide the specific question of whether incorporation of the AAA (or similar) rules constitutes clear and unmistakable evidence that the parties intended to delegate arbitrability to an arbitrator. According to Schein, Archer did not raise this argument until the remand, and then only in a footnote to its supplemental brief. In addition, it is unclear whether deciding the incorporation issue is necessary to reach a decision in the pending case. If the Court leaves the issue untouched, the law in twelve circuits (and in some states) will remain that incorporation of arbitration rules allowing arbitrators to determine their own jurisdiction constitutes clear and unmistakable evidence that the parties intended to delegate arbitrability to an arbitrator.