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August 16, 2011 Articles

The Supreme Court Erects Another Roadblock to Challenging Arbitration

By Rebecca Callahan

Arbitration involves the private, consensual resolution of disputes by agreement between the parties and disputants. As a fundamental principle, arbitration is a matter of contract. Moses H. Cone Mem'l Hospital v. Mercury Constr. Corp., 460 U.S. 1, 24 (1983). In practice, this means that a party can be required to arbitrate only those disputes that the party has agreed to submit to arbitration per the arbitration agreement. AT&T Techs. v. Commc'n Workers, 475 U.S. 643, 647–648 (1986). It also means that, like other contracts, arbitration agreements may be invalidated by "generally applicable contract defenses, such as fraud, duress, or unconscionability." Doctor's Assocs., Inc. v. Casarotto, 510 U.S. 681, 687 (1996).

Frequently, a party that is willing to sign a pre-dispute arbitration clause has a different view about who should hear and decide the matter once a dispute arises and may seek to circumvent the application of the arbitration clause. One end-run tactic is to attack the contract containing the arbitration clause by asserting contract avoidance defenses, such as fraud, duress, and illegality. Such attacks are initiated via a court proceeding based upon section 2 of the Federal Arbitration Act (9 U.S.C. § 2), which provides that covered arbitration agreements shall be enforced except "upon such grounds as exist at law or in equity for the revocation of any contract." Green Tree Fin. Corp. v. Bazzle, 539 U.S. 444, 452 (2003). Because arbitration is a creature of contract, the reasoning goes that if a contract containing an arbitration clause is induced by fraud, undue influence, or coercion, then the contract as a whole—including the agreement to arbitrate—should be unenforceable.

This line of attack was significantly curtailed by the Supreme Court in 1967 in Prima Paint Corp. v. Floyd & Conklin Mfg. Co., 388 U.S. 395, 402–406 (1967). In that case, one party sought to avoid arbitration by claiming that the contract containing the arbitration clause was voidable because it had been induced by fraud. The Supreme Court held that the claim of fraudulent inducement did not implicate the making of the agreement to arbitrate because the arbitration clause constituted a separate agreement that was severable from the underlying business contract. The Supreme Court then held that the arbitrators—not the court—should decide any challenge to the underlying contract as part of the parties' dispute and courts should only decide challenges raised specifically with regard to the enforceability of the arbitration clause (as distinguished from attacks on the contract as a whole). As discussed below, the Supreme Court's 2010 decision in Rent-A-Center West, Inc. v. Jackson, 130 S.Ct. 2772 (2010), appears to have changed this rule so that arbitrators can now decide attacks made on the enforceability or validity of the arbitration agreement when that agreement expressly delegates to the arbitrator the resolution of any dispute relating to enforceability.

In a 5–4 decision delivered by Justice Scalia, the United States Supreme Court recently held that an ex-employee's challenge to the enforceability of an arbitration agreement was subject to arbitration because the agreement specifically provided that disputes relating to enforceability were to be determined by an arbitrator. In Rent-A-Center, the parties'agreement to arbitrate had two relevant provisions. One provision provided for the arbitration of all "past, present or future" disputes arising out of plaintiff's employment, including "claims for discrimination" and "claims for violation of any federal . . . law." The second provision stated that "[t]he Arbitrator, and not any federal, state, or local court or agency, shall have exclusive authority to resolve any dispute relating to the interpretation, applicability, enforceability or formation of this Agreement including, but not limited to any claim that all or any part of this Agreement is void or voidable." This second provision was referred to by the parties and the Supreme Court as the "delegation provision" and was essentially treated as a sub-agreement severable from the agreement to arbitrate.

In the lower court proceedings, the former employee opposed defendant's motion to compel arbitration on the grounds that the arbitration agreement was unconscionable and thus unenforceable under state law. The District Court for Nevada granted defendant's motion. Citing Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79, 83 (2002), the district court found that, through the delegation provision, the parties had clearly given the arbitrator exclusive authority to decide whether the agreement was enforceable. The court also found that because the former employee had challenged the validity of the agreement as a whole, the "severability rule" applied and did not prevent the court from enforcing the parties' specific agreement to arbitrate any disputes concerning enforceability, irrespective of the nature of the defense being raised.

A divided panel of the Court of Appeals for the Ninth Circuit reversed. Jackson v. Rent-A-Center W., Inc., 581 F.3d 912 (9th Cir. 2009). The majority opinion stated that the general rule is that arbitrability is for the courts to decide unless there is "clear and unmistakable evidence" that the parties agreed to arbitrate arbitrability. 581 F.3d at 917, citing First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 943–944 (1995). The majority held that "where, as here, a party challenges an arbitration agreement as unconscionable, and thus asserts that he could not meaningfully assent to the agreement, the threshold question of unconscionability is for the court."

The Supreme Court reversed the Ninth Circuit and held that it was up to the arbitrator to decide plaintiff's claim of unconscionability because the parties had delegated enforceability issues to the arbitrator under the terms of their contract. The court found that the delegation provision of the agreement to arbitrate was severable from the remainder of the contract. 130 S.Ct. at 1779–1781. The court reasoned that because the former employee had challenged the agreement to arbitrate as a whole and had not specifically challenged the validity of the delegation provision, the "severability rule" applied and required that the threshold issue of enforceability be submitted to the arbitrator for determination.

The significance of Rent-A-Center is that the underlying contract was a stand-alone arbitration agreement (not a contract unrelated to arbitration that simply contained an arbitration clause). As discussed above, whether the parties have a valid arbitration agreement is an issue assigned to the courts by the Federal Arbitration Act, and any agreement to arbitrate arbitrability must be supported by "clear and unmistakable evidence" that the parties intended to submit such matters to an arbitrator. In Rent-A-Center, plaintiff claimed that the terms of and circumstances surrounding the arbitration agreement were unconscionable and that his consent to the arbitration agreement was not valid or legally binding. The Supreme Court acknowledged that the contract at issue in Rent-A-Center was different from the contracts involved in Prima Paint, Buckeye Check Cashing, Inc. v. Cardegna, 546 U. S. 440 (2006), and Preston v. Ferrer, 552 U.S. 346 (2008), but concluded that that distinction made "no difference." 130 S.Ct. at 2779. In this regard, the Supreme Court held that absent a specific challenge to validity or enforceability of the delegation provision, that provision would be treated as valid under section 2 and enforced under sections 3 and 4 of the Federal Arbitration Act, thus leaving the determination of the contract revocation defense to the arbitrator.

Justice Stevens's Dissent
Justice Stevens wrote a stinging dissent in which he chastised the majority for going beyond the severability rule established by the court's earlier decisions in Prima Paint and Buckeye and for making the "breezy assertion that the subject matter of the contract at issue . . . 'makes no difference.'" 130 S.Ct. at 2781–82.

"Prima Paint and its progeny allow a court to pluck from a potentially invalid contract a potentially valid arbitration agreement. Today the court adds a new layer of severability— something akin to Russian nesting dolls—into the mix; courts may now pluck from a potentially invalid arbitration agreement even narrower provisions that refer particular arbitrability disputes to an arbitrator." 130 S.Ct. at 2786.

The dissonance between the majority and the dissent seems to be based on their differing views of section 2 of the Federal Arbitration Act. Because the subject agreement in Rent-A-Center was a stand-alone arbitration agreement, the dissent reasoned that the court had to decide the challenge to the validity of the arbitration agreement before deciding defendant's motion to compel arbitration. The majority, on the other hand, found that an agreement to arbitrate a gateway issue "is simply an additional antecedent agreement the party seeking arbitration asks the federal court to enforce" and that the Federal Arbitration Act "operates on this additional arbitration agreement just as it does on any other" and is valid under section 2 unless grounds are found to exist for revocation. Because plaintiff's challenge was to the arbitration agreement as a whole, the majority reasoned that the delegation provision could be severed from the contract as a whole and enforced in its own right.

The stand-alone contract at issue in Rent-A-Center was a unique fact circumstance. Additionally, the timing of plaintiff's attack on the enforceability of the delegation provision may have presented a unique circumstance that influenced the court's decision. It was not until his brief to the Supreme Court that the plaintiff specifically challenged the delegation provision as substantively unconscionable. The court found that this challenge was made "too late" and, accordingly, was not considered.

Lessons to Be Learned from Rent-A-Center
One lesson to be learned from Rent-A-Center concerns the drafting of pre-dispute arbitration clauses. Not only does the drafter need to give consideration to the scope of the arbitration clause for purposes of defining what disputes that are subject to arbitration, but also the drafter now needs to give consideration as to (a) whether to include a delegation provision, and (b) whether to make the arbitration agreement separate from the companion contract relating to the business transaction. Such contract planning and drafting may serve to insulate arbitrability from attack.

A second lesson to be learned from Rent-A-Center concerns pleading. When the making of an arbitration agreement is an issue and that agreement includes a provision that delegates to the arbitrator the resolution of disputes relating to validity or enforceability of the agreement to arbitrate, that challenge must be directed specifically at both the agreement to arbitrate and the delegation provision. Without such specificity in pleading, an agreement to arbitrate arbitrability will be enforceable even when the validity of the arbitration agreement is challenged.

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