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May 12, 2015 Articles

Young Lawyers: Recognizing "Sham" Agreements to Arbitrate

By P. Jean Baker

When parties execute arbitration agreements, they typically do so because they believe the arbitral process will have a meaningful outcome and be fairly conducted. When the arbitration agreement specifies an established set of arbitration rules and administration by a recognized ADR provider, such as the American Arbitration Association (AAA), these are reasonable expectations.

But what if the arbitration agreement references an unknown provider of arbitration services, namely the Cheyenne River Sioux Tribe? Recent decisions by the Eleventh and Seventh Circuit Courts of Appeals addressed this issue and decided the arbitration agreements were unenforceable.

The Arbitration Agreements
The cases arise from disputes involving small, high-interest consumer loans originated by entities owned by, or doing business with, Martin A. Webb, an enrolled member of the Cheyenne River Sioux Tribe (Tribe). A number of the entities offered such loans online. Substantially similar arbitration provisions in the loan agreements specified that disputes would be resolved by arbitration, "which shall be conducted by the Cheyenne River Sioux Tribal Nation by an authorized representative in accordance with its consumer dispute rules," and arbitration was to be held on the Cheyenne River Sioux Tribe Reservation in South Dakota. The loan agreements further stipulated that the contract was subject to the Tribe's laws, that the debtor was subject to the jurisdiction of the Tribe's court, and that "no other state or federal law or regulation shall apply."

Eleventh Circuit Decision
Initially, the district court in Inetianbor v. CashCall, Inc., 768 F.3d 1346 (11th Cir. 2014), cert. denied (S. Ct. Apr. 6, 2015), granted CashCall's request to compel arbitration. Abraham Inetianbor attempted to comply, but returned to the district court after receipt of a letter from the Tribe explaining that "the Cheyenne River Sioux Tribal Nation, the governing authority, does not authorize Arbitration." The district court reversed itself and concluded that the arbitral forum was unavailable. Inetianbor v. CashCall, Inc., 962 F. Supp. 2d 1303 (S.D. Fla. 2013).

CashCall submitted a renewed motion to compel arbitration supported by a clarification from the Tribe that "Arbitration in a (private) contractual agreement is permissible," but the Tribal court would not be involved in the arbitral process. The district court concluded that the forum was available and again granted CashCall's motion to compel. Inetianbor again attempted to comply, but returned after learning that the Tribe does not administer arbitration, have a set of consumer rules, or have a mechanism in place for selecting or approving arbitrators.

Upon presentation of this new evidence, the district court concluded that CashCall "failed—despite numerous opportunities—to show that the Tribe . . . conduct[s] arbitrations," or that the Tribe even has consumer dispute rules. Inetianbor, 962 F. Supp. 2d at 1309. Finding that the designated forum was not available, the court vacated its previous order compelling arbitration. CashCall appealed.

The Eleventh Circuit focused its analysis on whether the district court had committed a clear error in finding the choice of forum was an integral part of the agreement to arbitrate, rather than an ancillary logistical concern. The court concluded that the designation of the particular forum pervaded the agreement, being referenced in five of its nine paragraphs. This constituted strong evidence that the party that drafted the agreement particularly desired arbitration before the Tribe. Had the clause merely referenced use of the Tribe's rules, the court might have been able to appoint another arbitrator. But the clause expressly stated that the Tribe shall administer the arbitration. The court affirmed the district court's decision refusing to compel arbitration.

Concurring opinion. In her concurring opinion, Judge Restani concluded that based on Inetianbor's repeated assertions that the arbitration agreement was a "sham," the court should have exercised its discretion to affirm the district court on an alternate ground, namely unconscionability. Based on the full record, Judge Restani found the agreement to be both procedurally and substantively unconscionable.

It was procedurally unconscionable because there were no set of rules or procedures and the Tribe expressly stated that it did not select or approve arbitrators. Thus, it was impossible for Inetianbor to understand the provision of the agreement to arbitrate that specified the Tribe, together with its set of rules, as the arbitral forum. In addition, the terms of the agreement were substantively unconscionable because they were so outrageously unfair as to shock the judicial conscience. "Although the FAA indicates a policy favoring enforcement of arbitration agreements, its purpose is not to allow parties to make up non-existent forums and rules in an effort to create the façade of a legitimate, reasonable dispute resolution system, especially one conducted by a sovereign entity." Inetianbor, 768 F.3d at 1356–57 (Restani, J., concurring).

Seventh Circuit
In Jackson v. Payday Financial, LLC, 764 F.3d 765 (7th Cir. 2014), the plaintiffs borrowed money through a website and agreed to pay 139 percent in interest per year. They sued for violation of Illinois usury and consumer fraud statutes. The defendants moved to dismiss for improper venue, arguing that the claims had to be brought in arbitration. The district court granted the defendants' motion, but before the Seventh Circuit would hear the appeal, the district court was ordered to engage in fact finding about the Tribe's arbitration rules and mechanisms.

The district court, echoing Judge Restani's concurring opinion in Inetianbor, found that the arbitral mechanism specified in the agreement was illusory—"a sham from stem to stern." Jackson, 764 F.3d at 779. This conclusion rested upon a finding that the tribal leadership had virtually no experience in handling claims made against the defendants through private arbitration. "The intrusion of the Cheyenne River Sioux Tribal Nation into the contractual arbitration provision appear[ed] to be merely an attempt to escape otherwise applicable limits on interest charges." Jackson, 764 F.3d at 770 (alteration in original).

In reaching its conclusion that the arbitral mechanism was a sham, the district court focused on the manner in which the arbitrator had been selected in the Inetianbor case. It found the arbitrator personally selected by Webb was not an attorney and had not been admitted to the practice of law either in South Dakota or the court of the Cheyenne River Sioux Tribal Nation. He had no training as an arbitrator, and the sole basis of his selection was because he was a tribal elder—who also happened to have a direct personal and indirect financial relationship with Webb, the party who unilaterally selected him—although he had stated in writing that there was no "pre-existing relationship."

Because the forum selection provision was illusory and therefore clearly unreasonable, the Seventh Circuit concluded that under federal common law, the Federal Arbitration Act (FAA) does not preempt state law nor operate to permit the creation, from scratch, of an alternate arbitral mechanism. "It hardly frustrates FAA provisions to void an arbitration clause on the ground that it contemplates a proceeding for which the entity responsible for conducting the proceeding has no rules, guidelines, or guarantees of fairness." Jackson, 764 F.3d at 779. In addition, being both procedurally and substantively unconscionable under Illinois law, the arbitration agreement was void. The Seventh Circuit reversed the district court, concluding that the plaintiffs' claims should not have been dismissed. The case was remanded to the district court for further proceedings.

Avoiding Sham Arbitration Agreements
When confronted with an arbitration agreement, it is essential that legal counsel conduct research concerning the validity of the arbitral mechanism before actively participating in the process. The recent court decisions provide guidance as to how counsel might conduct such an analysis: Is the entity that is required to administer or conduct arbitration an experienced, reputable provider of ADR services? Are there published, easily accessible rules? How are arbitrators selected? Is there an established mechanism for addressing potential conflicts of interest? Are there procedures in place that guarantee the process will be conducted fairly? Were the parties provided access to the rules and procedures prior to executing the arbitration agreement? If the answer to one or more of these questions is "no," counsel might consider inquiring as to whether opposing counsel is willing postdispute to submit the dispute to an established ADR provider, such as the AAA.

Remember, it can be both costly and time consuming for a client to go through arbitration and then be forced to seek vacatur of the award because its attorney failed to ascertain in the beginning that the arbitral mechanism was a sham from stem to stern.

Keywords: litigation, ADR, arbitration, unconscionability, ADR provider, Federal Arbitration Act