SCOTUS Eliminates Showing of “Prejudice” When Seeking Waiver of a Contractual Right to Arbitrate

The District Court Proceedings

Robyn Morgan was an hourly employee who agreed to arbitrate employment disputes when she applied for a job at a Taco Bell franchise in Iowa. Sundance, Inc., owns Taco Bell franchises throughout the U.S., including the one in Iowa that hired Morgan. The agreement stated that any employment dispute would be resolved in confidential binding arbitration in accordance with the American Arbitration Association’s Employment Arbitration Rules. Ms. Morgan worked as an hourly employee from August 2015 to October 2015. During that time, she claimed Sundance recorded hours worked in one week as instead worked in another to prevent any weekly total from exceeding 40.

In September 2018, Morgan sued Sundance, alleging that Sundance failed to pay her and “similarly situated employees” for overtime in violation of the Fair Labor Standards Act. See 29 U.S.C. § 201. In response, Sundance moved in November 2018 to dismiss the Iowa lawsuit, arguing that under the first-to-file rule, a similar lawsuit filed in Michigan barred the Iowa lawsuit. In its motion, Sundance suggested that Morgan “join” the Iowa suit or “refile her claim on an individual basis.” She declined the invitation to litigate differently. In March 2019, the district court denied Sundance’s motion.

Sundance filed an answer in the Iowa case, asserting 14 affirmative defenses. The answer did not assert Sundance’s right to arbitrate the dispute. Sundance participated in a private settlement mediation with the named plaintiffs in both the Michigan and Iowa collective actions. The Michigan case settled, but Morgan’s case did not. She and Sundance began to talk about scheduling the rest of the litigation. In May 2019, Sundance filed a motion to stay litigation and to compel arbitration. Morgan filed an objection, claiming Sundance had waived the right to compel arbitration by engaging in litigation for so long.

Sundance responded that it had asserted its right as soon as the Court’s decision in Lamps Plus, Inc. v. Varela, 139 S. Ct. 1407 (2019), clarified that the arbitration would proceed on a bilateral (not collective) basis. In addition, Rule 42(b) of the American Arbitration Association’s Employment Arbitration Rules states that “no judicial proceeding by a party relating to the subject matter of the arbitration shall be deemed a waiver of the party’s right to arbitrate.” The district court denied Sundance’s motion.

The Eighth Circuit Proceedings

Sundance appealed the district court decision to the Eighth Circuit. Morgan v. Sundance, Inc., No. 19-2435 (8th Cir. Mar. 30, 2021). The panel majority began its analysis by applying the three-part test enunciated by the Eighth Circuit in Messina v. North Central Distributing, Inc., 821 F.3d 1047 (2016). A party waives the right to invoke arbitration if the party knew of the existence of the right, acted inconsistently with exercise of that right, and the other party suffered prejudice because of the inconsistent actions. The majority acknowledged Sundance knew of the existence of the arbitration clause and intentionally failed to mention arbitration in either its motion to dismiss or its answer. Sundance’s litigation strategy, however, did not materially prejudice Morgan because the parties had not yet begun formal discovery or contested any matters “going to the merits” of the case. The Eighth Circuit panel majority reversed the district court’s decision and remanded the matter to arbitration.

In dissent, Judge Colloton wondered whether prejudice should be included in the test. He noted that a party in the Messina case had engaged in nearly identical conduct as Sundance—namely, waiting eight months to commence arbitration while pursuing a motion to transfer venue to another judicial district. The court in Messina had determined that this level of knowing inconsistent action constituted sufficient prejudice to the other party to support a determination of waiver. In Morgan, after the court denied the motion for a change of judicial venue, Sundance engaged in additional inconsistent behavior by participating in litigation-related mediation. Only after Morgan failed to settle did Sundance file the motion to compel arbitration. In Judge Colloton’s opinion, Sundance was content with a judicial forum until it believed an intervening Court decision in Lamps Plus regarding collective action improved its prospects in arbitration. Sundance’s multiple litigation-related actions prejudiced Morgan by forcing her “to waste time and money” opposing the motion to dismiss and “engaging in a fruitless mediation.”

The Supreme Court Opinion

Morgan appealed, and the Supreme Court granted certiorari to resolve the circuit split by deciding whether the Federal Arbitration Act (FAA) authorized federal courts to create an arbitration-specific procedural rule requiring a showing of prejudice. The Court unanimously held that it did not.

The Court began the decision by noting that defendants routinely failed to file immediately a motion to stay litigation and compel arbitration. Nine courts of appeals have decided the question as to whether a defendant can switch to arbitration by applying a rule of waiver specific to the arbitration context. In these nine districts, knowing inconsistent behavior must result in prejudice to the other side. These courts derived this special rule from the FAA’s “policy favoring arbitration.” Two circuits have rejected application of this special rule.

The Court noted that its decision did not address the role state law might play in resolving when a party’s litigation conduct results in the loss of a contractual right to arbitrate. Nor did the Court address the issues of waiver, forfeiture, estoppel, laches, or procedural timeliness. The sole issue addressed by the Court was whether federal courts have the authority to create arbitration-specific variants of federal procedural rules.

In reaching its conclusion that the FAA does not convey such authority, the Court concurred with Judge Colloton’s observation in his dissent that, in the context of waiver of a contractual right, “prejudice is a debatable prerequisite.” Outside the arbitration context, contractual waiver is the intentional relinquishment or abandonment of a known right and “normally is effective” without proof of “detrimental reliance.” The arbitration-specific rule requiring prejudice derived from a decades-old Second Circuit decision. Over the years, “both that rule and its reasoning spread.” The FAA policy, however, is to make “arbitration agreements as enforceable as other contracts, but not more so.” The FAA policy “is based upon the enforcement of contract, rather than a preference for arbitration as an alternative dispute resolution mechanism.” The text of the FAA makes clear that courts are not to create arbitration-specific procedural rules.

The Court vacated the judgement and remanded the case with instruction. The Eighth Circuit could determine whether Sundance knowingly relinquished the right to arbitrate by acting inconsistently with that right, or the Eighth Circuit might determine that a different procedural framework (such as forfeiture) was appropriate. “What the court may not do is make up a new procedural rule based on the FAA’s policy favoring arbitration.”

Conclusion

As noted in Sundance’s appellate brief, Rule 42(b) of the American Arbitration Association’s Employment Arbitration Rules states, “[N]o judicial proceeding by a party relating to the subject matter of the arbitration shall be deemed a waiver of the party’s right to arbitrate.” The wording of Rule 42(b) appears as differently numbered rules in both the American Arbitration Association’s Commercial Arbitration Rules and Construction Arbitration Rules. Following the Supreme Court’s decision in Morgan, the precise test for waiver of a contractual right to arbitrate remains an open issue to be decided by the courts, starting with the Eighth Circuit.

Postscript: On August 15, 2022, following remand from the Supreme Court, the Eighth Circuit granted the parties’ joint motion to stay supplemental briefing on remand, in light of the parties’ attainment of a tentative settlement.  

P. Jean Baker is a vice president of the American Arbitration Association in Washington, D.C.

_{Copyright © 2022, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Litigation Section, this committee, or the employer(s) of the author(s).}