June 20, 2016 Practice Points

New Jersey Becomes Third Recent State Court to Refuse to Enforce Delegation Clause

By Liz Kramer

In a decision that appears intentionally controversial, the Supreme Court of New Jersey has refused to enforce the delegation clause in a for-profit college’s enrollment agreement in a 5–1 opinion. Morgan v. Sanford Brown Institute, 2016 WL 3248016 (N.J. June 14, 2016). Although the delegation clause had never been specifically challenged by the plaintiffs, as is required by SCOTUS’s Rent-A-Center in order to avoid delegating the issue of arbitrability to the arbitrator, the court found that fact was immaterial.  

The plaintiffs alleged that Sanford Brown Institute had induced them to enroll via misrepresentations and deception. In response, the defendants moved to compel arbitration, based on an arbitration agreement in the plaintiffs’ enrollment agreement. The trial court denied the motion, but the intermediate appellate court reversed, concluding that an arbitrator should decide whether the arbitration agreement was enforceable due to the presence of a delegation clause. 

At the state’s highest court, the issue of whether the delegation clause was enforceable was the sole issue. The plaintiffs argued that they were unaware that the arbitration agreement “denied them their right of access to a judicial forum and to a jury trial,” making the arbitration agreement unenforceable under New Jersey’s Atalese decision. The plaintiffs—and the court—characterized their failure to understand that arbitration is a substitute for court, not an addition to court, as preventing a meeting of the minds, and therefore, a challenge to the very existence of the entire agreement. In response, the defendants pounded on Rent-A-Center, arguing that it is binding precedent and must be applied, thus concluding that since the plaintiff failed to challenge the validity of the delegation clause specifically, an arbitrator must address any challenges to arbitrability (including challenges under Atalese)

The delegation clause that was enforced in Rent-A-Center, because the plaintiff did not challenge its validity in particular, 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.” The delegation clause that New Jersey refused to enforce in Morgan stated: “Any disputes, claims, or controversies between the parties to this Enrollment Agreement arising out of or relating to…(v) any objection to arbitrability or the existence scope, validity, construction, or enforceability of this Arbitration Agreement shall be resolved pursuant to this paragraph (the “Arbitration Agreement”).” [Note that the New Jersey clause does not specifically say the issue will not be addressed by a court, but the words used to describe the types of disputes that will be arbitrated are very similar.] 

After acknowledging that the plaintiffs did not specifically challenge the delegation clause in Morgan, the court went on to establish some logical building blocks for distinguishing Rent-A-Center. First, it noted that state law governs whether the parties “entered an agreement to delegate” arbitrability. Second, delegation clause must be clear and unmistakable under First Options. Third, no one challenged the “clarity” of the delegation clause in Rent-A-Center (there is the wiggle room!). Therefore, because the New Jersey plaintiffs challenge whether the delegation clause was clear enough to allow a meeting of the minds, the New Jersey Supreme Court defines that as a challenge to the formation of the arbitration agreement containing the delegation clause, putting the issue of arbitrability squarely before the court. And, having concluded that the court, not an arbitrator, could decide the validity of the arbitration clause, this court went on to find it unenforceable: 

The arbitration provision in the Sanford Brown enrollment agreement suffers from the same flaw found in the arbitration provision in Atalese—it does not explain in some broad or general way that arbitration is a substitute for the right to seek relief in our court system. That flaw—non-compliance with the dictates of Atalese—extends to the purported delegation clause… 

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In conclusion, the arbitration provision and purported delegation clause do not meet the requirements of First Options and Atalese and do not satisfy the elements necessary for the formation of a contract, and therefore are unenforceable.

The lone dissenting justice stated, “I cannot reconcile the majority’s reasoning with the United States Supreme Court’s decision in Rent-A-Center.” 

All in all, I often feel that arbitration law is a big game of Whack-a-mole, where the U.S. Supreme Court is the kid holding the hammer, and the state courts keep randomly popping up with new and creative ways around arbitration precedent. But now, with only eight Justices, and no Scalia, will SCOTUS be willing to bring down the hammer on states for not following its controversial 5–4 decision in Rent-A-Center? I am guessing not.  

Key words: alternative dispute resolution, adr, litigation, delegation clause, contract formation, arbitrability, substitution 

Liz Kramer is with Stinson Leonard Street in Minneapolis, Minnesota.


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