March 12, 2020 Practice Points

A Tale of Two Clauses

Some recent cases illustrate how bad facts can make bad law.

By Robert L. Arrington

Two recent cases involving arbitration agreements with “delegation clauses” illustrate not only the benefits of sound draftsmanship, but also how really bad facts can lead to a decision that appears to bypass established precedent.

In VIP, Inc. et al v. KYB Corporation et al, No. 19-1150, _____F.3rd_______ (6th Cir. February 24, 2020), defendant KYB Corporation manufactured auto parts and sold them to distributors who bought the parts through “buying groups.” The distributors agreed to administer any “Limited Warranty” claims that KYB gave to the ultimate retail purchasers. The limited warranty included an arbitration clause incorporating the Commercial Rules of the American Arbitration Association (the rules), Rule 7(a) of which gives arbitrators the right to decide their own jurisdiction. There was no separate arbitration agreement between KYB and any buying group or distributor.

The distributors sued KYB in a putative class action that alleged “a myriad of anticompetitive activities in the auto parts industry.” KYB moved to dismiss the action under the provisions of the Federal Arbitration Act, 9 U.S.C § 1 et seq., contending that the arbitration provision contained in the limited warranty required the distributors to arbitrate their claims, and that the “delegation clause” in Rule 7(a) required the arbitrator to decide whether distributors were required to arbitrate.

The District Court denied KYB’s motion, and KYB appealed. The Sixth Circuit affirmed. The court accepted the proposition that a delegation clause that gives the arbitrator the authority to decide his or her own jurisdiction is enforceable. Henry Schein, Inc. v. Archer & White Sales, Inc., 139 S.Ct. 524, 530 (2019); Rent-A-Center, W. Inc. v. Jackson, 561 U.S. 63. 68-69 (2010).  Citing its prior holding in McGee v. Armstrong, 941 F.3rd 859, 866 (6th Cir. 2019), the Sixth Circuit also accepted the proposition that an effective delegation is made when an arbitration agreement incorporates the rules.

But KYB’s appeal nonetheless failed because there was no arbitration agreement between the distributors and KYB to which the delegation clause could apply. The distributors’ agreement to assist in KYB’s warranty administration did not make them subject to the arbitration agreement contained in the limited warranty, which applied only to retail purchasers. 

The moral of this well-reasoned opinion is that if you want to require a party to arbitrate its claims, you need to draft an agreement that says so and make sure that the party agrees to it.

Bad Facts Can Make Bad Law

In the second case, it was undisputed that there was a signed agreement between the parties that contained an arbitration clause which incorporated the rules. But the party seeking to compel arbitration still lost its motion to compel arbitration because of what might be termed not just bad facts but horrible ones, based on the allegations in the complaint.

In Brenda Gibbs v. Capital Resorts Group, LLC, No. E2019-00295-COA-R3-CV (Tenn. Ct. App. February 24, 2020), plaintiff Gibbs sought to set aside a time-share agreement. She alleged that she had purchased a time-share but found that she could not afford the escalating fees and costs and sought to sell it. She alleged that the defendants led her to believe that they were helping her sell her unit but instead they had her sign an agreement that exchanged her existing time-share unit for another time-share unit, opened and activated a credit card she did not want, and charged her credit card $7000 in transaction fees. She also alleged that when she tried to cancel the transaction within the applicable ten-day period, the defendants refused to meet with her. The upshot was that she was in more financial trouble after the transaction than before.

Defendant Capital Resorts Group moved to compel arbitration, arguing that the parties’ agreement contained an arbitration clause and that resolution of plaintiff’s fraud in the inducement claim was for the arbitrator to decide under applicable law and Rule 7(a). Capital Resorts relied on Prima Paint Corp. v. Flood and Conklin Mfg. Co., 388 U.S. 395 (1967), and Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440 (2006), holding that “a challenge to the validity of the contract as a whole, and not specifically to the arbitration clause, must go to the arbitrator.” 546 U.S. at 449. 

Gibbs responded by filing an amended complaint, alleging that the allegedly fraudulent representations that induced her to sign the contract at issue “specifically induced the plaintiff to enter into the ‘Mandatory Arbitration’ clause” contained in the agreement, because the purpose and effect of the agreements was misrepresented to her and she was asked to sign the agreements without being given time to read them. Her fraudulent misrepresentation claim did not appear to single out the arbitration clause itself, but instead to apply to the contract as a whole including its arbitration clause.

Nevertheless, the trial court denied Capital Resorts’ motion to compel arbitration, and the Court of Appeals affirmed. Both courts held that plaintiff’s allegations were sufficient to avoid the holdings of Prima Paint and Buckeye and justified the denial of defendant’s motion to compel arbitration. This ruling is difficult to square with Supreme Court cases enforcing arbitration clauses even when they are contained in contracts that allegedly are induced by fraud. In fact, it is difficult to distinguish this case from Prima Paint and Buckeye, both of which considered claims that the same fraud that induced the overall agreement also induced the arbitration clause in it, at all.

But, given that the Court of Appeals’ ruling on fraudulent inducement treated Gibbs’ claim as specifically directed to the arbitration, it is not surprising that the court also rejected the defendant’s argument that the arbitrator should decide whether the case should go to arbitration because Rule 7(a) delegated such jurisdictional issues to the arbitrator. Such delegation does not come into play if the arbitration clause itself is specifically challenged. See, Rent-A-Center, supra.

The court’s ruling is problematic for it appears to create another way to avoid the application of governing legal precedent. If all it takes to avoid Buckeye is to allege that the contract induced by misrepresentation includes an arbitration agreement, then anyone can allege his or her way out of Buckeye. But in the context of the allegations of pretty appalling conduct contained in the complaint, the decision appears to represent a variation of the old adage that bad facts make bad law.

Robert L. Arrington is an attorney and chairman of Employment and Litigation Sections at Wilson Worley in Kingsport, Tennessee.


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