August 09, 2017

When the Arbitration Forum Is Unavailable: What Happens Next?

Christopher J. Karacic and Howard S. Suskin – February 6, 2014

Selecting an appropriate forum is central to drafting a contract that provides for arbitration in the event of a dispute. But sometimes circumstances change and an agreed-upon arbitration forum becomes unavailable. The courts disagree on how to proceed in this situation. Indeed, a circuit split has emerged over whether a court should appoint substitute arbitrators and enforce arbitration, or simply excuse parties from their obligations to arbitrate when an agreed-upon arbitration forum is no longer available.

Courts’ approaches as to whether to enforce arbitration when a specified arbitration forum is unavailable have been influenced by two overarching principles. First, arbitration is a creature of contract and “courts must rigorously enforce arbitration agreements according to their terms, including terms that specify with whom [the parties] choose to arbitrate their disputes and the rules under which that arbitration will be conducted . . . .” Am. Express. Co. v. Italian Colors Rest., 133 S. Ct. 2304, 2309 (2013). Second, Congress has created a national policy favoring arbitration through the enactment of the Federal Arbitration Act (FAA). Hall St. Assocs., L.L.C. v. Mattel, Inc., 552 U.S. 576, 581 (2008). The FAA places arbitration agreements on equal footing with all other contracts. See Hall St. Assocs., 552 U.S. at 581.

The Eleventh, Ninth, and Third Circuits have reconciled these principles to hold that Section 5 of the FAA allows a court to appoint substitute arbitrators when the specified, unavailable forum is not “integral” to the arbitration agreement. Moreover, those courts consistently have held unavailable forums to be not integral to the parties’ arbitration agreements, and therefore the courts have appointed substitute arbitrators from another forum. The Second and Fifth Circuits have also recognized that Section 5 allows a court to appoint substitute arbitrators unless the unavailable forum was “integral” or “central” to the arbitration agreement. However, the Second and Fifth Circuits, unlike the Eleventh, Ninth, and Third Circuits, have found unavailable forums to be integral or central to the arbitration agreement and have refused to appoint substitute arbitrators in some instances. Adding another dimension to the split among the courts, the Seventh Circuit recently rejected using the standard of whether the forum was integral to the parties’ agreement and held that Section 5 enables the court to appoint substitute arbitrators when “for any reason something has gone wrong.”

Section 5 of the Federal Arbitration Act
The key provision governing court appointment of substitute arbitrators is found in Section 5 of the FAA, which provides in pertinent part:

"If in the agreement provision be made for a method of naming or appointing an arbitrator . . . such method shall be followed; but if no method be provided therein, or if a method be provided and any party thereto shall fail to avail himself of such method, or if for any other reason there shall be a lapse in the naming of an arbitrator . . . or in filling a vacancy . . . then upon the application of either party to the controversy the court shall designate and appoint an arbitrator or arbitrators or umpire, as the case may require, who shall act under the said agreement with the same force and effect as if he or they had been specifically named therein . . . .

Circuits Have Found Non-Integrality and Appointed Substitute Arbitrators
In Brown v. ITT Consumer Fin. Corp., 211 F.3d 1217 (11th Cir. 2000), the defendant sought to compel arbitration of an employment agreement that provided that “any dispute . . . shall be resolved by binding arbitration under the Code of Procedure of the [NAF] . . . .” The plaintiff resisted arbitration because the NAF had dissolved. Brown, 211 F.3d at 1220–21. The Eleventh Circuit examined Section 5 of the FAA and concluded that it “provides a mechanism for appointment of an arbitrator where ‘for any [] reason there shall be a lapse in the naming of an arbitrator . . . .’” Brown, 211 F.3d at 1222. The Eleventh Circuit then held: “[O]nly if the choice of forum is an integral part of the agreement to arbitrate, rather than an ‘ancillary logistical concern’ will the failure of the chosen forum preclude arbitration.” Brown, 211 F.3d at 1222. The Eleventh Circuit ruled there was no evidence that the parties’ designation of the NAF as the arbitration forum was integral to the arbitration agreement, and the court therefore upheld the district court’s appointment of substitute arbitrators.Brown, 211 F.3d at 1222.

The Ninth Circuit cited Brown and adopted the integral test in Reddam v. KPMG LLP, 457 F.3d 1054 (9th Cir. 2006). The defendants sought to compel arbitration of a stock purchase agreement that provided that “[a]ny arbitration under this agreement shall be determined pursuant to the rules then in effect of the [NASD].” Reddam, 457 F.3d at 1057. The plaintiff resisted arbitration on grounds that the NASD had already refused to arbitrate the matter because no named party was an associated person of the NASD. Reddam, 457 F.3d at 1057. The Ninth Circuit elaborated on the integral test from Brown: “[W]hen a court asks whether a choice of forum is integral, it asks whether the whole arbitration agreement becomes unenforceable if the chosen arbitrator cannot or will not act.” Reddam, 457 F.3d at 1060. The court then concluded that the use of the NASD was not integral to the arbitration agreement because the agreement merely designated the use of the NASD’s rules. See Reddam, 457 F.3d at 1060. The court ordered the district court to resume jurisdiction to appoint a substitute arbitrator under Section 5 of the FAA. See Reddam, 457 F.3d at 1061–62.

More recently, the Third Circuit adopted the integral test in Khan v. Dell, Inc., 669 F.3d 350 (3d Cir. 2012). The defendant sought to compel arbitration of a computer terms and conditions agreement that provided that “[disputes] shall be resolved exclusively and finally by binding arbitration and administered by the [NAF] under its code of procedures then in effect.” Khan, 669 F.3d at 353. The plaintiff resisted arbitration on grounds that the NAF was no longer permitted to conduct consumer arbitrations. Khan, 669 F.3d at 353. The Third Circuit cited Brown and Reddam and held that for a forum to be integral “the parties must have unambiguously expressed their intent not to arbitrate their disputes in the event that the designated arbitral forum is unavailable.” See Khan, 669 F.3d at 354. The court then concluded that it was ambiguous whether the designation of the NAF as arbitration forum was integral to the agreement to arbitrate. See Khan, 669 F.3d at 355.The court vacated the district court’s order so that the district court could appoint substitute arbitrators under Section 5 of the FAA. See Khan, 669 F.3d at 357.

Circuits Have Found Integrality and Refused to Appoint Substitute Arbitrators
In In re Salomon Inc. Shareholders’ Derivative Litig., 68 F.3d 554 (2d Cir. 1995), the Second Circuit refused to appoint substitute arbitrators, finding that the unavailable forum was “central” to the parties’ agreement to arbitrate. The defendants sought to compel arbitration of employment agreements that provided that all disputes were to be arbitrated “in accordance with the [NYSE] Constitution and rules.” In re Salomon, 68 F.3d at 557. The plaintiffs resisted arbitration on grounds that the NYSE had already declined to arbitrate the matter. See In re Salomon, 68 F.3d at 560. The Second Circuit concluded that the use of the NYSE was central to the parties’ agreement to arbitrate, and the court upheld the district court’s refusal to appoint substitute arbitrators and its decision to proceed to trial. In re Salomon, 68 F.3d at 561.

In Ranzy v. Tijerina, 393 Fed. Appx. 174 (5th Cir. 2010), the Fifth Circuit cited Brown and endorsed the integral test, concluded that the arbitration forum at issue was integral, and declined to appoint substitute arbitrators under Section 5 of the FAA. The defendants sought to compel arbitration of a consumer agreement that provided “any and all claims . . . shall be resolved by binding individual (and not class) arbitration by and under the Code of Procedure of the [NAF] . . . . Rules and forms of the NAF may be obtained and all claims shall be filed at any NAF office . . . .” Ranzy, 393 Fed. Appx. at 175. The plaintiff argued that arbitration could not be enforced because the NAF no longer conducted consumer arbitrations. See Ranzy, 393 Fed. Appx. at 175. The Fifth Circuit employed rules of contract construction to determine the intent of the parties in deciding whether the forum was integral to the arbitration agreement. Ranzy, 393 Fed. Appx. at 176. The Fifth Circuit also noted that any doubt concerning integrality should be resolved in favor of arbitration. See Ranzy, 393 Fed. Appx. at 176. Ultimately, the Fifth Circuit held that the forum was integral to the arbitration agreement, and the court upheld the district court’s denial of the defendants’ motion to compel arbitration: “[H]ere, the arbitration agreement plainly states that Ranzy ‘shall’ submit all claims to the NAF for arbitration and that the procedural rules of the NAF ‘shall’ govern the arbitration. Put differently, the parties explicitly agreed that the NAF shall be the exclusive forum for arbitrating disputes.” Ranzy, 393 Fed. Appx. at 176.

Circuit Has Rejected the Integral Test and Appointed Substitute Arbitrators
In Green v. U.S. Cash Advance Illinois, LLC., No. 13-1262, 2013 U.S. App. LEXIS 15565, at *1 (7th Cir. Jul. 30, 2013), the Seventh Circuit dismissed the integral test and appointed substitute arbitrators under Section 5 of the FAA. The defendants sought to compel arbitration of a lending agreement that provided that “[a]ll disputes . . . shall be resolved by binding arbitration by one arbitrator by and under the Code of Procedure of the National Arbitration Forum.” Green, 2013 U.S. App. LEXIS 15565 at *1–*2. The plaintiff resisted arbitration on grounds that the NAF had stopped accepting consumer arbitration cases years before the parties even signed the lending agreement. Green, 2013 U.S. App. LEXIS 15565 at *3. Thus, the NAF never was an available arbitration forum for the parties despite their designation of the NAF in the lending agreement. See Green, 2013 U.S. App. LEXIS 15565 at *3.

The Seventh Circuit rejected the integral test as having no basis in the FAA and for being unpredictable in application: “[T]oday opinions such as Kahn and Ranzy proceed as if it were an established rule of law that Section 5 cannot be used to appoint a substitute arbitrator when the contractual designation was an ‘integral part’ of the bargain, and they proceed to disagree about whether a given designation is ‘integral.’” See Green, 2013 U.S. App. LEXIS 15565 at *12. The Seventh Circuit instead reasoned that “arbitration clauses remain enforceable if for ‘any’ reason there is a ‘lapse in the naming of an arbitrator,’” and therefore “a judge can appoint an arbitrator when for ‘any’ reason something has gone wrong.” See Green, 2013 U.S. App. LEXIS 15565 at *10. The court then ordered the district court to appoint a substitute arbitrator and enforce arbitration, even though the chosen arbitration forum had never been valid: “[P]aragraph 17 makes one thing clear: these parties selected private dispute resolution. Courts should not use uncertainty in just how that would be accomplished to defeat the evident choice. Section 5 allows judges to supply details in order to make arbitration work. The district court must appoint an arbitrator, who will resolve this dispute using the procedures in the [NAF’s] Code of Procedure.” Green, 2013 U.S. App. LEXIS 15565 at *14–*15.

Conclusions and Practical Considerations
The current split among the courts hampers uniformity in the arbitration process and it may make some parties hesitant to designate forums for arbitration. Ultimately, the Supreme Court may be called upon to resolve the split among the circuits regarding the proper interpretation and application of Section 5 of the FAA. The issue is particularly salient because the NAF—a once-popular and oft-chosen arbitration forum—has become unavailable for all consumer arbitrations.

It is difficult to predict how the Supreme Court would resolve the current split. On one hand, the Supreme Court has viewed the FAA as creating a national policy favoring arbitration. Pursuant to a policy favoring arbitration, the Supreme Court may conclude that courts need to appoint substitute arbitrators if the parties genuinely chose arbitration over litigation. On the other hand, the Supreme Court has recognized that arbitration agreements are contracts chosen by the parties. The Court may hold that it is unfair to appoint substitute arbitrators when the parties bargained for and agreed to a different arbitrator.

Keywords: ADR, litigation, arbitration, forum, FAA, substitute, Section 5

Christopher J. Karacic and Howard S. Suskin – February 6, 2014