July 26, 2017 Practice Points

Supreme Court Applies FAA Preemption to Contract Formation

State courts have struggled with the interplay between the Federal Arbitration Act and the application of state law regarding contract formation.

By Margaret Flatt, Tom Byrne, Patricia Gorham, and Stacey Mohr

Professional-services contracts often contain arbitration clauses, and the willingness of courts to enforce such provisions can be important to professional-service providers facing claims. State courts have struggled with the interplay between the Federal Arbitration Act (FAA) and the application of state law regarding contract formation. A recent decision by the U.S. Supreme Court brings additional clarity to the interplay between the FAA and state contract formation law. Kindred Nursing Centers Ltd. P’ship v. Clark, No. 16-32, 2017 WL 2039160 (May 15, 2017).

In Kindred, the Supreme Court held that the FAA preempts state law governing contract formation if the state law discriminates against arbitration. In a 7–1 opinion authored by Justice Elena Kagan, the Supreme Court overruled the Kentucky Supreme Court and invalidated Kentucky’s “clear-statement rule,” which provided that agents holding a power of attorney cannot waive their principal’s rights to access the courts and to trial by jury unless expressly permitted. The Supreme Court was not persuaded by the argument that the FAA applies only to the enforcement of arbitration agreements, not to the formation of such contracts, and concluded that the FAA preempts the clear-statement rule.

Petitioner Kindred Nursing Centers L.P. operates nursing homes and rehabilitation centers. Respondents Beverly Wellner and Janis Clark held broad powers of attorney for two of their family members who were Kindred residents prior to their deaths. The respondents moved their family members into the nursing home using their powers of attorney, and signed several contracts with Kindred on behalf of their relatives that included arbitration agreements. Both relatives died shortly thereafter, and the respondents instituted legal actions against Kindred related to their deaths.

Kindred moved to dismiss these cases based on the arbitration agreements. The trial court, the Kentucky Court of Appeals, and the Kentucky Supreme Court each rejected Kindred’s motions to dismiss. The Kentucky Supreme Court applied the state’s “clear-statement rule” and held that a general grant of power of attorney does not permit the representative to enter arbitration agreements on behalf of the agent absent specific authority to “waive his principal’s fundamental constitutional rights to access the courts [and] to trial by jury.” Extendicare Homes, Inc. v. Whisman, 478 S.W.3d 306, 327 (Ky. 2015).

The U.S. Supreme Court preempted Kentucky’s clear-statement rule, holding that it fails to put arbitration agreements on an equal footing with other contracts. “By requiring an explicit statement before an agent can relinquish her principal’s right to go to court and receive a jury trial, the court did exactly what this Court has barred: adopt a rule hinging on the primary characteristic of an arbitration agreement.”

The respondents argued that the clear-statement rule affects only contract formation and that the FAA does not apply to contract-formation questions. Under the respondents’ theory, the clear-statement rule affects only contract formation because it bars agents without explicit authority from entering into arbitration agreements, and the FAA applies only after a court has determined that a valid arbitration agreement was formed. The Court held that the text of the FAA provides otherwise: “The [FAA] cares not only about the ‘enforcement of arbitration agreements, but also about their initial validity’—that is, about what it takes to enter into them.”

Justice Kagan’s opinion was joined by Justices Roberts, Kennedy, Ginsburg, Alito, and Sotomayor. Justice Thomas dissented, continuing “to adhere to the view that the [FAA] does not apply to proceedings in state court.”

Margaret Flatt, Tom Byrne, Patricia Gorham, and Stacey Mohr are with Eversheds Sutherland (US) LLP.

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