An arbitration agreement that requires parties to waive federal statutory claims is unenforceable. According to the U.S. Court of Appeals for the Third Circuit, limiting a plaintiff’s claims to those arising under tribal law is an impermissible prospective waiver of statutory rights and a violation of public policy. The appellate court also concluded that the clause limiting claims to tribal law was an essential term of the contract and therefore not severable, rendering the entire arbitration agreement unenforceable. The case is a reminder to contract drafters to be cautious when attempting to limit the scope of claims available to a claimant in arbitration.
The conflict in Williams v. Medley Opportunity Fund II, LP began when the plaintiffs obtained “payday loans” from an online lender owned by the Otoe-Missouria Tribe of Indians. Payday loans are short-term cash advances used by borrowers facing unexpected obligations or emergencies. In Williams, the loan borrowers filed a putative class action against the lender and related parties in the U.S. District Court for the Eastern District of Pennsylvania, alleging that the lender’s practices violated the federal RICO Act and Pennsylvania consumer protection laws.
The loan agreements at issue imposed gargantuan interest rates, ranging from 496.55 percent to 714.88 percent per year. An arbitration clause required the borrowers to arbitrate disputes before an arbitrator who would exclusively apply tribal law. The loan agreements also included a section that waived the borrowers’ right to participate in class actions. The defendants unsuccessfully moved to compel arbitration. In denying their motion, the district court explained that requiring an arbitrator to consider only tribal law violated public policy because the arbitrator could not consider any of the plaintiffs’ claims based on federal law, rendering the arbitration agreement unenforceable.
On appeal, the Third Circuit affirmed, holding that the prospective waiver doctrine barred enforcement of the arbitration agreement. In the arbitration context, the appellate court explained, the prospective waiver doctrine “refers to a situation in which the parties agree that, if disputes arise between them, then they waive the right to rely on federal law. The Supreme Court has observed that such waivers violate public policy.” As the loan agreements restricted the borrowers to bringing claims under tribal law, the contracts imposed “an impermissible prospective waiver of statutory rights.”
On related grounds, the court of appeals rejected the defendants’ argument that the parties had delegated to an arbitrator, not the court, the authority to resolve challenges to the arbitration agreement. The appellate court stated that while courts will generally enforce delegation clauses, delegation would have frustrated the prospective waiver doctrine in this case. Because an arbitrator could only consider tribal law, the circuit court observed, the arbitrator could not consider the federal public policy against prospective waivers. Enforcing the delegation clause would thus allow the lender to “subvert federal public policy” by denying the borrowers their federal rights before arbitration on the merits even began.
The defendants further argued that there was no waiver of federal claims because the plaintiffs could bring substantially identical claims under tribal law. The Third Circuit rejected this framing. “The question,” the appellate court noted, “is whether a party can bring and effectively pursue the federal claim—not whether some other law is a sufficient substitute.”
According to ABA leaders, although the facts were startling in some ways, the circuit court applied well-settled principles. “When you look at the facts, you know right away: there is a problem here,” observes Neal M. Eiseman, New York, NY, chair of the Arbitration Subcommittee of the ABA Litigation Section's Alternative Dispute Resolution Committee. “Nobody should be able to charge interest rates anywhere near the type of rates that allegedly were being charged. So the court found a way to get around that, and it found a way to get around it under well-settled legal principles that that were applied correctly.”
Williams makes clear that tribal choice-of-law clauses are subject to limits on enforceability if they operate to strip away federal rights. “The biggest hurdle in all Indian businesses, or Indian-involved service contracts, is what do you do if the deal falls apart?” poses Robert O. Saunooke, Cherokee, NC, chair of the ABA Section of State and Local Government Law’s Native American Tribal Law Committee. “I rarely have seen a contract, especially a contract that’s to be performed on a reservation, contain language that does not follow or bind participants to tribal law to some degree.”
Although the clause in Williams may not appear in most arbitration agreements, practitioners drafting customized terms still need to be wary. “Most arbitration agreements do not contain language that tries to limit the scope of claims,” states Henry R. Chalmers, Atlanta, GA, cochair of the Litigation Section’s Alternative Dispute Resolution Committee. “But for those drafters that do want to limit the scope of claims available to a claimant in arbitration, they need to be careful that they don’t run afoul of this doctrine.”
