Who Decides Arbitrability?

THE ANTITRUST LITIGATOR

Who Decides Arbitrability?

By Jeffery M. Cross

More and more contracts contain arbitration clauses, as parties realize that arbitration can be an efficient and cost-saving way to resolve disputes. Furthermore, arbitration allows for a dispute to be resolved confidentially, which is valuable when there is sensitive information that could be exposed in litigation. In addition, recent Supreme Court cases have held that an arbitration clause can bar class actions. Such decisions have spurred the use of arbitration clauses in contracts with large numbers of parties on one side, such as consumer cell phone contracts and bank credit card agreements.

However, sometimes the two sides to an agreement do not see eye-to-eye on the desirability or scope of arbitration. In such a situation, one or the other party seeks help from a court to compel arbitration, define the scope of arbitration or resist the demand for arbitration. Thus, it is important that the parties to contracts with arbitration clauses understand the rules regarding a court’s involvement in initially resolving whether a dispute must proceed to arbitration.

The Supreme Court has held that the FAA created a body of federal substantive law that is applicable to both state and federal courts. The Court has also held that the FAA applies to the enforcement of not only contract rights, but statutory rights.

The key provisions of the FAA in terms of the initial involvement of a court are Sections 2, 3, and 4. Section 3 permits a court to stay litigation involving an issue that is referable to arbitration. Section 4 permits a court to compel arbitration.

Section 2 is the centerpiece provision of the FAA. It establishes that a written agreement to arbitrate “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” This is the so-called “savings clause.” It is Section 2 that places a written agreement to arbitrate on the same footing as any other contract. Significantly, the Court has held that this provision manifests a “liberal federal policy favoring arbitration agreements,” which requires courts to rigorously enforce agreements to arbitrate, and that the savings clause permits agreements to be invalidated only by generally applicable contract defenses, not by defenses applicable only to arbitration.

THE SUPREME COURT HAS HELD THAT THE SAVINGS CLAUSE PERMITS AGREEMENTS TO BE INVALIDATED ONLY BY GENERALLY APPLICABLE CONTRACT DEFENSES.

A court considering an arbitration clause must apply state law principles of contract interpretation. Generally, this means that the parties’ intentions control as those intentions are reflected in the written agreement.

There are generally two questions that are referred to as “questions of arbitrability”: (1) whether the parties have agreed to arbitrate and (2) whether the agreement to arbitrate covers a particular controversy. These are the two questions that are at issue in the initial determination of who decides arbitrability — the court or the arbitrator.

As a matter of contract, the parties can agree that the arbitrator will decide these two questions. When one or both parties have injected a court into the arbitration process, the court must initially decide if the parties have in fact agreed to have the arbitrator decide these questions. The Supreme Court has held that a court making that decision must generally apply ordinary state law principles that govern contract formation, such as whether the intent of the parties has been objectively revealed in the written agreement. However, the Court has imposed a major qualification to this test. It has held that courts should not assume that the parties agreed to have the arbitrator decide arbitrability unless there is clear and unmistakable evidence that they did so.

Significantly, several appellate courts have held that a reference to arbitration rules granting the arbitrator the authority to rule on arbitrability is clear and unmistakable evidence that the parties intended that the arbitrator decide the question. An example of such rules is the American Arbitration Association Commercial Rules.Rule 7(a) expressly states that “the arbitrator shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope, or validity of the arbitration agreement or to the arbitrability of any claim or counterclaim.”

Several courts of appeal have held that a statement in the arbitration clause that these rules will be followed is clear and unmistakable evidence of intent for the arbitrator to decide questions of arbitrability.

As to the question whether a particular merits-related dispute is arbitrable because it is within the scope of a valid arbitration agreement (in contrast to the requirement that there be clear and unmistakable evidence), the Supreme Court has held that a court is to resolve any doubts concerning the scope of arbitrable issues in favor of arbitration.

In deciding the question of whether the parties have lawfully agreed to arbitrate, a court can consider the “savings” clause defenses that the agreement is not valid or enforceable on grounds in law or equity for the revocation of any contract. However, once again, the Supreme Court has limited a lower court’s analysis of such defenses. The Court has held that a lower court can only consider challenges to the validity and enforceability of the arbitration clause and not challenges to the contract as a whole. The Court has held that the arbitration clause is severable from the rest of the contract, and therefore the defenses set forth in the savings clause must be directed to the arbitration clause specifically. If the party opposing arbitration is challenging the validity or enforceability of the entire contract, such challenge is for the arbitrator, not the court.

The Court has also limited the lower court to considering only the two narrow questions of arbitrability, not other potentially dispositive “gateway” issues. The Court has held that potentially dispositive procedural questions, such as whether the statute of limitations has been met or whether conditions precedent to arbitrability have been fulfilled, are questions for the arbitrator, not the judge.

Jeffery Cross is a columnist for Today’sGeneral Counsel and amember of theEditorial AdvisoryBoard. He is a partnerin the LitigationPractice Group of Freeborn and Peters LLPand a member of the firm’s Antitrust andTrade Regulation Group. jcross@freeborn.com