In 1925, Congress passed the Federal Arbitration Act (FAA), 9 U.S.C. §§ 1, et seq. announcing a federal policy favoring arbitration as an alternative form of dispute resolution.
Supreme Court decisions in the following years reinforced that policy, limiting courts to determining whether the matter in dispute was subject to arbitration under the parties’ contract.
Arbitration became the dispute resolution procedure of choice in many contexts. In the late 1990s, however, arbitration agreements began to be challenged on numerous fronts, with significant success in forums and less than clear guidance from the Supreme Court.
Over the past year or so, the Supreme Court has resolved some important issues and made clear that the attempts to circumvent the FAA will no be tolerated. Nevertheless, the final word appears still to be spoken, as parties debate whether to arbitrate, or not to arbitrate.
The FAA provides that written arbitration agreements “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” 9 U.S.C. § 2.
In other words, the Act mandates that courts direct parties to proceed to arbitration on issues as to which an arbitration agreement has been signed. This is true even when the claims at issue are federal statutory claims, unless the FAA's mandate has been overridden by a contrary congressional command.
Similarly, while many states have their own statutes dealing with arbitration, the FAA applies to all transactions involving interstate commerce. The broad interpretation given that phrase by the courts, combined with the Supremacy Clause of the U.S. Constitution, makes the FAA applicable to most contracts and overrides those state statutes.
Arbitration enjoyed a long period of relative favor, particularly in certain areas of the law (e.g. labor disputes) or disputes involving specialized commercial issues (e.g. construction), and as the dockets of the state and federal courts became increasingly crowded and jury awards were perceived as increasingly unpredictable. Between 1976 and 2002, the American Arbitration Association’s caseload increased from 35,156 cases annually to 230,255.
Beginning in the late 1990s, however, the tide began to turn. As arbitration expanded significantly, its disadvantages as a form of dispute resolution became more obvious.
Many found that, contrary to popular belief, arbitration was not generally less expensive than litigation, particularly when factoring in the costs of paying the arbitrator (or, in many cases, three arbitrators) as opposed to a judge paid by the taxpayers.
Similarly, sophisticated parties in complex disputes often found that the relative informality of arbitration, long perceived as an advantage, had its downsides as arbitrators routinely allowed parties to present evidence that would have been excluded in a court.
Another major disadvantage that became more widely recognized was the severely limited right to appeal an unfavorable outcome. The statutory grounds on which an arbitration award may be overturned are limited to: (a) corruption, fraud or undue means, (b) evident partiality or corruption in the arbitrator(s), (c) arbitrator misconduct in refusing to postpone the hearing for good cause or refusing to hear pertinent and material evidence, or other prejudicial misbehavior, or (d) where the arbitrator exceeded its powers or “imperfectly executed them” preventing a final and definite award.
Because these grounds are so narrow, courts and parties attempted to graft on to the FAA their own formulations, including “manifest disregard for the law” and various contractual iterations.
In 2008, in Hall Street Assoc., LLC v. Mattel, the Supreme Court held that parties cannot formulate their own standard of appellate review and only those grounds expressly provided in the FAA apply. Despite the apparently clear holding of Hall Street, however, courts continue to debate whether the “manifest disregard for the law” standard still applies, with at least one court holding as recently as mid-February 2012 that the standard still has vitality.
The other primary challenge to arbitration resulted from the perceived one-sidedness of certain common provisions. As noted above, the FAA allows agreements to arbitrate to be challenged on the same grounds as contracts generally. The doctrine of unconscionability holds that where an agreement is so grossly unfair that it offends the conscience of the court, it may be unenforceable.
Thus, increasingly one-sided provisions in arbitration agreements (particularly choice of venue and choice of law provisions, cost-splitting and/or fee-shifting provisions, and damage limitations), drafted by parties perceived to be powerful (manufacturers, franchisors, employers), at the expense of “the little guy” (consumers, franchisees, employees) came under attack.
Arbitration and Consumer Litigation
Unconscionability was particularly favored by those seeking to avoid arbitration in consumer actions and, especially, consumer class actions. Before 2003, most courts had held that class actions were not arbitral without an express agreement of the parties. Not surprisingly, few (if any) contracts contained such a provision.
In 2003, however, the U.S. Supreme Court held, in Green Tree Financial Corp.-Ala. v. Randolph, that where an arbitration agreement was silent on the availability of class-wide arbitration, an arbitrator, not a court, must decide whether class relief is permitted. Thus, major consumer manufacturers, and many others, began replacing their existing contracts wherever possible with new ones that expressly rejected any kind of class action arbitration.
The popularity of unconscionability as a tool to challenge arbitration agreements dovetailed nicely with this change, giving plaintiffs an obvious way to fight back in the ongoing tug-of-war over the arbitration of their claims against manufacturers, with California leading the charge.
In 2010, the U.S. Supreme Court once again stepped into the dispute. In AT&T Mobility, LLC v. Concepcion, the Court held that the FAA preempted a California law that forbids agreements barring class actions, whether in arbitration agreements or in ordinary contracts, and upheld an arbitration clause in a cell phone contract between AT&T and one of its customers. The Court rejected the plaintiffs’ argument that without the availability of a class action, claims that are small individually, but significant in the aggregate, would go unremedied, simply stating: “[s]tates cannot require a procedure that is inconsistent with the FAA, even if it is desirable for unrelated reasons.”
In January 2012, the Court reiterated the broad reach of the FAA. In CompuCredit Corp. v Greenwood, the Court held that an arbitration clause containing a class action waiver was enforceable notwithstanding a federal statute, the Credit Repair Organizations Act, which provided for a right to bring a claim in a judicial form for its violation. In light of AT&T and CompuCredit, most commentators suggested that the Court had finally put to rest any arguments about the enforceability of arbitration clauses and class action waivers, and that further challenges to arbitration would be had in Congress.
Only a few short weeks later, however, on February 1, 2012, the U.S. Court of Appeals for the Second Circuit breathed new life into the debate in In Re: American Express Merchants’ Litigation. In that case, the court, relying on a statement in the 2003 Green Tree decision that when “a party seeks to invalidate an arbitration agreement on the ground that arbitration would be prohibitively expensive, that party bears the burden of showing the likelihood of incurring such costs.”
The Second Circuit concluded that expert testimony about the costs of pursuing an antitrust claim satisfied this requirement. However, in Green Tree, the discussion focused on comparing the “arbitration costs” to the costs of pursuing a claim in court. In AmEx,, the expert testimony focused solely on the costs of pursuing an antitrust claim as an individual—regardless of whether that claim was pursued in arbitration or in court – and held that the prohibitive costs for pursuing antitrust claims on an individual basis would prohibit plaintiffs from effectively vindicating their federal claims. The court therefore held that the arbitration agreement at issue was unenforceable. It seems likely that this case, unless resolved by agreement, is headed to the Supreme Court.
On February 21, 2012, the U.S. Supreme Court reversed a decision of the West Virginia Supreme Court that had invalidated an arbitration provision in an agreement in nursing home contracts that would have required the families of three patients who died as a result of the nursing homes’ negligence to arbitrate their claims. The West Virginia court had held that the agreements were prohibited by a state law expressing the fundamental policy of the state.
The U.S. Supreme Court had little use for that reasoning, stating: “As this Court reaffirmed last term, when state law prohibits outright the arbitration of a particular type of claim, the analysis is straightforward: The conflicting rule is displaced by the FAA. … That rule resolves these cases.” Interestingly, however, the Court remanded the case to West Virginia to determine whether the clauses were nevertheless unconscionable “under state common law principles that are not specific to arbitration and pre-empted by the FAA.”
In short, the debate continues. So long as plainti+ffs perceive that they are disproportionately disadvantaged in arbitration, and defendants perceive that arbitration is to their advantage, creative legal minds on both sides of the debate will continue to craft arguments intended to elicit their preferred answer to the question: To arbitrate, or not to arbitrate?
Roberta F. Howell is a partner at Foley & Lardner LLP in Madison, Wis. She is co-chair of the firm’s Distribution and Franchise Practice.