In June 2010, the U.S. Supreme Court issued the third in its series of recent opinions making an arbitration agreement—like Alcatraz prison—impossible to escape from. Beginning in 2006, the Court strengthened the severability doctrine from the Prima Paint decision in 1967 to further limit the arguments a litigant can make in court if that litigant is subject to an arbitration clause. The most recent chapter in the arbitration trilogy is Rent-A-Center, West, Inc. v. Jackson, 130 S. Ct. 2772 (2010), but to understand it requires a brief summary of the Prima Paint decision and the Federal Arbitration Act (FAA).
Quick Refresher on the FAA and Prima Paint
The FAA governs every agreement to arbitrate in a contract that involves interstate commerce, which means it governs almost every commercial arbitration agreement. The FAA requires courts to enforce the terms of a “written provision...to settle by arbitration a controversy,” except “upon such grounds as exist under law or in equity for the revocation of any contract.”1 Potential grounds for revoking contracts come from the statutes and common law of each state. The FAA also provides that a party aggrieved by the failure of another to arbitrate may petition a state or federal court and “upon being satisfied that the making of the agreement for arbitration or the failure to comply therewith is not in issue, the court shall make an order directing the parties to proceed to arbitration.”2 Under these two sections of the FAA, the only way to avoid arbitration when there is an arbitration agreement is to prove either that the party never agreed to arbitrate or that there are state law grounds for not enforcing the arbitration agreement.
Under the FAA and case law interpreting it, judges—and not arbitrators—are generally the appropriate people to determine the threshold issues of enforceability and scope of an arbitration agreement. However, if an arbitration agreement has clearly and unmistakably provided that even those questions of arbitrability shall be decided by an arbitrator, courts will generally enforce the parties’ agreement.3
In 1967, the U.S. Supreme Court decided Prima Paint Corp. v. Flood & Conklin Manufacturing Co.,4 which held that a party resisting arbitration could not have its arguments heard in court by asserting that the party had been fraudulently induced to enter into the contract containing the arbitration provision. Instead, the Court adopted what has since been called the “severability doctrine,” under which the enforceability of the arbitration clause of a contract is considered separately from the remainder of the contract. The Court used broad language in its holding: “in passing upon an application for a stay while the parties arbitrate, a federal court may consider only issues relating to the making and performance of the agreement to arbitrate.”5
Since Prima Paint, a party who wants to avoid its arbitration clause has been forced to argue that the arbitration clause itself was invalid under the governing state’s law. In other words, lawyers were stuck arguing that there was a unique and fatal flaw with the few paragraphs relating to arbitration that did not affect the contract as a whole, if they wanted the court to decide the issue of arbitrability under the Prima Paint decision. All other objections to the contract as a whole can certainly be raised, but they have to be raised with the arbitrator. Three justices dissented from the Prima Paint opinion with Justice Hugo Black writing, “the Court holds, what to me is fantastic, that the legal issue of a contract’s voidness because of fraud is to be decided by persons designated to arbitrate factual controversies arising out of a valid contract between the parties.”6
Supreme Court Strengthens Prima Paint in 2006 and 2008
Rent-A-Center v. Jackson is the culmination of the Court’s recent three-part severability series. In Buckeye Check Cashing, Inc. v. Cardegna,7 the Court disavowed a line of federal circuit court cases that had allowed courts to hear arguments that an entire contract was invalid, despite its arbitration agreement, as long as the invalidity would void the contract instead of just making it voidable.8 The Buckeye case, written by Justice Antonin Scalia, made clear that there is no such distinction between void and voidable in the Prima Paint doctrine: “unless the challenge is to the arbitration clause itself, the issue of the contract’s validity is considered by the arbitrator in the first instance.”9 The Buckeye decision was appealed from the Florida Supreme Court, which had affirmed the trial court’s refusal to compel arbitration of a check cashing contract in the face of legitimate arguments the contract was illegal (and therefore void) under Florida law due to usurious rates. Only Justice Clarence Thomas dissented, based on his belief that the FAA does not apply in state courts.
Two years later, in Preston v. Ferrer,10 the Court held that a party’s argument that a contract was illegal due to one party’s lack of licensure also must be heard by the arbitrator when that contract contained an arbitration clause. In Preston, an entertainment lawyer sought fees from his client, a TV personality, under a contract that required arbitration of disputes relating to the contract or its breach. After the lawyer demanded arbitration, the client petitioned the California Labor Commissioner to declare the contract void because the lawyer had lacked the appropriate license to serve as a talent agent. The California trial court denied the lawyer’s motion to compel arbitration, deferring to the Labor Commissioner’s jurisdiction, and the state court of appeals upheld the decision, noting that a state statute gave exclusive authority over licensure disputes to a state agency.
The California Supreme Court refused to review the Preston decision, but the U.S. Supreme Court took the unusual step of granting certiorari and reversing the California Court of Appeals. In a decision written by Justice Ruth Bader Ginsburg, the Court concluded that because the entertainment contract provided “any dispute...relating to the...vali-dity, or legality” of the agreement “shall be submitted to arbitration,” the issue of whether the lawyer was properly licensed should be heard by the arbitrator. The TV personality had raised no complaint with the validity of the arbitration clause in particular. The Court held: “When parties agree to arbitrate all questions arising under a contract, the FAA supersedes state laws lodging primary jurisdiction in another forum, whether judicial or administrative.” As with Buckeye, the only dissenter was Justice Thomas, and his basis, again, was the application of the FAA in state court.
Rent-A-Center West, Inc. v. Jackson Strengthens Prima Paint Even Further in 2010
The Rent-A-Center case11 posed an interesting challenge to the severability doctrine. What happens if the entire contract is an arbitration agreement? If the agreement to arbitrate is not simply a paragraph or two within a larger agreement, but a stand-alone contract, how should the courts apply Prima Paint and its severability doctrine? Will the party opposing arbitration then be allowed to raise with the court a flaw that affects all parts of the (arbitration) agreement equally?
In Rent-A-Center, an employee filed an employment discrimination case in federal court in Nevada, despite having signed a stand-alone “Mutual Agreement to Arbitrate Claims” with his employer. That agreement required arbitration of a broad scope of claims and specifically provided that the arbitrator “shall have exclusive authority to resolve any dispute relating to the interpretation, applicability, enforceability, or formation of this Agreement including, but not limited to any claim that all or any part of this Agreement is void or voidable.” The employee argued that the arbitration agreement was unconscionable under Nevada law and therefore unenforceable. Based on the clear language in the agreement indicating that even questions of arbitrability should be heard by the arbitrator, however, the U.S. District Court granted the employer’s motion to dismiss or stay the litigation. The 9th Circuit Court of Appeals reversed, finding the threshold question of unconscionability should be determined by the U.S. District Court, not the arbitrator.
The Court granted certiorari and reversed in a 5-4 decision. Justice Scalia signaled the outcome of the case early in the majority opinion by how he phrased the issue before the Court. He summarized the question in Rent-A-Center as whether the particular sentence within the mutual agreement to arbitrate claims that gave the arbitrator authority to decide arbitrability was void under Nevada law, thereby refusing to consider whether the entire mutual agreement was unconscionable.12 The Court stated that “application of the severability rule does not depend on the substance of the remainder of the contract.”13 Because the “written provision” for arbitration (see Section 2 of the FAA) that the employer wanted to enforce was the sentence delegating the arbitrability question to the arbitrator, the Court concluded that under the severability doctrine of Prima Paint, the employee had to show that particular sentence of the agreement was unconscionable.14 The employee had focused all his arguments on the mutual agreement as a whole and made no argument that was specific to the sentence regarding the arbitrator’s authority to determine arbitrability. Based on that failure, the Court reversed the 9th Circuit, determining that the employee’s court case must be dismissed.
The dissent written by Justice John Paul Stevens argued that “when a party raises a good faith validity challenge to the arbitration agreement itself, that issue must be resolved before a court can say that he clearly and unmistakably intended to arbitrate that very validity question.”15 Put differently, a court cannot conclude that a party truly agreed to arbitrate the question of arbitrability until it decides whether the agreement was unconscionable or not. The dissent also disagreed strongly with the majority’s holding that the employee had to challenge the particular line of the arbitration agreement delegating arbitrability to the arbitrator, stating that “the Court reads Prima Paint to require…infinite layers of severability.”16 The dissent even went so far as to suggest that Prima Paint itself was “likely erroneous.”17
How Will Rent-A-Center Play Out in Future Cases?
There are many interesting aspects to the Rent-A-Center case, but at least one of them is the fact that there were four dissenting justices. In contrast, both Buckeye and Preston, which also applied the severability doctrine of Prima Paint in a restrictive manner, attracted only a lone dissent from Justice Thomas relating to whether the FAA applies in state court. Why was it not until 2010 that Justice Stevens dared to suggest the Prima Paint ruling from 1967 is “likely erroneous”?
The Rent-A-Center case likely attracted a more significant dissent because it made Prima Paint’s severability doctrine a fiction: there are few legitimate bases to void a contract that can be addressed specifically to the arbitration provision that is challenged. Once that becomes clear, severability becomes more than a doctrine narrowing the arguments that may be heard by the courts, it becomes a complete bar to the courthouse for anyone whose contract calls for arbitration, even if that contract is legitimately unenforceable.
Prima Paint was a fraud case, and it was at least conceivable for the justices who joined the majority to imagine a scenario where a contracting party could allege a fraudulent representation that was specific to the paragraphs of the agreement in which the parties agreed to arbitrate. That hypothetical situation (“Just sign the agreement, the arbitration clause is not mandatory.”) may have offered comfort to the Court as it decided to interpret the FAA to require that a challenge to the validity of a contract containing an arbitration clause will be heard by the arbitrator unless the challenge is specific to the arbitration agreement. After Rent-A-Center, however, it is difficult to imagine a hypothetical situation in which a litigant will be able to have a court hear arguments relating to the validity of the arbitration agreement.
Two real-life examples of how courts were applying Prima Paint just before the Rent-A-Center decision help illustrate the impact Rent-A-Center is likely to have. In the first, the federal court in the Virgin Islands recently denied a motion to compel arbitration when the plaintiffs made a claim for fraudulent inducement of the arbitration clause in their employment contract. The employer had offered $25/hour if the employees agreed to arbitrate disputes and only $23/hour if the employees rejected arbitration, but after the employees selected arbitration, the employer stopped paying them the $25 hourly rate.18 The Court found that set of facts was sufficient to raise a material issue as to whether plaintiffs were fraudulently induced to agree to arbitration and denied the defendant’s motion to compel arbitration.19
The analysis in Fitz would probably be the same after Rent-A-Center because the wage and arbitration agreements were linked in a single sentence of the agreement: “I elect to resolve disputes with Employer by arbitration in accordance with paragraph 8 of this Agreement, and agree to accept $25.00 per hour as my initial, normal rate of compensation.” Given that sentence, the employees’ argument that the employer fraudulently induced them to agree to arbitration by falsely promising an hourly wage of $25 will probably still suffice after Rent-A-Center, which requires that any argument about invalidity be directed at the exact arbitration provision/sentence that the movant seeks to enforce.
A second example comes from Jackson v. S.A.W. Entertainment Ltd.20 In S.A.W., an exotic dancer had signed a contract with a club providing that she was not an employee and calling for arbitration of any disputes, and the dancer sued claiming she was in fact an employee. The dancer opposed the club’s motion to compel arbitration, arguing that the arbitration clause’s preclusion of class action lawsuits and its imposition of a six-month statute of limitation made it unconscionable. The district court analyzed California law, agreed with the dancer that the provisions were unconscionable, and denied the club’s motion to compel arbitration. S.A.W. could easily come out the opposite way, compelling arbitration, if it were decided after Rent-A-Center. In S.A.W., the sentences prohibiting class actions and shortening the statute of limitation were separate from the core sentence agreeing to arbitrate disputes. Given that the club was trying to enforce the sentence providing for arbitration of any disputes arising out of the contract, and not the sentences about class actions or statute of limitations, the Rent-A-Center case suggests that those unconscionability arguments are irrelevant to whether the dancer gets to be heard in court. This case illustrates how Rent-A-Center will narrow the illegality and unconscionability arguments that will suffice to entitle parties to be heard by judges instead of arbitrators.
Not only are more cases likely to compel arbitration after the Rent-A-Center decision, but also contract drafters are likely to take advantage of the decision. Smart contract drafters will now make sure that the contract has a stand-alone sentence containing a plain statement of the parties’ agreement to arbitrate any and all disputes arising out of the agreement. Any other, potentially objectionable, aspects of the agreement that relate to arbitration will be in separate sentences. In that way, anyone challenging the arbitration provision will be hard-pressed to argue that the sentence containing the agreement to arbitrate, which is what the party compelling arbitration wants to enforce, is invalid.
Remaining Legitimate Bases to Have a Court Hear a Dispute about Validity of Arbitration
While the U.S. Supreme Court has significantly narrowed the arguments courts may entertain about the invalidity of an arbitration clause over the past five years, arguments that the party never consented to arbitration remain valid.21 For example, if a party takes the position they never consented to the contract at issue (the oral agreement did not include arbitration or their signature on a written contract was forged), that is an issue that the court may address. Similarly, arguments that the individual who consented lacked authority to bind the contracting party or lacked capacity to consent may be heard by the court.22
Public Policy Issues Raised by Rent-A-Center
The question remaining is: Who cares? What does it matter whether it is arbitrators or courts that hear allegations regarding the validity of a contract or if it is an arbitration agreement? It matters for at least the following reasons. First, there are judicial economy issues. If parties have legitimately agreed to arbitrate, we may not want to allow them to clog the court system with creative arguments about why their agreement is unenforceable. That policy rationale favors the continuation of Prima Paint and the severability doctrine.
There are also significant public policy reasons to ditch Prima Paint and its progeny, however. Those include concerns that arbitrators are not always lawyers and may not be facile with arguments relating to invalidity of contracts; concerns that arbitration results are not public and that there is no way to verify whether arbitrators are addressing enforceability questions fairly and thoughtfully; concerns that arbitrators may be incentivized to declare the arbitration agreement valid (because they may be chosen by the enforcing party or may forego their own fees for hearing the underlying substantive dispute if they conclude the case should not be in arbitration). Finally, there are growing concerns that many contracting parties had no power to negotiate contracts that contain arbitration provisions and that some of those arbitration provisions provide for arbitration on terms that are not favorable to the consumer to an unconscionable extent, either because the consumer may have to bear all the fees if it loses, or because it provides for arbitrators hand-selected by the company, or because consumers are forced to arbitrate outside their home state, increasing the cost of the dispute.
For all these reasons, the Rent-A-Center case is important as it shifts more and more questions about contract enforcement to arbitrators and turns an arbitration agreement, especially an agreement to arbitrate gateway issues of arbitrability, into Alcatraz, an agreement from which there is no escape.
1 9 U.S.C. § 2 (2010).
2 9 U.S.C. § 4 (2010).
3 See Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79, 83-85 (2002).
4 Prima Paint Corp. v. Flood & Conklin Manufacturing Co., 388 U.S. 395 (1967).
5 Id. at 404.
6 Id. at 407.
7 546 U.S. 440 (2006).
8 A void contract is one that is of no legal effect at all and cannot be enforced. In contrast, a voidable contract is one with a flaw that allows one party to choose to affirm or reject the contract. The Minnesota Supreme Court had adopted the void/voidable distinction in Onvoy, Inc. v. SHAL, 669 N.W.2d 344 (Minn. 2003). That aspect of the Onvoy decision is likely overruled by Buckeye, Preston, and Rent-A-Center.
9 Id. at 445-46.
10 552 U.S. 346 (2008).
11 Rent-A-Center, West, Inc. v. Jackson, 130 S. Ct. 2772 (2010).
12 Id. at 2779.
14 Id. at 2779-81.
15 Id. at 2785.
16 Id. at 2787.
17 Id. at 2785.
18 See Fitz v. Islands Mech. Contractor, Inc., _____ F. Supp. 2d. _____, 2010 WL 2384585 (D. V.I. June 9, 2010).
19 Id. at 10-11.
20 629 F. Supp. 2d 1018 (N.D. Cal. 2009).
21 See 9 U.S.C. § 4.
22 Buckeye Check Cashing, 546 U.S. at 444, n.1.