Arbitration Agreements in Finance: The Value of a Delegation Clause
Arbitration protects financial institutions from the risk of a runaway jury in an unfavorable jurisdiction, so most consumer finance contracts contain arbitration clauses. And, of course, most plaintiffs’ lawyers try to avoid arbitration clauses for the same reason. Typical arguments are that the plaintiff’s claims fall outside the scope of the agreement; that the agreement was procured by fraud; or that the agreement is procedurally or substantively unconscionable.
If a plaintiff’s argument against arbitration is strong enough, he may be entitled to a jury trial on whether the claim should be arbitrated. This can be a lot of time and money to spend before the merits of the claim are ever even reached. Our firm has had success lately in the Southern District of Mississippi in short-circuiting these arguments by pointing to the parties’ agreement that the arbitrator will decide arbitrability.
The idea of an arbitrator deciding whether a claim is arbitrable makes some judges scratch their heads, but the law is well-established that the arbitration agreement can specify that the arbitrator decides questions of the arbitration agreement’s scope, validity, or conscionability, and that specification will be upheld. Such a clause is often called a “delegation clause” because it delegates to the arbitrator the authority to decide these questions of arbitrability. See Rent-A-Center West, Inc. v. Jackson, 130 S. Ct. 2772 (2010).
If a valid delegation clause exists, then when a lender moves to compel arbitration, the court’s analysis is limited to whether a valid contract to arbitrate was formed. This cuts off the possibility of having to go through arbitration-related discovery on often specious claims of unconscionability or fraud. But the delegation clause must be “clear and unmistakable,” and the usual presumptions in favor of arbitration do not apply to whether the parties agreed to arbitrate arbitrability. In fact, the burden is on the party seeking to compel arbitration to prove the delegation. See First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938 (1995).
What if your arbitration agreement lacks a delegation clause? There may still be a way to argue that the arbitrator decides arbitrability. Many arbitration services, such as JAMS or AAA, have internal rules holding that an arbitrator has jurisdiction to decide arbitrability. The Fifth Circuit and many other federal courts have held that incorporation of such rules into the arbitration agreement is a valid delegation of arbitrability issues to the arbitrator. Petrofac Inc. v. Petroleum Operations Co., 687 F.3d 671, 675 (5th Cir. 2012). Yet district courts within the Ninth Circuit have held that this delegation cannot be read into a consumer contract. Ingalls v. Spotify USA, Inc., No. C 16-03533 WHA, 2016 WL 6679561, at *3 (N.D. Cal. Nov. 14, 2016). And few state courts have weighed in on this issue. Because of this, the safer course of action is to incorporate an explicit delegation clause into the arbitration agreement.