Create Your Own Arbitration Provision: Two Recent Supreme Court Decisions Emphasize That Parties Have the Freedom to Define the Nature and Scope of Their Agreement to Arbitrate
Arbitration provisions are a common component of a wide array of contracts, including many commercial and consumer agreements. Recently, the Supreme Court of the United States issued two opinions addressing the enforceability of arbitration clauses that require businesses incorporating such clauses into their consumer agreements to re-evaluate how they are drafted and for those businesses that do not utilize such clauses in their agreements to reconsider whether to do so. First, in Stolt-Nielsen S.A. v. AnimalFeeds International Corp. (“Stolt-Nielsen”), 130 S. Ct. 1758 (2010), the Court held that consent to class arbitration cannot be assumed based upon the parties’ general agreement to arbitrate and that a court cannot compel class arbitration where the arbitration clause is silent as to class arbitration. Second, in Rent-A-Center, West, Inc. v. Jackson (“Rent-A-Center”), 130 S.Ct. 1758 (2010), the Court held that a party’s challenge to the validity of an arbitration agreement must be resolved by an arbitrator, not the District Court, where the agreement contains a provision delegating such issues to an arbitrator. Taken together, these opinions (in both of which Justices Alito, Kennedy, Roberts, Scalia, and Thomas were in the majority) demonstrate that the direction of the current Court is to respect the language the parties used in their arbitration clauses, with a corollary emphasis on the underlying principle of parties’ freedom to contract.
The Stolt-Nielsen Decision
In Stolt-Nielsen, the Court considered a relatively straight-forward dispute among commercial parties regarding the propriety of ordering class arbitration where the parties’ arbitration provision was silent on the issue. Specifically, the plaintiff, a supplier of raw ingredients utilized in animal fees, filed a demand for class arbitration seeking to represent a class of customers that had purchased transportation services from the defendant shipping companies. 130 S.Ct. at 1764-65. The parties agreed that their dispute was subject to arbitration, but disagreed as to whether it could be arbitrated on a class-wide basis. Ultimately, the parties agreed that an arbitration panel would decide whether class arbitration was appropriate in light of their arbitration agreement, which the parties stipulated was “silent” regarding class arbitration. Id. at 1765. When the arbitration panel determined that class arbitration could proceed under the arbitration clause because the parties’ evidence did not show an intent to preclude class arbitration, the shipping companies filed an application to vacate the arbitrators’ award. Id. at 1766. The District Court for the Southern District of New York vacated the award on the grounds that federal maritime law (and its emphasis on custom and usage) should have governed the issue, but the Court of Appeals for the Second Circuit reversed. Id. at 1766-67.
On appeal, the Supreme Court, in a five to three decision (with Justice Sotomayor abstaining), reversed and held that the decision of the arbitration panel must be vacated pursuant to Section 10(a)(4) of the Federal Arbitration Act (“FAA”), 9 U.S.C. § 1, et seq., because the panel exceeded its powers by imposing its own views with respect to the policy of class arbitration in lieu of what the parties actually agreed to. Id. at 1767-68. Specifically, the Court concluded that the panel had failed to identify any rule of decision from the FAA, maritime law, or New York law that addressed the question of class arbitration where the parties’ contract was silent on the issue and, instead, simply based its decision on its own policy choice. Id. at 1770.
In ascertaining the appropriate law to apply to the dispute, the Court held that “a party may not be compelled under the FAA to submit to class arbitration unless there is a contractual basis for concluding that the party agreed to do so.” Id. at 1775 (emphasis in original). The Court emphasized that, although interpretation of arbitration provisions is generally an issue of state law, the FAA imposes certain rules that must be considered, including that arbitration is principally an issue of consent. Id. at 1773. Noting that parties have the freedom to draft their arbitration provisions in accordance with their own preferences, including (1) the issues they want to arbitrate; (2) the rules under which an arbitration will occur; and (3) who will arbitrate the dispute, the Court said that in analyzing the nature and scope of an arbitration provision, courts and arbitrators must “give effect to the intent of the parties.” Id. at 1774-75.
Although the Court could have remanded to the Court of Appeals for a rehearing in accordance with these principles, it elected to resolve the issue of class arbitration itself because, in light of the parties’ stipulation that the arbitration provision was silent, the Court determined that there was only one permissible outcome. Id. Specifically, because the parties had stipulated that they had not reached an agreement on class arbitration, there was no basis to conclude that the parties had consented to arbitration on a class wide basis. Id. at 1775. Moreover, because of the significant differences between bilateral arbitration and class arbitration, the Court ruled that “[a]n implicit agreement to authorize class-action arbitration . . . is not a term that the arbitrator may infer solely from the fact of the parties’ agreement to arbitrate.” Thus, the parties’ silence on the issue could not be presumed to confer consent to class arbitration. Id. As a result, the Court held that because the parties had not expressly agreed on class arbitration, the parties could not be compelled to submit their dispute to class arbitration.
The Rent-A-Center Decision
The Rent-A-Center decision involved a dispute as to whether the court or the arbitrator decides the issue of whether the arbitration agreement is unconscionable. In this case, the plaintiff employee sued his employer, Rent-A-Center, in the United States District Court for the District of Nevada, alleging employment discrimination. 130 S.Ct. at 2775. The plaintiff had signed an arbitration agreement that expressly provided for arbitration of claims of discrimination and contained a provision that expressly delegated to the “[a]rbitrator, and not any federal, state, or local court or agency,  the exclusive authority to resolve any dispute relating to the interpretation, applicability enforceability, or formation of the” arbitration agreement. Based on the arbitration agreement, Rent-A-Center moved to dismiss or stay the proceedings under the FAA and to compel arbitration. In opposition, the plaintiff employee argued that the arbitration agreement was unenforceable on the grounds of unconscionability. Id.
The District Court granted Rent-A-Center’s motion to dismiss and to compel arbitration, finding that the “delegation clause” in the arbitration agreement, which provided that the arbitrator had the exclusive authority to resolve all disputes regarding the agreement, governed because the plaintiff was challenging the arbitration as a whole. Id. at 2775-76. On appeal, the Court of Appeals for the Ninth Circuit reversed on the question of whether the court or the arbitrator had the authority to determine whether the agreement was enforceable, concluding that where a party asserts that an arbitration agreement is unconscionable that threshold inquiry is for the court to decide regardless of what the agreement provides. Id. at 2776.
On appeal, the Supreme Court, in a five to three decision (with the same five Justices in the majority as were in the majority in Stolt-Nielsen) reversed, holding that the question of the validity of the subject arbitration agreement was reserved for the arbitrator by the delegation clause. Id. at 2779. The Court’s opinion focused on the FAA’s recognition of “the fundamental principle that arbitration is a matter of contract” and noted that “the FAA  places arbitration agreements on an equal footing with other contracts.” Id. at 2776. As a result, the Court stated that the delegation provision governed the dispute unless it was otherwise unenforceable pursuant to Section 2 of the FAA, which provides that arbitration provisions “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 analyzing the enforceability of the delegation provision, the Court noted that there are two ways to challenge the validity of an arbitration provision under Section 2 of the FAA: (1) to challenge the validity of the specific arbitration provision at issue, or (2) to challenge the entire contract as a whole. 130 S.Ct. at 2778. As the Court explained, only the former challenge implicates a court’s involvement because Section 2 of the FAA provides that a “written provision” to arbitrate is valid -- without regard to the validity of the entire contract in which the provision is contained. Thus, a party’s challenge to the entire contract does not preclude a court from enforcing a specific agreement to arbitrate, which is severable from the contract. Id. In other words, only if a party challenges the validity of the specific arbitration provision, rather than the validity of the entire contract, is the inquiry one for the court. Id.
Although the subject contract in this case was an arbitration agreement, the Court concluded, in the face of a strongly worded dissent, that was not a distinction with any significance, stating “[a]pplication of the severability rule does not depend on the substance of the remainder of the contract.” Id. In this case, the plaintiffs unconscionability challenges (i.e. that the arbitration agreement was one-sided in that it only applied to claims of an employee and that the arbitration procedures called for by the arbitration agreement, including fee-splitting and limitations on discovery, were unconscionable) were all directed at the arbitration agreement as a whole. Thus, because the plaintiff only challenged the validity of the contract as a whole (i.e. the arbitration agreement) and the not the specific arbitration provision at issue (i.e. the delegation provision in the arbitration agreement), the majority held that the delegation provision was enforceable under the FAA and the issue of the enforceability of the arbitration agreement was one that was within the exclusive authority of the arbitrator. Id.
Arbitration can, under certain circumstances, be a less expensive and more efficient forum in which to resolve disputes than traditional litigation. The Stolt-Nielsen and Rent-A-Center decisions provide parties with the ability to craft arbitration provisions with clearly defined parameters, and potentially allow parties to more readily ensure that their disputes are addressed in arbitration.
As an initial matter, the Rent-A-Center decision enables parties to exert greater control over the forum in which issues relating to their arbitration agreement are resolved. Specifically, parties can draft arbitration agreements limiting a court’s involvement in any subsequent dispute regarding the arbitration agreement by including a delegation clause in the agreement that expressly requires that all disputes regarding the arbitration agreement, including those that challenge the enforceability of the arbitration agreement, will be decided by the arbitrator rather than a court (conversely, parties may draft a delegation provision that requires the court to resolve such disputes, although the use of such provisions is unlikely given that the parties have agreed to arbitrate the underlying dispute). In such an agreement, only challenges specifically directed to the validity of the delegation clause could be heard by a court, while challenges to the arbitration agreement as a whole would be addressed by the arbitrator. Thus, the practical effect of the Rent-A-Center decision is that disputes between parties with arbitration agreements containing such delegation clauses are more likely to be arbitrated than in the past. That is, because a delegation clause referring disputes regarding the arbitration agreement to arbitration is generally more difficult to invalidate in court than an arbitration agreement as a whole, 130 S.Ct. at 2778 and Rent-A-Center provides that the court can only consider the former, arbitration should now be easier to successfully invoke in that (1) opposing parties will be less likely to resist referral to arbitration and/or (2) courts will be more likely to refer the dispute to arbitration because of the limitations imposed by Rent-A-Center on their authority to invalidate arbitration agreements.
While the Rent-A-Center decision related to a delegation provision in a stand-alone arbitration agreement, the Court’s holding should be equally applicable where the delegation clause is contained in an arbitration provision that is part of a larger contract. Indeed, as the dissent noted in Rent-A-Center, “the written arbitration agreement [was] but one part of a broader employment agreement between the parties.” Id. at 2782. Until further clarification is provided by District Courts or Circuit Courts of Appeal, however, it may be prudent for businesses to utilize arbitration agreements (containing the appropriate delegation clause) that are separate from, but still applicable to, the underlying contract.
The Stolt-Nielsen decision enables parties to more readily control the forum in which class claims will be resolved. That is, unless the parties specifically agree to arbitrate class claims, an agreement to arbitrate does not compel arbitration of class claims. This decision, thus, provides significant protection for parties that want to arbitrate individual claims, but ensure that any class claims are litigated in the courts. Although the decision in Stolt-Nielsen provides that silence on the issue of class arbitration does not equal consent, the preferred practice is for business to expressly include provisions in their arbitration agreements that the parties do not consent to class arbitration.
In addition, Stolt-Nielsen calls into question those decisions in which courts have held that class arbitration waivers are unconscionable and unenforceable, severed such waivers from the arbitration provision, and compelled arbitration of all claims, including class claims. If silence cannot be construed as consent to class arbitration, then arbitration provision containing a class arbitration waiver, even if that waiver is determined to be unenforceable, should not be construed as consent to class arbitration. Nevertheless, business can avoid any ambiguity on the issue by expressly stating that (1) the class arbitration waiver is not severable from the arbitration agreement and (2) if a court or other authority determines that the class action waiver is unenforceable, then the parties do not consent to arbitration of any class claims.
Finally, it is important to note that the Supreme Court’s grant of certiori in AT&T Mobility LLC v. Concepcion, 130 S.Ct. 3322 (May 24, 2010) has the potential to drastically alter the nature and scope of enforceable arbitration provisions and significantly increase the use of such provisions, particularly in consumer contracts. In this case, the Court of Appeals for the Ninth Circuit held that the FAA did not expressly or impliedly preempt California state law regarding the unconscionability of class arbitration waivers in the arbitration agreements. Laster v. AT&T Mobility LLC, 584 F.3d 849 (9th Cir. 2009). That the Supreme Court granted certiori suggests, particularly in light of the Stolt-Nielsen and Rent-A-Center cases, the potential that the Court may conclude that the FAA -- and not state law -- governs the issue of the enforceability of class action waivers and that such waivers are enforceable. If that were to occur, then such a decision could, depending upon the nature and scope of the Court’s decision, enable businesses to potentially insulate themselves from class actions in either the courts or arbitration proceedings through the utilization of arbitration agreements contain class arbitration waivers (i.e. an enforceable agreement that refers the parties to arbitration to resolve any dispute relating to the agreement, but expressly provides that such disputes may not be arbitrated on a class-wide basis).
The Supreme Court’s decisions in Stolt-Nielsen and Rent-A-Center evidence the significance of the FAA and signal that the Court, as currently constituted, is likely to enforce the terms of arbitration provisions in parties’ agreements as written. Thus, even in circumstances that may be susceptible to concern as to whether the parties really had a “freedom to contract,” parties will more likely be bound by the terms of their written arbitration agreements, and there is a significant likelihood that these decisions will result in the federal courts referring more litigation to arbitration where the parties’ agreements so provide. The Court’s pending decision in Concepcion promises to provide further direction from the Court regarding the scope of the FAA and, when the Court issues this decision, businesses and parties to contracts should further assess their use of arbitration provisions and the validity and enforceability of the language they include in such provisions.