Associate Justice Antonin Scalia wrote the majority opinion, joined by Chief Justice John G. Roberts and Associate Justices Anthony M. Kennedy, Clarence Thomas and Samuel A. Alito, Jr.  Justice Thomas wrote a concurring opinion and Associate Justice Stephen G. Breyer dissented, joined by Associate Justices Ruth Bader Ginsburg, Sonia Sotomayor and Elena Kagan.  

Stay tuned for more….

Part I (here) briefly discussed Chief Judge Frank H. Easterbrook’s decision in Trustmark Ins. Co. v. John Hancock Life Ins. Co. (U.S.A.), No. 09-3682, slip op. (7^th Cir. Jan. 31, 2011), and its implications on the pending Second and Fifth Circuit appeals in  Scandinavian Reinsurance Co. v. Saint Paul Fire & Marine Ins. Co, No. 09 Civ. 9531(SAS), 2010 WL 653481 (S.D.N.Y. Feb. 23, 2010), and Dealer Computer Svcs., Inc. v. Michael Motor Co., No. H-10-2132, slip op. (S.D. Tex. December 29, 2010).  This Part II examines in some detail Trustmark’s background and rationale, and Part III will focus on Trustmark’s implications on the Scandinavian Re and Dealer Computer appeals.

II.  Trustmark Background

The following facts were gleaned from both the district court and Seventh Circuit opinions (the district court opinion is reported at 680 F. Supp. 2d 944 and can be found here):

Pursuant to several contracts, Trustmark Insurance Company (“Trustmark”)  agreed to reinsure John Hancock Insurance Company (U.S.A.) (“Hancock”), but not with respect to “London Market Retrocessional Excess of Loss Treaties,” which were excluded from the contracts.  Each contract was subject to a broad arbitration agreement (the “arbitration agreement”), which said the arbitrators had to be “disinterested in the outcome.”

A.  The First Arbitration and Confidentiality Agreement

A dispute arose concerning the scope of the “London Market Retrocessional Excess of Loss Treaties” exclusion, and the parties submitted the dispute to arbitration as required by the arbitration agreement.  Pursuant to the agreement, each party selected an arbitrator, and the two arbitrators selected a neutral umpire.

As is customary in reinsurance arbitration, the parties entered into a confidentiality agreement during the arbitration, which was executed by the parties and the panel members, and which prohibited Trustmark and Hancock from disclosing information concerning the proceedings and award, including evidence adduced.  The confidentiality agreement did not contain an arbitration clause.  (An example of a form of confidentiality agreement frequently used in reinsurance arbitration can be found here.   Parties frequently amend this form to suit the needs of the case, and, in any event, the Trustmark opinions do not say whether the confidentiality agreement was based on this particular form.)

In March 2004 the arbitration panel ruled in favor of Hancock, and the United States District Court for the Northern District of Illinois, Eastern Division, confirmed the award a few months later.  Hancock, relying on its interpretation of the award, billed Trustmark for balances allegedly owed under the treaties, but Trustmark refused to pay.

B.  The Second Arbitration

Hancock commenced a second arbitration in October 2004 to resolve the dispute that had arisen over the prior award and its reinsurance claims based on the award.  As one would expect, Hancock selected the same arbitrator it had appointed in the prior arbitration.  Trustmark, which had lost the prior arbitration, appointed a new arbitrator.  The two arbitrators appointed a neutral umpire, who, like Trustmark’s arbitrator, had not served in the first arbitration.

The parties knew from the outset that resolution of their dispute potentially implicated the confidentiality agreement, which Hancock’s arbitrator had signed, but which the umpire and Trustmark’s arbitrator had not.  At an organizational meeting in 2005 Trustmark expressed concern about whether Hancock’s arbitrator could abide by the confidentiality agreement.  Hancock’s arbitrator replied that although he “would scrupulously abide by confidentiality,” it might be “hard to segregate, difficult to deal with” knowledge obtained during first proceeding, which the other two panel members did not have.  Trustmark asked some further questions and consented to the appointment of Hancock’s arbitrator.

Not surprisingly, Hancock asserted that the panel should base its decision on the record of the prior arbitration.  It asked the panel to “expressly authorize the use of all materials [from the prior arbitration], without limitation.  .  .  .”  Hancock argued that the confidentiality agreement prohibited disclosures to the outside world, but not disclosures in subsequent arbitration proceedings between the parties, even proceedings involving attorneys and arbitrators who were not parties to the agreement.  Trustmark argued that the agreement covered all disclosures, including those made in subsequent proceedings to lawyers and arbitrators not involved in the original arbitration.

The umpire and Hancock’s arbitrator, over the dissent of Trustmark’s arbitrator, ruled that the panel “accept[ed] and extend[ed] the confidentiality of [the prior arbitration] to the two members of the current arbitration.  .  .  who were not parties to the previous arbitration.”

Hancock also requested that the Panel prohibit Trustmark from litigating nineteen issues that Hancock contended had been decided in the first arbitration.  A majority of the panel, over the dissent of Trustmark’s arbitrator, ruled that Trustmark was barred from relitigating several issues, including whether the retrocessional business on which Hancock’s claims arose was excluded from the treaties.  (“Retrocessional business” is the reinsurance of other reinsurance business.)

C.  Trustmark Seeks an Injunction

In 2009 Trustmark belatedly attempted to vacate the prior arbitration award, but presumably Trustmark recognized that the three-month deadline for vacating the award had expired long-ago, and that Fed. R. Civ. P. 60(b) did not authorize reopening the confirmation judgment.  It accordingly recast its claim as one for injunctive relief.

Trustmark argued that Hancock had obtained the prior award by fraudulently failing to produce four documents during discovery, and that the panel’s preclusion order was thus tainted by fraud.  Trustmark requested an order enjoining further arbitration to prevent Hancock from furthering its alleged “fraudulent scheme.”  Trustmark also sought an order enjoining:  (a) further alleged breaches of the confidentiality agreement; (b) Hancock’s alleged obstruction of access to relevant documents; and (c) further arbitration before any members of the panel.

In light of the four new documents Trustmark said should have been produced in the first arbitration, Hancock agreed to withdraw its preclusion claim and to participate in further discovery.  This mooted in part Trustmark’s claims for injunctive relief, leaving for judicial resolution its confidentiality-agreement-based claim and its claim that no further arbitration should proceed before any of the panel members.

As to the confidentiality agreement, Trustmark said the panel had no authority to resolve disputes concerning that agreement, including the dispute it had already purported to resolve, and therefore an injunction was necessary to ensure that the panel would not continue to exceed its authority by deciding confidentiality-agreement issues.  As to the constitution of the panel, Trustmark said Hancock’s arbitrator was no longer “disinterested” because he:  (a) allegedly breached the confidentiality agreement by participating in the deliberations that resulted in the confidentiality-agreement order; and (b) served as Hancock’s arbitrator in the prior arbitration.  According to Trustmark, Hancock’s arbitrator’s interest in the outcome “infect[ed]” the other two panel members, rendering them unfit to serve.

D.  The District Court Enjoins Arbitration

The district court enjoined the parties’ participation in the arbitration for as long as Hancock’s arbitrator remained on the panel.  The district court held that Hancock’s arbitrator was not “disinterested” within the meaning of the arbitration agreements, and that the panel had no authority to resolve confidentiality-agreement disputes.

As respects Hancock’s arbitrator, the district court said he was not “disinterested” in the arbitration’s outcome because he had breached the confidentiality agreement, and Trustmark may seek to hold him liable for that breach.  The district court also said the knowledge he obtained from the first arbitration made him “a fact witness not subject to examination.”  680 F. Supp. 2d at 948.  Acknowledging that courts “typically operate under the presumption that judges and arbitrators can disregard what they already know[,]” the district court concluded that Trustmark rebutted the presumption:

[Hancock’s arbitrator] has already demonstrated that he may well be unable to do this if he continues to serve on the second panel.   In Trustmark’s vetting of [Hancock’s arbitrator] as part of the Second Arbitration, [Hancock’s arbitrator] expressed some doubt that he would be able “to segregate” information he had from the First Arbitration, and stated that he would find it “difficult to deal with where the other panel members did not have the same full knowledge.” Trustmark points to one instance where, in a conference related to the Second Arbitration, Hancock made a point about a disputed issue in the First Arbitration, and [Hancock’s arbitrator], in support of Hancock, described his recollection of the First Arbitration. In response to Trustmark’s objection, [Hancock’s arbitrator] commented with regard to characterizations of certain claims made in the First Arbitration, “I feel it is my duty to correct the record as best as I understand in that regard.” The hypothetical posited by [Hancock’s arbitrator] during the organizational meeting became realized, and by his actions, he rebutted the presumption that he could disregard knowledge he already had.

680 F. Supp. 2d at 948-49.

The district court also held that the panel had no authority to resolve confidentiality-agreement disputes because that agreement did not contain an arbitration clause and because those disputes were not within the scope of the parties’ arbitration agreements.  See 680 F. Supp. 2d at 949.

Hancock appealed and the Seventh Circuit reversed.

III.  Chief Judge Easterbrook’s Decision

The Seventh Circuit was reviewing an order granting injunctive relief, which must be supported by, among other things, irreparable injury on the part of the party seeking relief.   The Court said there were “two principal problems” with the district court’s analysis of irreparable injury, the “entire discussion” of which the Court said was contained in the following passage from the district court’s opinion:

‘Trustmark cannot be forced to arbitrate issues that it did not agree to arbitrate. Forcing a party to arbitrate a matter that the party never agreed to arbitrate, regardless of the final result through arbitration or judicial review, unalterably deprives the party of its right to select the forum in which it wishes to resolve disputes, causing irreparable harm. This is a harm faced uniquely by Trustmark if it is denied relief and such harm tips the scale in favor of granting injunction. This irreparable harm, coupled with Trustmark’s success on the merits, militates in favor of granting an injunction in this case.’

Slip op. at 4 (quoting 680 F. Supp. 2d at 949; other quotations and citations omitted).

First, said the Court, “Trustmark did agree to arbitrate the question whether the contracts provide reinsurance for certain risks[,]” but “the district court blocked, rather than enforced that contractual understanding.”  Slip op. at 5 (emphasis in original).  Second, a party seeking injunctive relief is not “’unalterably’” denied of its right to select the forum.  Federal Arbitration Act Section 10(a)(4) expressly authorizes courts to vacate awards where arbitrators have “exceeded their powers,” so in cases where arbitrators purport to decide issues outside the scope of their authority, the problem can be addressed when the arbitrators issue a final award.  That, in turn, allows the litigation to proceed in the proper forum.  See slip op. at 5.

The Court said the only “injury” Trustmark might suffer (assuming it was correct that the confidentiality issue was not arbitrable) was “the delay and.  .  . out-of-pocket cost of paying the arbitrators and legal counsel.”  Slip op. at 5.  But the United States Supreme Court has “held that the delay and expense of adjudication are not ‘irreparable injury’.  .  .  . [,]” and the Seventh Circuit has held that Trustmark’s argument to the contrary is “frivolous.”  Slip op. at 5 (citing Petroleum Exploration, Inc. v. Public Service Commission, 304 U.S. 209, 222 (1938); Renegotiation Board v. Bannercraft Clothing Co., 415 U.S. 1, 24 (1974);  FTC v. Standard Oil Co., 449 U.S. 232, 244 (1980); PaineWebber Inc. v. Farnam, 843 F.2d 1050 (7th Cir. 1988); and Graphic Communications Union v. Chicago Tribune Co., 779 F.2d 13 (7th Cir. 1985)).

Having held that the district court improperly granted injunctive relief, the Court acknowledged it could dispose of the case without more.  But the Court explained that “the district court’s decision leaves a cloud over this arbitration and the reputation of [Hancock’s] arbitrator.  .  .  , a reputation that Trustmark seems determined to tarnish.”  Slip op. at 6.  The Court decided to remove the cloud, and ruled “that the district court erred on the merits in addition to mistakenly believing that Trustmark has established irreparable injury.”  Slip op. at 6.

Turning to whether Hancock’s arbitrator was “disinterested” within the meaning of the arbitrator qualification provisions of the agreements, the Court said “disinterested” means “lacking a financial or other personal stake in the outcome.”  Slip op. at 6 (citing by way of general example  Caperton v. A.T. Massey Coal Co., 129 S. Ct. 2252 (2009)).  Citing ARIAS•U.S., Practical Guide to Reinsurance Arbitration Procedure §2.3 (rev. ed. 2004), the Court said “[n]orms of insurance industry arbitration track this understanding.”  Slip op. at 6.

The Court concluded that Hancock’s arbitrator had no “stake in the outcome of this arbitration.”  Slip op. at 6.  The Court acknowledged that he has “a reputational interest:  if his decision disappoints the person who put him on the panel, he is less likely to be selected as an arbitrator in the future.”  Slip op. at 6.  But, according to the Court, such reputational interests are “endemic to arbitration that permits parties to choose who will decide.”  Slip op. at 6 (citing  Sphere Drake Ins. Co. v. All American Life Ins. Co., 307 F.3d 617, 622 (7th Cir. 2002) (Easterbrook, J.), reh’g denied, Nov. 4, 2002, cert. denied, 538 U.S. 961 (2004).  Noting that parties sometimes agree that arbitration-providers select the arbitrators, here “Trustmark and Hancock reserved the power of appointment.”  Slip op. at 6-7.  The Court concluded that “[a] court cannot properly deem the interest in reemployment created by this arrangement a disqualifying event.”  Slip op. at 7.

The Court rejected the district court’s conclusion that Hancock’s arbitrator was not “disinterested” because “he had knowledge of the dispute,” something the district court viewed as “a form of prohibited interest.”  Slip op. at 7.  The Court explained that “private parties often select arbitrators precisely because they know something about the controversy.”  Slip op. at 7 (citing Sphere Drake, 307 F.3d at 620):

Arbitration need not follow the pattern of jury trials, in which a factfinder’s ignorance is a prime desideratum. Nothing in the parties’ contract requires arbitrators to arrive with empty heads.

Slip op. at 7.

Gently rebuking the district court, the Court said “[f]ederal judges, of all people, should not confuse knowledge with disqualifying ‘interest[:]’”

For judges regularly hear multiple suits arising from the same controversy. The district judge who resolved this very dispute also entered the order enforcing the 2004 award. If knowing about what happened in 2004 is an impermissible “interest,” or makes the person a ‘fact witness’ about what had occurred in 2004, then the district judge should have stepped aside from the current suit.

Slip op. at 7.

But ethical rules applicable to federal judges did not require recusal, because “[k]nowledge acquired in a judicial capacity does not require disqualification.”  Slip op. at 7 (citing Liteky v. United States, 510 U.S. 540 (1994)).  And that, said the Court, is also true of “knowledge acquired in arbitration.”  Slip op. at 7.

The Court concluded that Hancock’s arbitrator was as “disinterested” as “the district judge himself, and just as entitled to participate.”  Slip op. at 8.  And, to the extent there was “any difference between the two adjudicators, [Hancock’s arbitrator] has the stronger entitlement to participate in the second round, because, as [the Court] stressed in Sphere Drake, it takes more to disqualify an arbitrator than to disqualify a judge.”  Slip op. at 8 (citing Sphere Drake, 307 F.3d at 621; and Merit Ins. Co. v. Leatherby Ins. Co., 714 F.2d 673 (7th Cir.), cert. denied, 464 U.S. 1009 (1983) (Posner, J.):

No party in federal court is entitled to pick his judge, but contracts allowing parties to choose their arbitrators are common; these parties’ arrangement instantiates the practice. When one party is entitled to choose its own arbitrator, and in doing so follows all contractual requirements, a court ought not to abet the other side’s strategy to eject its opponent’s choice.

Slip op. at 8.

The Court also rejected the district court’s conclusion that Hancock’s arbitrator was not “disinterested” because he had allegedly breached the confidentiality agreement.  Hancock’s arbitrator had executed the agreement “as an adjudicator,” and was therefore similarly situated to the district court judge, who “himself implemented the confidentiality agreement, in a similar adjudicatory capacity, when confirming the first panel’s award.”  Slip op. at 8.

As to whether the panel had authority to interpret the confidentiality agreement, the Court invoked the procedural arbitrability doctrine.  While the Court acknowledged that the confidentiality agreement did not contain an arbitration agreement, it pointed out that “the parties did agree to arbitrate their disputes about reinsurance.”  Slip op. at 8.  Citing Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79, 84 (2002), the Court said “[a]rbitrators who have been appointed to resolve a commercial dispute are entitled to resolve ancillary questions that affect their task.”  Slip op. at 8.  The confidentiality agreement, which was executed when the first arbitration was underway, “is closely related to the substance of the first arbitration and presumptively within the scope of the reinsurance contracts’ comprehensive arbitration clauses, which cover all disputes arising out of the original dispute.”  Slip op. at 8-9.   The arbitrators were therefore “entitled to decide for themselves those procedural questions that arise on the way to a final disposition,” including disputes concerning the confidentiality agreement, and “the preclusive effect (if any) of an arbitration award.”  Slip op. at 9-10.

The Court went out of its way to inform the arbitrators that, in addition to having the power to resolve the confidentiality agreement issue, they had a great deal of discretion to decide how to resolve those issues.  Acknowledging that the district court could review those determinations under Section 10(a)(4)’s “excess-of-powers” provision, the Court reminded the arbitrators and parties that the district court’s standard of review would be exceedingly deferential:

[a]mong the powers of an arbitrator is the power to interpret the written word, and this implies the power to err; an award need not be correct to be enforceable. See, e.g., Major League Baseball Players Ass’n v. Garvey, 532 U.S. 504 (2001). It is enough if the arbitrators honestly try to carry out the governing agreements. “[T]he question for decision by a federal court asked to set aside an arbitration award . . . is not whether the arbitrator or arbitrators erred in interpreting the contract; it is not whether they clearly erred in interpreting the contract; it is not whether they grossly erred in interpreting the contract; it is whether they interpreted the contract.” Hill v. Norfolk & Western Ry., 814 F.2d 1192, 1194–95 (7th Cir. 1987) [(Posner, J.)]. See also, e.g., Operating Engineers Local 139 v. J.H. Findorff & Son, Inc., 393 F.3d 742 (7th Cir. 2004) [(Easterbrook, J.)].

Slip op. at 10.

And lest there be any lingering doubt, the Court – apparently speaking principally for the panel’s benefit – said “[w]hen this arbitration resumes, the panel is entitled to follow its own view about the meaning of the confidentiality agreement; it need not knuckle under to the district court’s prematurely announced understanding.”  Slip op. at 10.

Keep your eyes out for the upcoming discussion in Part III of Trustmark’s implications on Scandinavian Re and Dealer Computer.

[Editor’s Note:  We have published a materially identical version of this post on the Disputing blog (you can find Part I here and Part II here).]

Each involved a dispute about the existence of an arbitration agreement.  In UBS Securities United States District Judge Denise L. Cote of the United States District Court for the Southern District of New York entered a declaratory judgment that certain Swiss investors could not compel UBS to arbitrate their securities fraud claims, and permanently enjoined the Swiss investors from pursuing their claims in arbitration.  Affirming the district court, the Second Circuit held that UBS satisfied the three requisites of permanent injunctive relief:  1) success on the merits; 2) lack of an adequate remedy at law; and 3) irreparable harm.

As respects success on the merits, the Court held that UBS was not obligated to arbitrate with the Swiss investors, and therefore had succeeded on the merits.  Financial Industry Regulatory Authority (“FINRA”) Code Rule 12200 provides that members can be compelled to arbitrate only 1) pursuant to a written agreement; or 2) where a customer requests arbitration.  FINRA R. 12200.  There was no written agreement to arbitrate between UBS and any of the Swiss investors and the Swiss investors were not customers of UBS.  See UBS Securities, slip op. at 3. 

As respects the lack of an adequate remedy at law and irreparable harm, the Court explained that under  Merrill Lynch Inv. v. Optibase, Ltd., 337 F.3d 125, 129 (2d Cir. 2003), “[b]eing forced to arbitrate a claim one did not agree to arbitrate constitutes an irreparable harm for which there is no remedy at law.”  Slip op. at 3.  Because UBS was not legally obligated to arbitrate, and because “the lack of an injunction would result in UBS effectively being required to do so, UBS satisfie[d] the ‘irreparable harm’ and ‘lack of an adequate remedy at law’ requirements for an injunction.”  Slip op. at 3.

Dedon concerned the familiar rule that disputes about the existence of a contract containing an arbitration agreement must be decided by the court (absent a clear and unmistakable post-dispute submission of that issue to arbitration).  Janus sought to compel arbitration before the International Chamber of Commerce (“ICC”) of an exclusive-distribution-agreement dispute, contending 1) the parties had agreed to arbitrate “as evidenced by a draft exclusive distribution agreement or the standard terms and conditions that accompanied each purchase;” and 2) Dedon had “waived its right to arbitrate through its conduct before the ICC” in London.  Slip op. at 2.  United States District Judge Colleen McMahon of the United States District Court for the Southern District of New York denied the motion to compel and declined to stay the proceedings pending an ICC determination of the contract formation issue, holding that the dispute concerned the existence of an arbitration agreement and that Dedon had not unreservedly submitted the contract formation issue to ICC arbitration. 

The Second Circuit affirmed.  It said the United States Supreme Court in Granite Rock Co. v. Int’l Bhd. of Teamsters, ___ U.S. ___, 130 S. Ct. 2847, 2857-58 (2010), had “reconfirm[ed]” the Second Circuit’s “well-established precedent that where a party challenges the very existence of a contract containing an arbitration clause, a court cannot compel arbitration without first resolving the issue of the contract’s existence.”  Slip op. at 3 (citing Interocean Shipping Co. v. National Shipping & Trading Corp., 462 F.2d 673, 676 (2d Cir. 1972); Sphere Drake Ins. Ltd v. Clarendon Nat’l Ins. Co., 263 F.3d 26, 30 (2d Cir. 2001); Denny v. BDO Seidman LLP, 412 F.3d 58, 68 (2d Cir. 2005); Opals on Ice Lingerie v. Body Lines Inc., 320 F.3d 362, 369 (2d Cir. 2003); Sprecht v. Netscape Commc’ns Corp., 306 F.3d 17, 26 (2d Cir. 2002)).  Because Janus sought to compel arbitration based on a draft agreement containing an arbitration clause, the district court had to decide whether the parties had agreed to arbitrate. 

The Court held that Dedon had not waived its right to court determination of the contract formation issue.  The Court said that “Dedon’s submissions to the ICC were replete with statements that Dedon disputed the ICC’s jurisdiction; such repeated objections to ICC jurisdiction prevent a finding of waiver.  .  .  .”  Slip op. at 5 (citing First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 946 (1995); Opals on Ice, 320 F.3d at 368).   

The Court also rejected Janus’ argument that an agreement to arbitrate “may be found in the terms and conditions that accompanied each purchase order between Dedon and Janus.”  Slip op. at 5:

On their face, the terms and conditions in those purchase orders govern the particular exchange of goods occurring with that purchase order — “[a]ll contractual and extra-contractual disputes arising out of or in connection with contracts to which these International Terms and Conditions apply, shall be finally resolved by arbitration” (emphasis added) — and do not purport to create or refer to any exclusive distribution relationship between the parties, which is the sole focus of the present suit. 

Janus also argues that the exclusive distribution agreement should be encompassed within the meaning of ‘pre-contractual and collateral obligations’ to the purchase orders.  Janus would thus have this court find that “any dispute related to any obligation arising prior to or outside of the contract formed by each shipment of goods” is governed by the purchase orders’ terms and conditions.  (emphasis in original)  We decline to adopt Janus’s broad reading of that contractual language, as it ignores the plain language of the purchase order, and we agree with the district court that the terms and conditions do not provide an alternative basis for compelling arbitration.

Slip op. at 5-6 (emphasis in original).

Dedon — the party who prevailed in the district court — argued that the district court should have denied the motion to compel with prejudice.  Dedon relied on Kahn Lucas Lancaster, Inc. v. Lark Int’l Ltd., 186 F.3d 210, 218 (2d Cir. 1999), partially abrogated on other grounds by Sarhank Group v. Oracle Corp., 404 F.3d 657, 660 n.2 (2d Cir. 2005), which held that under the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, arbitration agreements, to be enforceable, “must be signed by the parties or contained within an exchange of letters or telegrams.”   186 F.3d at 218) (quoting Article II of the Convention).  But Dedon did not raise that argument before the district court, and so the Court said “the parties will have the opportunity to argue this issue at the trial on the existence of a contact.”  Slip op. at 6-7.  The Court also noted that the district court may “consider what effect, if any, [the Court's] holding in Kahn Lucas has on any renewed motion to compel.”  Slip op. at 7.

[EDITOR'S NOTE:  (Summary orders "filed on or after January 1, 2007 may be cited in a document filed" with the Second Circuit, subject to Rule 32.1 of the Federal Rules of Appellate Procedure and Local Rule 32.1.1.  See Second Circuit Local Rule 32.1.1(b)(1) ; Fed. R. App. P. 32.1.  "[A] party must cite either the Federal Appendix or an electronic database (with the notation ‘summary order)[,]” and “must serve a copy of it on every party not represented by counsel.”    Second Circuit Local Rule 32.1.1(c) & (d).]

Introduction

Part I of this two-part post (here) briefly discussed the background of  AT&T Mobility LLC v. Concepcion, No. 09-893, a case pending before the United States Supreme Court that will be argued on November 9, 2010.  We now delve into the details of the preemption questions before the Court and take a guess at the outcome. 

Federal Arbitration Act Preemption

The Federal Arbitration Act does not preempt all state law applicable to arbitration agreements, but it expressly preempts state law that conflicts with Section 2, and impliedly preempts all state law that “stands as an obstacle to the accomplishment and execution of the full purposes of Congress”  embodied in the Federal Arbitration Act.  See Shroyer v. New Cingular Wireless Serv., Inc., 498 F.3d 976, 988 (9^th Cir. 2007) (citations and quotation omitted). 

Does Section 2 of the Federal Arbitration Act Expressly Preempt the Discover Bank Rule?

Section 2 of the Federal Arbitration Act declares that arbitration agreements within its scope “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.  Section 2 establishes substantive federal law that expressly preempts all conflicting state law, except for state law that permits “the revocation of any contract” or governs the formation, interpretation, or construction of contracts generally. 

The exception to federal preemption is exceedingly narrow, for it saves from preemption only state laws that apply equally across the board to all contracts.  The United States Supreme Court summarized it well when it said:

States may regulate contracts, including arbitration clauses, under general contract law principles and they may invalidate an arbitration clause ‘upon such grounds as exist at law or in equity for the revocation of any contract.  What States may not do is decide that a contract is fair enough to enforce all its basic terms (price, service, credit), but not fair enough to enforce its arbitration clause.  The Act makes any such state policy unlawful, for that kind of policy would place arbitration clauses on an unequal footing, directly contrary to the Act’s language and Congress’s intent.

Allied-Bruce Terminix Cos. v. Dobson, 513 U.S. 265, 281 (1995) (citations and quotations omitted; emphasis in original).  

By preempting state laws that do not apply to all other contracts, it makes arbitration agreements as enforceable of all other contracts, and prevents states from discriminating against them or otherwise making them less enforceable than all other contracts.  

The Supreme Court has said that state law grounds for the revocation of “any contract” include “generally applicable contract defenses, such as fraud, duress, or unconscionability,”  and that these defenses “may be applied to invalidate arbitration agreements without contravening § 2.”  Doctor’s Associates, Inc. v. Casarotto, 517 U.S. 681, 687 (1996).  The United States Court of Appeals for the Ninth Circuit and the California Supreme Court say that the Discover Bank rule is a state law ground for the invalidation of any contract (or at least for invalidating a class action waiver made part of the contract) for two reasons. 

First, the Discover Bank rule is part of California’s unconscionability law, and unconscionability is a defense to the enforcement of “any contract.”  California permits any contract to be voided on unconscionability grounds if, at the time it was made, it was both procedurally and substantively unconscionable.  Procedural unconscionability can be established by showing that a party with superior bargaining power offered the agreement on a take-it-or-leave it basis or the bargaining process was otherwise unfair.  Substantive unconscionability is established if the agreement “shock[s] the conscience,” or is one that a person would have to be “under delusion” to enter.  Odell v. Moss, 130 Cal. 352, 358 (1900); Belton v. Comcast Cable Holdings, LLC, 151 Cal.App.4^th 1224, 1245 (1st Dist. 2007); California Grocers Ass’n v. Bank of Am., 22 Cal.App. 4^th 205, 215 (1st Dist. 1994).   California applies a “sliding scale” rule – if the degree of procedural unconscionability is relatively low, then a greater showing of substantive unconscionability is required, and vice-versa. 

The Discover Bank rule says that, as a matter of law, an agreement to waive class arbitration or litigation is procedurally unconscionable if it is contained in a contract of adhesion and is substantively unconscionable if it is:  (a) “in a setting in which disputes between the contracting parties predictably involve small amounts of damages;” and (b) “it is alleged that the party with superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money.”  Discover Bank v. Superior Ct., 36 Cal.4^th 148, 162-63 (2005). 

Second, the Discover Bank rule is an application of Cal. Civ. Code § 1668, which declares certain exculpatory contracts to be “against the policy of the law:”

All contracts which have for their object, directly or indirectly, to exempt anyone from responsibility for his own fraud, or willful injury to the person or property of another, or violation of law, whether willful or negligent, are against the policy of the law. 

Cal. Civ. Code § 1668. 

A key premise of the Discover Bank rule is that class waivers are exculpatory contract provisions because consumers that have been the victims of alleged small-dollar but widespread fraud will, for economic reasons, allegedly be deterred from pursuing their small-dollar claims in individual, bilateral arbitrations or litigations.  According to California law an agreement that deprives consumers of class procedures exculpates the corporate wrongdoer from full responsibility for its fraud, or at least is intended to do so.  

Because California law bars enforcement of all unconscionable contracts, and all exculpatory contracts falling within Section 1668 of its Civil Code, and because the Discover Bank rule applies to class action waivers in contracts that do not contain arbitration agreements, the California Supreme Court and the Ninth Circuit hold that it does not discriminate against arbitration agreements in violation of Section 2. 

While this conclusion admittedly has a superficial ring of reason to it, it cannot withstand scrutiny.  The Discover Bank  rule may be based on or derived from general unconscionability-law principles and Cal. Civ. Code Section 1668, but it is not a general rule that applies to all contracts. 

To be sure, the rule targets not only certain arbitration agreements, but also a very small class of other contracts that do not contain arbitration agreements, but which purport to require a party to waive the right to bring a class action in court.  That alone, however, cannot save the rule from preemption, for the rule is no less discriminatory of arbitration agreements simply because it also happens to apply to another small subset of – but not all other – contracts.   Far from a general ground for the revocation of “any contract,” it is a special rule that applies principally to arbitration agreements.   Section 2 expressly preempts all state laws that discriminate against arbitration agreements, and the Discover Bank rule does exactly that.

That doesn’t mean California law on unconscionability or exculpatory contracts can’t be invoked to void an arbitration agreement in whole or in part.  But it does mean that California must apply to arbitration agreements the same standards for assessing unconscionability or Section 1668 enforceability that it applies to all other contracts. 

California could therefore apply its general rule against unconscionable contracts to an arbitration agreement.  That rule allows courts to void only those adhesive contracts that “shock the conscience” or would be accepted only by the delusional.  The ultra-consumer-friendly arbitration agreement in AT&T could never meet this rigorous test, the Ninth Circuit never suggested that it could, and, to our knowledge, the Concepcions do not contend that it could.   

California could also probably apply its general rule against exculpatory contracts to an arbitration agreement without violating Section 2.  One might legitimately argue that an arbitration agreement would violate Section 1668’s general rule if, for example, the agreement required arbitration of fraud claims, but forbade the arbitrators from awarding full monetary relief for fraud.     But nothing in the AT&T Mobility arbitration agreement purports to impair the Concepcions’ rights – or those of any other party that has the same or a similar agreement with AT&T Mobility – to obtain in bilateral arbitration the same monetary relief from fraud that it might obtain in class arbitration or litigation.       

There is yet another reason why California’s Discover Bank rule is not a rule of general contract law:  it is not a rule that is intended to  govern the validity or enforceability of any particular contract viewed in isolation, but a dispute resolution or consumer protection policy that seeks to guarantee class procedures are available to consumers in circumstances where many consumer parties have entered into independent, substantially similar adhesive contracts with a common corporate party and one or more consumers allege small dollar but widespread fraud.  Even assuming there is an empirical basis for the Discover Bank rule, and that it otherwise reflects a reasonable exercise of judicial power to declare public policy, the policy it is designed to advance has nothing to do with the enforceability of contracts generally, everything to do with the enforceability of consumer dispute resolution contracts particularly, and most to do with regulating consumer arbitration agreements specifically.       

 Does the Federal Arbitration Act Impliedly Preempt the Discover Bank Rule?

Even if state law is not expressly preempted by the Federal Arbitration Act, it may be impliedly preempted if it conflicts with the purpose of the Act, or the strong federal policy in favor of arbitration that it seeks to advance.  State laws or policies that undermine “the goals and policies of the FAA” are preempted by the Act.  Volt Info. Sciences, Inc. v. Board of Trustees of Leland Stanford Univ., 489 U.S. 468, 477-78 (1990).  

The Ninth Circuit held that the Discover Bank rule did not conflict with policies and purposes of the Federal Arbitration Act for essentially the same reasons it held that Section 2 did not expressly preempt the rule.  Those reasons do not save the rule from implied preemption anymore than they save it from express preemption, but there is more. 

The Ninth Circuit decided AT&T Mobility before the Supreme Court decided Stolt-Nielsen, S.A. v. AnimalFeeds, Inc., 130 S. Ct. 1758 (2010), which spelled out in no uncertain terms what Federal-Arbitration-Act policy was as respects class arbitration.   In Stolt-Nielsen the Court reaffirmed that “the central or ‘primary’ purpose of the FAA is to ensure that ‘private agreements to arbitrate are enforced according to their terms” and according to “the contractual rights and expectations of the parties.”  130 S. Ct. at 1773 (citations and quotations omitted).  To that end, said the Court, the Act “imposes certain rules of fundamental importance, including the basic precept that ‘arbitration is a matter of consent, not coercion.’”  130 S. Ct. at 1773 (citations omitted).  These rules authorize the parties to:  

1. generally “structure their arbitration agreements as they see fit[;]” 
2. “agree to limit the issues they choose to arbitrate[;]”
3. “agree on the rules under which any arbitration will proceed[;]”
4. “choose who will resolve specific disputes[;]” and
5.  “specify with whom they choose to arbitrate.”

130 S. Ct. at 1773-74 (citations and quotations omitted; emphasis  in original).

The Court admonished “courts and arbitrators to give effect to these contractual limitations” and reminded them not to “lose sight of the purpose of the exercise:  to give effect to the intent of the parties.”  130 S. Ct. at 1774-75 (citations omitted). 

From these Federal Arbitration Act “fundamental rules of importance” Stolt-Nielsen derived a new rule that effectively puts the kibosh on judicial attempts to nullify class waivers:  “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.”  130 S. Ct. at 1775 (emphasis in original).  The Discover Bank rule squarely conflicts with this and other Federal Arbitration Act “rules of fundamental importance,” because it either (a) imposes class arbitration on parties that not only did not agree to it, but expressly forbade it; or (b) requires parties to submit their dispute to class-action litigation, all in derogation of their arbitration agreement. 

Stolt-Nielsen has set Discover Bank on a collision course not only with the Federal Arbitration Act, but with itself.  Discover Bank assumes that, if consistent with state law on severability a class waiver can be severed from an arbitration agreement that is otherwise silent on class relief, then an arbitrator could impose class arbitration.  That’s part of the justification for Discover Bank; it is allegedly not an anti-arbitration rule because it permits class arbitration. 

Stolt-Nielsen has negated this key premise of Discover Bank by rejecting the argument that class arbitration is a mere matter of arbitral procedure and holding that courts or arbitrators cannot impose class arbitration without the parties’ affirmative consent.  It teaches us that if the parties’ agreement is silent on class relief, then the parties have not agreed to class arbitration, and thus cannot be compelled to participate in it, even if state law would deem the parties to have consented to class arbitration.    

If the Supreme Court were to hold that the Federal Arbitration Act does not preempt Discover Bank, then it would transform Discover Bank into a rule that not only barred class waivers, but also a certain class of ordinary arbitration agreements that are simply silent on class procedures, something that the Discover Bank rule does not purport to do.  And the result could not be squared with the Federal Arbitration Act. 

Stolt-Nielsen renders class waivers irrelevant in most cases.   If the waiver can be severed consistent with state law on severability applicable to any contract, then what is left is usually an arbitration agreement that is silent on class arbitration.  But under the Federal Arbitration Act, such an arbitration agreement provides no basis for a court or arbitrator to compel class arbitration, and a court faced with such an agreement has no choice but to compel bilateral arbitration.

That demonstrates that the Federal Arbitration Act impliedly preempts the Discover Bank rule, because it does not allow the rule to accomplish its intended result, which was to require class arbitration in cases where the parties expressly provide for bilateral arbitration only.  In the recent, post-Stolt-Nielsen, Fensterstock v. Education Finance Partners, ___ F.3d ___ (2d Cir. July 12, 2010), case (blogged here), the United States Court of Appeals for the Second Circuit attempted to avoid this foregone conclusion by completely ignoring the Federal Arbitration Act “rules of fundamental importance,” and holding that, under Discover Bank, the entire arbitration agreement was void because merely severing the class waiver would not permit class arbitration.  In attempting to implement the purposes of the Discover Bank rule it was forced to effectively expand the scope of the rule into one that voids not only class arbitration waivers, but also arbitration agreements that do not affirmatively authorize class relief.     

Ironically, the conclusion the Second Circuit reached in Fensterstock negates the key premise on which it was based.  The reason the Second Circuit saw fit to apply the Discover Bank rule in the first place was that it was purportedly a state law rule that applied to all contracts generally because it applied equally to arbitration agreements and contracts that waived class litigation.  But the expanded Discover Bank rule cannot survive express preemption even on that questionable basis. 

The expanded Discover Bank rule discriminates against adhesive arbitration agreements that are silent on class arbitration by voiding them, but enforcing all other contracts that are silent on class litigation.  The Discover Bank rule does not condition enforcement of non-arbitration agreements on the parties agreeing to submit to class action litigation proceedings.  Class litigation is provided for by applicable state procedural law or the Federal Rules of Civil Procedure; nobody has to consent to it.   But the Discover Bank rule as applied by the Second Circuit conditions enforcement of adhesive arbitration agreements on the parties affirmatively consenting to class arbitration in cases where the consumer alleges small-dollar but widespread fraud. 

That inescapable conclusion causes the Second Circuit’s express and implied preemption analysis to collapse like a house of cards.  The Second Circuit’s expanded Discover Bank rule treats arbitration agreements that are silent on class arbitration differently than all other contracts that are silent on class litigation, and there is no basis – however thin – for contending otherwise. 

It also bulldozes the Ninth Circuit’s express and implied preemption analysis in AT&T Mobility.  For Stolt-Nielsen renders irrelevant the Discover Bank rule unless it is construed to apply in a way that puts arbitration agreements on a wholly different footing than all other contracts. 

What is the Likely Outcome in AT&T Mobility?

Predicting the outcomes of cases pending before the Supreme Court is, at best, educated guesswork.  But we do not think that the Supreme Court can affirm the Ninth Circuit unless it is prepared to make significant exceptions to its prior jurisprudence interpreting the Federal Arbitration Act, or fashion a whole new set of rules and policies that apply to adhesive arbitration agreements.   

It seems highly unlikely that a majority of the Court will be willing to take such a bold step, particularly in light of the recently decided Stolt-Nielsen case.  Congress could, of course, do so, and under the Dodd-Frank Act (blogged here), the Bureau of Consumer Financial Protection and the Securities and Exchange Commission may have the power to do so as respects arbitration agreements contained in the financial service, broker-dealer, and investment-advisory contracts that the Dodd-Frank Act authorizes them to regulate. 

Our best guess is that the Court will stay the course it has set over the last few decades in the many Federal Arbitration Act cases it has decided, and let Congress change the law if it sees fit. 

Stay tuned for further coverage of the perplexing and exceedingly important AT&T Mobility case.  .  .  .

Introduction

In our recent feature “What to Make of the Second Circuit Voiding a Class Action Waiver Under California’s Discover Bank Rule,” we briefly discussed AT&T Mobility LLC v. Concepcion, No. 09-893, a case which asks the United States Supreme Court to determine whether the Federal Arbitration Act preempts California’s Discover Bank rule.  The Discover Bank rule deems unconscionable class action and class arbitration waivers in adhesive contracts in circumstances where a consumer alleges that a party with superior bargaining power has committed widespread but small-dollar fraud.  Petitioner AT&T Mobility LLC (“AT&T Mobility”) has filed its brief (here); various organizations, including the Chamber of Commerce of the United States of America, have filed an impressive stack of amicus curiae briefs supporting AT&T Mobility (here); Vincent and Liza Concepcion (the “Concepcions”) have filed their brief, which was posted online earlier today (here); and AT&T will presumably submit a reply brief.  The Court has scheduled argument for November 9, 2010. 

AT&T Mobility is an extremely important case because it will decide whether the Federal Arbitration Act preempts certain state law unconscionability and public-policy-based rules that are principally directed at class arbitration and class action waivers.  This issue has spawned a number of conflicting decisions in the state and federal courts, including Feeney v. Dell, Inc. 454 Mass. 192 (2009), a case we blogged back in 2009 (posts here and here). 

This two-part feature takes a closer look at AT&T Mobility, considers the principal issues before the Court, and ventures a guess on what the outcome will be.   This Part I discusses the background of the case, and Part II (here) outlines Federal Arbitration Act preemption rules, analyzes and explains why we believe the Federal Arbitration Act expressly and impliedly preempts the Discover Bank rule, and provides our best guess as to what the Supreme Court will conclude.    

AT&T Mobility:  Background

Like plaintiffs in most other class waiver cases the Concepcions’ claim is small; they seek only about $30.00 in compensatory damages.  They say AT&T Mobility, a cell-phone communications provider, fraudulently represented that it would give them free cell phones, but allegedly charged federal and state taxes for these “free” phones. 

The Concepcions want to proceed on a class action basis, and to that end they wish to bypass a clear and unambiguous class waiver contained in the arbitration agreement in their contract with AT&T Mobility.  The arbitration agreement stipulates that it shall be void in its entirety if a court does not enforce the waiver. 

The Concepcions say the waiver is unenforceable under California’s Discover Bank rule, which renders a class-action or class-arbitration waiver unenforceable on unconscionability grounds if:    

[1]  found in a consumer contract of adhesion

[2]  in a setting in which disputes between the contracting parties predictably involve small amounts of damages, and

[3]  it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money. 

Discover Bank v. Superior Ct., 36 Cal.4^th 148, 162-63 (2005). 

AT&T Mobility’s arbitration agreement is unique in that it contains some very consumer friendly provisions, which were summarized this way in AT&T Mobility’s initial Supreme Court brief: 

Cost-free arbitration for non-frivolous claims: ‘[AT&T Mobility] will pay all [American Arbitration Association (“AAA”)] filing, administration and arbitrator fees’ unless the arbitrator determines that the claim “is frivolous or brought for an improper purpose (as measured by the standards set forth in Federal Rule of Civil Procedure 11(b))” [in which case arbitration costs payable by the consumer are capped at $125.00]. 

Convenience:  Arbitration takes place ‘in the county.  .  . of [the customer’s] billing address,’ and for claims of $10,000 or less, customers have the exclusive right to choose whether the arbitrator will conduct an in-person hearing, a hearing by telephone, or a “desk” arbitration in which ‘the arbitration will be conducted solely on the basis of documents submitted to the arbitrator.’

Flexible consumer procedures:  Arbitration is conducted under the AAA’s Commercial Dispute Resolution Procedures and the Supplementary Procedures for Consumer-Related Disputes, which the independent, non-profit AAA designed with consumers in mind;

Small claims court option:  Either party may bring a claim in small claims court in lieu of arbitration;

Full remedies available:  The arbitrator may award the claimant any form of individual relief (including statutory attorneys’ fees, statutory damages, punitive damages and injunctions) that a court could award; and

No confidentiality requirement:  Customers and their attorneys are not required to keep the results of the arbitration confidential. 

AT&T Mobility’s Br. at 5-6. 

The arbitration clause also contains a number of consumer-friendly features designed to encourage California consumers to submit to bilateral arbitration even small-dollar claims:   

$7,500 minimum recovery if arbitral award exceeds [AT&T Mobility’s] last settlement offer:  If the arbitrator awards a California customer relief that is greater than [AT&T Mobility’s] last ‘written settlement offer made before an arbitrator was selected’ but less than $7,500, [AT&T Mobility] will pay the customer $7,500 rather than the smaller arbitral award;

Double attorneys’ fees:  If the arbitrator awards the customer more than [AT&T Mobility’s] last written settlement offer, than [AT&T Mobility] will ‘pay [the customer’s] attorney, if any, twice the amount of attorneys’ fees, and reimburse any expenses, that [the] attorney reasonably accrues for investigating, preparing, and pursuing [the] claim in arbitration;” and

[AT&T Mobility] disclaims right to seek attorneys’ fees:  “Although under some laws [AT&T Mobility] may have a right to an award of attorneys’ fees and expenses if it prevails in an arbitration, [AT&T Mobility] agrees that it will not seek such an award [from the customer].”

AT&T Mobility’s Br. at 6-7.

The district court said these provisions “sufficiently incentivize[] consumers” to pursue “small dollar” claims and “prompts” AT&T to make settlement offers favorable to consumers “even for claims of questionable merit.”  It nonetheless denied AT&T Mobility’s motion to compel arbitration, holding that the class waiver was unconscionable under California’s Discover Bank rule because it forbid the Concepcions from representing a class of allegedly similarly-situated claimants. 

The United States Court of Appeals for the Ninth Circuit acknowledged that the arbitration agreement “essentially guarantee[ed]” that AT&T Mobility “will make any aggrieved customer whole who files a claim.”  Laster v. AT&T Mobility LLC, 584 F.3d 849, 856 n.9 (9th Cir. 2009), cert. granted sub nom. AT&T Mobility LLC v. Concepcion,  ___ U.S. ___, 130 S.Ct. 3322 (2010).  But relying on its previous decision in Shroyer v. New Cingular Wireless Serv., 498 F.3d 976 (9^th Cir. 2007), it held that the class waiver was unconscionable  under Discover Bank, and that the Discover Bank rule was not expressly or impliedly preempted by the Federal Arbitration Act.   

The question before the Supreme Court is: “Whether the Federal Arbitration Act preempts States from conditioning the enforceability of an arbitration agreement on the availability of particular procedures – here, class-wide arbitration – when those procedures are not necessary to ensure that the parties to the arbitration agreement are able to vindicate their claims.”  That’s simply another way of asking whether the Federal Arbitration Act preempts the Discover Bank rule under the circumstances presented in AT&T Mobility. 

If the Supreme Court affirms the Ninth Circuit, the Concepcions will be permitted to pursue the class action complaint they filed in the district court.  If the Supreme Court holds that the Federal Arbitration Act preempts the Discover Bank rule, and reverses the Ninth Circuit, then the Concepcions will be required to arbitrate their $30.00 dispute with AT&T Mobility on a strictly bilateral basis.

In Part II (here) we delve into the preemption issues and take a guess at how the Supreme Court will dispose of this case.

A.   Introduction

In Part V.A of our Stolt-Nielsen reinsurance-arbitration practice series (here), we said that after Stolt-Nielsen courts will likely get to decide in the first instance whether the parties consented to consolidated arbitration.  If we are correct, that will be a fundamental change because courts will presumably construe the terms of the parties’ contracts more strictly than many arbitrators might, and those constructions will be subject to appellate review. 

In this Part V.B we consider what a party will likely need to show to persuade a court to consolidate arbitrations, and explain why we believe that courts will not frequently order consolidation.  In Part V.C. we shall explain the strategic and practical implications of the changes that Stolt-Nielsen will likely bring about in consolidated reinsurance-arbitration practice.         

 B.   What Will One Have to Show to Establish Consent to Consolidated Arbitration?

What a party must show to establish consent to consolidated arbitration will depend  on whether the dispute involves (a) multiple, bilateral contracts between the same parties; (b) multiple, bilateral contracts between a cedent and different reinsurers; (c) one or more multilateral contracts between a cedent and the same group of multiple reinsurers; (d) multiple, multilateral contracts between a cedent and different groups of reinsurers; or (e) some combination of (a) or (b) and (c), or (d).  While a party may show consent to consolidated arbitration in Scenario (a) by demonstrating that at least one of the arbitration clauses is broad enough to encompass the multi-contract dispute (see Part V.A, here), the party seeking consolidation must show more to establish consent in Scenarios (b) through (e).   Our focus here will be establishing consent in those Scenarios.   

1.      Scenario (b):  Multiple, Bilateral contracts Between a Cedent and Different Reinsurers

Scenario (b) may arise where a cedent seeks consolidated arbitration of a dispute arising out of a group of separate, bilateral facultative or treaty reinsurance contracts between the cedent and different reinsurers.  Suppose that Cedent C entered into a series of three consecutive, one-year bilateral facultative reinsurance agreements, Contracts 1, 2 and 3, with three different reinsurers, Reinsurers 1, 2 and 3.  Cedent C has billed each reinsurer for a portion of the settlement of an environmental claim that it has allocated to the three-year period covered by the contracts. 

Cedent C can easily demonstrate that it agreed to separate, bilateral arbitrations with R1, R2 and R3 and vice-versa, and that the dispute over each reinsurer’s share of the settlement falls within the scope of its arbitration agreement with that reinsurer.  But Stolt-Nielsen requires more. 

Cedent C must somehow demonstrate that each of the reinsurers consented to arbitrate in a single proceeding to which each of the other reinsurers are parties.  And since most reinsurance arbitration agreements provide for tri-partite arbitration — with each of the parties appointing an arbitrator, who in turn appoint a neutral  umpire — the reinsurers must agree to act as a single party for the purposes of arbitrator selection. 

If the reinsurers had contemplated consolidated arbitration involving nonparties to their contracts each presumably would have included a provision in their arbitration agreement that allowed for that.  Consider, for example, the relevant terms of Brokers and Reinsurance Markets Association standard arbitration clause 6K:

As a condition precedent to any right of action hereunder, any dispute arising out of this Contract, whether arising before or after termination, shall be submitted to the decision of a board of arbitration composed of two arbitrators and an umpire,  meeting in (City, State), unless otherwise agreed. 

.  .  .  .

If more than one reinsurer is involved in the same dispute, all such reinsurers shall constitute and act as one party for purposes of this Article, and communications shall be made by the Company to each of the reinsurers constituting the one party, provided that nothing therein shall impair the rights of such reinsurers to assert several, rather than joint, defenses or claims, nor be construed as changing the liability of the Reinsurer under the terms of this Contract from several to joint. 

(A compilation of BRMA standard contract provisions can be found here.) 

This clause, of course, was designed for use in multilateral reinsurance treaties – not bilateral facultative certificates — otherwise the phrase “provided that nothing .  .  .  shall.  .  .  be construed as changing the liability of the Reinsurer under the terms of this Contract from several to joint[,]” would be unnecessary.  But if this provision, or something very much like it, was included in each of the arbitration agreements in our hypothetical, then it would least arguably establish consent to consolidated arbitration on the part of R1, R2 and R3. 

Note that the last paragraph uses “reinsurer” and “reinsurers” in the lower case in the first part of the provision, but uses “Reinsurer” in the upper case in the last part:  “nor be construed as changing the liability of the Reinsurer under the terms of this Contract from several to joint.”  If “Reinsurer” in the upper case is defined elsewhere as denoting a reinsurer that is a party to the contract, then “reinsurer” or “reinsurers” in the lower case could – and perhaps should – be construed to refer to any reinsurer, irrespective of whether it is a party to the contract containing an arbitration clause.  A court could therefore construe the provision as consent to consolidated arbitration involving nonparties to the contract.  Or a court might conclude that the provision was ambiguous, and direct an arbitration panel to determine whether “reinsurer” and “reinsurers” in the lower case includes reinsurers that are not parties to the contract (an issue could arise whether that should be determined by three separate arbitration panels or a court).   

But suppose our hypothetical agreements did not expressly authorize consolidated arbitration.  Unless all three reinsurers unreservedly appointed the same arbitrator in response to the arbitration demand, there would be nothing to suggest the parties agreed to consolidation.  

Indeed, a persuasive argument might be made that the agreements prohibited arbitration, because many arbitrator selection provisions expressly say each party gets to appoint its own arbitrator.  Consider BRMA clause 6l: 

 Should an irreconcilable difference of opinion arise between the parties to this Contract as to the interpretation of this Contract or transactions with respect to this Contract, such difference will be submitted to arbitration upon the request of one of the parties, one arbiter to be chosen by the Company and one by the Reinsurer and an umpire to be chosen by the two arbiters before they enter into arbitration. 

.  .  .  . 

Assuming “Company” is defined as the cedent and ”Reinsurer” is defined only as a reinsurer that is a party to the contract, this provision entitles each of two parties to appoint their own arbitrator.  It is not susceptible of an interpretation that would require a reinsurer that is a party to the contract to appoint an arbitrator with the advice and consent of any non-parties, let alone one that would act on behalf of the reinsurer and those non-parties.   

So if our hypothetical arbitration agreements contained arbitrator selection provisions like this one, then R1 would be entitled to appoint arbitrator A under Contract 1, R2 would be entitled to appoint arbitrator B under Contract 2, and so on.  The provision would therefore effectively prohibit consolidated arbitration, which would require R1, R2 and R3 to appoint a single arbitrator to act on their collective behalf, all in derogation of the arbitration agreements.        

The provision may also effectively prohibit consolidation because the arbitration clause expressly applies to “irreconcilable difference[s] of opinion.  .  . between the parties to this Contract.  .  .  .”  (Emphasis added)  That strongly suggests that the parties did not agree to arbitrate disputes between the parties to the contracts and parties to other contracts.  While a semantic argument may be made that “between the parties to this Contract” is not the same as “between the parties to this Contract  and no others,” requiring the parties to affirmatively exclude the existence of an agreement to arbitrate with third parties when the agreement to arbitrate does not provide for arbitration with them in the first place would contradict the letter and spirit of Stolt-Nielsen and its “FAA rules of fundamental importance.”  As discussed in Part IV, here, those rules require affirmative consent to class or consolidated arbitration, not intent to exclude class or consolidated arbitration. 

Let’s assume that our hypothetical agreements are silent on consolidated arbitration in the sense that they neither authorize nor prohibit it.    The question before the court would then be whether it could imply consent to consolidation.    

As discussed in Part IV, here, the Stolt-Nielsen Court considered whether consent to class arbitration might be implied as a matter of law.  The Court did so from the standpoint of the procedural arbitrability doctrine, explaining that “in certain contexts, it is appropriate to presume that parties that enter into an arbitration agreement implicitly authorize the arbitrator to adopt such procedures as are necessary to give effect to the parties’ agreement.”  Stolt-Nielsen, slip op. at 20-21 (citations omitted; emphasis added).  The Court said that such a presumption was grounded “in the background principle that ‘[w]hen the parties to a bargain sufficiently defined to be a contract have not agreed with respect to a term which is essential to a determination of their rights and duties, a term which is reasonable in the circumstances is supplied by the court.’”  Slip op. at 21 (quoting Restatement Second of Contracts § 204 (1979)).

While the Court could and should have concluded its analysis at that point — the parties’ agreements were undisputedly bilateral, and could be given effect by ordering bilateral arbitration, rendering it unnecessary to imply consent to class arbitration – the Court went on to explain that class arbitration “changes the nature of arbitration to such a degree that it cannot be presumed the parties consented to it by simply agreeing to submit their disputes to an arbitrator.”  Slip op. at 21.  For, in what the Court termed “bilateral arbitration,” the “parties forgo the procedural rigor and appellate review of the courts in order to realize the benefits of private dispute resolution:  lower costs, greater efficiency and speed, and the ability to choose expert adjudicators to resolve specialized disputes.”  Slip op. at 21 (citations omitted).

In reaching that conclusion the Court said that “the relative benefits of class-action arbitration are much less assured, giving reason to doubt the parties’ mutual consent to resolve disputes” in that manner.  Slip op. at 21-22.  The Court emphasized “just some of the fundamental changes brought on” by class arbitration:

1.  “An arbitrator chosen according to an agreed upon procedure .  . . no longer resolves a single dispute between the parties to a single agreement, but instead resolves many disputes between hundreds or perhaps even thousands of parties[;]”

2.  Under the AAA Class Arbitration Rules the “presumption of privacy and confidentiality” that ordinarily applies in bilateral arbitration does not apply in class arbitration, “thus frustrating the parties’ assumptions when they agreed to arbitrate[;]”

3.  A class arbitration award does not simply purport to bind the parties to a single arbitration agreement, but “adjudicates the rights of absent parties as well[;]” and

4. “[T]he commercial stakes of class-action arbitration are comparable to those of class-action litigation, even though the scope of judicial review is much more limited.” 

Slip op. at 22-23.  

These considerations are not fully applicable to consolidated arbitration: 

1.  As in class arbitration, in consolidated arbitration an arbitrator chosen according to an agreed upon procedure no longer resolves a single dispute between the parties to a single agreement, but instead resolves many disputes .  Unlike class arbitration, however, consolidated arbitration generally involves disputes ranging from a few to perhaps tens of parties, not “hundreds or perhaps even thousands of parties.” 

2. Unlike class arbitration governed by the AAA Class Arbitration Rules, the presumption of confidentiality can be maintained in consolidated reinsurance arbitrations.  But reinsurers forced to participate in consolidated arbitration must sacrifice some of that confidentiality vis-à-vis their fellow reinsurers. 

3.   A consolidated arbitration award does not simply bind parties to a single arbitration agreement, but, unlike a class arbitration award, it does not purport to “adjudicate[] the rights of absent parties.  .  .  .”   

4.  Like those of class arbitration, the commercial stakes of consolidated arbitration are comparable to those of consolidated litigation, even though the scope of judicial review is much more limited.  But generally those commercial stakes are not as high as those of class arbitration. 

Even though the considerations the Court cited are not fully applicable to consolidated arbitration, there are a number of significant reasons why implying consent to consolidated arbitration may materially alter the nature of what would otherwise be bilateral arbitration, thereby frustrating the parties’ expectations.  A non-exhaustive list of these would include:    

1.  In consolidated arbitration, the reinsurers are forced to agree collectively on a single, party-appointed arbitrator to resolve multiple disputes even though most arbitrator selection provisions would allow each reinsurer to choose what it –  and no one else – concludes to be the most suitable party-appointed arbitrator for a given dispute.   Most arbitrator selection provisions also allow the parties considerable input in selecting the most suitable umpire candidates for a particular dispute.  These arbitrator-selection rights are considerably watered down – if not eliminated — when a group of reinsurers is required to select collectively a single party-appointed arbitrator and to agree collectively on a list of suitable umpire candidates.       

2.  Consolidated proceedings are an incident of litigation that the parties could have taken advantage of had they not agreed to arbitrate.  Parties who agree to arbitration typically sacrifice the procedural niceties of court adjudication for the informality, efficiency, speed and confidentiality of bilateral arbitration.    

3.   Consolidated proceedings may be more efficient from the standpoint of the institution or persons hearing the matter, that is, the court or the arbitration panel.  Judicial efficiency is important from a public policy standpoint because it is publicly funded.  But arbitration is privately funded, and multiple, private arbitration proceedings do not usually impose a significant extra burden on the public fisc (other than the relatively modest increased cost associated with multiple summary-enforcement proceedings, which may or may not be necessary, or which may not be contested). 

4.  To the extent that consolidated arbitration promotes efficiency it does so principally for the benefit of the cedent, which is spared the expense of multiple proceedings.  But each individual reinsurer may incur more time and monetary costs in a multi-party, consolidated proceeding than it might incur in bilateral arbitration. 

5.  Consolidated arbitration tends to tactically benefit the cedent at the expense of the reinsurer for the reasons to be set forth in Part V.C.  To the extent cedents may be tactically disadvantaged by having to commence multiple, bilateral proceedings, they may avoid that disadvantage by not agreeing to arbitrate or insisting on a provision authorizing consolidation. 

These and other considerations may convince courts not to imply consent to consolidated arbitration in the face of silence. 

2.      Scenarios (c) through (e)  

Scenarios (c) through (e) arise where there are:

1. One or more multilateral contracts between a cedent and the same  group of multiple reinsurers (Scenario (c));
2. Multiple, multilateral contracts between a cedent and different groups of reinsurers (Scenario (d)); or
3. Some combination of Scenarios (a), (b), (c) or (d) (Scenario (e)). 

As in Scenario (b), to establish consent to consolidated arbitration in any of these scenarios a cedent would have to show that all of the reinsurers consented to consolidation.  For essentially the same reasons discussed in Section B.1., above, cedents will likely have difficulty doing so in the absence of a provision authorizing consolidation.    

C.   How Frequently will Courts Consolidate Arbitrations or Direct Arbitrators to Determine Whether the Parties Consented to Consolidation? 

The answer is probably “not very.”  If courts decide whether the parties consented to consolidated arbitration, they are likely to apply state law principles of contract construction fairly strictly – at least more strictly than many arbitrators have.  Their decisions will also be subject to appellate review, which will presumably make it more likely that any decision imposing consolidation will have a sound basis in applicable law and the parties’ agreement. 

For the reasons discussed in Section B.1., above, there will probably be a number of cases where the agreements are not susceptible to an interpretation permitting consolidated arbitration or where they effectively prohibit it.  Where the agreements are silent, many courts may conclude that there is no sound basis for implying consent to consolidation.  

That does not mean that courts will never find consent to consolidated arbitration.  In Scenario (a) cases – where there are multiple, bilateral contracts between the same parties – courts may find that the parties’ arbitration clauses are broad enough to encompass a consolidated proceeding.  There may also be cases where state arbitration law permits courts or arbitrators to impose consolidated arbitration where the agreements are silent on that score.  If the parties clearly and unambiguously agreed that state arbitration law governs, then courts may find that the parties consented to the application of that state law.  And certain agreements provide for consolidated arbitration of one form or another or have language that is ambiguous as to whether consolidated arbitration is permitted.  In those cases, courts will likely either compel consolidated arbitration or submit the construction question to arbitrators, who may in turn order consolidation.    

But Stolt-Nielsen has changed the legal landscape on consolidated arbitration fairly dramatically, and on balance we think that courts will not readily consolidate arbitrations in the way that arbitrators have under the Bazzle regime.  In Part V.C, we explore the practical and strategic implications of this change.

Editor’s Note:  Here’s a list of links for Parts I through V of our Stolt-Nielsen reinsurance-arbitration series: 

Part I, Part II, Part III, Part IV, Part V.A, Part V.B, and Part V.C

Jay debunks the media hype surrounding the United States Supreme Court’s recent decision in Rent-A-Center v. Jackson, ___ U.S. ___, slip op. (June 21, 2010), and argues (persuasively) that the case is a reasonable, natural and modest interpretation of the Court’s prior Federal Arbitration Act jurisprudence.  With one minor caveat we agree wholeheartedly with his insightful and pragmatic view of the case.

Our view of the decision may differ very slightly in that we believe that its scope is broader than the holding might suggest.  Jay is absolutely correct when he says that the decision permits parties to challenge delegation agreements (agreements to arbitrate arbitrability) on unconscionability grounds.  He says that there may be “dozens” of grounds on which to make such a challenge, and we think he is right about that, too. 

But we think that it will be very difficult to mount a successful challenge specifically directed at a delegation agreement.  And if we are right about that, then the practical effect of the decision will be that delegation agreements will usually be enforced, enabling arbitrators to decide most unconscionability challenges.  The scope of the decision is, in our view, therefore quite broad. 

We nevertheless agree with Jay that the decision makes perfect sense in light of the Court’s prior Federal Arbitration Act jurisprudence, and apart from our caveat about the decision’s scope, we are otherwise on the same page as Jay.  Of course, it may turn out that challenges to delegation agreements prove more successful than we think they will.

Jay is an American-Arbitration-Association certified arbitrator and mediator, and serves on the AAA’s Large Complex Case Panel.  He is a Fellow of the College of Commercial Arbitrators and a Distinguished Fellow of the International Academy of Mediators.   He offers arbitrator and mediator services through Judicate West and Professional Mediation Associates. 

Jay also serves as an adjunct professor of arbitration law at Pepperdine Law School, the University of Missouri-Kansas City Law School and the Werner Institute of Creighton Law School.  An AV-rated attorney, he is a member of the California bar and is admitted to practice before the United States Supreme Court.  He is listed in “Best Lawyers in America” for ADR, and in “Southern California Super Lawyers,” also for ADR.  You can visit his website here.

We hope you enjoy Jay’s article.

Despite all the alarmist reaction already showing up in the press, the holding in Rent-A-Center v. Jackson, ___ U.S. ___, slip op. (June 21, 2010) is both modest and predictable.   Arbitration agreements always do one thing:  take decisions from judges and give them to arbitrators.  Ever since 1925, such agreements have always been enforced to exactly the same extent as any other agreement is enforced.   Not less so, but also not more so.  Are they enforced even when the decision in question is the “gateway” decision of whether the parties must arbitrate their dispute?  Yes, as long as the agreement delegating even that decision to the arbitrator is explicit and unmistakeable.  Is that news? No. See, e.g., First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938 (1995) (dictum).

Should it matter that this delegation language is physically located within the challenged arbitration agreement itself?  No.  (If the answer were “Yes,” any contract drafter could “solve” the problem by plucking out the delegation provision and pasting it onto another sheet of paper to be separately executed as the “delegation agreement.”)  What does matter is whether the challenge brought against the arbitration agreement is the kind that goes to the enforceability of the delegation provision itself.  Are there such challenges in theory?  Sure, dozens of them.  Does that fact put severe brakes on the implications of the Rent-a-Center holding for other cases?  Yes, that’s the point.  Were there any such challenges in the Rent-a-Center case?  No.  None whatsoever.  As the Court noted, the party challenging arbitration in this particular case did not even attempt to raise one.  Would the Court have been open to listening to such a challenge?  Yes.  Not just by implication.  It expressly said it would.

Some of the alarmist commentary stands on the cynical premise that law is pure politics, such that the statement “the outcome of this case is pro-business” is thought to serve as a principled basis the court should have used to distinguish the precedent it is required to honor.  Some of these commentaries, remarkably enough, even come from lawyers.

The more sophisticated of the alarmist commentaries made a more sophisticated mistake.  They took the way Justice Scalia framed the issue in the first sentence of the decision, and leaped to the conclusion that that sentence could serve as the entire holding.

Justice Scalia said:  “We consider whether.  .  .  a district court may decide a claim that an arbitration agreement is unconscionable, where the agreement explicitly assigns that decision to the arbitrator.”

His answer (the holding) was not exactly “It may not.”  His answer was really, “It may not, unless, of course, the provision assigning the decision to the arbitrator is itself subject to any challenge whatsoever  (including unconscionability) recognizable to anyone familiar with the common law of contracts.

To which I would only add the not very dramatic commentary:  “Nothing very remarkable about that.”

EDITOR’S NOTE: John (Jay) McCauley is an American-Arbitration-Association certified arbitrator and mediator, and serves on the AAA’s Large Complex Case Panel.  He is a Fellow of the College of Commercial Arbitrators and a Distinguished Fellow of the International Academy of Mediators.   He offers arbitrator and mediator services through Judicate West and Professional Mediation Associates. 

Jay also serves as an adjunct professor of arbitration law at Pepperdine Law School, the University of Missouri-Kansas City Law School and the Werner Institute of Creighton Law School.  An AV-rated attorney, he is a member of the California bar and is admitted to practice before the United States Supreme Court.  He is listed in “Best Lawyers in America” for ADR, and in “Southern California Super Lawyers,” also for ADR.  You can visit his website here.

Our post introducing Jay is here.

In a 5-4 opinion by Associate Justice Antonin Scalia, joined in by Chief Justice John G. Roberts, Jr. and Associate Justices Anthony M. Kennedy, Clarence Thomas and Samuel A. Alito, Jr , the Court held that the employee had to arbitrate its claim that certain provisions of an arbitration agreement were allegedly unconscionable because the parties clearly and unmistakably agreed to arbitrate arbitrability questions, and the employee did not specifically claim that that agreement was unconscionable.  The Court said that the parties’ clear and unmistakable agreement to arbitrate arbitrability was, as a matter of federal law, severable from the other provisions of the arbitration agreement, including the ones the employee said were unconscionable.  

Prior to the decision we had advocated in the Forum (here and here), and in our cover story published in the March 2010 issue of Alternatives to the High Cost of  Litigation (blogged here), that the Court should resolve the case in favor of Rent-A-Center using a severability analysis of sorts derived from Buckeye Check Cashing v. Cardegna, 546 U.S. ___ (2006) and Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395 (1967).   And that’s exactly what happened, even though neither side advocated or addressed the severability argument before the Court, a point made by Associate Justice Stevens’ dissenting opinion, which was  joined in by Associate Justices Ruth Bader Ginsburg, Stephen G. Breyer and Sonia Sotomayor.  See Dissenting Op. at 1.  (The district court’s analysis, however, which was reversed by the Ninth Circuit, was, according to the Court, consistent with the Buckeye Check Cashing and Prima Paint severability principle.  See Slip op. at 9.) 

Readers may recall that before certiorari was granted in Rent-a-Center  we argued: 

There is logic to the rule adopted by the [Court of Appeals for the Ninth Circuit].  .  .  in that unconscionability is a state law defense that goes to the enforceability of an agreement.  When a party challenges the enforceability of an arbitration agreement, the court ordinarily decides it – unless the parties clearly and unmistakably agree otherwise.  And while the parties clearly and unmistakably agreed to arbitrate arbitrability,  that agreement was – as is often the case – simply a component of the rest of the arbitration agreement.  If the entire arbitration agreement is unenforceable because of unconscionability, then so too must be the agreement to arbitrate arbitrability. 

The problem with the majority’s logic is that it does not distinguish between the enforceability of the clear and unmistakable agreement to arbitrate arbitrability and the enforceability of the parties’ agreement to arbitrate all other disputes.  The Rent-A-Center parties envisioned that a dispute concerning the enforceability of their agreement to arbitrate all other disputes would be decided by the arbitrators.  That is what the parties’ agreement said, and the United States Supreme Court has said that parties can enter into such agreements, provided they are clear and unmistakable. 

We think courts would better advance the purposes of the Federal Arbitration Act by engaging in a severability analysis of sorts when confronting questions like the one in Rent-A-Center.   When parties agree not only to arbitrate the merits of controversies unrelated to the arbitration clause, but also clearly and unmistakably agree to arbitrate arbitrability, the latter agreement is tantamount to an arbitration agreement within an arbitration agreement.  One agreement concerns who decides disputes concerning the existence, formation or enforceability of the other agreement.  And the other agreement concerns the parties’ obligation to arbitrate all other disputes.  Each should be analyzed separately under Federal Arbitration Act Section 2. 

What the court did in Rent-A-Center was assume that, if any part of the arbitration agreement was unenforceable for any reason, then the entire arbitration agreement – including the clear and unmistakable agreement to arbitrate arbitrability – must fail.  Perhaps ironically, the Court found support for this analysis in the Prima Paint/Buckeye Check Cashing line of cases that hold that an enforceability challenge directed at the contract as a whole – as opposed to the arbitration agreement specifically – must be decided by the arbitrators rather than the court.  Because the challenge here was to a stand-alone arbitration agreement that included a clear and unmistakable agreement to arbitrate arbitrability, the Court simply assumed that Federal Arbitration Act Section 2 required the Court to decide it.  But doing so was inconsistent with the parties’ clearly expressed intent that the arbitrators would decide arbitrability questions, at least arbitrability questions that did not concern the enforceability of the parties’ agreement to arbitrate arbitrability. 

The Court should have limited its inquiry to whether the parties’ agreement to arbitrate arbitrability was substantively unconscionable.  If not, then the Court should have directed that the arbitrators decide the question whether the remainder of the arbitration clause was substantively unconscionable.  Had the Court looked at the problem from that perspective, we believe it would have concluded that the unconscionability defense did not apply to the parties’ clear and unmistakable agreement to arbitrate, and that, accordingly, the arbitrators had to decide whether the challenge to the remainder of the arbitration clause had merit.  

.  .  .  . 

So we think the Court should have enforced the agreement to arbitrate arbitrability by committing to the arbitrators the question whether the parties’ agreement to arbitrate all other claims was unconscionable because it was allegedly one-sided.  Had it done so, it would have given full force and effect to the parties’ clearly expressed intentions, the pro-enforcement policies of Federal Arbitration Act Section 2, and the letter and spirit of First Options.

(See Jackson v. Rent-A-Center West, Inc.: Who Gets to Decide Whether an Arbitration Agreement is Unconscionable when the Parties Clearly and Unmistakably Say the Arbitrators Decide Arbitrability?, Loree Reinsurance and Arbitration Law Forum (Sept. 23, 2009) (emphasis added)). 

In a similar vein, the Supreme Court explained:  

The Agreement here contains multiple “written provision[s]” to “settle by arbitration a controversy.”  Two are relevant to our discussion.  First, the section titled “Claims Covered By The Agreement” provides for arbitration of all “past, present or future” disputes arising out of Jackson’s employment with Rent-A-Center.  Second, the section titled “Arbitration Procedures” provides that “[t]he Arbitrator . . . shall have exclusive authority to resolve any dispute relating to the . . . enforceability . . . of this Agreement including, but not limited to any claim that all or any part of this Agreement is void or voidable.”  The current “controversy” between the parties is whether the Agreement is unconscionable.  It is the second provision, which delegates resolution of that controversy to the arbitrator, that Rent-A-Center seeks to enforce.  .  .  . 

The delegation provision is an agreement to arbitrate threshold issues concerning the arbitration agreement.  .  .  . 

An agreement to arbitrate a gateway issue is simply an additional, antecedent agreement the party seeking arbitration asks the federal court to enforce, and the FAA operates on this additional arbitration agreement  just as it does on any other.  The additional agreement is valid under §2 “save upon such grounds as exist in law or in equity for the revocation of any contract,” and federal courts can enforce the agreement by staying federal litigation under §3 and compelling arbitration under §4.  The question before us, then is whether the delegation provision is valid under §2. 

.  .  .  . 

Here, the “written provision.  .  . to settle by arbitration a controversy,” 9 U.S.C. §2, that Rent-a-Center asks us to enforce is the delegation provision — the provision that gave the arbitrator “exclusive authority to resolve any dispute relating to the .  .  .  enforceability .  .  .  of this Agreement[.]“.  .  .  The “remainder of the contract[]” [as that term was used in Buckeye Check Cashing,] is the rest of the agreement to arbitrate claims arising out of Jackson’s employment with Rent-A-Center.  To be sure this case differs from Prima Paint, Buckeye, and [Preston v. Ferrer, 552 U.S. 346 (2008)] in that the arbitration provisions sought to be enforced in those cases were contained in contracts unrelated to arbitration — contracts for consulting services, check cashing services, and “personal management” or “talent agent” services.  In this case the underlying contract itself is an arbitration agreement.  But that makes no difference.  Application of the severability rule does not depend on the substance of the remainder of the contract.  Section 2 operates on the specific “written provision” to “settle by arbitration a controversy” that the party seeks to enforce.  Accordingly, unless Jackson challenged the delegation provision specifically, we must treat it as valid under §2 and must enforce it under §§3 and 4, leaving any challenge to the validity of the Agreement as a whole for the arbitrator. 

Slip op. at 4-6 & 8 (citations and footnote omitted).  The Court concluded that the District Court correctly found that Jackson had challenged only the arbitration agreement as a whole, not the delegation provision specifically, and accordingly reversed the Ninth Circuit’s judgment.  See Slip op. at 9 & 12. 

The Supreme Court has now decided two arbitration cases this term – this one and Stolt-Nielsen, S.A. v. AnimalFeeds Int’l Corp., ___ U.S. ___, slip op. (April 27, 2010) – in favor of the party-autonomy principle inherent in the Federal Arbitration Act, even though the effect of those decisions may not necessarily lead to the fairest result for parties of limited bargaining power.  Both cases were decided 5-4 along ideological lines (with Justice Kennedy supplying the swing vote).  These decisions may provide  fodder for those in Congress that favor anti-arbitration legislation designed to protect consumers, employees and other claimants.  

 And, as most readers are aware, the United States Supreme Court recently granted certiorari in another Ninth Circuit case,  AT&T Mobility v. Concepcion, No. 09-893 (see report in our good friend Karl Bayer’s Disputing Blog here), a case that will test whether Stolt-Nielsen’s reasoning that consent to class arbitration cannot be implied applies in the adhesive context, and, if so, whether the FAA rules of “fundamental importance” discussed in Stolt-Nielsen supercede a state law invalidating class arbitration waivers on unconscionability grounds.   That will surely be a closely-watched case next term, and one you will hear more about in the future here at the Forum.

A.   Introduction

In this Part V.A of our consolidated-reinsurance-arbitration series, we delve into Stolt-Nielsen’s legal implications on consolidated reinsurance-arbitration practice, focusing on how courts are likely to decide the allocation-of-power question:  Who gets to decide whether the parties consented to consolidated arbitration?  In Part V.B we shall examine Stolt-Nielsen’s other specific legal and practical implications, focusing on what a party will likely need to show to obtain consolidated arbitration and how frequently consolidated arbitration is likely to be granted after Stolt-Nielsen.    

B.   Who Gets to Decide Whether the Parties Consented to Consolidated Arbitration?

Readers will recall from Part III (here) that courts interpreted Bazzle  as governing the allocation-of-power issue.  Now that the Court has said Bazzle never commanded a majority on that issue, and that it remains open, courts must reconsider it not only in the class-, but in the consolidated-arbitration context.   

Consolidated arbitrations, like class arbitrations, raise two types of questions:  Common-dispute and party-consent questions.  We think that courts will likely conclude that both are questions of arbitrability for the court to decide in the first instance, unless the parties clearly and unmistakably agree otherwise.   Arbitrators may play a role in resolving contractual ambiguities identified by the court.  

1.      Who Gets to Decide Common-Dispute Questions?

All consolidated-arbitration questions concern whether at least one arbitration agreement encompasses not only disputes concerning one, but all other contracts at issue.  We call this the “common-dispute” question.    

In some consolidated-arbitration disputes the “common dispute” question is the only one presented.  Suppose reinsurer R  enters into two treaties with cedent C, Contracts A and B, each of which incept on the same date and are in force for one year.  Contract A’s limits are $1 million per occurrence excess a $500,000 retention.  Contract B has per occurrence limits of $2 million excess of $1.5 million.  Both contain broad arbitration clauses under which the parties agreed to arbitrate “any dispute arising out of or relating to this contract.”

C pays a $3 million claim and seeks $1,000,000 from Contract A and $1.5 million from Contract B.  R says the claim should have been horizontally allocated over a six-year period.  R is not a party to any of C’s contracts covering the five-year period subsequent to the inception of contracts A and B. 

C demands a consolidated arbitration under Contracts A and B, seeking $2.5 million.  R opposes consolidation, forcing C to bring a motion to compel consolidated arbitration. 

The consolidated-arbitration decision maker in this hypothetical need only resolve whether the claim “arises out of or is related to” Contracts A, B, or both.   There is no issue concerning the parties with whom R agreed to arbitrate because R agreed to arbitrate with C under both contracts.     

Under the Supreme Court’s Federal Arbitration Act jurisprudence the court would ordinarily decide this type of question.  Questions concerning the scope of an arbitration agreement itself are ordinarily for the court, including whether “an arbitration clause in a concededly binding contract applies to a particular type of controversy. . . .”  Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79, 84 (2002).  When a court decides that type of question, it – not the arbitration panel – applies state law rules of contract interpretation to the scope provision of the arbitration agreement (and sometimes other provisions, as well) to determine what the parties agreed to submit to arbitration.  See, generally,  Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52, 58-63 (1995). 

To the extent there is ambiguity as to whether the  disputes are encompassed by at least one of the arbitration clauses, the court would be aided by the presumption of arbitrability, under which any ambiguities as to the scope of the arbitration clauses themselves would be resolved in favor of arbitration.  See, e.g., 514 U.S. at 62.  That would presumably mean a finding that one or both of the arbitration clauses covered the disputes. 

While common-dispute issues will typically raise scope questions, depending on the facts, there may be other, interrelated issues concerning contract interpretation that are ordinarily for the arbitrators to decide.  Suppose a dispute arises over a horizontal, even, pro-rata allocation of a continuing occurrence to a continuous, excess-of-loss treaty that was in effect for five years, but which was also subject to annual resigning.  Depending on the facts, a question might arise as to whether the dispute arose under one contract or five.  Resolution of that question might require interpretation of the treaty language, the slips, the placing information and other matters, all in light of reinsurance custom and practice. 

Whether or not the number of contracts question is one of arbitrability or simply contract interpretation and construction is not necessarily clear.  But a court might well conclude that it is one for the arbitrators. 

The arbitrators – as experts in reinsurance custom and practice – are presumably better equipped to resolve the dispute than most judges, and the parties probably expected that the arbitrators would decide the question if it arose.  It might also be intertwined with the merits (e.g., the number of per occurrence limits and retentions that apply).  Were the court to decide the issue, the court might be deciding a matter the parties agreed to arbitrate.  And, depending on how the arbitrators rule on the matter, they might moot the controversy over consolidation, saving the court valuable time and resources. 

2.      Who Gets to Decide Party-Consent Questions?

Not all putative consolidated arbitrations involve simply multiple contracts between the same parties.   Additional parties may be involved that are not parties to all other agreements.  One or more parties to one contract may be parties to all or none of the other contracts.  Or there may be one treaty under which the cedent is seeking consolidated arbitration against all participating reinsurers.  Consolidated-arbitration disputes of this variety raise “party-consent” questions. 

Party-consent questions make consolidated-arbitration disputes look much more like class-arbitration disputes.  For what typically distinguishes class from bilateral arbitration is the presence of not only multiple, bilateral contracts involving the same parties, but multiple bilateral contracts involving multiple parties. 

What principally motivated the Stolt-Nielsen Court to hold that class arbitration cannot be imposed without a contractual basis other than a broad arbitration clause was the Federal Arbitration Act rule of “fundamental importance” that parties may “specify with whom they chose to arbitrate.”  See Stolt-Nielsen, slip op. at 19-20 (emphasis in original).   A reasonable corollary is that a party may not be compelled under the FAA to submit to a consolidated arbitration presenting party-consent issues absent a contractual basis other than the parties’ broad arbitration clause. 

Suppose that R and C are parties to Contracts A, B and C, a consecutive series of one-year “First Excess of Loss Treaties,” each with per occurrence limits of $1,000,000 excess of $500,000.  While R and C are the only parties to Contract A, R and R1 are the reinsurers participating in Contract B, and R1 and R2 are the reinsurers participating in Contract C.  The contracts contain identical, tri-partite arbitration clauses providing, among other things, that the parties agree to arbitrate any dispute “arising out of or relating to” the contract. 

C bills R, R1 and R2 for their respective shares of a $3 million claim it has allocated on an even, pro-rata basis over the three contract years.  The reinsurers object, arguing that the loss should have been allocated over a six-year period.   

C demands a consolidated arbitration against R, R1 and R2 under Contracts A, B and C.  The reinsurers object and C moves to compel arbitration. 

To decide whether the parties consented to consolidated arbitration, the decision maker must not only resolve the common-dispute question, but also find some contractual basis under at least one of the arbitration agreements to conclude that:  (a) R agreed not only to arbitrate with C in a bilateral arbitration, but in a consolidated arbitration involving R1 and R2; and (b) both R1 and R2 agreed to arbitrate with C in a consolidated proceeding to which R and they are all parties.  Under Stolt-Nielsen the contractual basis must be something other than the contracts’ broad arbitration clauses.    

Courts considering the allocation-of-power question after Stolt-Nielsen will likely conclude that these party-consent issues should be decided by the court in the first instance.  A classic arbitrability question is whether “the parties are bound by a given arbitration clause.  .  .  .”  See Howsam v. Dean Witter Reynolds, Inc.,, 537 U.S. 79, 83 (2002).

Party-consent issues concern whether all of the parties are “bound by a given arbitration clause” to arbitrate together in a single, consolidated proceeding.  R was bound to arbitrate with C under Contracts A and B, but not Contract C; R1 was bound to arbitrate with the C under Contract B and C, but not A; and R2 was bound to arbitrate with C under Contract C, but not Contracts A and B.  Furthermore, R is not a party to Contract C, or any other contract with R2; and R1 was a party to only one contract with R (Contract B) and one contract with R2 (Contract C).   Even assuming that the arbitration clause of each contract encompasses disputes arising out of each of the others (the common-dispute question), nothing indicates that R, R1, and R2 agreed to arbitrate together in a single arbitration with C.  

The party-consent question is also a question for the court under Section 4 of the Federal Arbitration Act.  Section 4, though a procedural statute technically applicable only in federal court, reflects an allocation of power between courts and arbitrators that is derived from the substantive enforceability command of Section 2 (which is applicable in both state and federal courts).  See Buckeye Check Cashing v. Cardegna, 546 U.S. 440, 447 (2006); Prima Paint v. Conklin Mfg. Corp., 388 U.S. 395, 403-04 (1967).  Section 4 provides that “A party aggrieved by the alleged failure, neglect, or refusal of another to arbitrate under a written agreement for arbitration may petition any United States district court which, save for such agreement, would have jurisdiction.  .  .  of the subject matter of a suit arising out of the controversy between the parties, for an order directing that such arbitration proceed in the manner provided for in such agreement.”  9 U.S.C § 4 (emphasis added).  On hearing a motion to compel, the court must “make an order directing the parties to proceed to arbitration in accordance with the terms of the agreement” if “the making of the agreement for arbitration or the failure to comply therewith is not in issue. . . .” Id. (emphasis added)

When one party demands consolidated arbitration involving party-consent issues and another objects because it contends it never agreed to arbitrate in a single proceeding with all of the parties, a question arises whether there has been a failure, neglect or refusal to perform one or more arbitration agreements.   And that question implicates whether the resisting party is bound by an arbitration agreement requiring it to arbitrate with all of the parties, or whether certain parties to the proposed consolidated arbitration may invoke the benefit of one or more arbitration clauses to which they are not parties.  

Faced with that question, the court must resolve it and ensure that arbitration proceeds in the manner provided by the parties’ agreements and in accordance with their terms.  That necessarily requires the court to determine whether the agreements permit, forbid or are silent on consolidated arbitration involving party-consent issues, or whether they are ambiguous on that score. 

Outside of the class or consolidated arbitration context, when a party contends on a Federal Arbitration Act Section 4 or 3 motion that a nonsignatory is subject to the arbitration clause, or cannot invoke the clause, the court determines whether there is a state law basis for requiring the nonsignatory to arbitrate or allowing it to invoke the arbitration clause.   If there is such a state law basis, the court enforces the arbitration agreement accordingly.   But it does not refer the question to the arbitrators.  See Arthur Andersen LLP v. Carlisle, 129 S. Ct. 1896, 1901-02 (2009); Ross v. American Express Co., 547 F.3d 137, 143 & n.3 (2d Cir. 2008); Ross v. American Express Co., 478 F.3d 96, 99 (2d Cir. 2007); Astra Oil Co. v. Rover Navigation, Ltd., 344 F.3d 276, 279-80 & n.2 (2d Cir. 2003); Thomson-CSF, S.A. v. American Arbitration Assoc., 64 F.3d 773, 776-80 (2d Cir. 1995). 

When the question arises under Section 9 of the Federal Arbitration Act whether a third-party is bound by an arbitration award or is entitled to a benefit under it, then the court likewise decides the question.  Courts do not hesitate to vacate awards that purport to bind or confer a benefit in favor of a non-party to an arbitration agreement.  See, e.g.,  Nationwide Mutual Ins. Co. v. Home Ins. Co., 330 F.3d 843, 846-47 (6^th Cir. 2003); Orion Shipping & Trading Co., Inc. v. Eastern States Petroleum Corporation Of Panama, S.A., 312 F.2d 299, 300-01 (2d Cir. 1963).  But courts do not remand such cases back to the arbitrators to determine whether the non-party really was a party, or was otherwise bound by or entitled to invoke the arbitration clause. 

We do not perceive a meaningful distinction between the party-consent questions presented by the motion to compel a consolidated arbitration in our party-consent hypothetical and those presented in the cases cited above.  The questions are essentially the same and the key, underlying purpose of the Federal Arbitration Act that the cases serve is the same – to enforce the parties’ arbitration agreements as written. 

We therefore think that courts that consider the party-consent issue in a dispute over consolidated arbitration will likely conclude that it presents an issue of arbitrability for courts – not arbitrators to decide.  But there is another important consideration that augurs in favor of allocating the power to the court. 

Party-consent questions raise important issues arising out of the parties’ arbitrator-selection provisions.  One of Stolt-Nielsen’s Federal Arbitration Act rules of “fundamental importance” is that parties may “choose who will resolve specific disputes.”  Slip op. at 19 (emphasis in original).  Assuming there is otherwise a contractual basis for imposing consolidated arbitration in a multi-party dispute, there must also be contractual basis for the arbitrator-selection method that the decision maker imposes.   So the decision maker in our party-consent hypothetical would have to find a contractual basis under at least one of the arbitration clauses under which R, R1 and R2 collectively agreed to appoint on their behalf only one party-appointed arbitrator, who, along with C’s party-appointed arbitrator, would select a single umpire to preside over a consolidated proceeding.  Otherwise, the decision maker would be imposing on the parties a method of arbitrator selection to which they never agreed. 

Just as courts make the call on arbitrator-selection questions in other contexts, so too should they make them in consolidated-arbitration disputes presenting party-consent issues.   The parties’ rights to choose what decision makers will resolve what disputes is a vitally important issue that has, by statute and treaty, been committed to the courts to decide.  As Circuit Judge Richard A. Posner wrote, “Selection of the decision maker by or with the consent of the parties is the cornerstone of the arbitral process.”  Lefkovitz v. Wagner, 395 F.3d 773, 780 (7^th Cir.), cert. denied, 546 U.S. 812 (2005).  Federal Arbitration Act § 5 provides that, “[i]f in the agreement provision be made for a method of naming or appointing an arbitrator or arbitrators or an umpire, such method shall be followed.  .  .  .”  Article V(1)(d) of the Convention on the Recognition and Enforcement of Foreign Arbitral Awards ( here) provides a defense to recognition and enforcement of an award where “[t]he composition of the arbitral authority or the arbitral procedure was not in accordance with the agreement of the parties.”  And courts will not hesitate to vacate domestic or non-domestic awards if arbitrator selection procedures were not followed.  See, e.g.,  Encyclopaedia Universalis S.A. v. Encyclopaedia Brittanica, Inc., 403 F.3d 85, 91-92 (2d Cir. 2005); Cargill Rice, Inc. v. Empresa Nicaraguense Dealimentos Basicos, 25 F.3d 223, 226 (4^th Cir. 1994); Avis Rent A Car Sys., Inc. v. Garage Employees Union, 791 F.2d 22, 25 (2d Cir. 1986).

As we shall discuss in more detail in Part V.B, we think that in many cases courts will find that there is no express or implied contractual basis for imposing consolidated arbitration on the parties in cases involving party-consent questions.  But there are many variants on how consolidated-arbitration disputes may arise and some arbitration clauses expressly provide for some form or another of consolidated arbitration.  Ambiguities may arise, as they did in Bazzle. 

We think that, at least in certain cases, those ambiguities might be for the arbitrators to resolve, assuming the issues they raise fall within the scope of the parties’ arbitration agreements.  But the court should, at a minimum, determine whether the contract unambiguously forbids or permits consolidated arbitration or is ambiguous or silent on that score.    

Stay tuned for more….

Editor’s Note:  Here’s a list of links for Parts I through V of our Stolt-Nielsen reinsurance-arbitration series: 

Part I, Part II, Part III, Part IV, Part V.A, Part V. B, and Part V. C