Lawyers who litigate generally find this scene particularly amusing because we know firsthand what goes into preparing and delivering an opening (or closing) statement, and Vinny mocks that process and all its formalities.  But more than that, Vinny distills to its essence (seven words, in fact) the central message of just about every argument:  What the other side is saying is simply not accurate.  Yet at the same time, he completely omits the sine qua non of a good argument — a reasoned basis for the conclusion it asks the decision maker to draw. 

Fortunately, neither party in AT&T Mobility, LLC v. Concepcion, No. 09-893, is represented by our fictional hero, Vinny.  Both sides are represented by very able counsel who have fully articulated the bases for their clients’ position in their briefs and argument in the United States Supreme Court. 

One of the key differences between the parties concerns the scope of Federal Arbitration Act Section 2′s savings clause, which saves from preemption state-law “grounds.  .  .  for the revocation of any contract.”  9 U.S.C. § 2 (emphasis added).  According to AT&T Mobility, the Discover Bank rule — unlike the general “shocks the conscience” standard California ordinarily applies to assess whether a contract of whatever kind is unconscionable — is not a “ground” “for the revocation of  any contract,” but a rule that discriminates against certain arbitration agreements and other forum selection agreements vis-à-vis all other contracts.  According to the Concepcions, the Discover Bank rule is simply an application of California’s general unconscionability standard, and, in any event, consistent with the United States Court of Appeals for the Ninth Circuit‘s analysis, the rule is not discriminatory because it “place[s] arbitration agreements with class action waivers on the exact same footing as contracts that bar class action litigation outside the context of arbitration.”  Shroyer v. New Cingular Wireless Serv., Inc., 498 F.3d 976, 990 (9^th Cir. 2007) (citing Discover Bank v. Superior Court of Los Angeles, 36 Cal.4th 148,165-66 (2005)) (emphasis in original). 

When I first began to analyze AT&T Mobility, I thought that the Ninth Circuit’s “equal footing” interpretation made sense.  But as I delved a little deeper, studied Section 2′s text more carefully, reviewed (for the nth time) the Supreme Court’s cases bearing on Federal Arbitration Act preemption, studied the parties’ briefs, and reviewed the argument transcript, I became more and more convinced that the Ninth Circuit’s conclusion about the “equal footing” principle — while catchy, clever and creative — was simply wrong, and would, if adopted by the United States Supreme Court, effectively rewrite Section 2 and undermine Congress’ intent and purposes in enacting the Federal Arbitration Act.  

Were I our intrepid, over-confident and sometimes ethically-challenged hero, Vinny, my comments regarding the Ninth Circuit’s “equal footing” analysis might be summarized in seven words or so.  But Vinny’s approach to legal argument would not be very effective in a case like AT&T Mobility because to understand why the United States Supreme Court should reverse the Ninth Circuit, you really need to delve into the details a bit. 

To that end, I’ve set out to analyze AT&T Mobility in quite some detail, not only for those who believe AT&T Mobility is correct, but also for the benefit of those who do not.  I’d love to hear from anyone who disagrees with my analysis on legal – as distinguished from political or policy-oriented grounds. 

My good friends Karl Bayer and Beth Graham at the Disputing blog have been kind enough to publish my ongoing, multi-part series on AT&T Mobility case, which sets out my analysis.  So far we have published Parts I, II.A, and II.B, and while I have certainly not yet analyzed all of the issues, I have addressed pretty thoroughly the interpretation and construction of Section 2′s savings clause, and how I believe AT&T Mobility’s interpretation and construction best reflects not only Section 2′s text, but also Congress’ intent and purpose.  

Here’s an excerpt from Part II.B of the series, which summarizes some of the key points on that score:

Interpreting the savings clause to mean what it says best reflects Congress’ intent and advances its purposes.  Presumably every Justice would agree that Congress’ principal goal was to abrogate the “ouster” doctrine, at least in cases brought in federal court.  Likewise presumably every Justice would agree that construing the savings clause to save from preemption only state revocation laws applicable to all contracts accomplishes that goal.  If those relatively uncontroversial propositions are true, then – putting aside outcome-based political considerations – all Justices should agree that California must apply exactly the same standard for invalidating a class waiver in an arbitration agreement on unconscionability grounds as it would otherwise apply to invalidate a contract of whatever kind.

The Concepcions, however, contend that the savings clause should be interpreted to save the Discover Bank rule from preemption because it allegedly applies to class waivers in an arbitration clause in the same way it applies to waivers of class action proceedings in litigation.  Thus, a centerpiece of the Concepcions argument – and of those of commentators and amicus curiae that agree with the Concepcions– is the following, slogan-like proposition, endorsed by the Ninth Circuit:  the Discover Bank rule “placed arbitration agreements with class action waivers on the exact same footing as contracts that bar class action litigation outside the context of arbitration.”  Shroyer v. New Cingular Wireless Serv., Inc., 498 F.3d 976, 990 (9^th Cir. 2007) (citing Discover Bank v. Superior Court of Los Angeles, 36 Cal.4th 148,165-66 (2005)).

Like many great slogans, the proposition has a rhetorical ring to it — as well as a ring of truth – but it wilts under scrutiny.  Even assuming the Discover Bank rule is the same one applied to class waivers outside the arbitration context (a question we will explore in one or more future installments), that doesn’t mean it is a rule that is applied to a contract of whatever kind.  Nor does it mean – or even purport to mean – that the Discover Bank rule places an adhesive arbitration agreement with a class waiver on the same footing with all other contracts.

Take, for example, a contract pursuant to which A sells B a tract of land and which is silent on arbitration or litigation.  Nobody would seriously contend that the Discover Bank rule has any application to such a contract, let alone provides any basis for not enforcing it.  Because the Discover Bank rule would render an adhesive arbitration agreement containing a class waiver unenforceable, but would not render our hypothetical, garden-variety real estate contract unenforceable, it places the adhesive arbitration agreement on a very different footing than that garden-variety contract.

But depending on the facts surrounding the formation of our hypothetical real estate contract, perhaps B might have a general defense to enforcement, such as fraud in the inducement or unconscionability.  Assuming the same legal standards apply to this defense as apply to all other contracts under applicable state law, applying that defense to arbitration agreements merely puts arbitration agreements on the same footing as all other contracts (including, of course, our hypothetical real estate contract).

All of this is consistent with a textual construction of Section 2’s savings clause, and serves to reinforce the validity of such a construction.  But there is more:  the Ninth Circuit’s narrow interpretation of the equal footing principle is inconsistent with one of the key goals of the Federal Arbitration Act – the elimination of the “ouster doctrine.”

Recall that the ouster doctrine rendered not only arbitration agreements, but non-arbitration forum selection clauses unenforceable.  In that sense it certainly did not discriminate between forum selection clauses in the arbitration context and forum selection clauses in the litigation context.  And to paraphrase the Ninth Circuit, the ouster doctrine unquestionably “placed arbitration agreements on the exact same footing as forum selection clauses outside the context of arbitration.”

But nobody says that Section 2’s equal footing principle was intended to save the ouster doctrine from preemption.  Since the Ninth Circuit’s narrow interpretation of that principle would do exactly that, it cannot possibly be the correct one from a purposive (or any other) perspective.

.  .  .  . 

The Ninth Circuit’s “equal footing” interpretation essentially echoes the position that [Associate] Justice [John Paul] Stevens unsuccessfully advanced in [Southland Corp. v. Keating, 465 U.S. 1 (1984)] more than 25 years ago.  Indeed, it would support the conclusion – soundly rejected by Southland — that the Federal Arbitration Act does not preempt the no-waiver provision of California’s Franchise Investment Law, because the no-waiver provision, to paraphrase the Ninth Circuit, “places arbitration agreements on the exact same footing as other contracts that purport to waive the protections of the Franchise Investment Law outside the context of arbitration.”

Finally, the Ninth Circuit’s interpretation of the equal footing principle would save from preemption any number of no-waiver rules that apply equally in the arbitration and litigation context.  For example, a state might conclude that, to ensure parties of lesser bargaining power receive a fundamentally fair hearing in a dispute with a more sophisticated party, the party with lesser bargaining power must have access to the same scope of document discovery permitted by state procedural rules, irrespective of whether the dispute is heard in state court or in arbitration.  It might, in turn, pass a statute that declares void against public policy any provision in a contract of adhesion that purports to waive a party’s right to the same scope of document discovery permitted by state procedural rules.

Once again, if the Court adopted the Ninth Circuit’s interpretation of the equal footing principle, this hypothetical state statute would not be preempted by the Federal Arbitration Act.   For it “places arbitration agreements waiving state court document discovery procedures on the exact same footing as contracts that bar such procedures outside the context of arbitration.”

In sum, an analysis of the intent and purpose of the savings clause simply underscores the necessity of interpreting Section 2 according to its plain meaning, and a purposive construction of the savings clause would thus be no different than the one a natural reading of the text requires.

Stayed tuned to Disputing and the Loree Reinsurance and Arbitration Law Forum for further coverage of the controversial AT&T Mobility case.  .  .  .

After reviewing the oral argument transcript a number of times, and listening to the audio, we still believe it more likely than not that AT&T Mobility will prevail.  We’ll develop that thought further in upcoming installments of our Disputing guest post, ”AT&T Mobility LLC v. Concepcion:  Can Discover Bank Withstand Stolt-Nielsen Scrutiny?” (Part I, here).

There have been a number of differing opinions post argument on how the Court will likely rule.  Some believe the argument foreshadows victory for the Concepcions.  Others are not so certain, and still others believe that AT&T Mobility may emerge the victor.  Like all such opinions, they are are really nothing more than educated guesswork, and should be taken with a grain of salt. 

We don’t suggest our take on things is anything more, but we share it for what it is worth.  We think the oral argument was basically a toss-up, and that it mainly confirmed what we already knew or surmised:  That this is a very difficult case, and that the eight Justices who asked questions appear to be split along ideological lines.  We expected no less in light of the 5-3 and 5-4 split decisions in Stolt-Nielsen, S.A. v. AnimalFeeds Int’l Corp., 559  U.S. ___, 130 S. Ct. 1758 (2010); and  Rent-A-Center West v. Jackson, 561 U.S. ___, 130 S. Ct. 2772 (2010). 

The key point on which the argument shed no meaningful light is what Associate Justice Clarence Thomas makes of this case.  Justice Thomas joined the Stolt-Nielsen and Rent-A-Center majority opinions, but those cases, unlike this one, did not concern the preemptive scope of the Federal Arbitration Act. 

Preemption is controversial, and its importance extends far beyond the AT&T Mobility case.    Particularly controversial — and very supportive of AT&T Mobility’s position — is the doctrine of “implied preemption,” also known as “conflict” or “obstacle” preemption. In Federal Arbitration Act cases this doctrine tells us that  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).

But Justice Thomas believes that the implied preemption doctrine is unconstitutional.  See Wyeth v. Levine, 555 U.S. ___, 129 S. Ct. 1187, 1205 (2009) (Thomas, J. concurring) (“implied pre-emption doctrines that wander far from the statutory text are inconsistent with the Constitution.  .  .  .”).  He also believes that Congress intended the Federal Arbitration Act to be a procedural statute that applies only in federal court.  See, e.g., Allied-Bruce Terminix Cos. v. Dobson, 513 U.S. 265 (1995) (Thomas, J., dissenting); Buckeye Check Cashing, Inc. v. Cardegna, 546 US 440 (2006) (Thomas, J., dissenting) (“[I]n state-court proceedings, the FAA cannot be the basis for displacing a state law that prohibits enforcement of an arbitration clause contained in a contract that is unenforceable under state law.”). 

He thus believes that state courts can apply state arbitration law as they see fit, irrespective of whether the result would be different had the case been brought in federal court.  While AT&T Mobility – like Stolt-Nielsen and Rent-A-Center – was brought in federal court, and everybody concedes that the Federal Arbitration Act applies, Justice Thomas remains a strong proponent of federalism.  

Justice Thomas’ deference to state law is problematic for AT&T Mobility.  Perhaps AT&T Mobility’s best argument is that the Federal Arbitration Act impliedly preempts the Discover Bank rule for the reasons set forth in Stolt-Nielsen.   Apparently concluding that the Justices in the Stolt-Nielsen majority – including Justice Thomas —  are the ones most likely to support AT&T Mobility’s position, AT&T Mobility deliberately downplayed the implied preemption issue, although it made clear that it believes the Federal Arbitration Act both expressly and impliedly preempts the Discover Bank rule. 

That was a wise strategy given Justice Thomas’ rejection of implied preemption.  Its wisdom was borne out by what transpired at the argument:  of the eight Justices that asked questions, the four more liberal ones (Associate Justices Ruth Bader Ginsburg, Stephen G. Breyer, Sonia M. Sotomayor and Elena Kagan) appear to be leaning in favor of finding that the Federal Arbitration Act does not preempt the Discover Bank rule, while the four more conservative ones (Chief Justice John G. Roberts, and Associate Justices Antonin G. Scalia, Anthony M. Kennedy, and Samuel J. Alito, Jr.) appear to be leaning in favor of finding that the Federal Arbitration Act preempts Discover Bank.      

That means Justice Thomas is likely to hold the deciding vote, but where he’ll ultimately cast it, nobody knows (at least outside the Supreme Court).  We believe there are equally plausible reasons why he might vote  for or against preemption.  

We will find out whether the Court intends to continue down the same path when it decides AT&T Mobility v. Concepcion next term, a case that raises the question whether California’s Discover Bank  unconscionability rule is pre-empted by the Federal Arbitration Act.  That rule deems unconscionable under California law class-action or class-arbitration waivers where:  (a) “the waiver is found in a consumer contract of adhesion in a setting in which the disputes between the contracting parties predictably involve small amounts of damages”; and (b) “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 Court, 36 Cal. 4th 148, 162-63 (2005) (citing Cal. Civ. Code § 1668). 

The Discover Bank rule is grounded in a California-law principle – embodied in Cal. Civ. Code § 1668 – that “contracts which have for their object, directly or indirectly, to exempt anyone from responsibility for his own fraud.  .  .  are against the policy of the law.”   See Cal. Civ. Code § 1668.  If a company is allegedly engaging in fraudulent acts designed to cheat numerous consumers out of small amounts of money, a class action or class arbitration waiver may, if enforced, effectively act as an exculpatory provision that insulates the company from the consequences of its small scale, but widespread fraud, because the individual, allegedly defrauded consumers have little incentive to pursue separate actions or arbitrations to recoup trivial amounts of damages.  See Discover Bank, 36 Cal. 4th at 162-63.  Any contract that had that effect – whether it is a class action waiver in an arbitration clause, an exculpatory agreement or a contract that simply forbids class actions  – would be unconscionable under the rule.  

In Fensterstock v. Education Finance Partners, No. 09-1562-cv, slip op. (2d Cir. July 12, 2010), the United States Court of Appeals for the Second Circuit suggested one path that the United States Supreme Court might take on Discover Bank preemption.  In an interesting opinion, Senior Circuit Judge Amalya Lyle Kearse, joined by Circuit Judges José A. Cabranes and Chester J. Straub, held that the Discover Bank rule was not preempted by the Federal Arbitration Act.  According to the Second Circuit, California’s  Discover Bank rule “’places arbitration agreements on the exact same footing as contracts that bar class action litigation outside the context of arbitration,’” and for that reason the rule is not preempted by the Act.  Slip op. at 16-17 (quoting Shroyer v. New Cingular Wireless Serv., Inc., 498 F.3d 976, 990 (9^th Cir. 2007) (emphasis in original)). 

On first blush the Second Circuit’s decision seems reasonable.  But there are some important issues lurking beneath the surface that the Supreme Court will need to address when it decides AT&T Mobility. 

In Stolt-Nielsen the Supreme Court, among other things, established certain Federal Arbitration Act “rules of fundamental importance,” which trump inconsistent state law.  (Blogged here.)   One of these is that parties may “specify with whom they chose to arbitrate.”  Stolt-Nielsen, slip op. at 19 (emphasis in original).   And another – the one that controlled the outcome of Stolt-Nielsen – is that  “a party may not be compelled under the FAA to submit to class arbitration unless there is a contractual basis for concluding that the party agreed to do so.”  Slip op. at 20 (emphasis in original).  The Court admonished that it “falls to courts and arbitrators to give effect to these [and other enumerated] contractual limitations, and when doing so, courts and arbitrators must not lose sight of the purpose of the exercise:  to give effect to the intent of the parties.”  Slip op. at 20. 

Application of these rules to an arbitration agreement containing a class-arbitration or class-action waiver would presumably result in enforcement of that waiver as a matter of federal law.  The rule that the parties can choose with whom they arbitrate necessarily preempts any state law or policy that would declare void or unenforceable such an express choice made by the parties to limit the universe of persons with whom they agreed to arbitrate.  And the Discover Bank  rule – for all its reasonableness and good intentions – is just such a rule.

Alternatively, the Stolt-Nielsen rule that affirmative consent — not mere silence – is required for a court or arbitration panel to compel class arbitration strongly suggests that class-arbitration or class-action waivers are irrelevant.  Even if one is excised from the arbitration clause, what is left is usually an arbitration clause that is silent on class arbitration.  But under Stolt-Nielsen courts and arbitrators cannot compel class arbitration in the face of silence.   So the net effect of including such a waiver in a contract that is otherwise silent on class arbitration is zero, which hardly makes the waiver a candidate for nonenforcement under the Discover Bank rule.  

The Supreme Court’s disposition of the American Express Merchants’ Litigation matter suggests that it believes Stolt-Nielsen is relevant to the question whether class arbitration waivers are enforceable or simply irrelevant.  Readers may recall that in May 2009 American Express filed a cert petition in the American Express Merchants’ Litigation.  The Second Circuit had held that an arbitration agreement provision forbidding class-action arbitration was invalid and unenforceable on federal public policy grounds under the circumstances of that case, which involved federal antitrust claims.  See Re American Express Merchants’ Litigation, 554 F.3d 300 (2d Cir. 2009), vacated and remanded sub nom., American Express Co. v. Italian Colors Restaurant, No. 08-1473 (May 3, 2010). 

On May 3, 2010 the Court issued a summary order in American Express Co. v. Italian Colors Restaurant, granting certiorari, summarily vacating the Second Circuit judgment, and remanding it “for further consideration in light of” Stolt-Nielsen.   Justice Sotomayor “took no part in the consideration or decision” of the petition.   See Italian Colors, No. 08-1473 (May 3, 2010) (summary disposition).  It is unclear whether the Court vacated the judgment because it believed the waiver was enforceable or irrelevant, or whether there was some other Stolt-Nielsen-related reason.  

In Fensterstock the Second Circuit apparently did not figure Stolt-Nielsen or Italian Colors into its preemption analysis.  Oddly enough it relied on Stolt-Nielsen for the proposition that the class-arbitration waiver could not be severed from the remainder of the arbitration agreement, because if the class arbitration waiver were removed, the arbitration clause would be silent on class arbitration, which in turn meant that the court could not compel class arbitration.  While that conclusion probably should have led the court to rethink its preemption analysis, instead it led the court to conclude further (and implausibly) that the entire arbitration clause could not be enforced, and that the claimant could pursue a class action in court.  But that reasoning makes little sense because it suggests that an arbitration clause that contains no class-arbitration waiver, and  is simply silent on class arbitration,  would violate the Discover Bank rule.        

The question that will likely arise in AT&T Mobility is whether Stolt-Nielsen’s “rules of fundamental importance” require enforcement of the waiver despite contrary state law governing contracts generally.  If the Court decides to follow the same path it was on this past term, then it might well find that the Stolt-Nielsen rules of “fundamental importance” trump the Discover Bank rule, or render irrelevant both the class waiver and the Discover Bank rule.  But if at least one member of the Stolt-Nielsen/Rent-A-Center majority decides to break ranks, then it could be that the Court adopts an analysis similar to that used in Fensterstock. 

The narrow nature of the Discover Bank rule, coupled with strong public policy considerations against allowing parties to effectively insulate themselves from liability for fraud, could cause such a break in the ranks.  If that turns out to be the case, perhaps the Court will say that the “rules of fundamental importance” are subject to state law defenses applicable to ordinary contracts, and that the Discover Bank  rule constitutes such a defense.  Or the Court might say that the “rules of fundamental importance” are different – or are to be applied differently – in cases involving adhesive contracts.   

Whatever position a majority of the Court may take, the stakes are fairly high.  There has already been a good deal of political fallout resulting from the Court’s arbitration decisions this term, and the practical implications of that fall-out are not entirely clear in terms of whether the Arbitration Fairness Act of 2009 is likely to be passed.  But even if Rent-A-Center does not precipitate legislative action on the Arbitration Fairness Act, a reversal in AT&T Mobility could well be the proverbial straw that broke the camel’s back.  On the other hand, an affirmance in AT&T Mobility — coupled with an adjustment of the “rules of fundamental importance” in the adhesive contract context — might well shift public attention from anti-arbitration legislation on to something more – for lack of a better phrase — fundamentally important.

The opinion following rehearing is substantially the same as the August 31, 2009 opinion, save for a few additional paragraph the majority added to respond further to Perren, J.’s dissenting opinion.  Perren, J.’s dissent was reissued without material change. 

The additional paragraphs the majority added to address the dissenting opinion are set forth for our readers’ convenience below:

We disagree with the dissent’s suggestion that the arbitrator considered the lot-line adjustment evidence in the in limine motion.  In the context of the case, we agree with the discerning comments of our colleagues in Gonzales v. Interinsurance Exchange (1978) 84 Cal.App.3d 58, 63:  ”One cannot ‘consider’ what one has refused to ‘hear.’  Legally speaking the admission of evidence is to hear it, and the weighing of it is to give it consideration.”

The situation here is different than that in Hall v. Superior Court, supra, 18 Cal.App.4th 427.  In Hall, a party wished to reopen the arbitration hearing with additional evidence.  After hearing the party’s offer of proof, the arbitrator announced that his decision would be the same even with the proffered evidence.  The appellate court concluded the arbitrator did not prevent the losing party from fairly presenting his defense.  (Id. at p. 439.)  The trial court’s ruling to vacate the arbitration award was reversed, however, because “[w]here . . . a party complains of excluded material evidence, the reviewing court should generally focus first on prejudice, not materiality.  To find substantial prejudice the court must accept, for purposes of analysis, the arbitrator’s legal theory and conclude that the arbitrator might well have made a different award had the evidence been allowed.”  (Ibid.)  Unlike Hall, the trial court here found on substantial evidence that “[t]he Arbitrator’s refusal to admit these subsequent circumstances directly affected the issue of damages, thereby substantially prejudicing  Defendant’s [Spencer's] ability to dispute the amount of damage suffered by Plaintiffs [the Burlages].”

It may be argued that to avoid the imposition of section 1286.2, arbitrators will simply admit evidence to insulate their decisions from review.  We do not subscribe to this cynical view.  It is through judicial review that the law is shaped and developed.  Arbitrators do not subvert this process because a court might vacate an award.  Arbitrators base their decisions on a careful analysis of the law and facts.  They, like the arbitrator here, are professionals who conduct themselves according to the canons of ethics and the high degree of integrity their profession demands.

Slip op. at 6-7 (opinion following rehearing).

We shall keep readers apprised of any further developments as and when they occur.

Section 10(a)(3) of the Federal Arbitration Act authorizes courts to vacate awards “where the arbitrators were guilty of misconduct.  .  . in refusing to hear evidence pertinent and material to the controversy, or of any other misbehavior by which the rights of any party have been prejudiced.”  California’s arbitration statute says courts “shall” vacate an award where a party’s rights “were substantially prejudiced . . . by the refusal of the arbitrators to hear evidence material to the controversy . . . .”  Cal. Civ. Code § 1286.2(a)(5) (here). 

On August 31, 2009 the California Court of Appeal, Second Appellate District decided Burlage v. Superior Court of Ventura Cty., ___ Cal. App. 4^th ___, slip op. (Cal. App. 2d Dist. Aug. 31, 2009), petition for rehearing granted.  (A copy of the opinion is here.)  At the time we viewed Burlage as an excellent and relatively easy to understand example of how courts should – and do – deal with those relatively rare situations where a party is prejudiced by an arbitrator refusing to hear evidence material to the controversy, whether under the Federal Arbitration Act Section 10(a)(3) or a state law equivalent like California Civil Code Section 1286.2(a)(5).  While we still believe that the court correctly affirmed the trial court decision vacating the arbitration award, the decision has proved to be more controversial than we initially suspected it would be.  

Background 

The facts are fairly straightforward.  A seller and buyer entered into a contract to purchase land.  Seller knew that the land  — including a swimming pool and a fence — encroached on an enjoining property but did not tell buyer.  A dispute arose between the parties concerning the encroachment, and buyer claimed that seller had defrauded it.  The dispute was submitted to arbitration as required by the arbitration agreement in the contract of sale. 

After the escrow closed, but before the arbitration hearing, the title insurer paid the adjoining landowner $10,950 for a lot-line adjustment that gave buyer title to the encroaching land.  But despite this buyer sought damages for alleged diminution in value of the property, and for the cost of moving the pool and fence that were situated on previously encroaching land that buyer now owned because of the lot-line adjustment. 

Seller sought to introduce evidence of the lot-line adjustment, and buyer moved to exclude it.  Buyer said that damages must be ascertained from the date of the escrow closing, a contention the seller disputed.  The arbitrator granted the motion, ruling that damages were to be fixed as of the date of the escrow closing, and excluded evidence of the effect of the lot-line adjustment had on buyer’s damages claim. 

At the hearing buyer’s experts testified that, as of the date of the closing, it would have cost approximately $100,000 to fix the problem.  The arbitrator’s prior ruling precluded the seller from rebutting that expert testimony by showing either:  (a) that there were no damages; or (b) that damages were limited to the amount of money the title company paid to fix the encroachment problem.  After the hearing the arbitrator ruled that:  (a) seller knew that the pool and fence encroached on adjoining land; (b) seller did not disclose this fact to buyer; and (c) the encroachment materially affected the property’s value.  The arbitrator awarded buyer $552,750 in compensatory damages, $250,000 in punitive damages, and $732,570 in costs and attorney fees. 

The trial court vacated the award and the Court of Appeal, Second District, affirmed 2-1.  The court held that the evidence the seller sought to introduce was material, its exclusion was prejudicial and vacatur was therefore warranted under Cal. Civ. Code § 1286.2(a)(5):  

The arbitrator excluded evidence that the title company paid the cost of the lot-line adjustment and purchase of the encroachment. The arbitrator did not state his reasons for the evidentiary ruling, but likely it stemmed from his earlier ruling that damages are fixed at the date escrow closed.

The question whether the arbitrator was right or wrong about the proper date from which to measure damages arguably is not subject to judicial review. But it is self-evident that his ruling disallowing evidence that the title company solved the problem through a modest payment to the country club was more than a mere erroneous evidentiary ruling. The ruling substantially prejudiced Spencer and undermined the fundamental principle embodied in section 1286.2, subdivision (a)(5) that an arbitrator must consider material evidence.

Evidence of an Absolute Defense – The Problem is Fixed

What could be more material than evidence that the problem was “fixed” and there are no damages?  Yet, the Burlages presented expert testimony about the effect of what had become a nonexistent encroachment.  Their experts testified about the cost to move a pool and fence, neither of which had to be moved.  Spencer was not even permitted to refute the Burlages’ expert who opined that the encroachment reduced the value of the property $100,000.  Spencer could not show that the title company solved the encroachment issue through a payment of approximately one-tenth that amount.

Without this crucial evidence, the arbitration assumed the nature of a default hearing in which the Burlages were awarded $1.5 million in compensatory and punitive damages they may not have suffered. An arbitrator must consider this evidence to make an informed decision.

Slip op. at 5-6. 

Like many things in life – and particularly, in law – Burlage is not as straightforward as it first appears.   The dissent (Perren, J.) reasoned that the exclusion of evidence of post-closing events was a natural consequence of the arbitrator’s ruling that evidence of mitigation of damages was not permitted in a land fraud case, which meant that seller was not prejudiced.  See Slip op. at 1 (dissenting opinion).  That ruling was not subject to judicial review, as the majority acknowleged, albeit equivocally.  Slip op. at 2 (dissenting opinion).  To find prejudice, said the dissent, the court must (a) accept the arbitrator’s legal theory that damages must be ascertained as of the date of the closing without evidence of mitigation; and (b) nevertheless conclude that ”the arbitrator might well have made a different award had the [lot-line-adjustment]  evidence been allowed.”  Slip op. at 3 (dissenting opinion; emphasis deleted).    Because the dissent believed  the evidence was probative only as respects mitigation of damages, and because such evidence was inadmissible under the legal theory adopted by the arbitrator, there was no basis for finding that the arbitrator would have reached a different conclusion had it considered the evidence.  See Slip op. at 3 (dissenting opinion). 

Critical Analysis

There is definitely a tension in Burlage between the limited role of a court in reviewing arbitration awards and the need to protect parties from prejudice resulting from the exclusion of evidence material to the controversy.  Veteran-blogger Victoria Pynchon of Settle-It-Now has written some nice posts about this tension.  (Posts here, here and here)  And the Court of Appeal has granted a rehearing in the case.  (See Victoria Pynchon’s post here.) 

But we think that the outcome was correct and that the trial court decision should be affirmed on rehearing.  The case is really not about the mitigation of damages, nor is it about the fact of damages.  It is really about the amount of damages. 

Let us give the arbitrator the benefit of doubt, and assume that:   (a) the fact of damages is to be established as of the escrow closing;  and (b) applicable law does not permit evidence of mitigation of damages post closing.  No doubt that the fact of damages was established:  at the time of the escrow closing, the property encroached on adjoining property.  The question boils down to amount:  what would it have cost to fix the encroachment as of the date of the closing? 

Evidence of what subsequently transpired was material to the controversy over the amount of damages.   The amount the title company actually paid the adjoining landowner for the lot-line adjustment after the closing  is highly probative of the amount it would have cost as of  the closing.  If the title company was able to resolve the encroachment problem for approximately $11,000 shortly after the closing, then it is more probable than not that buyer could have done the same thing at the time of the closing, even if it did not have title insurance.

The exclusion of the lot-line adjustment was undoubtedly prejudicial to seller.  Even when, to paraphrase the dissent,  we “accept for the purposes of analysis, the arbitrator’s legal theory,” it is easy to “conclude that the arbitrator might well have made a different award had the evidence been allowed.”   Slip op. at 3 (dissenting opinion).  Had the lot-line-adjustment evidence been allowed, the arbitrator might well have concluded that buyer’s damages as of the date of closing attributable to diminution in the value of the property were approximately $11,000, not the $100,000 the buyer’s experts testified they were, and certainly not the $552,750  the arbitrator awarded.  And given the reduction in the amount of compensatory damages, the arbitrator might not have awarded punitive damages, or might have awarded much less than $250,000. 

Because the evidence was material to, at a minimum, the amount of damages, and because prejudice is, for all practical purposes, self-evident, we believe that the Second Appellate District should affirm the trial court on rehearing.  It will be interesting to see what actually happens, and whether this case ultimately ends up before the California Supreme Court.  And if this case goes back to the arbitrator or a new arbitrator, it will be interesting to see if the arbitrator will ignore economic reality and award some amount of damages to the buyer even though any amount would be a windfall, albeit one that the law apparently sanctions.  

We shall keep readers apprised of developments as and when they occur.

EDITOR’S NOTE:  On October 20, 2009 the California Court of Appeal issued its opinion on rehearing, which affirmed the trial court’s judgment vacating the award.  See our update, here.

Under the Federal Arbitration Act and federal labor law, arbitrators can decide arbitrability questions subject only to deferential review, provided the parties “clearly and unmistakably” delegate that power to them.  California’s state arbitration law follows this familiar federal rule. 

On June 11, 2009 the California Court of Appeal, Fourth District, Division 3, held that the parties to an arbitration agreement did not “clearly and unmistakably” agree to arbitrate arbitrability by incorporating the Commercial Rules of the American Arbitration Association into their contract, because at the time the parties agreed to arbitrate, the rules were silent on whether arbitrators could decide arbitrability questions.  See Gilbert Street Developers, LLC v. La Quinta Homes, LLC, ___ Cal. Rptr.3d ___, slip op (Cal. App. 4^th Dist. June 11, 2009) (certified for publication) (copy available here).  The Court so held even though the parties agreed that the arbitration would be “conducted in accordance with the Rules of the American Arbitration Association existing at the date [of the arbitration].  .  .  . ,” and by the date of the arbitration the rules had been amended to provide expressly that the arbitrators had the authority to determine their own jurisdiction.  See slip op. at 2-3.  The Court also held that the operation of a “buyout” clause in the parties’ agreement did not fall within the scope of the parties’ arbitration clause because it involved discretionary matters, which were expressly excluded from arbitration.  See slip op. at 15-16. 

Background

In July 1998 Tone Yee Investments and La Quinta Homes formed a limited liability company, Gilbert Street Development, to acquire and develop certain properties.  Prince Properties, controlled by Tone Yee, became a member of Gilbert in February 1999.  Gilbert’s operating agreement contained an arbitration clause that provided, in pertinent part: 

Any controversy or dispute arising out of or relating to this agreement or the breach thereof (exclusive of matters which are expressly within the discretion of the Members) shall be settled by binding arbitration.  Such arbitration.  .  .  shall be conducted in accordance with the Rules of the American Arbitration Association existing at the date thereof.  .  .  . 

The operating agreement also contained a “buyout” clause, which will be discussed in more detail below.  Essentially, it enabled a member that invoked the clause to either buy out another member’s interest, or have another member buy out the interest of the member invoking the clause. 

In 1998, when Yee and La Quinta formed Gilbert, and in 1999, when Prince joined Gilbert, the AAA Commercial Rules were silent on whether an arbitrator had the power to decide his or her own jurisdiction.  In September 2001, however, the AAA adopted Rule 8-(a), which provided that arbitrators “shall have the power to rule on.  .  .  jurisdiction, including any objections with respect to the existence, scope or validity of the arbitration agreement.”  (Rule 8-(a) was later recodified as Rule 7 of the AAA Commercial Rules.)

In 2008 a dispute arose between Yee and Prince (the “Lee Parties”) and La Quinta over a third-party offer to purchase one of Gilbert’s properties for $13.3 million.  The Yee Parties wanted to sell, but La Quinta did not, which prompted the Lee Parties to invoke the buyout clause and demand arbitration.  La Quinta objected to the arbitration demand, contending:  (a) the buyout clause was a matter within the “discretion” of the parties and therefore was not subject to arbitration; (b) the arbitrators were not authorized to decide their own jurisdiction, that is, whether the buyout clause was a proper subject of arbitration.   

An arbitration hearing was held later in 2008, but La Quinta did not appear.  The arbitrators determined that they had the power to decide their own jurisdiction and made the following rulings: 

1. Gilbert owed Tone Yee more than $29 million;
2. The Yee Parties properly invoked the buyout provision;
3. La Quinta is no longer a member of Gilbert;
4. Gilbert could sell the property;
5. $13.3 million was a fair price for the property;
6. La Quinta was not entitled to any of the proceeds from the sale of the property; and
7. La Quinta had to execute all documents necessary to relinquish its interest in Gilbert and effectuate the sale of the property.

The Yee Parties moved to confirm the award, but the trial court vacated it on the ground that the arbitrators did not have the power to determine their own jurisdiction.  The trial court said that the AAA rules were silent in 1998 on whether the arbitrators could determine their own jurisdiction and “‘the possibility of a change in the [AAA] Rules is not sufficient to show a clear and unmistakable intent by the parties that the arbitrator would decide issues of arbitrability at the time the agreement was entered.’”  See slip op. at 4.  The trial court also held that the buyout clause procedure was discretionary and thus not subject to arbitration.   The Yee Parties appealed. 

Did the Parties Clearly and Unmistakably Delegate to the Arbitrators the Power to Determine their own Jurisdiction? 

The Court held that, under the circumstances of this case, the parties’ incorporation of the AAA Rules did not provide clear and unmistakable evidence that the parties delegated to the arbitrators the power to determine their own jurisdiction.   First, the Court reviewed the the evolution of the “clear and unmistakable rule” from the Steel Workers Trilogy through AT&T Technologies, Inc. v. Communications Workers, 475 U.S. 643, 648-49 (1986) and First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 944-45 (1995), and concluded that the purpose of the rule was to ensure that the parties had thought about and focused on the issue of who – judge or arbitrator – would decide arbitrability. 

Second, noting that “the hard part” of the clear and unmistakable rule “is applying it,” the Court briefly examined two California appellate court cases that held that incorporation of the AAA Commercial Rules satisfied the rule, but concluded that those cases “represent[ed] the outer limits of the use of incorporation by reference” to establish a clear and unmistakable intent that the arbitrators would decide arbitrability.  See  slip op. at 9.  In those cases, observed the Court, the pertinent AAA Commercial Rule was in existence at the time the parties incorporated the rules by reference, and “the parties could go look up the AAA rules to which they were agreeing before hand, and see that .  .  . they were conferring on arbitrators the power to decide if a dispute was arbitrable in the first place.”  Id.  (emphasis in original)  Declining to extend those cases to the situation before it, the Court said that “[t]o go beyond the incorporation of an existent rule and allow for the incorporation of a rule that might not even come into existence in the future.  .  . contravenes the clear and unmistakable rule.”  Id.  (emphasis in original)  Far from meeting the clear and unmistakable requirement, “[i]ncorporating the possibility of a future rule by reference simply doesn’t even meet the basic requirements for a valid incorporation by reference under simple state contract law.”   Id.  (emphasis in original): 

To allude to that old medieval con game from which we get the expression ‘pig in a poke’ – where an unsuspecting buyer would buy what he or she thought was a pig in a bag only to later discover that it was an inedible cat or rat – in [the other two California appellate court cases].   .  . there was at least some thing in the bag that the parties could look at.  Here, by contrast, the bag was empty at the time of the transaction and might or might not, be later filled with a pig.  Or a cat or rat or, for that matter, nothing. 

Slip op. at 10.  (emphasis in original)

Third, the Court found “instructive” a split in the federal courts over whether incorporation of the NASD Rules (now, the FINRA Rules) satisfied the clear and unmistakable rule.  Those cases considered NASD Rule 35, which stated:    

The arbitrators shall be empowered to interpret and determine the applicability of all provisions under this Code and to take appropriate action to obtain compliance with any ruling by the arbitrator(s).  Such interpretations and actions to obtain compliance shall be final and binding upon the parties.

The Court observed that the majority of the federal circuit courts of appeals held that incorporating the NASD Rules, including Rule 35, did not satisfy the clear and unmistakable rule, while a minority of courts held that such incorporation demonstrated the requisite clear and unmistakable intent.  See slip op. at 10; cf. Miller v. Flume, 139 F.3d 1130, 1134 (7^th Cir. 1998) (majority rule) with Painewebber Inc. v. Bybyk, 81 F.3d 1193, 1199 (2d Cir. 1996) (minority rule).  The Court found the cases espousing the majority rule to be persuasive, whereas the minority rule cases did “not focus on what First Options made explicit (and AT&T had earlier implied), about the importance of the parties specially focusing on the issue.”   Slip op. at 12.  (emphasis in original)  The minority rule cases simply reasoned ”that the parties agreed that all disputes would be arbitrated between them, and jurisdiction to decide jurisdiction is necessarily included in the category of all disputes.”  Slip op. at 11.   

The majority rule cases emphasized what the Court considered to be the key to the clear and unmistakable rule:  the need for the parties to have actually have considered and focused on whether they were agreeing to alter the ordinary allocation of power between courts and arbitrators.  Here, from the standpoint of ordinary contract law, the parties clearly and unmistakably took the risk that the AAA Commercial Rules might one day provide that the arbitrators have the power to determine their own jurisdiction.  But in the Court’s view that was not enough.   To satisfy the clear and unmistakable rule, the parties, at the time of contracting, had to have evidenced their intent in no uncertain terms that the arbitrators should have the power to determine their own jurisdiction.   But query what the result would have been if  there was clear and unmistakable extrinsic evidence that:  (a) the parties were aware that there was a risk that the AAA Commercial Rules might one day provide that the arbitrators would have the power to determine their own jurisdiction; and (b) after carefully considering the risk, the parties were willing to take it by agreeing to be bound by whatever version of the AAA Commercial Rules happened to be in effect at the time an arbitration was commenced?   

Was the Buyout Clause within the Scope of the Parties’ Arbitration Agreement? 

Having concluded that arbitrability was a matter for the Court to decide, the Court  considered whether the arbitrators had the authority to decide a dispute that turned on the buyout clause.  La Quinta contended, and the Court agreed, that the operation of the buyout clause involved matters within the parties’ discretion and therefore was not subject to arbitration. 

The arbitration clause exempted from arbitration “matters which are expressly within the discretion of the Members.”  Quoting the Oxford English Dictionary, the Court said that “matters” are the “stuff of which a thing is made,” and in the context most closely related to a contract, it meant “Material for expression, something to say.”  The Oxford English Dictionary defined “discretion” as “the action of separating or distinguishing, or the condition of being distinguished or disjunct; separation, disjunction, distinction.”  See slip op. at 13. 

The “matters” the Yee parties wanted to arbitrate were its claims that:  “(a) it properly exercised its rights under the buy-out clause[;] and (b).  .  . La Quinta must either (i) pay $1.3 million to the Yee parties or (ii) transfer its entire interest in the company to the Yee parties.”    See slip op. at 13.  (emphasis in original).  But the rather lengthy buyout clause – fully reproduced in the Court’s opinion – provided that “[i]n the event of a dispute among the Members which cannot be resolved, then either Member (“electing member”) may elect to either buy the other Member’s Interest or sell its own Interest to the other Member as follows: .  .  .  .”  Id. (emphasis supplied by the Court)  What followed was a detailed procedure for effectuating the buying or selling of a member’s interest, which conferred upon each party a good deal of discretion to choose how the sale or purchase would take place.  The last paragraph of the clause said:  “If the Other Member fails to elect to either buy or sell pursuant to the Offer within the prescribed time period, the Electing Member, at its option, may (i) continue the Company, or (ii) elect within thirty days to buy the interest of the Other Members pursuant to the Offer.”   Slip op. at 15.  (emphasis supplied by the Court)

The Court reasoned that “[a] simple binary choice as here (should I buy or should I sell?) qualifies under the ordinary person’s definition of  discretion.  .   .  .”   The Yee parties’ “petition identified matters which necessarily involve member choice:  whether the Yee parties properly invoked the buy-out clause in the first place, and, if they did, who has in effect elected to buy whom out, and for what.”   Slip op. at 16.   The arbitrators, however, essentially made all of those choices for La Quinta, thereby ruling on matters that were within La Quinta’s discretion and outside the scope of the arbitration clause.

We also understand (but have not independently verified) that Mr. Ringgenberg, who assumed the defense of the arbitration, was not a licensed attorney.  Ordinarily, corporate officers not licensed to practice law cannot lawfully represent corporations pro se.  Whether, and if so, to what extent, JAMS was aware that Mr. Ringgenberg was unlicensed (assuming he was unlicensed), and concluded that his representation of iFreedom was lawful,  is unclear to us.  It is also unclear to what extent the State Bar of California would consider such representation to be unlawful or simply a matter within the discretion of the ADR provider.   Whatever the facts and governing legal principles, from the standpoint of iFreedom and its shareholders, this case arguably demonstrates that allowing non-lawyer corporate officers to represent their corporations is not only inadvisable, but perhaps also should be the subject of more stringent and active regulation.  

For readers wishing to learn more about this award, we recommend reading Victoria Pynchon’s follow-up post on the subject (here), which includes a link to a National Law Journal interview of Alston & Bird partner Michael D. Young, who practices company-side employment law.  Mr. Young has also written two posts on the subject (here and here), and prominent employee-side lawyer Ellen Simon has written an interesting and informative  piece, here.  

Stay tuned….

The award arose out of an employment dispute between Paul Chester, the former chief operating officer of  iFreedom Communications, Inc., and iFreedom and its founder, Timothy Ringgenberg.  Mr. Chester claimed, and JAMS arbitrator William F. McDonald, a retired judge, agreed, that iFreedom did not receive commissions, back wages and other benefits due him under his employment agreement, and that he was fired without cause after he confronted his employer about this.  The compensatory component of the award is roughly $1 billion, which Arbitrator McDonald trebled based on iFreedom’s alleged bad faith.  The award is quite lengthy (27 pages), and provides a detailed breakdown of the various claims and corresponding damages.  The award states that the damages are ” appropriate to punish and make an example of defendants.”  (Query whether “making an example of Defendants” is a proper subject of private arbitration. )

Apparently, iFreedom fired its outside counsel midway through the arbitration, and Mr. Ringgenberg took over the defense.  iFreedom apparently did not appear at the final arbitration hearing, which might, depending on the facts and applicable law, raise waiver issues.  Judge Teresa Sanchez-Gordon confirmed the award, and as far as we know, did not issue a written opinion.  Presumably, there will be an appeal, unless the parties reach a settlement.  

Assuming there is an appeal, this is definitely a case to watch.  We shall keep readers advised of developments as and when they occur. 

As a side note, the Arbitration Fairness Act of 2009, if passed, would render unenforceable pre-dispute arbitration agreements requiring arbitration of employment disputes, such as Mr. Chester’s dispute with iFreedom.  (Our posts on the Arbitration Fairness Act of 2009 can be found here.)  It is unclear to us whether a court would have issued an award of this magnitude based on the same facts, although we tend to think not.   And even if it did, it would have to withstand the scrutiny of at least one — and perhaps, two – appellate courts.   Both the House and Senate versions of the Arbitration Fairness Act are predicated on the assumption that arbitration of employment disputes is unfair.  Somehow, we doubt Mr. Chester would agree!