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….

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.  .  .  .

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.

As we discussed nearly four months ago Rent-A-Center concerns an important “who” question that arises in unconscionability cases:  When the parties clearly and unmistakably agree that the arbitrators will decide arbitrability questions, who gets to decide whether the arbitration clause is unenforceable on unconscionability grounds? 

We think the question answers itself.  But the Ninth Circuit, in a 2-1 decision, held that the court decides the unconscionability question irrespective of the parties clearly expressed intent to the contrary.  We argued that the Ninth Circuit should have applied a severability analysis of sorts, and referred the unconscionability question to the arbitrators.  The ”Analysis” section of our prior post is reprinted in pertinent part below:  

There is logic to the rule adopted by the majority 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.

 We shall keep readers apprised of developments as and when they occur.  It will be interesting to see how the United States Supreme Court decides this case.

We have explained in prior posts the First Options/AT&T Technologies rule that arbitrators get to decide arbitrability when the parties clearly and unmistakably so agree.  (See, e.g., here and here.)  That’s all well and good, but what happens when:  (a)  two parties sign an arbitration agreement which says, among other things, that the arbitrators shall decide any claim, including any claim concerning the applicability, formation or enforceability of the arbitration agreement; and (b) despite that clear and unmistakable agreement to arbitrate arbitrability, one of the parties challenges the arbitration agreement in court on unconscionability grounds?      

That is, for all practical purposes, what happened in Jackson v. Rent-A-Center West, Inc., ___ F.3d ___, slip op. (9^th Cir. Sept. 9, 2009) (here).  And the United States Court of Appeals for the Ninth Circuit ruled 2-1 that the court gets to decide the question. 

II.            Background

Rent-A-Center arose out of a stand-alone arbitration agreement signed by  an  employer and the employee. The agreement expressly included discrimination claims among those that were arbitrable.  The agreement also expressly delegated arbitrability questions to the arbitrators: 

The Arbitrator, and not any federal, state, or local court or agency, shall have exclusive authority to resolve any dispute relating to the interpretation, applicability, enforceability or formation of this Agreement including, but not limited to any claim that all or any part of this Agreement is void or voidable.

The employee brought suit in the United States District Court for the District of Nevada,  alleging race discrimination and retaliation under 42 U.S.C. § 1981.  The Employer moved to dismiss, contending that the parties agreed to arbitrate the employee’s claims.  The employee opposed the motion on the ground that the stand-alone arbitration agreement was unconscionable under state law.  He said that it was substantively unconscionable because it was one-sided as far as the claims coverage and discovery provisions were concerned, and required the parties to share equally the arbitrator’s fee.  He said it was procedurally unconscionable because the contract was a take-it-or-leave-it condition of employment.  The employer argued that the parties had clearly and unmistakably agreed to arbitrate arbitrability, and that the arbitrator must decide the unconscionability issue.

The District Court agreed with the employer, holding that the agreement “’clearly and unmistakenly provides the arbitrator with the exclusive authority to decide whether the Agreement to Arbitrate is enforceable’” and that “’the question of arbitrability is for the arbitrator.’”  Slip op. at 4 (quoting District Court).  The District Court also held that, even were it to decide the merits of the unconscionability challenge, the employee had not shown that the agreement was substantively unconscionable. 

III.            The Ninth Circuit’s Decision

On appeal the Ninth Circuit reversed, and remanded to the District Court to determine whether the coverage and discovery provisions of the agreement were substantively unconscionable.  On the threshold issue of who gets to decide unconscionability, the Court held that “where, as here, a party challenges an arbitration agreement as unconscionable, and thus asserts that he could not meaningfully assent to the agreement, the threshold question of unconscionability is for the court.”  Slip op. at 11.  The Court said that the employee’s unconscionability challenge concerned not what the arbitration agreement said, but whether he assented to it in the first place:     

Jackson does not dispute that the language of the Agreement clearly assigns the arbitrability determination to the arbitrator. What he does dispute, however, is that he meaningfully agreed to the terms of the form Agreement to Arbitrate, which he contends is procedurally and substantively unconscionable.  Jackson argues that, in light of the parties’ unequal bargaining power, the fact that the Agreement was presented as a non-negotiable condition of his employment, and the absence of any meaningful opportunity to modify the terms of the Agreement, he did not meaningfully assent to the Agreement.

Slip op. at 7-8.  (quotations omitted). 

Noting that the employer argued that the court should limit its inquiry to the language of the contract when determining whether the parties clearly and unmistakably agreed to arbitrate arbitrability, the Court said that was not what the Supreme Court had in mind in First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938 (1995):   

First Options indicates that the presumption—that courts determine whether parties agreed to arbitrate—can only be overcome with “clear and unmistakable evidence” of such an intent. It did not suggest, however, that where arbitration provisions—unlike other contractual provisions—are concerned, clear contractual language is enforceable per se.  Rather, the Court stated that ‘[w]hen deciding whether the parties agreed to arbitrate a certain matter (including arbitrability), courts generally . . . should apply ordinary state-law principles that govern the formation of contracts.”  The Court explained that “[j]ust as the arbitrability of the merits of a dispute depends upon whether the parties agreed to arbitrate that dispute, so the question ‘who has the primary power to decide arbitrability’ turns upon what the parties agreed about that matter.” First Options, then, directs that as a threshold matter the court must decide—by applying “ordinary state-law principles”—whether the parties agreed to arbitrate arbitrability.

Slip op. at 8-9  (quoting First Options, 514 U.S. at 943 & 944 (emphasis added by Ninth Circuit)) (citations omitted). 

On the merits, the Court noted that Nevada law required that a person challenging an agreement on unconscionability grounds must demonstrate both substantive and procedural unconscionability.  While there was apparently no dispute that the agreement was procedurally unconscionable – it was nonnegotiable – the District Court considered and rejected only one of the employee’s three arguments for substantive unconscionability:  that the agreement was substantively unconscionable because it required the parties to share arbitration costs equally.  While the Ninth Circuit affirmed this finding, it remanded to the District Court to determine whether the agreement was unconscionable because its (a) claims coverage and (b) discovery provisions were one-sided.  Slip op. at 11-12.

The dissent (Hall, J.) said that “what we have.  .  .  is an arbitration agreement more favorable than most and unconscionability allegations that are thinner than most.”  Slip op. at 14.   According to the dissent, “the majority’s opinion will send this case (not to mention all those run-of-the-mill ones) to a mini-trial in the district court to determine an agreement’s validity based on just the bare allegation of unconscionability, even when the contract language “clearly and unmistakably” chooses a different forum for that question.”  Slip op. at 15 (emphasis in original).  This said the dissent “makes it difficult to understand what the Supreme Court meant when it said that, although the general rule gives the threshold question of arbitrability to courts, parties may provide for the arbitrator to decide the question instead if they do so clearly and unmistakably.”  Slip op. at 15 (citation and quotation omitted). 

The dissent concluded that the majority expanded the role of the district court beyond what was envisioned in First Options:  “[T]o the extent the district court has a role to play here, it should certainly be a more limited one than the majority envisions, perhaps permitting courts to remain attuned to well-supported claims of unconscionability or the potential that arbitration might be illusory, while still resolving any doubts as to what the parties agreed in favor of arbitration.”  Slip op. at 16-17 (citations and quotations omitted; emphasis in original). 

IV.            Analysis

There is logic to the rule adopted by the majority 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.  

In Rent-A-Center the unconscionability challenge was not directed at the parties’ agreement to arbitrate arbitrability.  Under applicable Nevada law, the employee had to demonstrate both procedural and substantive unconscionability.  Procedural unconcionability addresses the question whether the agreement was a take-it-or leave it proposition — whether the employee basically had no choice but to agree to it as written — while substantive unconscionability addresses whether there are provisions in the contract that are unfair.  Substantive unconscionability is a “no-harm, no foul” requirement; the law may be concerned about enforcing adhesion contracts, but only when they are unfair.

The Court said that a question of the employee’s assent to the arbitration agreement was presented “in light of the parties’ unequal bargaining power, the fact that the Agreement was presented as a non-negotiable condition of his employment, and the absence of any meaningful opportunity to modify the terms of the Agreement.  .  .  . “   Slip op. at 7-8.  Yet  these considerations — if true — merely establish procedural unconscionability, which means the contract was one of adhesion.  But in the absence of a showing that the agreement contains substantively unconscionable terms, that adhesion contract – including the parties’ clear and unmistakable agreement to arbitrate arbitrability —  is fully enforceable under Nevada law.  Thus, the Court’s assumption that these considerations undermined the enforceability of the agreement to arbitrate arbitrability — or even the remainder of the arbitration agreement — was not well grounded. 

Instead, the Court should have considered whether the agreement to arbitrate arbitrability was in and of itself unconscionable.  In Rent-A-Center the substantive unconscionability issue boiled down to this:  were the claims-covered clause and discovery provisions one-sided?   But even if the answer to that question were “yes,” that does not mean the clear and unmistakable agreement to arbitrate arbitrability was unconscionable.   The claims coverage and discovery provisions are not essential elements of the agreement to arbitrate arbitrability, and their alleged unconscionability should therefore not have been treated as undermining the enforceability of that agreement.  

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.