Introduction: Assignment and the Separability Doctrine
Suppose A and B enter a contract imposing mutual obligations on them. The contract contains an arbitration agreement requiring arbitration of all disputes arising out of or related to the contract. The contract does not purport to prohibit assignment, and the parties’ rights under the contract are otherwise capable of assignment.
A assigns to assignee C its rights to receive performance under the contract. B commences an action against A under the contract and A demands arbitration. B resists arbitration, arguing that A has assigned to C its right to enforce the contract (we’ll call it a “container contract” because it contains an arbitration agreement) and thus there is no longer any arbitration agreement that A can enforce against B. Judgment for whom?
In Sanders v. Svannah Highway Auto Co., No. 28168, slip op. (July 26, 2023), the Supreme Court of North Carolina said that, under the Federal Arbitration Act’s “separability” doctrine, the claim that the contract—including the arbitration agreement— could no longer be enforced was an issue that concerned the enforceability of the container contract as a whole, not the enforceability of the arbitration agreement specifically. And because the assignment concerned only the continued existence of the container contract, and not a claim that the container contract was never formed, the exception to the separability doctrine under which courts get to decide whether a contract has been concluded did not apply.
Accordingly, explained the South Carolina Supreme Court, it was for the arbitrator to decide what effect, if any, the assignment had on A’s right to enforce the container contract, including the arbitration agreement.
Sanders: Background
The contract in Sanders was an installment sales contract for the purchase of a vehicle by buyer. The dealership assigned the contract to a bank. The installment sales contract contained an arbitration clause, which stated:
Any claim or dispute, whether in contract, tort, statute or otherwise (including the interpretation and scope of this Arbitration Clause, and the arbitrability of the claim or dispute), between you and us or our employees, agents, successors or assigns, which arises out of or relates to your credit application, purchase or condition of this vehicle, this contract, or any resulting transaction or relationship (including any such relationship with third parties who do not sign this contract) shall, at your or our election, be resolved by neutral, binding arbitration and not by a court action.
Slip op. at 2-3.
The buyer made various claims against the dealership and its representatives, including an assertion that those persons had misrepresented the buyer’s income to the bank, which resulted in the bank accepting a contract that imposed a monthly payment on the buyer that was 37% of buyer’s actual pre-tax income.
The dealership moved to compel arbitration and the buyer opposed the motion, claiming that the assignment extinguished the dealership’s right to enforce the arbitration agreement in the container contract. The trial court and the intermediate court of appeals determined that the question whether the matter was arbitrable was for the court, and the matter was not arbitrable because the dealership had assigned the contract to the bank and therefore could no longer enforce the arbitration agreement. The South Carolina Supreme Court reversed. Slip op. at 2, 13.
The Court’s Decision: Separability Doctrine Governs
Separability Doctrine
Rather than rule on whether the contract clearly and ambiguously delegated arbitrability questions to the arbitrators, the Court premised its decision on the separability doctrine of Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 404-06 (1967); Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, 444-46, 448-49 (2006); and Rent-A-Ctr., W., Inc. v. Jackson, 561 U.S. 63 (2010). We have discussed the separability doctrine in prior posts. (See, e.g., here and here.)
The so-called doctrine of “separability” (sometimes referred to as the doctrine of “severability”) was first articulated by the U.S. Supreme Court in Prima Paint, and reaffirmed in Buckeye Check Cashing. Grounded in Federal Arbitration Act Section 2, the separability doctrine permits courts to compel arbitration of fraudulent inducement claims and defenses—and other contract-validity or contract-enforceability claims and defenses—that fall within the scope of a broad arbitration clause, provided that they relate to the contract as a whole, and do not specifically and independently relate to the arbitration agreement itself (and thus give rise to a bona fide question of arbitrability within the meaning of FAA Section 2).
The doctrine of separability helps implement the Federal Arbitration Act’s enforcement command by preventing courts from being inundated with non-arbitration-agreement-specific contract enforceability and validity claims and defenses. That is important not only to preserve arbitration as a viable alternative to litigation, but also, and relatedly, to discourage parties from asserting contract-enforceability or contract-validity defenses as a pretext to delay or avoid arbitration of disputes for purposes of obtaining an unwarranted strategic advantage in the dispute resolution process.
There is an important exception to the separability doctrine: if the defense is that the container contract never existed (and thus was never concluded) then the question whether the parties agreed to arbitrate the dispute is for the Court. See, e.g., Buckeye, 546 U.S. at 444 n.1 (“The issue of the contract’s validity is different from the issue whether any agreement between the alleged obligor and obligee was ever concluded.”); Henry Schein, Inc. v. Archer & White Sales, Inc., 139 S. Ct. 524, 530 (2019) (“To be sure, before referring a dispute to an arbitrator, the court determines whether a valid arbitration agreement exists.”) (citation omitted).
Separability: Arguments on Appeal
The dealer did not request the Court to reverse the lower appellate court’s finding that the assignment extinguished the buyer’s right to compel arbitration. While it argued that the assignment of a container contract does not always divest the assignor’s right to compel arbitration under the Federal Arbitration Act, the seller requested the Court to hold only that the question of whether the assignment had such an effect was a “gateway question” to be decided by the arbitrators.
The seller’s appeal made two principal arguments: (1) the gateway question was for the arbitrator because the buyer did not argue that the arbitration agreement itself was invalid or unenforceable (a separability argument); and, alternatively, (2) the arbitration agreement contained a delegation provision under which the parties clearly and unmistakably agreed to arbitrate arbitrability issues.
The Court explained that when one challenges another’s right to invoke arbitration, “the gateway question sometimes becomes: Does the court or arbitrator decide whether the dispute is arbitrable.” Slip op. at 6 (citations omitted). That was true, said the Court, whether: (1) under the separability doctrine—according to which “challenges to the. . . ‘container contract’[] are for arbitrator to decide, while challenges to the arbitration provision itself are for the court to decide,” slip op. at 6 (citations omitted); or (2) the parties have “delegated threshold arbitrability issues to the arbitrator” by “clear and unmistakable evidence.” Slip op. at 6 (citations and quotation omitted).
The Court discussed the separability doctrine in some detail in the opinion, and noted that “[t]he Prima Paint doctrine has been roundly criticized, and applying the doctrine is unnecessarily muddled.” Slip op. at 6; see slip op. at 6-10.) Applying it to the “set of facts” before it, was “not so simple.” Slip op. at 8.
Separability: Application of the Law to the Sanders Facts
Was the assignment challenge directed at the container contract as a whole or to the arbitration agreement itself? The Court agreed with the seller that the assignment challenge was not “directed” “specifically” to the arbitration agreement. Slip op. at 8. But the buyer argued that because of the assignment, the agreement between the buyer and the dealer “ceased to exist[,]” and that, accordingly, the “court must decide the challenge—even though it is directed to the contract as a whole.” Slip op. at 8.
That required the Court to determine whether the assignment raised a question of whether the arbitration agreement was concluded, a contract formation question that the Court had to decide before it could legitimately compel arbitration.
The Court concluded that the assignment challenge was not a claim that the contract never existed; it was a claim that the contract, indisputably formed, ceased to exist. Slip op. at 11-12. Reviewing pertinent case law, the Court concluded there were two reasons why the buyer’s “‘contract existence’” argument had no merit. Slip op. at 11-12. First, the contract formation cases lent “no support for the conclusion that a challenge to he continued existence of a container contract is for the court to decide under the Prima Paint doctrine.” Slip op. at 11.
Second, there are good grounds for distinguishing between contract formation challenges and “continued existence” challenges. Slip op. at 11. In contract formation challenges the question of whether an agreement was ever concluded necessarily arises. Slip op. at 11. Given arbitration is a matter of consent, “it would be illogical for an arbitrator to resolve such a challenge.” Slip op. at 11. But by allowing arbitrators to resolve “continued existence” challenges courts never “risk. . . sending a party to arbitration when that party never agreed to arbitration.” Slip op. at 11 (emphasis in original).
The Court summed up by saying the separability “doctrine is not the model of clarity[,]” but nevertheless “requires us to hold that the arbitrator must decide the gateway question of whether [the seller] retained the right to compel arbitration after assignment of [the retail instalment sales contract].” Slip op. at 13.
The Dissent: Contract Existence Exception Applies
Associate Justice George C. James, Jr. wrote the majority opinion in which two other members of the Court joined. Acting Justice Kaye Gorenflo Hearn wrote a thoughtful dissenting opinion in which Acting Justice James E. Lockemy joined.
The dissent thought the “majority place[d] too fine a point on the slight distinction between whether an agreement to arbitrate ever existed versus if one continues to exist.” Slip op. at 16. It also disputed the majority’s characterization of certain cases from other jurisdictions that had concluded that an assignment precluded the assignor from enforcing an arbitration agreement. Slip op. at 14-15. The dissent “would [have] follow[ed] the general rule that an assignment extinguishes the rights under a contract. . . .” Slip op. at 16. “Without an agreement to enforce,” said the dissent, it follows that the [Court] must generally resolve this threshold question.” Slip op. at 16 (citing and quoting Schein, 139 S. Ct. at 530).
Contacting the Author
If you have any questions about this article, arbitration, arbitration-law, arbitration-related litigation, or the services that The Loree Law Firm offers, then please contact the author, Philip J. Loree Jr., at (516) 941-6094 or PJL1@LoreeLawFirm.com.
Philip J. Loree Jr. has more than 30 years of experience handling matters arising under the Federal Arbitration Act and in representing a wide variety of clients in arbitration, litigation, and arbitration-related litigation. He is licensed to practice law in New York and before various federal district courts and circuit courts of appeals.
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Tags: Agreement, Assignee, Assignment, Assingnor, Buckeye, Compel Arbitration, Consent, Continued Existence, Existence of Contract, Prima Paint, Rent-A-Center, Separability, severability, South Carolina, Supreme Court
