Powers of an Arbitrator up for Review by the Us Supreme Court

RULE GOVERNING THE AUTHORITY OF AN ARBITRATOR UP FOR REVIEW BY THE US SUPREME COURT

By: Paul Bennett Marrow

In a contract containing an arbitration clause subject to the Federal Arbitration Act (“FAA”), who gets to decide if the contract itself is legally valid, i.e. an arbitrator or a court? That issue, last visited by the US Supreme Court in 1967 in Prima Paint Corp. v. Flood & Conklin Mfg. Co.[1] will again be considered by the Court during the 2005-06 Term when it decides Buckeye Check Cashing, Inc. v. Cardegna, docket 04-1264. The outcome may have implications for the draftsman of arbitration agreements and for advocates.

Background

Buckeye is an appeal from the Florida State Supreme Court’s holding that where there is an assertion that under state law an entire contract is voidab initio, a court must resolve the issue of the contract’s legality.[2] Buckeye involved a check-cashing program that was said to be in actuality a scheme promoting illegal usurious loans in violation of various Florida statutes. The arbitration clause, which was not attacked as being void or voidable, recited that the arbitration agreement was to be governed by the FAA.

The Buckeye State Supreme Court decision collides head on with a number of Federal Circuit Appeals Court decisions.[3] And it may even be in conflict with the US Supreme Court’s decision in Prima Paint.

In Prima Paint the Supreme Court considered the question within the context of a claim that the contract in question was the result of fraud in the inducement. The Court held that the FAA dictated the extent of a court’s authority to review any contract with an arbitration clause embedded in it and that the FAA limited judicial inquiries to matters involving the making of the arbitration clauses as distinguished from the making of the entire contract. The Prima Paint Court found the issue of fraud in the inducement was an issue that ran to the making of the entire contract and therefore an issue to be resolved by an arbitrator.[4]

The Florida State Supreme Court accepted the argument that because the contract in Buckeye was distinguishable from the one in Prima Paint and because the issue of the legal status of the contract involved interpreting state law, the issue of the contract’s validity should be determined by the judiciary. The court concluded:

In other words, there are no severable, or salvageable, parts of a contract found illegal and void under Florida law. Judge Sharp's observation in Party Yards, Inc., that a contrary holding would lead to an absurd result is right on point. We do not believe federal arbitration law was ever intended to be used as a means of overruling state substantive law on the legality of contracts. (894 So. 2d at 865)

The Prima Paint Court was faced with a choice between the view of the Court of Appeals for the Second Circuit below that “ – except where the parties otherwise intended – arbitration clauses as a matter of federal law are “separable” from the contracts in which they are embedded”[5] and the view of the Court of Appeals for the First Circuit in a similar case[6] that “the question of ‘severability’ is one of state law, and that where a State regards such a clause as inseparable a claim of fraud in the inducement must be decided by the court.”[7] Of the two possibilities, the Court favored the former on the grounds that the result was consistent with the legislative history underpinning the FAA as well as the statutes explicit language.

Where might the Supreme Court go with Buckeye?

The issues framed by Buckeye are not unknown to the US Supreme Court even though it has yet to address the distinction relied on by the Florida Supreme Court. As was noted earlier, no less than three cases that appear to be on all fours with Buckeye (at least to the extent that they all involved claims that the underlying contract was void ab initio) have been resolved by Federal Courts of Appeals in favor of the arbitrator making the determination. Two of these decisions were challenged in unsuccessful petitions for certiorari.[8] So it seems safe to conclude that the US Supreme Court, in granting certiorari in Buckeye is at the very least prepared to revisit the logic of Prima Paint.

Perhaps the Buckeye Court will elect to discard it’s previous thinking and accept the argument that the FAA doesn’t envision arbitration clauses as separable “super” clauses, a conclusion that will require acceptance of the arguments approved by the court below. Or the Court may re-affirm the logic of Prima Paint and resolve the validity of the distinction made by the Florida State Supreme Court within it’s context.

Implications for the draftsman and the advocate

Parties favoring arbitration do so in large measure because of concerns about financial efficacy, finality and confidentiality. The Prima Paint rule ensures that these sensitivities are addressed. But there is a price to be paid. By increasing the authority of the arbitrator the rule creates an opportunity for arbitrators to ignore or misapply state laws. For some this may present a risk that far out-weights the benefits of efficiency and confidentiality with the result that they will shy away from arbitration. Still others may be willing to accept the risk and address concerns about “lawlessness” and/or error by providing that the arbitrator must apply state law and for an “internal” appeal to another arbitrator.[9]

If the Court preserves the Prima Paint rule, little will change. But if it retools the rule, parties and their counsel will have to stop and take notice if they want to continue with arbitration without judicial directives on questions of law. One way to do this might be to include in agreements a declaration that they want the arbitrator to determine the legal validity of the entire contract. However, it is far from clear how successful this effort will be because of the judicial unwillingness to permit parties to fashion private rules that violate public policy. For others, especially the “repeat player,” the change may be welcomed because it insures consistency in the interpretation of applicable state laws.

A makeover of the Prima Paint rule may also have implications for the controversy surrounding the viability of an arbitration clause that attempts to confer appellate jurisdiction on a court for the purpose of reviewing legal error. That issue runs parallel to the issue discussed in this article. A Buckeye rule favoring judicial review suggests a bias in favor of broadening of the role of the judiciary in the arbitration process when the interpretation of state laws is involved. This suggests that a future Court may side with those who advocate the validity of clauses conferring limited jurisdiction.

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 2005 Paul Bennett Marrow. All rights reserved

 Member, Section of Dispute Resolution Arbitration Committee. Arbitrator, American Arbitration Association, Commercial Roster and National Arbitration Association, Commercial Roster.

[1] 388 US 395, 18 L. Ed. 2d 1270

[2] 894 So. 2d 860 (2005) Florida is not alone. For example, seeHotels Nevada, LLC v. Bridge Banc, LLC, 2005 Cal App Lexis 1074 (2d App Dist, Div, 5 2005); Barrett v. McDonald Investments, Inc., 2005 ME 43 (2004) (Alexander, J. concurring)

[3]Bess v. Check Express, 294 F. 3d 1298 (11th Cir. 2002); Snowden v. Checkpoint Check Cashing, 290 F 3d 631 (4th Cir. 2002) cert. denied, 537 US 1087, 154 L. Ed. 2d 631 (2002); Burden v. Check Into Cash of Kentucky, LLC, 267 F. 3rd 483 (6th Cir. 2001), cert. denied, 535 US 970, 152 L. Ed. 2d 380 (2002). All three of these decisions are discussed by the Buckeye court and rejected as controlling precedent. 894 So. 2d at 870-873.

[4]The Court looked to the language of § 4 of the FAA for the answer to the inquiry:

Under § 4, with respect to a matter within the jurisdiction of the federal courts save for the existence of an arbitration clause, the federal court is instructed to order arbitration to proceed once it is satisfied that "the making of the agreement for arbitration or the failure to comply [with the arbitration agreement] is not in issue." Accordingly, if the claim is fraud in the inducement of the arbitration clause itself -- an issue which goes to the "making" of the agreement to arbitrate -- the federal court may proceed to adjudicate it. But the statutory language does not permit the federal court to consider claims of fraud in the inducement of the contract generally. Section 4 does not expressly relate to situations like the present in which a stay is sought of a federal action in order that arbitration may proceed. But it is inconceivable that Congress intended the rule to differ depending upon which party to the arbitration agreement first invokes the assistance of a federal court. (388 US at 403, 404)

[5] 388 US at 402

[6]Lummus Co. v. Commonwealth Oil Ref. Co., 280 F. 2d 915, cert. denied 364 US 911 (1960)

[7] 388 US at 402.

[8] see Snowden v. Checkpoint Check Cashing, supra note 3 and Burden v. Check Into Cash of Kentucky, LLC, supra note 3

[9] see Paul Bennett Marrow, A Practical Approach to Affording Review to Commercial Arbitration Awards: Using an Appellate Arbitrator, 60 (no.3) Dispute Resolution Journal (August-October 2005)