Adjunct Professor George Friedman wrote a blog post in Arbitration Resolution Services, Inc. (ARS) regarding the Supreme Court’s continued support for arbitration in the Trump era.
A Primer on FAA Preemption
A core element of SCOTUS’ support for predispute arbitration agreements (“PDAA”) is the so-called separability doctrine, which holds that, under the Federal Arbitration Act , 9 U.S.C. §§ 1 et seq., a PDAA is a separate contract from the one in which it is embedded, and must be on “equal footing” with any other contract. Section 2 of the FAA provides that a PDAA must be enforced “save upon such grounds as exist in law or in equity for the revocation of any contract.” The issue of how far states can go in applying the “revocation of any contract” language in section 2 came to a head in AT&T Mobility, LLC v. Concepcion, 563 U.S. 321 (2011). There, SCOTUS invalidated a California rule of law because it singled out PDAAs for suspect, disparate, burdensome treatment. Said the Court, “Although [FAA] § 2’s saving clause preserves generally applicable contract defenses, nothing in it suggests an intent to preserve state-law rules that stand as an obstacle to the accomplishment of the FAA’s objectives.” After Concepcion, the bottom line on FAA preemption of state law on arbitration was this: consistent with FAA § 2, states may refuse to enforce PDAAs based on laws applicable to contracts in general, as long as they don’t single out PDAAs for burdensome or negative treatment.
Wriggle Room for States on Contract Formation?
Following Concepcion both state and federal courts – even in California – seemed to have gotten the Supreme Court’s memo that the FAA generally preempts state laws that impinge on enforcing arbitration agreements. But given that PDAAs must be enforced like any other contract, and we look to state law on contract formation, state courts explored the limits of this apparent Concepcion loophole. In other words, while Concepcion barred state laws negatively impacting on PDAA enforcement, it appeared that state laws on contact formation could be used to invalidate PDAAs as long as arbitration contracts weren’t singled out for negative treatment. How? Section 2 of the FAA allows a court to invalidate a PDAA “… upon such grounds as exist at law or in equity for the revocation of any contract,” so the key factor is whether the state law applies to contracts in general (permitted) or arbitration clauses in particular (forbidden). Here are some examples:
Sonic-Calabasas A, Inc. v. Moreno, 57 Cal.4th 1109, 311 P.3d 184 (2013): “After Concepcion, courts may continue to apply unconscionability doctrine to arbitration agreements… As the FAA contemplates in its savings clause (9 U.S.C. § 2), courts may examine the terms of adhesive arbitration agreements to determine whether they are unreasonably one-sided. What courts may not do, in applying unconscionability doctrine, is to mandate procedural rules that are inconsistent with fundamental attributes of arbitration, even if such rules are ―desirable for unrelated reasons” [citations omitted].”
Iskanian v. CLS Transportation Los Angeles, LLC, 59 Cal.4th 348, 327 P.3d 129 (2014), den., 574 U.S. __, No. 14-341 (2015): A divided Court held that an employee could pursue claims against his employer under the California Private Attorneys General Act (“PAGA”), despite the existence of a PDAA waiving such claims. How was this possible in light of Concepcion? The Court reasoned that allowing an employee to waive PAGA claims violated public policy, rendering that part of the PDAA unenforceable. Specifically, the Court squared this part of its decision Concepcion by noting that PAGA does not stand as an obstacle to the aims of the FAA: “We conclude that the FAA’s goal of promoting arbitration as a means of private dispute resolution does not preclude our Legislature from deputizing employees to prosecute Labor Code violations on the state’s behalf.”
Spirits: Two Key Elements
To review, SCOTUS granted certiorari last October in Kindred Nursing Centers v. Clark, No. 16-32, related preemption cases involving an arbitration agreement in a nursing home admission agreement signed by an attorney-in-fact. The issue as framed in the Petition for Certiorari was: “Whether the FAA preempts a state-law contract rule that singles out arbitration by requiring a power of attorney to expressly refer to arbitration agreements before the attorney-in-fact can bind her principal to an arbitration agreement.” This became known as the “clear-statement” rule.
But Don’t Overlook this Part
Justice Kagan also rejected the argument that the FAA’s preemptive reach did not impact contract formation issues. “Both the FAA’s text and our case law interpreting it say
otherwise… By its terms, then, the Act cares not only about the ‘enforce[ment]’ of arbitration agreements, but also about their initial ‘valid[ity]’ — that is, about what it takes to enter into them. Or said otherwise: A rule selectively finding arbitration contracts invalid because improperly formed fares no better under the Act than a rule selectively refusing to enforce those agreements once properly made” (brackets in original).
Just in case the message to the states wasn’t clear enough, Justice Kagan adds this breath-taking language:
And still more: Adopting the respondents’ view would make it trivially easy for States to undermine the Act — indeed, to wholly defeat it. As the respondents have acknowledged, their reasoning would allow States to pronounce any attorney-in-fact incapable of signing an arbitration agreement—even if a power of attorney specifically authorized her to do so… (After all, such a rule would speak to only the contract’s formation.) And why stop there? If the respondents were right, States could just as easily declare everyone incompetent to sign arbitration agreements. (That rule too would address only formation.) The FAA would then mean nothing at all — its provisions rendered helpless to prevent even the most blatant discrimination against arbitration (emphasis in original).