Post Image
State Supreme Courts Exploring Limits of FAA Preemption
Posted on Categories Arbitration Agreements, Court DecisionsTags , ,

By George H. Friedman*

When the U.S. Supreme Court decided AT&T Mobility, LLC v. Concepcion, 131 S. Ct. 1740 (2011), many in the ADR field thought the Federal Arbitration Act (“FAA”) preemption war was over. Turns out that may have been premature. In a series of recent decisions discussed below, state Supreme Courts have been exploring the limits of Concepcion and the FAA.

A Primer on FAA Preemption

A core element of SCOTUS’ support for PDAAs 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 Concepcion. 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 invalidate PDAAs based on laws applicable to contracts in general, as long as they don’t single out PDAAs for burdensome or negative treatment.

Testing the Limits

Recent Supreme Court decisions from three states – Arkansas, Missouri, and New Jersey – are attempting to define just how far states can go. I analyze them below:

Lack of Mutuality - Regional Care of Jacksonville, LLC v. Henry, 2014 Ark. 361 (Sept. 11, 2014):  A PDAA that allowed the dominant party to litigate the only claims it would likely have while requiring the weaker party to arbitrate all claims, fails for lack of mutuality the Arkansas Supreme Court holds.   The admission agreement executed by a nursing home resident contained a broad PDAA, but excluded disputes involving billing or collections. After the resident died, the administrator of her estate brought suit for negligence, medical malpractice, breach of contract, and violations various state and federal statutes. On appeal, the Arkansas Supreme Court holds the one-sided PDAA as a contract failed for lack of mutuality and could not be enforced under the FAA. Why? Because the PDAA allowed the nursing home to litigate the one type of claim it logically might have – billing or collections matters – while it required the patient to arbitrate virtually every sort of claim she might assert. Says the Court, “The fact remains that [the nursing home] retained the right to litigate its billing and collection claims, while strictly limiting the residents to arbitration. Thus, the clause imposes no real liability on [the nursing home] to arbitrate its own claims. For these reasons, the arbitration clause offends our law requiring mutuality of obligation and cannot be enforced [footnote omitted].”

My take: This decision is on the right side of the FAA preemption divide. The Court here applies to a PDAA a rule of law applied to contracts in general – lack of mutuality – and doesn’t single out the PDAA for negative treatment.

Lack of Mutuality II - Alltel Corp. v. Rosenow, 2014 Ark. 375 (Sept. 18, 2014): For the second time in September, in a case with a Concepcion-like fact pattern, a sharply divided Arkansas Supreme Court held unenforceable for lack of mutuality a PDAA in a cell phone contract. The customer contract signed by Alltel customers among other things contained a PDAA. Eventually, the plaintiffs sought class certification over early termination fees imposed by Alltel. The cellular carrier resisted based on the PDAA. Eventually, the trial court declined to compel individual arbitrations, and granted class certification. On appeal, the Arkansas Supreme Court affirms the trial court, finding, “This court has been resolute that there is no mutuality of obligation where one party uses an arbitration agreement to shield itself from litigation, while reserving to itself the ability to pursue relief through the court system... As set out above, Alltel clearly reserved to itself the option of pursuing remedies other than arbitration, without the consequence of waiver. Moreover, that reservation and protection was limited solely to Alltel and was not extended to the customer. Succinctly put, Alltel provided itself with an ‘out’ to the required arbitration; Alltel customers, such as Rosenow, however, were limited to pursuing relief against Alltel in the form of arbitration, while Alltel alone was provided absolution if it chose to pursue an alternate remedy [citation omitted].”

The Court also rejected Alltel’s argument that the trial court decision ran afoul Concepcion, because here, the Arkansas rule of law on mutuality of contracts, unlike the California law in Concepcion, does not single out PDAAs for disparate treatment. “This court, however, considers the doctrine of mutuality to determine whether there has even been a valid agreement to arbitrate in the first instance, as we would do with another contract.”

My take: This decision is on the right side of the FAA preemption divide. The Court here applies to a PDAA a state rule of law applied to contracts in general – lack of mutuality – and doesn’t single out the PDAA for adverse treatment.

Failure of Consideration - Baker v. Bristol Care, Inc., No. SC93451 (Mo., Aug. 19, 2014): The Missouri Supreme Court, sitting en banc, holds that continued employment for an at-will employee and the employer’s revocable agreement to arbitrate do not provide sufficient consideration to support a PDAA. Says the Court, “An offer of continued at-will employment is not valid consideration because the employer makes no legally enforceable promise to do or refrain from doing anything it is not already entitled to do. The employer still can terminate the employee immediately for any reason.” The Court also found that the employer’s promise to arbitrate was “illusory” because it could be cancelled unilaterally, “If Bristol retains unilateral authority to amend the agreement retroactively, its promise to arbitrate is illusory and is not consideration.”

My take: Because the Court invalidated the PDAA based on a state law ground for invalidating contracts in general, and there was no disparate treatment or burden on arbitration, this holding seems to be on safe ground FAA preemption-wise.

“Clear and Unambiguous” Waiver of Right to Litigate - Atalese v. U.S. Legal Services Group, L.P., No. A-64 (N.J., Sept. 23, 2014): A unanimous New Jersey Supreme Court rules that a predispute arbitration agreement in a consumer contract must give clear notice that the right to litigate is being surrendered. Here, the PDAA contained in the debt-relief contract did not expressly state that the consumer was giving up the right to sue. The Supreme Court refused to enforce the PDAA, finding that the PDAA did not make it “sufficiently clear to a reasonable consumer” that they were giving up the right to sue. The Court stated that its decision was consistent with the FAA because under New Jersey law there must be mutual assent to a contract, and a waiver of rights must be expressed “clearly and unambiguously.” The Court stresses that this rule of law does not single-out PDAAs for “burdensome treatment.” How might a PDAA pass muster? “The waiver-of-rights language … must be clear and unambiguous -- that is, the parties must know that there is a distinction between resolving a dispute in arbitration and in a judicial forum.” In a consumer context, the PDAA must “at least in some general and sufficiently broad way” explain that the right to go to court is being waived. The Court declined to articulate precisely what language would be acceptable, instead stating that the PDAA “must be clear and unambiguous that a consumer is choosing to arbitrate disputes rather than have them resolved in a court of law.”

My take: One wonders whether this case will withstand a preemption challenge, despite the Court’s efforts to square its holding with the FAA. It seems like PDAAs are being treated in a negative fashion from contracts in general, a Concepcion red flag. Also, no matter how one looks at it, the Court is establishing a new requirement for PDAAs that is not contained in the FAA. This opinion underscores the value of FINRA Rule 2268, which governs the content of PDAAs in customer-broker agreements. Subsection (a)(1)requires that the PDAA state “All parties to this agreement are giving up the right to sue each other in court, including the right to a trial by jury, except as provided by the rules of the arbitration forum in which a claim is filed.”

The Bottom Line

It’s anyone’s guess whether one or more of these cases will end up at SCOTUS. I continue to believe what I stated at the onset: states may under the FAA invalidate PDAAs based on laws applicable to contracts in general, as long as they don’t single out PDAAs for burdensome or negative treatment. If I am correct, then Alltel, Baker, and Regional Care are on solid ground, and Atalese is skating on thin preemption ice. On the other hand, I think it makes sense for PDAA drafters to state in clear terms that the parties are agreeing not to go to court.


*George H. Friedman, an ADR consultant and SAC Board of Editors member, retired in 2013 as FINRA’s Executive Vice President and Director of Arbitration, a position he held from 1998. In his extensive career, he previously held a variety of positions of responsibility at the American Arbitration Association, most recently as Senior Vice President from 1994 to 1998. He is an Adjunct Professor of Law at Fordham Law School. He is Chairman of the Board of Directors of Arbitration Resolution Services, Inc. Friedman holds a B.A. from Queens College, a J.D. from Rutgers Law School, and is a Certified Regulatory and Compliance Professional (Wharton-FINRA Institute). Follow him on Twitter @GFriedmanADR.