By: Bryan Schatz
July 28, 2022
Arbitration provisions are ubiquitous in modern contracts. Before Congress enacted the Federal Arbitration Act (“FAA”), federal courts often refused to enforce arbitration provisions and favored resolving disputes in court. The FAA statutorily required federal courts to enforce arbitration provisions to the same extent as any other contract provision. Subsequently, in many jurisdictions, arbitration provisions went from being disfavored to receiving preferential treatment. But a few recent decisions – two from the United States Supreme Court and one from the Seventh Circuit Court of Appeals – have warned against enforcing arbitration provisions under circumstances where other contract terms would not be enforced. We previously wrote about recent federal legislation that will affect enforcement of arbitration provisions, specifically when a party brings claims of sexual assault or harassment. That article is available here. These changes mean that companies should take a careful look at their use of arbitration provisions going forward.
No Special Rules of Interpretation or Application Apply to Arbitration Provision
Federal courts have long interpreted the FAA to embody “an overriding federal policy in favor of arbitration.” As a result, federal courts would provide greater protection to arbitration clauses than most other contractual rights and thereby artificially heighten the burden on parties raising defenses to arbitration clauses.
Recent decisions have clarified that such an interpretation of the right to arbitrate is incompatible with the FAA. In a case regarding the common law defense of waiver (Morgan v. Sundance), the Supreme Court faced the question whether waiver of an arbitration clause required an additional element of prejudice, which was not required for waiver of any other contractual right.
Generally, a party waives a contractual provision if the party has demonstrated an “intentional relinquishment or abandonment of a known right.” Nothing in the FAA requires additional elements be added to a claim of waiver to apply to the arbitration provision of a contract. Several federal courts of appeal, however, have enforced a more stringent test for finding a waiver of the right to arbitrate. Specifically, to demonstrate waiver, a party has also been required to show it was prejudiced due to the other party’s delay in asserting the right to arbitrate. In a unanimous decision, the Supreme Court clarified that “a court must hold a party to its arbitration contract just as the court would to any other kind. But a court may not devise novel rules to favor arbitration over litigation.” More directly, the FAA serves as a “bar on using custom-made rules, to tilt the playing field in favor of (or against) arbitration.” In light of this decision, the separate “prejudice” element will no longer be required to establish waiver of an arbitration provision – rather, usual contractual rules should apply.
Federal courts had also narrowly construed statutory provisions declaring certain kinds of disputes non-arbitrable. In another recent decision (Southwest Airlines Company v. Saxon) the Supreme Court clarified that such statutory text must be read by its plain terms and applied accordingly. Under that approach, if a statute plainly exempts a certain class of dispute from arbitration, no federal court is empowered to read that statute narrowly, or the FAA broadly, to circumvent that outcome.
Finally, a recent Seventh Circuit decision (CCC Intelligent Solutions, Inc. v. Tractable, Inc.) applied similar principles and relied on general rules of contract interpretation to resolve a dispute regarding a contract containing an arbitration provision. In that case, the court considered whether a company could compel arbitration against a competitor when the company was not a signatory to the contract containing the arbitration clause at issue. Instead, the company had propositioned one of its employees to act as a “front” company and contract with its competitor. Rather than bending over backwards to enforce the arbitration provision, the Seventh Circuit applied general rules of contract formation to hold that the company could not compel arbitration when it was not a party to the contract containing the arbitration clause.
These recent decisions provide important clarification as to how federal courts may interpret arbitration provisions going forward. They confirm that, although the FAA may embody an “overriding federal policy in favor of arbitration,” arbitration provisions remain a creature of contract law and should be interpreted accordingly. These recent cases and the recent federal legislation will likely affect arbitration rights. Individuals and entities who rely on contracts containing arbitration provisions may want to consult with their legal counsel to determine whether those arbitration provisions may survive judicial scrutiny in light of these recent decisions and legislation.