In Southland Corporation v. Keating, a landmark 1984 decision, the U.S. Supreme Court definitively interpreted the Federal Arbitration Act (FAA) almost 60 years after its congressional enactment.1 Concluding that the federal statute abrogated any state legislative or judicial animus to arbitration, the Court cited the commerce clause2 and supremacy clause3 of the U.S. Constitution to invoke the doctrine of preemption. States could no longer mandate a judicial forum for the resolution of disputes. According to the Court, arbitration offered an equally valid alternative to litigation in state and federal courts.
Disagreement with Southland was immediate and fierce. Within the Court itself, dissenting justices criticized the decision as unwarranted by the congressional record and njustifiable “judicial legislation.” As late as 1996, state attorneys general urged the Court to overrule its judicially formulated preemption doctrine. The Court refused and continues to endorse arbitration subject to legislative exceptions in collective bargaining agreements and administrative law.4
The judicial rationale for the Court’s preemption doctrine is twofold: to reverse historic judicial hostility to arbitration, and to con firm the right of individuals to contract according to their own terms with minimal judicial intervention in the event of a dispute. At the heart of this doctrine is “freedom of economic choice.”5
Paradoxically, the doctrine of preemption in arbitration mirrors an argument as old as the founding of the U.S. Constitution and the seminal jurisdictional clashes evidenced in Swift v. Tyson6 and Erie Railroad Company v. Tompkins.7 These two cases, long relegated to the dustbin of legal history, have emerged again, Phoenix-like, and hover over arbitration as the FAA continues to engage the issue of the sovereignty of state governments and the federal government.
Federalism is generally understood as the allocation of power between federal and state governments. The doctrine of federalism unfolds in various forms, including the federal preemption of state and local legislation, but it also is evidenced by jurisdictional conflicts between the federal and state judicial systems. Federalism is inherently associated, however, with the sovereignty of states in their relationship to the national government.
Linking a governmental doctrine with arbitration thus seems intuitively
incoherent. After all, arbitration is explicitly a private resolution
of disputes that combines an extralegal format with minimal judicial intrusion
into the process. Yet congressional enactment of the FAA in
1925 and the subsequent interpretation of the statute by the Supreme Court,
including the Court’s evisceration of state laws limiting arbitration,
are manifestations of the continuing tension inherent in interpreting
sovereignty.
Jurisdiction
The concept of sovereignty was present at the creation of the Constitution. While the delegates at the Constitutional Convention in 1787 confronted a wide range of disputes, the thread of sovereignty wove pervasively throughout the debates. Zealously guarding their prerogatives and suspicious of creating an overwhelming national judicial power, states forced the ultimate draft of the Constitution to include language of compromise. Federal original jurisdiction was cabined into three areas: “federal questions,” constitutional issues, and treaties.8
In subsequently adopting the doctrine of diversity jurisdiction in the Judiciary Act,9 Congress implicitly acknowledged the potential for judicial bias when litigation between citizens of different states required a citizen of one state to appear in the courts of another. By providing federal courts—staffed by life-tenured judges immune from public retribution—to serve as a neutral forum, Congress offered litigants a safe harbor from state court parochial decisions. At the same time, states preserved dominance in civil litigation among their own citizenry.
Federal and state courts existed in relative harmony until the Civil War except for a handful of significant exceptions. In 1842, the Supreme Court invoked diversity jurisdiction to superimpose federal substantive common law on state courts. The Court’s decision in Swift authorized federal courts to craft their own interpretation of state law in litigation removed from state courts on diversity grounds. The vast majority of civil litigation had always occurred in state courts—with each state applying its laws of contract, tort, and property— but Swift significantly reallocated judicial power. Reaction to the decision was unrelenting and pervasive, but not until 1938 in Erie Railroad Company v. Tompkins did the Supreme Court retreat from Swift. The justices instructed district courts to henceforth apply state substantive law in diversity cases.
In the years between Swift and Erie, the business community urged Congress
to enact a legislative alternative to expensive and dilatory litigation
in federal courts. In 1925, Congress enacted the FAA consistent with Swift,
which constituted existing federal common law. The FAA empowered courts
to enforce written arbitration agreements unless they were revocable on
grounds of “law and equity.” The statute excluded admiralty and railroad
matters from its reach in recognition of the historic role of federal
legislation in those two categories. Pursuant to the terms of the FAA
and Swift, a federal district
court lacking original jurisdiction in an underlying litigation could
utilize diversity jurisdiction (if applicable) to enforce arbitration
clauses in federal courts under federal common law.
For litigation originally filed in state court and removed to federal
court, the FAA enabled federal courts to undermine state court animus
toward arbitration in commercial interstate transactions. However, 13
years after the FAA’s enactment, Erie reversed Swift and its federal common
law rationale. Erie required federal district courts to apply the substantive
law of the state within its local federal jurisdiction. In doing so, the
Court indirectly resuscitated state legislation prohibiting or inhibiting
arbitration whether litigation remained in state court or was removed
to federal court. The federal common law doctrine
of Swift expired, and Erie resurrected state substantive law in both federal
and state jurisdictions. To critics of arbitration, the balance of sovereignty
was restored.
Antiarbitration bias in states continued, but in the ensuing years before
Southland the Supreme Court resolved two routine state court arbitration
cases that had been removed to federal court but were seemingly unimportant
to the issue of sovereignty. First, in Prima Paint v. Flood & Conklin
Manufacturing Company,10 the Court held that the
terms of the FAA restricted federal courts solely to determining whether
an arbitration clause in a contract (the “making of the agreement [to
arbitrate]”) was valid and enforceable. Consistent with Erie, the Court
ruled that the district court should apply state substantive contract
law in resolving this issue. Determining the issue of “arbitrability”
assured federal dominance in the interpretation of arbitration clauses
in diversity cases but submitted resolution of the underlying transaction
to arbitration.
This rendering of the FAA, which permitted the “severability” of an arbitration
clause from the contract, superficially confirmed that the resolution
of factual disputes would be the province of the arbitrator. In reality,
the arbitrability decision placed federal courts in a
supervisory role to determine whether to compel arbitration in diversity
cases and simultaneously ignore state antiarbitration legislative or judicial
bias. In nondiversity litigation, a state court or legislature could continue
opposing arbitration.
Next, in Moses H. Cone Memorial Hospital v. Mercury Construction Company,11
the plaintiff had originally filed civil actions against two defendants
in state court alleging breach of contract. One defendant, who had signed
a contract containing an arbitration clause, removed the litigation to
federal court on diversity grounds and petitioned to
compel arbitration. The district court lacked jurisdiction over the other
defendant, whose contract contained no arbitration clause. Sensing the
potential for inconsistent decisions and increased costs, the district
court abstained from exercising jurisdiction.
On appeal, the Supreme Court held that state court litigation removed
to federal court on diversity grounds did not warrant district court abstention
despite potential duplication of parallel judicial proceedings. The Court
acknowledged that arbitration and litigation
might proceed in two jurisdictions, but the district court has an
unflagging obligation” to accept jurisdiction and not abstain. In its
decision, the Court hinted that the state court might not have allowed
arbitration if the district court abstained. In other words, abstention
would subvert the role of federal courts in determining arbitrability.
Years later the Court would confront the dilemma caused by splitting jurisdiction
between state and federal court in the same case.12
Preemption
Almost 60 years after Congress enacted the FAA, and citing only Prima
Paint and Moses H. Cone as precedent, the Supreme Court concluded that
the FAA preempted any state statutory or decisional law prohibiting, inhibiting,
or subverting arbitration.13 Southland con-
firmed the right of a diverse party to seek removal of a civil action
originally filed in state court, subsequently file a petition in federal
court to compel arbitration, and seek an order staying litigation. More
dramatically, the justices simultaneously prohibited state courts
from mandating a judicial forum for the resolution of disputes in nondiverse
litigation.
Citing the commerce clause and the supremacy clause of the U.S. Constitution
as grounds for invoking the doctrine of preemption, the Court conceded
the anomaly of the FAA in not granting independent jurisdiction to federal
courts.14 The FAA could not satisfy the constitutional
requirement of a “federal question,” and the language of the
statute referenced federal jurisdiction under the diversity statute. Until
Southland, litigation originally filed in state court but removed on diversity
grounds to federal court would languish until the federal court resolved
the arbitrability of the litigation or remanded it for lack of diversity.
In a single decision, the Court eviscerated state statutory and decisional
law antithetical to commercial arbitration, whether plaintiffs filed a
civil action in state court or the defendant removed litigation to federal
court. In either event, arbitration clauses were subject to
a form of substantive federal common law in all courts—Swift redux. State
contract law governed the ultimate arbitrable resolution of the merits,
but federal courts became the gatekeepers under the doctrine of preemption.
The commerce clause, cited by the Supreme Court in justifying the constitutional
ground for preemption, authorized the federal government to regulate interstate
commerce—transactions “involving commerce”—in historic recognition of
the rivalry among states and the prospect of local law in one state adversely
affecting trade in an adjoining state. In Allied-Bruce Terminix Companies
v. Dobson,15 which was decided several years after
Southland, the Supreme Court concluded that Congress had intended to exercise
federal power under the commerce clause to the maximum degree. The underlying
transaction only had to “affect” commerce. Under this expanded interpretation,
the scope of the FAA embraced almost any contractual transaction containing
an arbitration clause, no matter how tenuous its interstate dimension.
State legislatures did not universally embrace the preemption doctrine
and attempted to avoid its coverage by imposing rules applicable only
to arbitration clauses in contracts. In Doctor’s Associates v. Casarotto,16
the Supreme Court sternly reminded a recalcitrant state court that federal
preemption forbids legislation singling out arbitration
for any contractual requirement inapplicable to contract law. A court
can only invalidate or refuse to enforce an arbitration clause consistent
with general contract law.
The Supreme Court also has held that the doctrine of preemption confirms
the right of private parties to negotiate commercial transactions according
to their own interests.17 This rationale embodies
an ideological commitment to the underlying principle of capitalism: maximize
freedom of contract and eliminate, or moderate, governmental
interference with private transactions. Adherence to this principle, commendable
in the abstract, does not always translate into the values of efficient
and inexpensive disposition of disputes in arbitration.
Whether grounded in constitutional law or ideology, the basis for preemption
inevitably impinged on the role of state sovereignty by withdrawing the
right of state courts and legislators to offer or reject arbitration as
an alternative to the judicial resolution of disputes. After Southland,
state courts must honor written arbitration agreements
under a quasi-federal common law doctrine that had been repudiated in
Erie. While the FAA limited its scope to “commercial” agreements, the
reach of the FAA has been broadened under Allied-Bruce.
In another post Southland decision, the Court validated arbitration
clauses not only in litigation alleging common law counts but also in
litigation involving allegations of statutory violations. In Gilmer v.
Interstate Johnson/Lane Corporation,18 the plaintiff
filed litigation alleging violation of a federal statute prohibiting discrimination
in employment on the basis of age.19 Enforcing the
arbitration clause in the contract, the Court signaled an intent to include
federal statutory claims within the scope of the FAA in the absence of
congressional legislation to the contrary. Subsequent decisional law confirmed
this prophecy, not only in employment litigation but unrelated federal
statutes.20
The Supreme Court effectively controlled the future of arbitration by
1) insisting that district courts not abstain from jurisdiction regardless
of parallel or potential inconsistent proceedings in federal and state
courts, 2) invoking the doctrine of arbitrability to establish the court
as gatekeeper in determining whether an arbitration clause is valid and
enforceable, 3) preempting state antiarbitration laws, and 4) expanding
the scope of arbitration beyond common law to statutory issues.
Jurisdictional Clashes
Tension between federal and state courts interpreting the arbitration jurisprudence of the Supreme Court emerges frequently. With the prospect of parallel litigation in state courts, federal appellate courts have enjoined state courts from proceeding under authority of the Anti- Injunction Act21 and the All Writs Act.22 But jurisdictional clashes are not confined to disagreements between state and federal courts on arbitrability. A federal appellate court in Cigna Health Care of St. Louis, Inc. v. Kaiser23 highlights several ramifications of the collateral procedural doctrines that are involved in a federal trial court refusal to abstain from pending state litigation: consolidation of issues and parties, certification of class actions in both courts, res judicata of state court judgments on identical issues asserted in federal court, issuance of a federal injunction ordering the state court not to proceed in its litigation, and the invocation of the federal Full Faith and Credit Act.24
Each of these issues emerged in Cigna based upon arbitration clauses in a multiparty class action. In 1999, approximately 300,000 health care providers filed an Illinois class action alleging breach of contract against the defendant insurance carrier. To avoid federal jurisdiction, the plaintiffs included one nondiverse party and sought certification of the class from the state court judge. The defendant filed a petition to compel arbitration, alleging that several of its contracts with the plaintiffs contained a standard arbitration clause and others contained a collateral agreement incorporating the arbitration clause by reference.
The defendant requested the state court judge to determine the arbitrability of both categories of arbitration clauses. Instead of holding a hearing on this issue, the judge certified a “national” class without ordering discovery. Also, the court ordered the defendant to disclose all contracts related to the merits of the litigation. One year later, discovery was complete, but the judge had not ruled on the petition to compel arbitration.
Shortly after the time elapsed for parties to opt out of the class, the
defendant insurance
carrier filed a petition to compel arbitration in federal district court,
naming many of the
same plaintiffs in the state court class action as defendants. To achieve
diversity, the complaint omitted the nondiverse plaintiff and other putative
members of the class. Having
established diversity jurisdiction, the insurance carrier as plaintiff
alleged breach of contract and sought arbitration only with those defendants
who held contracts containing
arbitration clauses incorporated by reference.Pursuant to the FAA, the
plaintiff insurance
carrier sought to stay litigation of the defendants’ claims despite previously
having sought arbitration on the same issue in state court. The issue
of arbitrability in state court had not been resolved at the time of the
federal suit. The district court judge abstained from exercising jurisdiction
and dismissed the case.25
In abstaining, the district court judge cited the pending ruling on arbitrability
in the state
court, the potential conflict in ruling only on contracts incorporated
by reference in the arbitration clause, and the effect of a potential
judgment on an award if the court ordered
arbitration. Also, the state court judge had certified the class and ordered
discovery on the
merits of the litigation rather than determining whether the class satisfied
Illinois law.
Class actions, authorized by Rule 23 of the Federal Rules of Civil Procedure,
are essentially a consolidation of multiple litigants—but they are not
subject to consolidation in federal court unless an arbitration agreement
specifically authorizes it.
If the state court invalidates the arbitration clause incorporated by reference, the parties in the segment of the class action in state court with this type of clause in their contracts will continue in litigation. But the federal court, in resolving the case filed in its jurisdiction, must address those parties as well. The specter of collateral estoppel, res judicata, and the Full Faith and Credit Act is obvious.
State Sovereignty
Jurisdictional clashes between state and federal courts exist beyond
the civil law world of
arbitration and are far more controversial in unrelated litigation. After
the Civil War, constitutional amendments were enacted that circumscribed
state sovereignty,26 and the
due process and equal protection clauses of the Fourteenth Amendment have
provided
authority for federal courts to cut a wide constitutional swath limiting
state autonomy. Still,
arbitration is a private dispute resolution process that is not susceptible
to constitutional
scrutiny in any degree. Although courts initially determine whether to
grant or deny petitions to compel arbitration and may correct or vacate
an award, no court has suggested that arbitration satisfies the legally
indispensable element of “state action” necessary for judicial intervention
in constitutional issues.27
Strictly speaking, the doctrine of preemption invoked under the aegis
of the supremacy clause does not deny states the power to conduct arbitration
but rather mandates the process as an alternative to litigation. And,
unlike direct challenges to state sovereignty
prohibited under the Eleventh Amendment to the Constitution,28
the Supreme Court endorses arbitration but shares jurisdiction. As a result,
federal and state courts resolve arbitration issues but reach different
results. On a practical level, lawyers drafting arbitration clauses in
contracts face conflicting decisions in California attributable to disagreements
between the California Supreme Court and the Ninth Circuit.
For example, the U.S. Supreme Court and the California Supreme Court
had each con-
firmed arbitration as an appropriate forum for resolution of alleged violations
of federal
statutory rights29—as had every other circuit court
of appeals except the Ninth Circuit,
which incomprehensibly concluded that the FAA did not authorize the enforcement
of
mandatory arbitration regarding the alleged violation of federal statutory
rights contained
in employment contracts.30 As a result, forum shopping
in California is common, and drafting arbitration clauses applicable to
different forums poses an obvious dilemma for lawyers.
One federal court described conflicting interpretations of the FAA in state and federal courts as a “judicial train wreck.”31 Another court described the potential of parallel proceedings as the price paid for federalism.32 The principle of federalism waxes and wanes in a variety of contexts, but arbitration jurisprudence is unique. Preemption addresses sovereignty by confirming it in one context but subordinating it in another. The result is an uneasy alliance between the state and federal systems regarding arbitration.
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1 Southland Corp. v. Keating, 465 U.S. 1 (1984); Federal
Arbitration Act, 9 U.S.C. §§1-16.
2 U.S. CONST. art. 1, §8, cl. 3.
3 U.S. CONST. art. 6, cl. 2.
4 Wright v. Universal Mar. Servs. Corp., 525 U.S. 70
(1998); EEOC v. Waffle House, Inc, 534 U.S. 279 (2000);
Chemical Tech., Inc. v. Barber, 297 F. 3d 337 (4th Cir.
2002).
5 Vulcan Chem. Techs., Inc. v. Barker, 297 F. 3d 332 (4th
Cir. 2002).
6 Swift v. Tyson, 41 U.S. 1 (1842).
7 Erie R.R. Co. v. Tompkins, 304 U.S. 64 (1938).
8 U.S. CONST. art. 3, §2, cl. 1.
9 Judiciary Act, 28 U.S.C. §1332.
10 Prima Paint v. Flood & Conklin Mfg. Co., 388 U.S. 395
(1967).
11 Moses H. Cone Constr. Co. v. Memorial Hosp., 60
U.S. 1 (1983).
12 Dean Witter Reynolds, Inc. v. Byrd, 47 U.S. 213
(1985).
13 Southland Corp. v. Keating, 465 U.S. 1 (1984).
14 U.S. CONST. art. 1, §8, cl. 3; U.S. CONST. art. 6, cl. 2.
15 Allied-Bruce Terminix Cos. v. Dobson, 513 U.S. 265
(1995).
16 Doctor’s Assocs., Inc. v. Casarotto, 517 U.S. 681
(1996).
17 See Vulcan Chem. Techs., Inc. v. Barker, 297 F. 3d 332
(4th Cir. 2002).
18 Gilmer v. Interstate Johnson/Lane Corp., 500 U.S. 20
(1991).
19 Age Discrimination in Employment Act, 29 U.S.C.
§621 (1967).
20 Circuit City Stores v. Adams, 532 U.S. 105 (1967).
21 Anti-Injunction Act, 28 U.S.C. §2203; Great Earth
Cos., Inc. v. Simons, 288 F. 3d 828 (6th Cir. 2002).
22 All Writs Act, 28 U.S.C. §1651; Nearticley v. Enron Corp.,
302 F. 3d 295 (5th Cir. 2002).
23 Cigna Health Care of St. Louis, Inc. v. Kaiser, 249 F.
3d 849 (7th Cir. 2002), reversing and remanding, 181 F.
Supp. 2d 914 (2002). The circuit court ruled that the district
court must take action pending the state court’s
decision, which has still not occurred.
24 Full Faith and Credit Act, 28 U.S.C. §1738; Matsushita
Corp. v. Epstein, 516 U.S. 367 (1996).
25 Cigna Health Care of St. Louis, Inc. v. Kaiser, 181 F.
Supp. 2d 914 (2002), reversed and remanded, 249 F. 3d
849 (7th Cir. 2002).
26 U.S. CONST. amends. XIII, XIV, XV.
27 Rifkind & Stirling, Inc. v. Rifkind, 28 Cal. App. 4th 1282
(1994); FDIC v. Air Florida Sys., Inc., 822 F. 2d 833 (9th
Cir. 1987).
28 Federal Mar. Comm’n v. South Carolina Port Auth.,
126 S. Ct. 186 (2002); Kimel v. Florida Bd. of Regents,
528 U.S. 62 (2000).
29 See Gilmer v. Interstate Johnson/Lane Corp., 500
U.S. 20 (1991); Broughton v. Cigna Healthplans of Cal.,
21 Cal. 4th 1066 (1999).
30 Craft v. Campbell Soup Co., 161 F. 3d 1199 (9th Cir.
1998).
31 Black Sea Inv. Ltd. v. United Heritage Corp., 204 F.
3d 674 (5th Cir. 2000).
32 Green v. Tucson, 255 F. 3d 1086 (9th Cir. 2001).
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