Arbitration-Jurisdictional Disagreements

The question before the house is: what is happening in contractual arbitration? The answer is: it depends. It depends on the applicability of either the Federal Arbitration Act (FAA; 9 U.S.C. 1-16) or the California Arbitration Act (CAA; CCP 1280 et seq.) to the facts of the case; it depends on whether the arbitration initiated in federal court or state court, or one party removed the case from state to federal court; it depends on whether the decision is authored by the California Supreme Court, the Court of Appeal, the Ninth Circuit or the United States Supreme Court.

It also depends on the perspective of counsel. Those opposed to arbitration not only bemoan the loss of a jury but the limited grounds of appeal and absence of plenary appellate review. Opponents have also objected to arbitration clauses unilaterally imposed and not negotiated, particularly in employment, consumer and franchise disputes. Supporters of arbitration have expressed dismay at the increasing “litigization” of arbitration.

Counsel are familiar with the general “two step” rule that requires the court to initially decide whether an arbitration clause is valid and enforceable under either the FAA or the CAA. Validity of the arbitration clause, resolved under state general contract law, is a question of law for the court to ascertain the existence of an arbitration clause in a contract, determine arbitrable issues and identify relevant parties. The enforcement prong of federal and state statutes is an equitable doctrine denying enforcement of an arbitration clause on grounds consistent with revocation (rescission) of any contract or, in the alternative, to sever inequitable terms.

Pursuant to U.S. Supreme Court jurisprudence, the FAA preempts all state statutory and decisional law prohibiting or burdening arbitration of disputed interstate commercial transactions. If the underlying transaction does not involve interstate commerce, state courts can develop their own arbitration law under the CAA. California has several statutory rules affecting local interests such as health care, construction defect and medical negligence potentially unaffected by the requirement of a “commercial” transaction in interstate commerce mandated by the FAA. The jurisdictional clash occurs when the underlying transaction involves interstate commerce and is resolved in state court. Or, when the parties agree to use FAA rules in a state court action or proceeding.

The California Supreme Court has addressed the preemption doctrine and the intersection of the FAA and the impact on the CAA in a trilogy of cases. Discover Bank v. Superior Court, 36 Cal.4th 148 (2005) involved an arbitration clause prohibiting consumers from filing class actions, class wide arbitration, consolidated cases or representational proceedings. These class action waivers were challenged as unilaterally imposed, but plaintiffs faced universal federal and state court approval of this procedural bar.

Class actions and classwide arbitration are essentially consolidated proceedings and not ordinarily classified as substantive California law. Under United States Supreme Court jurisprudence, a state court cannot invoke procedural law as an artifice to subvert arbitration. Because the consumers in Discover Bank had individual arbitration clauses in their contracts, the California Supreme Court could not deny arbitration per se and risk preemption by the FAA.

Confronted with an unquestionably valid arbitration clause providing arbitration of individual claims, but not consolidated claims, the Court unearthed vintage substantive law in Civ. Code s.1668. This statute prohibits a party from contractually excusing itself from its own fraud, willful injury to person or property of another, or violation of laws against public policy. The California Supreme Court, after lauding the role of class actions, held that consolidated proceedings vindicate the statutory substantive law recited in Civ. Code s. 1688 and are indispensable to its enforcement. In other words, the court reformulated “consolidation” from its conventional procedural role into a substantive one, thereby labeling it “substantive “ state law insulating it from preemption challenge.

Under the rubric of substantive law, unquestionably a state court prerogative in reviewing the enforcement of arbitration clauses, the the California Supreme Court pronounced the classwide arbitration clause “unconscionable” and refused to enforce it; Civ. Code 1670.5. Despite that holding, the underlying contract contained a choice of law clause invoking Delaware law, a state that enforces class action waivers. Absent a Court of Appeal resolution of that issue, the California Supreme Court remanded to the Court of Appeal.

On remand, the Court of Appeal wrote, pursuant to conventional choice of law analysis, Delaware law trumps California law; Discover Bank v. Sup.Ct., 134 Cal.App.4th 886 (2005); Despite language in the California Supreme Court opinion suggesting the appellate court rule otherwise, the Court of Appeal declined the invitation. Since then, another Court of Appeal case has interpreted the choice of law clause differently; Klussman v. Cross Country Bank, 134 Cal.App.4th 1283 (2005).

The second case in this trilogy is Cronus Investments, Inc. v. Concierge Services, 35 Cal.4th 376 (2005). The court faced an intractable problem: the plaintiff had signed contracts with multiple parties, some of whom had arbitration clauses in their contracts, some did not. CCP 1281.2 permits the court faced with this dilemma several options, including an order staying arbitration. This option clearly burdens arbitration, indeed it defies Supreme Court jurisprudence; Volt Information Sciences, Inc. v. Bd. of Trustees of Leland Stanford Jr. University, 489 U.S. 468 (1989). The California Supreme Court, citing a U.S. Supreme Court case approving the option of staying arbitration, held that the court could stay arbitration pending the results of litigation. Volt permits state courts to apply their own procedural rules if the underlying arbitration clause incorporates California law.

This rule does not prevail in federal courts. Federal courts must compel arbitration and stay litigation despite the prospect of inconsistent results under the facts in Cronus.

The last case in the trilogy is the recurring doctrine of contractual “unconscionability” initially discovered by the California Supreme Court in Graham v. Scissor-Tail, Inc., 28 Cal.3d 807 (1990) and subsequently ratified by the Legislature in CC 1670.5. Armendariz v. Foundation Health Psychcare Services, Inc., 24 Cal.4h 83 (2000), a familiar case, imposed a five fold requirement on employment clauses in order to avoid a challenge of an “unconscionable” arbitration clause. The United States Supreme Court did not review Armendariz, presumably on the ground the state court was enforcing substantiate law.

In all these cases, litigation originated in state court. What happens when the parties commences an action in state court but the arbitration clause in the contract requires application of the FAA? Rodriguez v. American Technologies, Inc., 136 Cal.App. 4th (2006) holds that the agreement of the parties prevails, and the CAA does not apply. Under FAA rules, the court must order arbitration and stay litigation despite the potential of inconsistent results.

How does this play out for arbitrators? The U.S. Supreme Court has incrementally expanded not only the scope of arbitrable issues within the ambit of the FAA to include employment and consumer cases, but increased the authority of arbitrators. Buckeye Check Cashing, Inc. v. Cardegna, 126 S.Ct. 1204 (2006), recently decided by the United States Supreme Court, holds under well established law that judges decide the validity of the clause; arbitrators decide the merits. What if the moving party alleges the contract is void, ab initio? Buckeye holds this issue is a determination on the merits of the underlying contract and resolved by the arbitrator, not the court.

In Green Tree Fin. Corp v. Bazzle, 539 U.S. 1029 (2003) the U.S. Supreme Court held that the arbitrator, not the court, decides whether a contract silent on prohibition of class actions is enforceable. In PacifiCare Health Systems, Inc. v Book, 538 U.S. 401 (2003), the Supreme Court refused to permit the trial court to review an arbitration clause containing remedial limitations applicable to one party, instructing the trial court to ultimately review this issue when confirming or denying an arbitrator’s award. In California, the state Supreme Court has ruled that the trial court may deny enforcement of an arbitration clause limiting remedies imposed on one party; Armendariz, supra.


As above, it depends.