Tuesday, September 7, 2010

Arbitrating Arbitrability: Part One of the Effect of Recent SCOTUS Decisions on Arbitration in South Carolina

The U.S. Supreme Court issued three decisions this term addressing “arbitrability”—what matters are appropriate for arbitration-- pursuant to the Federal Arbitration Act (the “Act”): Shady Grove, Stolt-Nielsen, and Rent-A-Center.

The South Carolina Supreme Court also recently issued a significant decision addressing arbitrability in the context of the Act. Herron v. Century BMW (“Herron”) was briefed and argued before all three of these Supreme Court decisions were issued. This post and two subsequent posts will analyze Herron in the context of some of the issues in play in Shady Grove, Stolt-Nielsen, and Rent-A-Center.

Herron

Plaintiffs brought a class action in state court against Century BMW and other South Carolina auto dealers alleging that the dealers charged an illegal administrative fee in violation of the South Carolina Regulation of Manufacturers, Distributors, and Dealers Act ("Dealers Act"). Century moved to compel arbitration pursuant to a written agreement between the parties and the Act, and the Plaintiffs challenged the arbitration clause in that agreement as unconscionable. (Broad brush, an unconscionable contract is one with terms so "one-sided" and "oppressive" that no fair and honest person would accept them). The trial court ruled that the arbitration clause was unconscionable, and refused to compel arbitration, relying on Simpson v. MSA of Myrtle Beach, Inc. (“Simpson”).

The S.C. Supreme Court ultimately affirmed in result the order of the trial court, as will be described in a subsequent post.

Arbitrability

The Herron plaintiffs' unconscionability challenge to the arbitration agreement-- the threshold issue of whether the arbitration clause was enforceable under South Carolina law -- was addressed by the trial court, (and reviewed by the South Carolina Supreme Court on a de novo basis), and not by an arbitrator. South Carolina recognizes the rule established by the United States Supreme Court that courts, and not arbitrators, will consider "threshold" questions of "arbitrability" unless there is "clea[r] and unmistakabl[e] evidence" that the parties intended otherwise. AT&T Technologies, Inc. v. Communications Workers. "Arbitrability" has typically involved certain "gateway matters, such as whether the parties have a valid arbitration agreement at all." Green Tree Financial Corp. v. Bazzle ("Bazzle").

However, South Carolina case law has also recognized the SCOTUS rule (of Prima Paint and Buckeye Check Cashing) that an arbitration provision is severable from the remainder of the contract between the parties, and that unless a party has brought a “discrete challenge” to the arbitration clause itself, the issue of contract validity (e.g. fraud in the inducement) is for the arbitrator, not the courts. S.C. Pub. Serv. Auth. v. Great Western Coal, Inc., Jackson Mills v. BT Capital Corp. (Our Court of Appeals has actually referred to the Prima Paint rule as a “surprising result”—See New Hope Missionary Baptist Church v. Paragon Builders).

Rent-A-Center

Rent-A-Center involved a challenge to an arbitration agreement similar to that lodged in Herron. Plaintiff Jackson filed an employment discrimination suit against Rent-A-Center in a Nevada Federal District Court. Rent-A-Center moved to dismiss and compel arbitration, and Jackson opposed same on the basis that his arbitration agreement (Agreement) with Rent-A-Center was unconscionable under Nevada state law.

Rent-A-Center argued, and the District Court concluded, that language within the Agreement required that the parties "arbitrate arbitrability." Referred to as the "delegation provision," this language gave the arbitrator "exclusive authority to resolve any dispute relating to the [Agreement's] enforceability . . . including . . . any claim that all or any part of this Agreement is void or voidable." Put another way, the Agreement's language provided that the "gateway" question of contract enforceability was to be decided by the arbitrator.

The Court of Appeals for the Ninth Circuit reversed. While acknowledging that the "delegation provision" in the Agreement "assigns the arbitrability determination to the arbitrator," the Court of Appeals reasoned that an unconscionability challenge subsumes and incorporates a challenge to the "agreement to arbitrate arbitrability": "where . . . a party challenges an arbitration agreement as unconscionable, and thus asserts that he could not meaningfully assent to the agreement, the threshold question of unconscionability is for the court." The 9th Circuit’s reasoning is strikingly similar to that employed by the South Carolina Supreme Court in Simpson, rejecting a claim that a delegation provision required an arbitrator to determine arbitrability.

Justice Scalia, writing for a five-justice majority, reversed the 9th Circuit's decision, on the basis that Jackson had not challenged the validity of the delegation provision, but merely the arbitration agreement as a whole. According to Prima Paint, the delegation provision (itself an agreement to arbitrate) was severable from the Agreement, meaning it could be enforced under the Act separate and apart from the Agreement.

Justice Stevens, writing for the dissent, pointed out that it would be bizarre indeed for an arbitrator to determine whether or not the parties agreed to arbitrate. According to Justice Stevens, Prima Paint merely required that a party challenge the “validity of the agreement to arbitrate,” and did not establish “infinite layers of severability.”

Going Forward

Rent-A-Center establishes a predicate "gateway" judicial determination in arbitration agreements subject to the Act. Challenging an arbitration agreement in the way the plaintiffs in Herron and Simpson did may not be enough to keep that challenge in court. Moreover, the question of whether a delegation provision is invalid may be quite different from an unconscionability challenge to a “broader” arbitration agreement.