Sunday, May 19, 2013

The Only Thing Settled About Arbitrability is its Continued Litigatibility

Introduction

Although both the United States Supreme Court and the South Carolina Supreme Court often attempt to define arbitrability -- the question of whether a contractual provision purporting to send disputes to arbitration is enforceable --  the case-by-case analysis applied in considering it means that like the Lernaean Hydra, a determination on one set of facts will only spawn numerous other challenges.  

The South Carolina Court of Appeals' recent decision in Smith v. D.R. Horton, Inc., et al. is the latest in this line of arbitrability cases, affirming a circuit court determination that an arbitration clause in a purchase agreement was unenforceable because it was unconscionable. 

For this Blog's previous posts chronicling arbitrability decisions and related topics, see Recent Cases on the Reach of the S.C. and Federal Arbitration Acts, Asserting the Right to Compel Arbitration, Arbitrating Arbitrability: Part One of the Effect of Recent SCOTUS Decisions on Arbitration in South Carolina, Shady Grove and Class Actions: Part Two of the Effect of Recent SCOTUS Decisions on Arbitration in South Carolina, or Deconstructing Bazzle: Stolt-Nielsen and Class Arbitration.  Or see Effects of Recent U.S. Supreme Court Decisions on Arbitrations and Class Action Litigation in South Carolina.

Background


The Smiths filed a construction defect case against builder D.H. Horton ("Horton") alleging negligence, breach of contract, breach of warranties, and unfair trade practices, in connection with a house they purchased from Horton.  Horton moved to compel arbitration based upon an arbitration clause found in Section 14(g) of the purchase agreement.  The arbitration clause was a subsection of the purchase agreement's Section 14 "Warranties and Dispute Resolution." The circuit court considered  Section 14 "Warranties and Dispute Resolution" "as a whole," and denied Horton's motion to compel because certain provisions contained in Section 14 made the arbitration clause unconscionable.

Unconscionability and Arbitration Agreements

 "In South Carolina, unconscionability is defined as the absence of meaningful choice on the part of one party due to one-sided contract provisions, together with terms that are so oppressive that no reasonable person would make them and no fair and honest person would accept them." Simpson v. MSA of Myrtle Beach. ("Simpson").  "In analyzing claims of unconscionability in the context of arbitration agreements, the Fourth Circuit [Court of Appeals] has instructed courts to focus generally on whether the arbitration clause is geared towards achieving an unbiased decision by a neutral decision-maker." Id.


The Court of Appeals affirmed the trial court's decision based upon "the supreme court's analysis in Simpson," and citing Section 14(c)'s disclaimer of of certain warranties and Section 14(i)'s limitation of liability provisions as examples of "oppressive and one-sided provisions."

Prima Paint, a Court's Limited Role in Considering Unconscionability, and Severability

Horton claimed that the rule of Prima Paint Corp. v. Flood and Conklin Mfg. Co. (“Prima Paint”) prevented court consideration of other provisions in the purchase agreement outside the arbitration clause.  

According to Prima Paint, the issue of contract validity (as opposed to the issue of the validity of an arbitration agreement found within that contract) is for the arbitrator, not the courts. Prima Paint’s rationale is that the Federal Arbitration Act (FAA) applies only to those agreements to arbitrate between parties, and therefore a court is empowered only to hear a “discrete challenge” to the parties’ arbitration agreement.     Justice Black, dissenting in Prima Paint, characterized the Court’s holding as “fantastic” and inconsistent with the language of § 2 of the FAA.  The Court of Appeals, perhaps echoing Justice Black, has referred previously to the Prima Paint rule as a “surprising result,” See New Hope Missionary Baptist Church v. Paragon Builders, because the FAA empowers a court to hear an unconscionability challenge to an arbitration agreement that is part of a contract, but not the contract itself.

In considering the purchase agreement, the Court of Appeals acknowledged the application of Prima Paint in South Carolina:   "'[A]n arbitration clause is separable from the contract in which it is embedded and the issue of its validity is distinct from the substantive validity of the contract as a whole.' Munoz v. Green Tree Fin. Corp. (citing Prima Paint).'" However, the Court of Appeals construed Horton's claim as seeking to sever the offending provisions from the purchase agreement and send the remainder of the purchase agreement to arbitration.  Accordingly, because the Simpson court determined that severability was not an appropriate remedy, the Court of Appeals declined to do so also.
 

Of course, Horton undoubtedly sees "separability" and "severability" as two very different things. Likewise, echoing Munoz, a ruling on whether the FAA applied to the purchase agreement might have brought the issue of separability into sharper focus.  However, the Court of Appeals did not address the issue of whether the FAA or the South Carolina Uniform Arbitration Act ("SCUAA") applied to the purchase contract, based on its disposition of the case on unconscionability grounds.

Conclusion

Although I am not in the prediction business, there is some sense that this case may receive further examination.  The takeaway for practitioners is that arbitrability involves a unique and ongoing interplay of state and federal law, and getting a handle on that context is essential for both trying to get into (or stay out of) arbitration.