'Fairness' Looms in New Congress

24 November 2008 Publication
Author(s): Michael J. Lockerby

The National Law Journal

Since 1925, when Congress enacted the Federal Arbitration Act (FAA), federal policy has encouraged the arbitration of private disputes. Rising costs and risks of civil litigation — including the potential for punitive damage awards imposed by so-called "runaway juries" — have prompted ever more companies to include arbitration provisions in their standard form contracts. Citing the federal policy in favor of arbitration, the U.S. Supreme Court repeatedly has struck down the efforts of some states to limit the enforceability of arbitration provisions. For example, earlier this year the court held in Preston v. Ferrer, 128 S. Ct. 978 (2008), that the FAA pre-empted a California statute that purported to require "exhaustion of remedies" in a state administrative forum before arbitration could proceed. But if a growing number of members of Congress have their way, the federal policy in favor of arbitration would no longer apply to many types of contracts.

When the new Congress convenes next year, it is expected to give serious consideration to one or more of three bills that would — in the name of "arbitration fairness" — make many agreements to arbitrate unenforceable unless they were entered into after a dispute arose. The first such bill, the Arbitration Fairness Act of 2007 (AFA), would invalidate predispute agreements to arbitrate "employment," "consumer" and "franchise" disputes, among others. The second bill, the Automobile Arbitration Fairness Act of 2008 (AAFA), would invalidate predispute agreements to arbitrate contained in motor vehicle consumer sales and lease contracts. The third, the Fairness in Nursing Home Arbitration Act of 2008 (FNHAA), would invalidate predispute agreements to arbitrate contained in contracts between a long-term care facility and any resident of the facility.

The broadest of the three bills, the AFA, would apply retroactively to contracts entered into before its enactment. It also would change the procedure for challenging the enforceability of agreements to arbitrate. Under existing law, if a contract contains an arbitration clause, an arbitrator generally determines whether a particular claim is subject to arbitration. The only exception is when a contrary intention to have a court decide the issue appears in the arbitration agreement. First Options v. Kaplan, 514 U.S. 938, 943 (1995). In contrast, the Arbitration Fairness Act (and its counterpart for nursing home contracts) would require that "the validity or enforceability of an agreement to arbitrate shall be determined by the court."

The most significant change that all three bills would make, however, would be to expand the grounds for invalidating agreements to arbitrate. Since its enactment in 1925, the FAA has created a presumption that contractual provisions requiring binding arbitration of disputes are "valid, irrevocable, and enforceable" — except "upon such grounds as exist at law or in equity for the revocation of any contract." 9 U.S.C. 2. Under existing law, the two grounds on which arbitration agreements are most frequently challenged are "unconscionability" and "fraud in the inducement." Successful challenges, however, are rare. For example, to invalidate an arbitration agreement based upon "fraud in the inducement," the party challenging enforceability must prove by clear and convincing evidence that the arbitration clause itself — not just the agreement of which it is part — was fraudulently induced. Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 403-404 (1967).

'Arbitration fairness'
In contrast, the Arbitration Fairness Act would empower a federal court to invalidate an arbitration provision "irrespective of whether the party resisting arbitration challenges the arbitration agreement specifically or in conjunction with other terms of the contract containing such agreement." AFA § 4. More significantly, many predispute agreements to arbitrate would no longer be presumptively "valid, irrevocable, and enforceable." Instead, they would become "invalid, revocable, and unenforceable" if a dispute arose that was subject to the new "arbitration fairness" provisions. In particular, the AFA would invalidate predispute agreements to arbitrate "employment," "consumer" and "franchise" disputes, defined as follows:

  • "Employment" disputes would include any dispute between an employee and an employer as that relationship is defined in the Fair Labor Standards Act (while excluding arbitration provisions in collective-bargaining agreements).
  • "Consumer" disputes would include any dispute over goods or services obtained for personal, family or household purposes between a "person" — i.e., an individual, not an organization — and a seller or provider of property, services, money or credit. The AFA thus defines "consumer" disputes broadly enough to include disputes arising under contracts to purchase or lease automobiles (the object of the AFAA) and contracts signed by a resident of a nursing home or other long-term care facility (the object of the FNHAA).
  • "Franchise" disputes would include any dispute arising under a contract whereby a franchisee is granted the right to engage in business under a marketing plan prescribed in substantial part by the franchisor; the operation of the franchisee's business is substantially associated with a commercial symbol such as a trademark or logo, which designates the franchisor or an affiliate of the franchisor; and the franchisee is required to pay a franchise fee, either directly or indirectly.

The stated rationale for the AFA is that agreements to arbitrate employment, consumer and franchise disputes are the product of "unequal bargaining power." In this regard, the AFA contains a number of legislative "findings" about the current status of arbitration under the FAA. These include the following:

  • The FAA was intended to apply to commercial entities of similar sophistication and bargaining power.
  • Various U.S. Supreme Court decisions have since broadened the applicability of the FAA to extend to parties of very disparate economic power, so that millions of consumers and employees must submit disputes to binding arbitration.
  • Many of these consumers and employees may not have understood the arbitration clauses in agreements they accepted, or had little choice in accepting the agreements.

Consistent with the foregoing findings, the AFA would invalidate certain other predispute agreements to arbitrate even if they were beyond the scope of the statutory definitions of "employment," "consumer" and "franchise." Specifically, an arbitration clause would no longer be enforceable if it applied to "a dispute arising under any statute intended to protect civil rights or to regulate contracts or transactions between parties of unequal bargaining power." AFA § 4.

This latter provision in particular might well provide businesses large and small with an opportunity to invalidate arbitration provisions commonly found in many commercial contracts. After all, most business disputes arise — at least in part — under federal or state statutes "intended . . . to regulate contracts or transactions." Even if the statute at issue was not enacted to address inequality of bargaining power, would an arbitration provision in a commercial contract be unenforceable simply because the statute "regulate[s] contracts or transactions between parties of unequal bargaining power"? Litigation to resolve the arbitrability of commercial disputes arising under such statutes could itself become a cottage industry.

Legislation's status
Of the three "arbitration fairness" bills, only the one whose scope is limited to arbitration agreements with nursing homes made it out of committee before Congress recessed for the elections. In July, the House Judiciary Committee approved the House version of the FNHAA, H.R. 6126. The House bill's Senate counterpart, S. 2838, won approval from the Senate Judiciary Committee on Sept. 11.

The Automobile Arbitration Fairness Act, H.R. 5312 (it has no Senate counterpart), has yet to be voted on by the full House Judiciary Committee. It has attracted opposition from every segment of the auto industry. For example, one of the trade associations comprising auto dealers, the American International Auto Dealers Association (AIADA), claims that enactment of H.R. 5312 would "diminish chances for consumers to resolve claims quickly and easily by requiring protracted court battles for all disputes."

According to AIADA, "studies show that consumers prefer arbitration and the efficiency and cost savings that it represents." See www.aiada.org/policyIssues/issue%5F4/position1.asp. Whatever the merits of the dealers' position, it is somewhat ironic because currently there is only one exemption from the Federal Arbitration Act — one that was enacted at the behest of auto dealers. That exemption, which became law in 2002 pursuant to the Motor Vehicle Franchise Contract Arbitration Fairness Act, allows auto dealers to invalidate arbitration provisions in motor vehicle franchise agreements with their suppliers. See 15 U.S.C. 1226(a)(2). In support of this law, auto dealers argued that manufacturers used their superior bargaining power to impose arbitration provisions in motor vehicle franchise agreements on a "take-it-or-leave-it" basis. That is, of course, the same rationale for the provisions of the AAFA that would invalidate predispute agreements to arbitrate disputes arising under "motor vehicle consumer sales or lease contract(s)" — and for the much broader provisions of the Arbitration Fairness Act.

The Arbitration Fairness Act, which has both a House and Senate counterpart (H.R. 3010 and S. 1782, respectively), has yet to reach the floor of either house of Congress. Since its introduction in July 2007, however, the AFA has attracted increasing numbers of co-sponsors, especially in the House of Representatives. Like the original sponsors, most of the co-sponsors hail from the Democratic side of the aisle. Enough House Republicans have become co-sponsors, however, that the AFA can be fairly characterized as having bipartisan support. Not surprisingly, the advocates for the AFA include various interest groups that purport to speak for consumers, such as Ralph Nader's Public Citizen. The opponents include the U.S. Chamber of Commerce and many individual companies whose stepped-up lobbying efforts suggest genuine concern that some variant of the AFA might well pass.

Winners and losers
From the lineup both for and against the legislation, it might be tempting to conclude that enactment of the AFA would benefit consumers (and perhaps small business) to the detriment of large corporations. This view may be overly simplistic, however. One of the supposed benefits of arbitration is that it is less expensive than litigation in many state and federal courts. If that is the case, litigation may prove to be more expensive and therefore more burdensome for the employees, consumers and franchisees who are among the intended beneficiaries of the AFA. It may be easier for "deep pocket" defendants to shoulder the costs of discovery, appeals and other aspects of the litigation process that make it relatively expensive — or to pass such costs along to consumers as a whole in the cost of goods and services.

To be sure, arbitration requires plaintiffs to give up their right to a jury trial. And one of the benefits of arbitration to large corporations is that large punitive damage awards are relatively rare. On the other hand, outright dismissals are also rare in arbitration. As a result, it is not unusual to see arbitrators award not insubstantial sums to claimants whose claims — had they been brought in court — might well have been dismissed as a matter of law.

In short, the likely winners and losers if the AFA or similar legislation becomes law may not necessarily be as clear as the politics of the debate might seem to suggest — with one possible exception. Enactment of the AFA will surely benefit the members of one of the advocacy groups that supports limiting the enforceability of arbitration clauses. That organization, the American Association for Justice, is perhaps more commonly known by its former name: the Association of Trial Lawyers of America.

Reprinted with permission from Incisive Media.