Two cases, discussed below, provide good examples of circumstances in which U.S. courts have not held in favor of upholding arbitration clauses.
Hooper v. Advance America, Cash Advance Centers of Missouri, Inc.: A motion to dismiss for failure to state a claim for relief waived an arbitration agreement in a class action suit
U.S. courts strongly favor enforcing arbitration clauses, even against claims that litigants waived their arbitration rights by participating in the litigation process. Although the standards vary somewhat among jurisdictions, most U.S. courts apply a "totality of circumstances test" to determine whether a party seeking to compel arbitration substantially invoked the litigation process to the other party's detriment.
When applying that test, courts typically consider factors such as: which party is seeking to enforce the arbitration agreement; how long the party waited before moving to compel arbitration; how long the case has been on file; how far discovery has proceeded; who initiated the discovery; whether the discovery related to the merits or to preliminary procedural issues; whether the moving party sought relief on the merits; to what extent will litigation effort be duplicated if arbitration is compelled; how much expense has been incurred in litigation; how close the case was to trial; to what extent has the movant obtained an advantage through litigation before moving to compel arbitration.
In Hooper, No. 08-3252, 2009 WL 4825132 (8th Cir. Dec. 16, 2009 (Mo)), the 8th U.S. Circuit Court of Appeals, which covers much of the Midwestern United States from Minnesota to Arkansas, affirmed a trial court order denying a defendant's motion to stay litigation and to compel arbitration, because the defendant waived the arbitration agreement. The plaintiffs filed a putative class action complaint in which they sought a declaration that the parties' arbitration agreement was unconscionable and unenforceable. They also included six counts alleging various statutory claims. Before answering the complaint's factual allegations, the defendant asked the district court to dismiss the case based on a failure to state a claim for relief. The defendant also purported to preserve its right to compel arbitration at a later time. The district court denied both the motion to dismiss and the defendant's subsequent motion to compel arbitration.
The appellate court affirmed the trial court's rulings - although the dispute was within the arbitration agreement's scope, the only discovery was an exchange of required disclosures, the parties had (as required) agreed to a scheduling order, and the case had been on file for only four and a half months when the defendant moved to compel arbitration. In so doing, the court held that the defendant acted inconsistently with its right to arbitrate by substantially invoking the litigation machinery before asserting its arbitration right. Critical to the court's analysis was its view that, by filing a motion to dismiss the complaint on the merits before moving to compel arbitration, the defendant "wanted to see how the case was going in federal district court before deciding whether it would be better off there or in arbitration." The court further held that the defendant's conduct prejudiced the plaintiffs by forcing them to litigate substantial issues on the merits in responding to the motion to dismiss, and that they could be forced to duplicate their effort in the arbitration if the defendant raised the same arguments before the arbitrator.
The key lesson from this case is that parties need to promptly assert their arbitration rights and that they run a substantial risk of waiving those rights if they seek any substantive relief in the courts that is not expressly agreed to in the parties' contract. For example, parties frequently agree that an arbitration agreement does not prevent a party from seeking injunctive relief in the courts to protect trade secrets, trademarks or other intellectual property rights. Parties need to consider such exceptions when drafting their arbitration agreements. Otherwise, they should not ask a court to provide substantive relief on the merits if they want to enforce their arbitration agreements.
Vestra Resources, Inc. v. Thompson: Absence of license to do business precluded enforcement of arbitration agreement
In Vestra Resources, Inc. v. Thompson, No. C054241, 2008 WL 193252 (Cal. Ct. App. Jan 24, 2008) California Court of Appeals held that the claimant's failure to obtain the required license to practice engineering in California precluded it from enforcing its contracts in California due to a California statute. This vacated a lower court judgment confirming the arbitration award for the claimant. The respondent had advised the claimant and the arbitrator that it would not proceed with the arbitration because the claimant's failure to meet the licensing requirement rendered the contracts illegal. The arbitration went forward and the arbitrator found for the claimant holding that the licensing requirement did not render the contract illegal and unenforceable. The lower court confirmed the arbitrator's award. On appeal, the award was vacated.
It should be noted that the majority of states have similar statutes pertaining to various professional activities. Almost all states have statutes that preclude a corporation from suing to enforce its contracts if they have not met the requirements to qualify to do business in the state and paid current franchise taxes. In the case of the later statutes, most states allow retroactive qualification.
The lesson from Vestra is that before instituting arbitration proceedings, a check should be made to determine if the claimant has complied with statutory requirements to qualify under state law to bring proceedings to enforce the contract. If that is not the case, one should determine whether the statutory requirement can be satisfied retroactively. (Because this is an unpublished opinion, under California law it has no precedential value and cannot be cited as authority. Therefore, this case is discussed solely for illustrative purposes.)