U.S. Supreme Court Instructs Lower Courts to "Look Through" Arbitration Petition to Determine Jurisdiction

On March 9, 2009, the U.S. Supreme Court made it a little harder to enforce arbitration agreements. The facts of Vaden v. Discover Bank are routine. Discover sued Betty Vaden in Maryland state court to collect more than $10,000 in unpaid credit card debt. Ms. Vaden counterclaimed, saying Discover breached its contract with her and violated state statutes governing credit card fees. Discover then moved to compel arbitration of Ms. Vaden’s state court counterclaims under Section 4 of the Federal Arbitration Act (FAA). It argued that because it is a federally insured bank, the Federal Deposit Insurance Act preempts Ms. Vaden’s state law claims. At issue is whether a federal court has jurisdiction in such a situation. The Supreme Court concluded that under these facts, a federal court has no authority to compel arbitration.

First, to be clear, the FAA itself creates no federal court jurisdiction. In other words, a motion to compel arbitration brought under the FAA does not raise a federal question upon which to base federal court jurisdiction. It is simply a procedural mechanism. There must be a federal question or diversity of citizenship for the federal court to become involved. In Vaden, the question was whether the federal court was limited to reviewing the motion itself to determine jurisdiction or whether it could “look through” the motion to the underlying controversy to determine whether it “arises under federal law.” The Supreme Court unanimously concluded that a “look through” is appropriate. However, that led to the next question: What should courts look at once they “look through” the motion?

It has been well established that Section 4 did not enlarge federal court jurisdiction. What the Court clarified in Vaden, however, is that a federal court lacks jurisdiction to consider a motion to compel arbitration unless the “whole controversy” between the parties qualifies for federal adjudication under rules traditionally applicable to removal. As a practical matter, that means that if a lawsuit filed in state court is not removable to federal court, the federal court will not have jurisdiction to decide the motion to compel.

In Vaden, the controversy between the parties arose from Ms. Vaden’s “alleged debt.” It was the first filed claim. By a 5-4 majority, the Court held it must apply the strictures of the well-pleaded complaint rule. Ms. Vaden’s defenses to the complaint, even if preempted by federal law, would not have given Discover access to the federal courts. A preempted counterclaim remains a counterclaim, and does not open the federal court’s door.

The significance of Vaden is that consumers often look to counterclaims in an effort to avoid foreclosure, collections, and other similar matters. While many companies prefer to file these types of actions in small claims court or in state court actions, by initiating their action in state court, these companies will often lose the ability to have a federal court compel arbitration of related claims by the consumer. As the Court stated, Discover and other defendants can move to compel arbitration in state court. That is not so simple, as many state courts take a much dimmer view of the arbitration process than their federal counterparts.

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Authors:

Michael C. Lueder
Chair, Consumer Financial Services Litigation Practice
Milwaukee, Wisconsin
414.297.5643
[email protected]

Michael D. Leffel
Partner
Madison, Wisconsin
608.258.4216
[email protected]