U.S. Supreme Court Says: We Mean It–You Can’t Single Out Arbitration Agreements for Disfavored Treatment

On Monday, May 15, 2017, the Supreme Court issued its latest reminder to state and lower federal courts that they must treat arbitration agreements as equally valid as all other contracts. In Kindred Nursing Centers Limited Partnership v. Clark et al., 581 U.S. ___ (2017), the Court confronted a rule imposed by the Kentucky Supreme Court that barred contracts conferring broad “powers of attorney” — contracts that authorize individuals to act on behalf of, and legally bind, others—from entering into an arbitration agreement, on the principal’s behalf, absent a “clear statement” of authority that allows the agent to waive the principal’s right to a jury trial.

By 7-1 vote (absent Justice Gorsuch’s participation), the Court held that Kentucky’s so-called “clear statement rule” ran afoul of the Federal Arbitration Act, 9 U.S.C. §§ 1 et seq. ( FAA). The FAA provides that written agreements to arbitrate “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.”  9 U.S.C. § 2.  As the Supreme Court has observed repeatedly, Congress passed the FAA to address states’ longstanding hostility to arbitration. Towards that end, the FAA prohibits any state rule that discriminates against arbitration — either expressly on the face of the rule (i.e., a law prohibiting the arbitration of any particular type of claim) or covertly by disfavoring contracts that have the effect of declining to enforce arbitration agreements (i.e., a law that requires dispute resolution by jury trials only). In a series of recent decisions, the Supreme Court has applied a recurring test in applying the FAA to state-law rules affecting arbitration agreements: Does the rule have the effect of singling arbitration agreements out for disfavored treatment compared to other types of contracts?

The Court held that the Kentucky clear statement rule at issue in Kindred failed the FAA’s test. Writing for the majority, Justice Kagan explained that Kentucky’s clear statement rule fails to put arbitration agreements on an equal plane with other contracts because it has the effect of allowing agents to bind principals to some agreements (i.e., contracts for the purchase/sale of property), but not agreements to arbitrate. Responding to the Kentucky Supreme Court’s rationale that the clear statement rule did not discriminate against arbitration because the rule applied to other “fundamental constitutional rights” beyond the right to trial by jury, the Court pointed out that “[n]o Kentucky court, so far as we know, has ever before demanded that a power of attorney explicitly confer authority to enter into contracts implicating constitutional guarantees.” Op. at 6.  In fact, as the Court pointed out, the clear statement rule did not even apply to other agreements that would have the effect of relinquishing a principal’s right to jury trial, such as settlement agreements or consent to bench trials. Op. at 6 n.1. This evidence, the Court concluded, further demonstrated that Kentucky’s stated principle of protecting “fundamental constitutional rights” was simply a pretext to discriminate against arbitration.

The Court also rejected the argument that Kentucky’s clear statement rule did not run afoul of the FAA because it addressed the formation of a contract, rather than its enforcement. Quoting the FAA’s direction that arbitration agreements should be “valid, irrevocable, and enforceable,” 9 U.S.C. § 2, the Court pointed out that the FAA applies equally to questions concerning contract “validity”—“that is, about what it takes to enter into them”—as it does to contract “enforceability.” Moreover, the Court reasoned that limiting the FAA to only state laws that affect contractual enforcement could have the effect of undermining the FAA completely, as states would then be free to adopt rules that declared any party to a contract to be incompetent to sign arbitration agreements—thus rendering all such arbitration agreements null and unenforceable. “The FAA would then mean nothing at all—its provisions rendered helpless to prevent even the most blatant discrimination against arbitration.”  Op. at 8-9.

While Kindred breaks little new ground in the Court’s interpretation of the FAA, it is a useful reminder that state court rules and decisions invalidating arbitration agreements will be met with heavy skepticism. As we explained in our May 10 post “Shouldn’t You Be Using Arbitration Agreements to Reduce the Costs of Litigation and the Risk of Class Action Claims,” a properly-drafted arbitration agreement can provide a cost-effective manner to manage dispute resolution by reducing discovery costs and, potentially, controlling the number of consumers who are parties to any such cases. Parties who sign a contract that is otherwise valid and enforceable, which contains an arbitration provision, should expect to be held to all aspects of the contract—including the agreement to arbitrate.