U.S. Supreme Court’s First Opinion of 2019: Kavanaugh Favours Arbitrators’ Power to Decide Arbitrability

The U.S. Supreme Court’s first opinion of 2019, written by recently appointed Justice Brett Kavanaugh, confirms the long-standing support of the Court for arbitrators to decide the issues of arbitrability of a dispute submitted to arbitration.  The unanimous ruling defends the provisions of the Federal Arbitration Act, confirming that a contract’s terms control who decides, in the first instance, whether a dispute is subject to arbitration.

Background

On January 8, 2019, the U.S. Supreme Court (the “Court”) vacated the judgment issued by the Court of Appeals for the Fifth Circuit in Henry Schein, Inc. et al v Archer and White Sales Inc., finding that the “wholly groundless” exception to the arbitrators’ power to decide arbitrability issues was contrary to the Federal Arbitration Act (“FAA”) and the Court’s precedent.  The judgment arose out of an action brought by Archer and White Sales Inc. (a small business that distributes dental equipment) (“Archer and White”) against Henry Schein Inc. (“Schein”) with the United States District Court for the Eastern District of Texas on August 31, 2012.  The complaint alleged violations of federal and state antitrust law, and sought money damages and injunctive relief.  The plaintiff and the defendant in that action had entered into a distribution contract, which arbitration clause provided in relevant part that:

Disputes. This Agreement shall be governed by the laws of the State of North Carolina. Any dispute arising under or related to this Agreement (except for actions seeking injunctive relief and disputes related to trademarks, trade secrets, or other intellectual property of [Schein]), shall be resolved by binding arbitration in accordance with the arbitration rules of the American Arbitration Association [(AAA)]. […]”[1]

Invoking the FAA, Schein filed a motion to stay all proceedings and to compel arbitration and refer the parties’ dispute to arbitration.  The plaintiff objected arguing that the dispute could not be subject to arbitration under the relevant contract as the complaint sought injunctive relief, and the arbitration clause prevented disputes seeking injunctive relief, even if only in part.  The District Court agreed with the plaintiff that Schein’s argument to compel arbitration was wholly groundless and based on the Fifth Circuit precedent upholding the “wholly groundless” exception, it rejected Schein’s motion to compel on December 7, 2016.  The Fifth Circuit affirmed the district court’s decision on December 21, 2017.  Schein then filed a petition for a writ of certiorari on March 9, 2018.

The Court’s Judgment

The Court noted the disagreement in the Court of Appeals over whether the “wholly groundless” exception was consistent with the FAA.  This exception had been used by certain federal courts to block frivolous attempts to transfer disputes from the court system to arbitration.  The Court, however, found that the exception was inconsistent with the FAA and the Court’s own precedent.

First, the Court noted that under the FAA, arbitration is a matter of contract and courts must enforce arbitration contracts according to their terms.  Second, the Court, relying on First Options, pointed out that parties to a contract may agree to have an arbitrator decide not only the merits of a particular dispute but also ‘gateway’ questions of arbitrability.[2]  These comprise questions such as “whether the parties have agreed to arbitrate or whether their agreement covers a particular controversy.”[3]  In this case, given that the parties’ arbitration agreement incorporated the American Arbitration Association Rules, arbitrability questions were to be decided by arbitrators.

Third, the Court looked at the text of FAA and held that:

“We must interpret the Act as written, and the Act in turn requires that we interpret the contract as written. When the parties’ contract delegates the arbitrability question to an arbitrator, a court may not override the contract. In those circumstances, a court possesses no power to decide the arbitrability issue. That is true even if the court thinks that the argument that the arbitration agreement applies to a particular dispute is wholly groundless.”[4]

The Court therefore based its decision on the provisions of the FAA and its reference to the terms of a contract freely agreed by its parties.

Finally, the Court dealt with the arguments raised by Archer and White in defense of its proposed interpretation of the FAA.  Among these, Archer and White raised a novel “practical and policy matter”[5], arguing that it would be a waste of the parties’ time and money to send the arbitrability question to an arbitrator if the argument for arbitration was wholly groundless. The arbitrator would inevitably conclude that the dispute was not arbitrable and then send the case back to the district court.  According to Archer and White, this would be a waste of time and money.  The Court disagreed, finding that: (i) the FAA contains no “wholly groundless” exception and the Court cannot re-write the FAA; (ii) the raising of the exception would create collateral litigation in court over whether an argument for arbitration is “wholly groundless” as opposed to “groundless” and therefore generate a time-consuming debate; (iii) the assumption that an arbitrator would always agree with a judge that an argument for arbitration is wholly groundless is not absolute as an arbitrator might hold a different view of the arbitrability issue than a court does.

Conclusion

The Court’s decision provides a clear answer to the question of who determines whether a dispute is subject to arbitration: the arbitrators provided that there is “clear and unmistakable evidence”[6] that the parties agreed to arbitrate arbitrability, the question should be referred to an arbitral tribunal.  This had been the rule under the FAA and the Court’s long-standing precedent. The development of the “wholly groundless” exception through certain Circuit’s case law had confused the position and had made the Court’s opinion on the Circuits’ split decisions necessary.  The opinion in Schein has now put an end to that debate.

The judgment also evidences a general pro-arbitration approach from the Court, which issued the decision in a unanimous vote, and more specifically, from the two new Justices Neil Gorsuch and Brett Kavanaugh – who authored the opinion.

[1]        Henry Schein, Inc. v. Archer and White Sales, Inc., Supreme Court of the United States, No. 17-1272 (January 8, 2019), p. 2.

[2]        First Options of Chicago, Inc. v. Kaplan, 514 U. S. 938, 943 (1995).

[3]        Rent-A-Center, West Inc. v. Jackson, 561 U.S. 63, 69 – 70 (2010).

[4]        Henry Schein, Inc. v. Archer and White Sales, Inc., Supreme Court of the United States, No. 17-1272 (January 8, 2019), p. 5.

[5]        Id., at 7.

[6]        First Options of Chicago, Inc. v. Kaplan, 514 U. S. 938, 944 (1995).

For further information, please contact Christian Leathley, Partner, Daniela Paez, Associate, or your usual Herbert Smith Freehills contact.

Christian Leathley
Christian Leathley
Partner
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+1 917 542 7812
Daniela Paez
Daniela Paez
Associate
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+1 917 542 7829

 

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