Originally published by Thomas J. McGoey II and Philip Dore.
Commercial and employment agreements often include provisions requiring arbitration of disputes between the parties. Some of these agreements contain “delegation clauses” requiring the arbitrator (as opposed to a court) to decide whether the dispute is subject to arbitration. Despite such provisions, one party may sue the other because it perceives an advantage to proceeding in court or wants to test the outer limits of the arbitration provision. The first battle in these suits is over who—the court or an arbitrator—decides whether the dispute must be arbitrated. In unanimous decisions issued over the last week, the Supreme Court addressed two scenarios where the parties fought over this question, despite having delegated questions of “arbitrability” to an arbitrator. Read together, the Court’s decisions clarify that a court should first decide whether the Federal Arbitration Act (“FAA”) applies to the parties’ agreement. If so, the court must honor the delegation clause and refer the matter to arbitration.
Henry Schein, Inc. v. Archer & White Sales, Inc., 586 U.S. __ (2019)—issued January 8th.
The parties in Schein, a manufacturer and a distributor, entered into a contract providing that “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 . . .), shall be resolved by binding arbitration in accordance with the arbitration rules of the American Arbitration Association.” The distributor filed suit against the manufacturer in federal district court alleging antitrust violations and seeking damages and injunctive relief, and the manufacturer moved to compel arbitration under the FAA. The distributor objected, arguing that the dispute was not subject to arbitration because its complaint sought injunctive relief, at least in part, and was therefore “carved out” of the arbitration provision. Relying on Fifth Circuit precedent permitting the application of a “wholly groundless” test as a means of blocking frivolous attempts to transfer disputes from the courts to arbitration, the district court denied the manufacturer’s motion to compel arbitration. After the Fifth Circuit affirmed, the manufacturer sought Supreme Court review to resolve a split among the circuits regarding court authority to apply the “wholly groundless” test.
The Supreme Court explained that under the FAA, parties may agree to have an arbitrator decide not only the merits of a particular dispute but also the “gateway” question of arbitrability. The Court held that the “wholly groundless” test adopted by several circuit courts is inconsistent with the text of the FAA and the Court’s past decisions: “When the parties’ contract delegates the arbitrability question to an arbitrator, the court may not override the contract. In those circumstances the 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.”
The Schein decision clarifies that a delegation clause must be “clear and unmistakable,” but it does not define the parameters of “clear and unmistakable.” Those parameters may vary from circuit to circuit. For example, in the Fifth Circuit, when an arbitration agreement provides that the American Arbitration Association’s rules govern the arbitration, courts have held that such provisions constitute a valid delegation clause.
New Prime Inc. v. Oliveira, 586 U.S. __ (2019)—issued January 15th.
One week after Schein was decided, the Supreme Court issued its opinion in New Prime, where an independent contractor driver named Oliveira filed a collective action lawsuit against a trucking company under the Fair Labor Standards Act. Oliveira alleged that he and his fellow drivers were misclassified as independent contractors, and that they were actually employees entitled to overtime wages. Based on a delegation clause in its agreement with Oliveira, the trucking company moved to compel arbitration under the FAA. Oliveira argued that the FAA does not apply to this dispute at all because §1 of the FAA (which limits the scope of the statute) does not apply to “contracts of employment” with transportation workers, including independent contractor agreements. Oliveira further argued that, despite the delegation clause, the court must decide whether the FAA applies. The district court agreed with Oliveira on both counts and denied the motion to compel arbitration. The First Circuit affirmed, and the Supreme Court granted certiorari.
In New Prime, the Supreme Court addressed two issues: (1) When a contract delegates questions of arbitrability to an arbitrator, who (the court or the arbitrator) should decide whether an exception under §1 of the FAA applies?; and (2) Does the term “contracts of employment” in the §1 exception include contracts with independent contractors? Without referencing Schein, the Court noted that “[w]hile a court’s authority under the [FAA] to compel arbitration may be considerable, it isn’t unconditional.” The Court held that “a court should decide for itself whether §1’s ‘“contracts of employment”’ exclusion applies before ordering arbitration.” Turning to the second question, the Court confirmed the absence of any dispute that Oliveira was a “worker[] engaged in . . . interstate commerce.” Interpreting the words of the §1 exception in accordance with their ordinary meaning when the FAA was enacted in 1925, the Court held that “contracts of employment referred to agreements to perform work,” even by independent contractors.
Practical Impact of the Decisions
Whereas the Schein decision is another in a long line of Supreme Court pronouncements favoring arbitration under the FAA, New Prime is a rare win for an arbitration challenger and a glimmer of hope for those who believe arbitration eviscerates workers’ rights to jury trials and class/collective actions, thereby preventing meaningful recovery under employment discrimination and wage statutes. Schein confirms the importance of drafting clear delegation clauses, and it should discourage lawsuits, or at least make referrals to arbitration faster and more predictable when a typical commercial contract contains such a clause. On the other hand, New Prime will have a significant impact on wage litigation because it paves the way for misclassified independent contractors to get their overtime claims into court and avoid arbitration. The decision may also cause employers to seek enforcement of arbitration agreements under state laws, which may have no exceptions or different exceptions than the FAA’s §1 exception for “contracts of employment.”
Issues related to the scope of the FAA and gateway questions of arbitrability will continue to be fleshed out in the lower courts based on the guidelines, and questions left unanswered, in Schein and New Prime. If you need assistance drafting arbitration agreements or interpreting an agreement already drafted, contact Tommy McGoey or Philip Dore.
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