Why State Efforts to Preclude Arbitration Usually Violate Federal Law

Chris Micheli
Chris Micheli is a Principal with the Sacramento governmental relations firm of Aprea & Micheli, Inc.

The Federal Arbitration Act (FAA) provides that 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.” (see 9 USC Section 2) How has the U.S. Supreme Court viewed the reach of the FAA and state efforts to limit or preclude the use of arbitration?

More than three decades ago, the high court explained the purpose of the FAA. In Southland Corp. v. Keating (1984) 465 US 1, the US Supreme Court held: “In enacting Section 2 of the FAA…Congress declared a national policy favoring arbitration and withdrew the power of the states to require a judicial forum for the resolution of claims which the contracting parties agreed to resolve by arbitration.”

The FAA, as well as the California Arbitration Act (CAA), evidence a strong preference for enforcement of arbitration agreements, so long as the underlying contract is fair. Half a dozen years ago, the U.S. Supreme Court ruled in the key case of AT&T Mobility LLC v. Concepcion (2011) 131 S.Ct. 1740 that the FAA prohibits states from conditioning the enforceability of an arbitration agreement on the availability of class wide arbitration procedures as such a requirement would be inconsistent with the intent of the FAA.

Specifically, the Supreme Court stated “[w]hen state law prohibits outright the arbitration of a particular type of claim, the analysis is straightforward:  The conflicting rule is displaced by the FAA.” Furthermore, the Court ruled a state law that frustrates or interferes with a prime objective of arbitration to streamline proceedings and provide expeditious results is preempted by the FAA.

In another California case, the high court limited employees’ rights. In Sonic-Calabasas A, Inc. v. Moreno (2013) 57 Cal.4th 1109, the U.S. Supreme Court reversed its initial holding and stated that an arbitration agreement that waived an employee’s right to pursue a claim with the Labor Commissioner was not per se unconscionable. While the Court specified that states could still regulate contractual defenses, those defenses must be applicable to all contracts, not just those targeted at arbitration.

In re-emphasizing this point, the U.S. Supreme Court issued another opinion in DIRECTV, Inc. v. Imburgia (2015) 136 S.Ct. 463 that criticized California for discriminating against consumer arbitration agreements.  In DIRECTV, a California court had applied a rule of law to invalidate an arbitration agreement.

In the opinion authored by Justice Breyer, the Court stated, because California applied an invalid state law to only arbitration agreements and no other contracts, such an application did not place arbitration agreements on “’equal footing’” with other contracts and, therefore, was preempted by the FAA. This decision represented a similar holding to that of Doctor’s Associates, Inc. v. Cassarotto (1996) 517 U.S. 681 where the Supreme Court struck down a state requirement for a special notice required only for arbitration agreements, not contracts in general, as preempted by the FAA.

Additionally, in August 2015, the California Supreme Court issued a similar decision in Sanchez v. Valencia Holding Co., LLC 61 Cal.4th 899, in which Justice Goodwin Liu delivered the opinion of the court and held that the Consumer Legal Remedies Act (CLRA), which prohibited any waiver of the provisions of that law, including the right to pursue a class action, was preempted by the FAA.

The California Supreme Court determined that the anti-waiver provisions under the CLRA that barred class action waivers interfere with the “fundamental attributes of arbitration, such as speed and efficiency, and thus disfavors arbitration as a practical matter.”  Sanchez, 61 Cal.4th at 923-924.

There are numerous other instances of U.S. Supreme Court rulings that state laws or court decisions that limit the use of arbitration to adjudicate disputes usually run afoul of the FAA and are preempted by federal law. For example, the FAA preempted a California statute that provided wage collection actions could be maintained “without regard to the existence of any private agreement to arbitrate.” Perry v. Thomas (1987) 482 US 483.

In addition, the U.S. Supreme Court struck down a California law that prohibited mandatory arbitration clauses for franchisees because such a law directly conflicted with the FAA.  Southland Corp. v. Keating (1984) 465 US 1. And, the U.S. Supreme Court held that a California statute was invalid because the FAA allows arbitration of Fair Employment & Housing Act claims. Circuit City Stores, Inc. v. Adams (2001) 532 US 105.

Similarly, the U.S. Supreme Court invalidated a Montana statute that attempted to render an arbitration clause unenforceable if it did not meet certain notice requirements. The high court held that the state statute was preempted by the FAA because the state law applied only to arbitration provisions and not to contracts in general. Doctor’s Associates, Inc. v. Casarotto (1996) 517 US 681.

Moreover, there are numerous instances wherein the U.S. Supreme Court has rejected other state limitations on arbitration agreements. In American Express Co. v. Italian Colors Restaurant (2013) 133 St.Ct. 2304, the Court held the FAA does not permit courts to invalidate a contractual waiver of class arbitration on the ground that plaintiff’s cost of individually arbitrating a federal statutory claim exceeds potential recovery. Also, in CompuCredit Corp. v. Greenwood (2012) 132 S.Ct. 665, the Court held that the FAA requires an arbitration agreement in a credit card application to be enforced according to its terms.

Most recently, on May 15, 2017, the United States Supreme Court held that a Kentucky statute violates the FAA by singling out arbitration agreements for disfavored treatment. In an opinion for seven Justices that was authored by Justice Kagan, the Court held the FAA not only preempts any state law rule that discriminates against arbitration on its face, but also “any rule that covertly accomplishes the same objective by disfavoring contracts that (oh so coincidentally) have the defining features of arbitration agreements.”

Specifically, the Court ruled that arbitration agreements may only be invalidated based on “generally applicable contract defenses like fraud or unconscionability, but not on legal rules that apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue.” The Court reasoned that limiting the FAA to only state laws that affect contractual enforcement could have the effect of undermining the FAA completely. “The FAA would then mean nothing at all — its provisions rendered helpless to prevent even the most blatant discrimination against arbitration.”

The Court underscored that the FAA applies to rules governing contract formation, not just rules governing contract enforcement. The Court explained that the FAA “cares not only about the ‘enforce[ment]’ of arbitration agreements, but also about their initial ‘valid[ity]’—that is, about what it takes to enter into them.” And, the Court pointed out that a contrary interpretation would make it “trivially easy” for courts hostile to arbitration to undermine the FAA— “indeed, to wholly defeat it.”

Additionally, the Court rebuffed Kentucky’s argument that the state was merely regulating contract formation. The high court also said Kentucky’s stated principle of protecting fundamental constitutional rights was simply a pretext to discriminate against arbitration. As such, the U.S. Supreme Court held that the FAA preempts state law governing contract formation where a state rule discriminates against arbitration. Kindred Nursing Centers Ltd. P’ship v. Clark, No. 16-32, 2017 WL 2039160 (May 15, 2017).

In light of all these consistent decisions by the United States Supreme Court, it is highly unlikely that any California statute that targets arbitration for disparate treatment will be upheld by the high court. As a result, state legislators should refrain from enacting bills that discriminate against the use of arbitration or apply limitations against the use of arbitration only.

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