IN MY OPINION ... Federal Preemption Limits Arizona Ruling on State Arbitration Law

Dispute Resolution Journal, Feb-Apr 2005 by Meyerson, Bruce

Author Bruce Meyerson argues that, for most employment disputes, the recent Arizona Supreme Court ruling that employment disputes are not covered by the state arbitration law will not apply due to preemption by the FAA.

For almost 80 years, the Arizona Arbitration Act has contained an exclusion for employment agreements "between employers and employees or their respective representatives."1 Last year, Arizona's highest court was called upon to determine whether that exclusion applied to all arbitration agreements between employers and employees, or just to arbitration agreements found in collective bargaining contracts. The court's holding in North Valley Emergency Specialists, L.L.C. v. Santana2 is straightforward. The court held that the exclusion exempts from the arbitration act "all arbitration agreements between employers and employees."

Much has been made of this decision. Indeed, the headline about this case ("Employment Arbitration Dealt a Blow in Arizona") in the previous issue of this Journal suggested that employment arbitration agreements may no longer be enforceable in Arizona. However, that is not likely to be the result of the court's decision. The reason is that the court was not called upon to consider the relationship between the Arizona Arbitration Act and the Federal Arbitration Act (FAA), which applies to any "contract evidencing a transaction involving commerce." I believe that U.S. Supreme Court decisions have made the FAA applicable to virtually every employment relationship. Thus, the ruling in North Valley Emergency Specialists should have an extremely limited impact because the Arizona exclusion for employment agreements will be preempted to the extent the agreement at issue is covered by the FAA.

The Federal Arbitration Act

The FAA is not only a procedural statute that may be invoked in federal and state court, it is also a substantive statute prohibiting state laws that single out arbitration agreements as unenforceable. The Supreme Court stated in Southland Corp. v. Keating,3 that in "enacting § 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." In subsequent decisions, the Supreme Court ruled that the FAA preempts state laws that interfere with or limit the ability of parties to enter into arbitration agreements. Although parties may challenge arbitration agreements on the same grounds applicable to all contracts, states may not impose barriers to arbitration that are unique to those agreements.

In Doctor's Associates v. Casarotto, the Supreme Court addressed the enforceability of a Montana statute. The statute provided that for an arbitration agreement to be valid, the contract in which it was contained must have a "notice" of arbitration typed on the first page of the contract in underlined capital letters. Because this requirement was not applicable to contracts generally, the High Court held that the Montana statute was preempted by the FAA. The Court stated unequivocally: "Courts may not ... invalidate arbitration agreements under state laws applicable only to arbitration provisions. [W]e have several times said, Congress precluded States from singling out arbitration provisions for suspect status."4

As interpreted by the Arizona Supreme Court, the exclusion for employment agreements in the Arizona Arbitration Act applies to all employment contracts, not just collective bargaining agreements (which are not covered by the FAA). Accordingly, in my view, the exclusion in A.R.S. § 12-1517 constitutes a state law restricting arbitration on a ground not applicable to contracts generally. Thus, for agreements evidencing a transaction "involving commerce," the FAA would govern and the Arizona Arbitration Act would be preempted. The important question that must be answered next is what effect would the FAA have?

The Scope of the FAA

First, there is the issue of the exclusion in § 1 of the FAA for "contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce." Most federal courts of appeal had found this exclusion to be limited to transportation workers. The 9th Circuit was the only holdout, ruling that § 1 excludes all employment agreements. But in 2001, in Circuit City Stores v. Adams,5 the U.S. Supreme Court rejected the 9th Circuit's interpretation. The Court held that the narrow interpretation of § 1 was correct. This interpretation only excluded workers engaged in interstate transportation. Thus, if an employment arbitration agreement not involving a transportation worker evidences a transaction "involving commerce," that agreement would be covered by the FAA. So, what is a transaction involving commerce? It is to that question we now turn.

The Supreme Court considered this question in two cases. In the first case, Allied-Bruce Terminix Companies v. Dobson,6 the Court held that the term "commerce" should be viewed broadly, extending the FAA to the limits of Congress's Commerce Clause power. In rejecting the view that the FAA's coverage should be limited to cases where interstate commerce is contemplated by the parties, the Court relied on the breadth of the phrase "involving commerce," which it found was broader than the commonly-used phrase "in commerce." "Involving commerce," the Court said, "signals an intent to exercise Congress's commerce power to the full." The Court also determined that if a transaction turns out to involve interstate commerce, even if the parties did not "contemplate" such involvement, the FAA will apply.