High Court Boosts Arbitration in Buckeye

Dispute Resolution Journal, May-Jul 2006 by Singletary, Cary

Upholds Arbitrability of Contract Defense

Arbitrability issues continue to interest the nation's highest court. On Feb. 21, 2006, the U.S. Supreme Court unanimously held in Buckeye Check Cashing v. Cardegna (126 S. Ct. 1204), that an arbitrator, not a court, should determine whether a dispute is arbitrable when the contract containing the arbitration clause is alleged to be void because of illegality.

Florida's highest court had held otherwise. But the Supreme Court reversed in an opinion written by Justice Antonin Scalia that reaffirms the severability principle established in 1967 in Prima Paint v. Flood & Conklin Manufacturing Co. (388 U.S. 395). Under that principle, an arbitration provision is severable from the remainder of the contract as a matter of substantive federal arbitration law. Unless the challenge is to the arbitration clause itself, the validity of the contract (even a challenge based on illegality) must be determined by the arbitrator. The High Court said that its ruling did not depend on whether the challenge to the contract as a whole was made in federal or state court.

Buckeye involved consumer disputes, which, together with employment disputes, have generated a considerable amount of important arbitration case law. In each case the High Court has supported the use of arbitration based on established arbitration principles and federal policy favoring arbitration, provided that due process is accorded.

Facts and Procedural Background

The plaintiffs in Buckeye commenced a putative class action in state court in Florida, alleging that the company's check cashing business in fact disguised illegal usurious loan transactions. Buckeye Check Cashing moved to abate the action and compel arbitration based on an arbitration agreement in the deferred deposit and disclosure agreement signed by the representative plaintiffs. This agreement stated in relevant part:

This arbitration agreement is made pursuant to a transaction involving interstate commerce, and shall be governed by the Federal Arbitration Act. The arbitrator shall apply applicable substantive law constrait [sic] with the FAA and applicable statu[t]es of limitations and shall honor claims of privilege recognized by law....

The Florida trial court denied Buckeye Check Cashing's motion to compel arbitration. However, that decision suffered a series of reversals at the appellate level. First, Florida's 4th District Court of Appeal reversed, then its Supreme Court reversed, siding with the lower court. It held that an arbitration clause cannot be enforced while a claim is pending in a Florida trial court that the contract in which it resides is illegal and therefore void ab initio. The Florida Supreme Court felt strongly that to prevent bootstrapping, the issue of illegality had to be addressed first by a court. It explained, "A court's failure to first determine whether the contract violates Florida's usury laws could breathe life into a contract that not only violates state law, but also is criminal in nature, by use of an arbitration provision."

Response to Bootstrapping Claim

The Supreme Court How did the U.S. Supreme Court deal with this bootstrapping argument? First, the Court relied on basic principles established in prior decisions in Southland Corp. v. Keating, 465 U. S. 1, (1984) and Prima Paint, and on § 2 of the Federal Arbitration Act, which makes a written agreement to arbitrate "valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract."

In Southland, the Court determined that in enacting § 2 of the FAA, Congress declared a national policy favoring arbitration and withdrew the power of states to require a judicial forum for the resolution of claims that contracting parties agreed to resolve by arbitration. It further held that the FAA "create[d] a body of federal law ... applicable in state and federal court." It rejected the view that state law could bar enforcement of § 2, even in the context of state law claims brought in state court.

The Court placed only two limitations on the enforceability of arbitration provisions under the FAA: They must be part of a written maritime contract or a contract "evidencing a transaction involving commerce."

The Southland Court went on to identify two types of challenges to the validity of arbitration agreements that could be raised on the grounds alluded to in FAA § 2. One type challenges the validity of an arbitration agreement and the other challenges the validity of the contract as a whole. The Court addressed both types of challenges in the landmark Prima Paint decision. There it determined that challenges to the validity of the arbitration clause only may be adjudicated by a court, but challenges to the validity of the contract generally may be adjudicated by an arbitrator. In reaching this conclusion the Court relied on § 3 of the FAA, which requires a court to stay any lawsuit brought in federal court on the application of a party, where the court is satisfied that there is an "issue referable to arbitration" under a written arbitration agreement, "provid[ed that] the applicant for the stay is not in default in proceeding with such arbitration."