In Vaden v. Discover Bank (pdf), decided March 9, a divided U.S. Supreme Court resolved a long-standing circuit split regarding parties' ability to seek federal court assistance to compel arbitration of litigation pending in state court. The case pitted credit card purveyor Discover Bank against a defaulted credit card customer. The consumer counterclaimed in state court on behalf of a class of disgruntled card holders for alleged violation of Maryland's usurious interest laws.
Discover sought to avoid the class claims by bringing a new action in federal court to compel arbitration. The Supreme Court, in a 5-4 majority opinion issued by Justice Ruth Bader Ginsburg, rejected this procedural gambit, holding that federal jurisdiction to compel arbitration will arise only when the entire controversy, as framed by the underlying complaint, satisfies traditional tests for federal jurisdiction.
In 2003, Discover sued Betty Vaden in Maryland state court for failing to pay more than $10,000 in past-due charges on her account. We do not know if Vaden spent her credit well, but we do know she hired an enterprising defense counsel. In addition to filing counterclaims for violation of Maryland's usurious interest statutes, her attorneys brought class action claims on behalf of thousands of Maryland credit card holders.
The counterclaims upped the ante. Discover reasoned that the allegations were completely pre-empted by federal law regulating bank interest charges, and hoped to avoid a fight in state court. In fact, the company hoped to avoid a fight in any court, anywhere. A forum selection clause in Vaden's card holder agreement allowed Discover to elect, at its discretion, to compel arbitration of any dispute, or any part of any dispute, arising under the agreement. The company thus decided to do what it might have done at the outset of the matter and decided to arbitrate.
Discover, however, liked its chances for summary judgment on its original state court complaint and had no interest in arbitrating that issue. The only matter the company hoped to arbitrate was Vaden's counterclaim -- a gambit that would create dual proceedings (along with the attendant costs of each) and implicitly defeat Vaden's class action ambitions.
Unfortunately for Discover, Maryland's procedural rules harkened to the state's motto, "Fatti Maschii Parole Femine," ("Strong Deeds, Gentle Words") and codified no reliable mechanism for splitting a case or avoiding Discover's potential waiver of arbitration by having first filed the suit in state court. Enter Discover's petition to federal court under the Federal Arbitration Act. Section 4 of the FAA entitles a party to bring a petition to compel arbitration of a state court proceeding if the federal court "would have jurisdiction ... of the subject matter of a suit arising out of the controversy between the parties." In search of a federal question, Discover claimed that Vaden's counterclaims implicated and were pre-empted by federal law regulating bank interest charges, and the district court agreed.
Vaden obviously opposed the argument. She argued that jurisdiction could not be found by "looking through" a petition to compel arbitration; rather, such jurisdiction must be apparent on the face of the petition. Further, even if such look-through inquiry was permissible, the court could not use Vaden's federal law-preempted counterclaims to secure federal jurisdiction.
Six years later, following two trips to the 4th U.S. Circuit Court of Appeals and one to the Supreme Court, the parties and our readership finally have answers. All nine Supreme Court justices held that the federal courts properly may "look through" to an underlying action in order to ascertain subject matter jurisdiction under §4 of the FAA. But, in a blow to Discover, five of the justices rejected the company's argument that courts may evaluate a discrete part of an underlying dispute, including counterclaims, to find a federal question.
Writing for the majority, Ginsburg opined that "Parties may not circumvent [the well pleaded complaint rule] by asking a federal court to order arbitration of the portion of a controversy that implicates federal law when the court would not have federal-question jurisdiction over the controversy as a whole." 556 U.S. ____ (2009), Slip Op. at 19. The majority reasoned that "a federal counterclaim, even when compulsory, does not establish 'arising under' jurisdiction" [Id. at 14] such that even for purposes of §4, "a completely preempted counterclaim remains a counterclaim and thus does not provide a key capable of opening a federal court's door." Id. at 16, citing Holmes Group, Inc. v. Vornado Air Circulation Systems, Inc., 535 U.S. 826 (2002).
Discover can find some solace in having split the Court nearly as well as it hoped to split Vaden's counterclaims. Writing for the dissent, Chief Justice Roberts argued it was anomalous to reject jurisdiction in such a case when federal jurisdiction was founded on the only issue subject to arbitration: "Discover's petition does not seek to arbitrate its state-law debt-collection claims, but rather Vaden's allegation that fees Discover has been charging her (and other members of her proposed class) violate the [Federal Deposit Insurance Act]." Dissent Op. at 3. The fact that the original complaint contained no federal claim was of little moment to the dissent, as the text of §4 only required that the controversy subject to arbitration -- whether part of a larger state court action or not -- raise a federal question.
This view, however, did not carry the day. In a welcome sign of sustained vigor, Ginsburg pointedly characterized the dissent as a "bizarre" attempt to allow litigants "to slice off responsive pleadings for arbitration while leaving the remainder of the parties' controversy pending in state court." Slip Op. at 18. Just enough of a pen prick perhaps to entice Justice Antonin Scalia to join the majority.
J. Noah Hagey is co-chair of the ABA's Section of Litigation International ADR Subcommittee. He is a senior associate at Quinn Emanuel Urquhart Oliver & Hedges in San Francisco.
