This April, the Supreme Court heard arguments on the issue of who should decide claims as to the unenforceability of an agreement to arbitrate the enforceability of an arbitration agreement–an arbitrator or a court. The high court delivered its opinion June 21 and in doing so established guidance for where such claims belong.

The case stemmed from 2007 claims that Antonio Jackson filed in Nevada federal court against his former employer Rent-A-Center, West Inc.

As a condition of Jackson’s employment he had previously signed an agreement to arbitrate all “past, present and future” disputes with his employer. The agreement included a provision stating that “[t]he Arbitrator, and not any federal, state, or local court or agency, shall have exclusive authority to resolve any dispute relating to the interpretation, applicability, enforceability or formation of this Agreement.”

Rent-A-Center moved to compel arbitration of the claim, and Jackson opposed, arguing that the arbitration agreement was “clearly unenforceable in that it is unconscionable.” Rent-A-Center countered that the question of enforceability itself belonged before an arbitrator, not the court, as the agreement provided. But Jackson argued that because he was challenging the entire agreement, including the provision to arbitrate disputes over the validity of the agreement, a court first had to rule the agreement enforceable.

In its ruling in Rent-A-Center, West, Inc. v. Jackson, the Supreme Court set forth a new rule: Claims that challenge the entire agreement, such as Jackson’s, must go before an arbitrator; however, claims that challenge the specific agreement to arbitrate the validity of the agreement must be heard by a court. It relied mainly on an interpretation of the Federal Arbitration Act (FAA) that the high court set forth in its 1967 opinion in Prima Paint Corp. v. Flood & Conklin Mfg. Co.

“[Section 2 of the FAA] states that a ‘written provision’ ‘to settle by arbitration a controversy’ is ‘valid, irrevocable and enforceable’ without mention of the validity of the contract in which it is contained,” Justice Antonin Scalia wrote for the majority. “Thus, a party’s challenge to another provision of the contract, or to the contract as a whole, does not prevent a court from enforcing a specific agreement to arbitrate.”

Considering another recent high court ruling on arbitration, Supreme Court watchers weren’t surprised by the Rent-A-Center ruling.

“The court has been quite pro-arbitration; they really want to enforce arbitration agreements,” says Tom Goldstein, co-leader of Akin Gump’s litigation management committee and the publisher of SCOTUSblog. “But the theory of the decision is a little surprising because it is an argument that no one else had made in the case. The majority came up with its own theory that is kind of a middle ground, and it’s not clear how broadly it will apply. … Rent-A-Center is definitely going to have some follow-up cases.”

Breezy Assertion

The reasoning in Rent-A-Center goes hand in hand with another Supreme Court case of this term that dealt with the class arbitration issue, Stolt-Nielsen S.A. v. AnimalFeeds International Corp. In its April 27 opinion, the majority said parties cannot be compelled to submit to class arbitration absent evidence that it contractually agreed to do so, and the court also restated the “foundational FAA principle that arbitration is a matter of a consent.”

The decision in Rent-A-Center also seems to rely on that maxim. “It was pretty consistent with the Supreme Court’s decision in Stolt-Nielsen,” says James P. Duffy, a member of DLA Piper’s litigation practice group. “They’re taking a pro-arbitration line and enforcing arbitration agreements as they’re written, treating arbitration clauses as a typical contract that requires courts to enforce it as written. It’s a fairly good, pro-arbitration development.”

In Jackson’s case, he had agreed to arbitrate all claims, including claims about enforceability. “If that’s the case, you’re going to arbitration,” says Stephen Harvey, a partner at Pepper Hamilton. “It was that simple from the majority standpoint.”

Justice Stevens called the majority’s rule a “breezy assertion” in his dissent. The reasoning in Prima Paints, on which the majority relied, was “likely erroneous,” he wrote, continuing: “Were a court to decide the fraudulent inducement question in Prima Paint, in order to decide the antecedent question of the validity of the included arbitration agreement, then it would also, necessarily, decide the merits of the underlying dispute.”

Harvey also finds the nature of the split noteworthy: Scalia and the majority said an individual who signed an arbitration clause like the one Jackson did is subject to arbitration and required to bring the claim of unconscionability to the arbitrator. Meanwhile, Stevens was joined in his dissent in viewing the situation from “a more practical angle,” Harvey says. “That neatly demonstrates the difference between the right and left branches of the court.”

Harvey believes Stevens’ dissent made a valid point. “Is it reasonable to conclude that Congress would have expected someone in Jackson’s shoes, who’s claiming that an arbitration clause is unconscionable, would have to go through what he says is an extremely unfair process to find out whether it’s unfair or not?” he says.

Congressional Compass

Questions of fairness surrounding arbitration are nothing new. In the past few years, researchers purported to show anti-consumer biases among certain arbitration providers, and legislators worked to address the concerns.

For example, the financial services reform bill that Congress passed this year included limitations on arbitration agreements in consumer financial service contracts.

“It doesn’t include employment agreements like this, but it’s a pretty big world–all your credit card and bank agreements, anything like that,” Harvey says. “Not only that, but if someone said arbitration clauses were unfair, like if the Bureau of Consumer Financial Protection outlawed them in the consumer context, that might turn out to be the end of arbitration clauses all around, outside of the commercial context.”

It’s yet to be seen how Supreme Court reasoning like that seen in Rent-A-Center may impact the Arbitration Fairness Act, still pending in Congress. If passed, the bill would ban compelled arbitration in the employee, consumer, franchise and civil rights contexts.

“One of the clear implications of that bill is that arbitration is viewed as something unfair in employment and consumer cases, and that act seeks to invalidate pre-dispute arbitration agreements in certain cases,” Duffy says. “So this decision would seem to be directly at odds.”

Clause Reviews

Despite uncertainties over interpretation and pending legislation, simply reviewing arbitration contracts is a logical solution for in-house counsel reacting to Rent-A-Center.

“[Rent-A-Center] puts a premium on lawyering more than anything else–lawyers writing employment agreements including these clauses, and plaintiffs lawyers generating a basis of challenging that law,” Goldstein says. “For inside counsel, the real lesson is making sure to update your arbitration agreements to say if you’re challenging the agreement. If you’re challenging the enforceability of the arbitration provision itself, then that has to be decided in arbitration.”

Of course, parties resisting arbitration will adjust their methods as well. “If people are looking for a court challenge, they will have to specifically challenge the direct provision that says the
arbitrator shall have the ability to determine threshold issues or jurisdiction,” Duffy says.

There will also have to be a careful balancing act in consideration of the threat of costly class arbitration, Harvey says, when including clauses that refer all disputes to arbitration. Doing so could mean that the decision about whether the dispute can be adjudicated on a class or individual basis will be made by the arbitrator, which does not provide for an appeal.

“Be careful what you wish for,” Harvey says. “Sometimes the bigger question is whether the parties intended for there to be class arbitration. Some courts and arbitrators were saying that you can go to arbitration, but then you have to proceed with a class in arbitration. That just makes companies go nuts.”