US Sup Ct: Will the “Next Big Arbitration Issue” Be Whether Provisions of Arbitration Rules Constitute Clear and Unmistakable Evidence That the Disputing Parties Allocated “Who Decides” Authority to the Arbitrators?

By Mark Kantor

Kantor Photo (8-2012)

The U.S. Supreme Court heard oral argument in two arbitration-related cases on Monday, Henry Schein Inc. v. Archer & White Sales Inc. and Lamps Plus Inc. v. Varela.  The issue before the Court in Henry Schein was whether or not there is a “wholly groundless” exception to the general Federal Arbitration Act caselaw rule that, if the parties have “clearly and unmistakably” allocated the “who decides” question to the arbitrators, then issues of jurisdiction/arbitrability are for the arbitrator to decide in the first instance, not the courts.

The facts of the Henry Schein case involved the relatively commonplace occurrence of a commercial arbitration agreement referencing arbitration rules (here, AAA Commercial Arbitration Rule 7(a)) that grant the arbitrators the power to decide their own jurisdiction.  The lower courts in Henry Schein, like many other Federal courts before them, concluded that provision of the Rules constituted “clear and unmistakable evidence” (as called for by the Supreme Court in First Options of Chicago, Inc. v. Kaplan) allocating the “who decides” authority to the arbitrators, and then proceeded to consider whether or not an exception to that allocation exists if the claim of arbitrability is “wholly groundless”.

The 5th Circuit Court of Appeals ruled below in Henry Schein that such a “wholly groundless” exception does exist.  Further, said the Court of Appeals, that “wholly groundless” exception applied in the dispute such that the Federal courts could refuse to compel arbitration in the circumstances.  The disappointed claimant then sought, and obtained, U.S. Supreme Court review on the question of whether such a “wholly groundless” exception to the “clear and unmistakable evidence” allocation rule exists under Federal arbitration law.

However, Prof. George Bermann of Columbia Law School, known to many of us as inter alia the chief reporter of the ALI’s Restatement of the U.S. Law of International Commercial and Investor-State Arbitration, felt moved to submit an amicus brief in Henry Schein questioning, not the issue expressly before the Court, but instead the underlying principle that incorporation of arbitration rules granting jurisdiction/arbitrability power to the arbitrators satisfies the “clear and unmistakable evidence” test for allocating “who decides” authority to the arbitrators .

Although a majority of courts have found the incorporation of rules containing such a provision to satisfy First Options’ “clear and unmistakable” evidence test, the ALI’s Restatement of the U.S. Law of International Commercial and Investor-State Arbitration has concluded, after extended debate, that these cases were incorrectly decided because incorporation of such rules cannot be regarded as manifesting the “clear and unmistakable” intention that First Options requires.

https://www.supremecourt.gov/DocketPDF/17/17-1272/65270/20181001112810079_REPRINT%20Amicus-GAB.pdf .

Many of the Supreme Court Justices commented that this issue of “clear and unmistakable evidence … due to incorporation by reference” was not part of the Question Presented on which the Supreme Court granted certiorari in Henry Schein.  Based on those comments, it seems unlikely that the eventual decision of the Court in Henry Schein will resolve the issue posed by Prof. Bermann.  Nevertheless, Justices from across the judicial spectrum commented respectfully regarding Prof. Bermann’s amicus argument.  See comments and questions of Justice Ginsburg, Tr. 7:16-23; Justice Breyer, Tr. 49:15-23; Justice Gorsuch, Tr. 42:13-20; Justice Sotomayor, Tr. 38:4-7; Justice Alito, Tr. 35:7-36:4.

Counsel for the Petitioner did take substantive issue with Prof. Bermann’s argument, in addition to arguing that the issue was not within the Question Presented and thus in any event not before the Court.

What is going on in this case, if you look at the four corners of the delegation -of the arbitration agreement **** is that the arbitration agreement by its terms incorporates the rules of the American Arbitration Association and it does so very clearly. That is a quite common arrangement, particularly in commercial arbitrations like the one at issue here.

Then, if you take a look at the rules of the American Arbitration Association, those rules, and, in particular, Rule 7(a), clearly give the arbitrator the authority to decide arbitrability.  And under this Court’s decision in First Options, the relevant inquiry is whether or not the parties were willing to be bound by the arbitrator’s determination on the issue in question.

And so, with all due respect to Professor Bermann and his amicus brief, the position that he propounds has been rejected by every court of appeals to have considered this issue.  And if the Court has any interest in this issue, I would refer the Court to the very thoughtful opinion of the Tenth Circuit in the Belnap case, which discusses this issue in some detail.

Tr. 8:9-9:13.

The transcript of the oral argument in Henry Schein, available at https://www.supremecourt.gov/oral_arguments/argument_transcripts/2018/17-1272_bqmc.pdf, is very much worth reading in this regard.

The arguably positive comments by some Justices in reaction to Prof. Bermann’s amicus argument create the possibility that opportunistic counsel in other cases will see a signal that raising the principle to the Supreme Court in a future case might be worth the effort.  Consequently, I suggest that the “Next Big Arbitration Issue” to come to the U.S. Supreme Court may be whether or not an arbitration agreement incorporating arbitration rules that include within themselves a provision authorizing the arbitrators to rule on their own competence satisfies the “clear and unmistakable evidence” test in First Options for allocating “who decides” authority to the arbitrators in the first instance.

By the way, reading the tea leaves in the Henry Schein oral argument, at least some observers believe the comments/questions of the Supreme Court Justices indicate that the Court is not inclined to validate a “wholly groundless” exception to the allocation of “who decides” authority to the arbitrators.  See, e.g., http://www.scotusblog.com/2018/10/argument-analysis-justices-signal-opposition-to-vague-exceptions-that-would-limit-enforceability-of-arbitration-agreements/#more-276785.

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Mark Kantor is a CPR Distinguished Neutral. Until he retired from Milbank, Tweed, Hadley & McCloy, Mark was a partner in the Corporate and Project Finance Groups of the Firm. He currently serves as an arbitrator and mediator. He teaches as an Adjunct Professor at the Georgetown University Law Center (Recipient, Fahy Award for Outstanding Adjunct Professor). Additionally, Mr. Kantor is Editor-in-Chief of the online journal Transnational Dispute Management.

This material was first published on OGEMID, the Oil Gas Energy Mining Infrastructure and Investment Disputes discussion group sponsored by the on-line journal Transnational Dispute Management (TDM, at https://www.transnational-dispute-management.com/), and is republished with consent.

US Sup Ct Grants Cert to Review Whether Courts Can Decline to Enforce Delegation of Arbitrability to Arbitrators When Court Concludes Arbitrability Claim is Wholly Groundless

By Mark Kantor

Kantor Photo (8-2012)

Continuing their now years-long effort to mold the relationship between the courts and arbitrators, the US Supreme Court today granted certiorari in Henry Schein Inc. v. Archer and White Sales Inc., No. 17-1272, to answer the question of “[w]hether the Federal Arbitration Act permits a court to decline to enforce an agreement delegating questions of arbitrability to an arbitrator if the court concludes the claim of arbitrability is “wholly groundless.””  In the lower appellate phase of this dispute, the US Court of Appeals for the 5th Circuit had ruled last December that Federal courts did indeed have the authority to do so.

Granting this cert petition will allow the Supreme Court to resolve a “Circuit split” on the issue between the Fourth, Fifth, Sixth, and Federal Circuits, holding on the one hand that Federal courts may decide an arbitrability issue if the claim for arbitrability is “wholly groundless,” and the Tenth and Eleventh Circuits, holding on the other hand that if there is a contractual delegation of arbitrability to the arbitrators then the courts must compel arbitration to resolve the arbitrability issue even if it appears to the court that the claim of arbitrability is entirely groundless.

The dispute will be argued in the October Term of the Court.

The case record for this matter, including the appeals court decision and the filings relating to certiorari, can be found on www.Scotusblog.com at http://www.scotusblog.com/case-files/cases/henry-schein-inc-v-archer-and-white-sales-inc/.

 

Mark Kantor is a CPR Distinguished Neutral. Until he retired from Milbank, Tweed, Hadley & McCloy, Mark was a partner in the Corporate and Project Finance Groups of the Firm. He currently serves as an arbitrator and mediator. He teaches as an Adjunct Professor at the Georgetown University Law Center (Recipient, Fahy Award for Outstanding Adjunct Professor). Additionally, Mr. Kantor is Editor-in-Chief of the online journal Transnational Dispute Management.

This material was first published on OGEMID, the Oil Gas Energy Mining Infrastructure and Investment Disputes discussion group sponsored by the on-line journal Transnational Dispute Management (TDM, at https://www.transnational-dispute-management.com/), and is republished with consent.

Delaware Chancery Defines ‘Quick’ Court Inquiry Before Referral to Arbitration

By Kelly Zhang

An action for a preliminary injunction to enjoin arbitration proceedings by officers of a Delaware limited liability company has been denied by the Delaware Court of Chancery.

The decision supports the vitality of a limited liability company’s use of arbitration in its operating agreement. But as it develops the Delaware business court’s view of cases to be sent for arbitration, the case arguably increases the chancery court’s gatekeeping function. Angus v. Ajio LLC, Civil Action No. 11895-VCG (May 13, 2016)(available for download at http://bit.ly/1sXAChn).

The matter concerned whether a dispute was arbitrable, and the question was whether the dispute should go to an arbitrator, or be decided by a court. The underlying suit included allegations of a breach of fiduciary duties and fraud brought by some members the company, MoGo Sport LLC, against MoGo’s officers, for entering into a transaction that ultimately sold the company.

Traditionally, questions of arbitrability have been left to the arbitrators, once a court has found that parties had agreed to submit their disputes to arbitration. The landmark case of Moses H. Cone Memorial Hosp. v. Mercury Construction Corp., 460 U.S. 1, 24 (1983) confirmed that the Federal Arbitration Act created a “liberal federal policy favoring arbitration agreements,” and that “any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration.”

This suggested a first look to the arbitration tribunal, which further U.S. Supreme Court cases developed. But the determination of arbitrability ultimately follows the contract. First Options of Chicago Inc. v. Kaplan, 514 U. S. 938 (1995), enshrined the principle that “courts should not assume that the parties agreed to arbitrate arbitrability unless there is “clea[r] and unmistakabl[e]” evidence that they did so.” (Internal citation omitted.) The First Options inquiry turned upon what parties agreed to; the question was settled by the court once it was shown that parties had not agreed to arbitrate.

Subsequent cases like Howsam v. Dean Witter Reynolds Inc., 537 U.S. 79 (2002), and Green Tree Financial Corp. v. Bazzle, 539 U.S. 444 (2003), further narrowed courts’ ability to decide on arbitrability.

Howsam focused on time bars on arbitration, which the Supreme Court ruled was to be determined by arbitrators. Green Tree Financial further held that an ambiguity in the arbitration provision was to be resolved by an arbitration tribunal.

But the May Angus opinion in Delaware’s Chancery Court doesn’t follow the general deference toward arbitration. It shows the Delaware business court examining the frivolity of claims.

In his 12-page opinion, Vice Chancellor Sam Glasscock III affirmed a two-pronged test to show a “clear and unmistakable” intent to arbitrate issues of arbitrability in James & Jackson LLC v. Willie Gary LLC, 906 A.2d 76 (Del. 2006)(available at http://bit.ly/1NZBonr).

The test, Glasscock wrote, requires a “’clear and unmistakable evidence’ of intent to arbitrate arbitrability . . . where there is:

‘1) an arbitration clause that generally provides for arbitration of all disputes; and
2) a reference to a set of arbitration rules that empower arbitrators to decide arbitrability, such as the American Arbitration Association . . . Rules.’”

Glasscock then expanded the test by citing McLaughlin v. McCann, 942 A.2d 616 (Del. Ch. 2008)(available at http://bit.ly/1RGfmke), noting that

only where “a non-frivolous argument in favor of substantive arbitrability exists and the first two prongs of Willie Gary are satisfied, [should] the Court . . . defer to the arbitrator.” [Emphasis added; citation omitted.]

The Angus opinion notes that the additional requirement serves the interests of justice by preventing wasted resources from the adjudication or arbitration of frivolous claims, allowing the court to strike the frivolous claims. But the court’s examination is limited; cases where “more than a quick, facial review of claims would be required” would proceed to arbitration.

Out of the four officers against whom the arbitration demand was brought, only Bruce Angus was a party to the MoGo operating agreement. Consistent with the contractual approach, the motion to halt the arbitration preliminarily against the remaining three officers was granted, as it was held that they would more likely would not be bound to arbitrate because of the lack of contractual obligations under the LLC operating agreement.

On the other hand, the court found at least one “non-frivolous” claim with regard to the original plaintiffs’ standing to force arbitration. As a result, Vice Chancellor Glasscock denied the motion for a preliminary injunction in Angus’s case, and deferred the decision to the arbitrators on the substantive issue of whether the case should be arbitrated.

The court conducted an analysis to determine if there were non-frivolous claims to arrive at the conclusion that the case should be arbitrated.

First, Angus and the other officers who sought to block the arbitration argued that the LLC members who filed for arbitration over the company’s sale lacked standing to enforce arbitration under the operating agreement when they cited a covenant not to compete. The theory was that only MoGo itself could enforce the non-compete provisions, and not the Members.

Glasscock saw these “issues of standing by signatories to a contract to enforce breaches of that contract” as non-frivolous, and that the officers failed to demonstrate that the original plaintiffs’ assertion of standing was frivolous. That finding sent the case to arbitrators for the determination of whether the case arbitrable.

In addition, the defendant officers had said that the arbitration claims against them for a breach of fiduciary duties were outside the scope of the LLC operating agreement because the contract was silent on fiduciary duty.

The court noted that the arbitration provision only covered disputes “among Members or former Member over the provisions of the Operating Agreement.” [Emphasis is the court’s.] It said that whether a breach-of-fiduciary-duties claim would arise from the agreement, and whether the agreement’s silence on the point incorporates default fiduciary duties from state law, was a “nice question” that needed deeper examination.

“This question,” Glasscock wrote, “which warrants more than a cursory inquiry by the Court into the frivolousness of the claim, should be referred to arbitration” under the parties’ agreement.

Angus arguably paves the way for courts to have more say in deciding the arbitrability of disputes despite arbitration provisions. “Litigants’ economy,” the opinion notes, mandates courts to conduct at least the “quick, facial review” of the frivolousness of claims, discussed above, before allowing them to proceed to arbitration. Cases would have to both show a clear intent to arbitrate, as well as present non-frivolous claims, in order to strike a balance between serving the economy and providing parties the benefits of their bargain.

Attorneys from both sides declined to comment.

The case proceeds. An answer and counter-claim was filed by the MoGo LLC members, as they proceed on their fiduciary and fraud claims against the officers not subject to arbitration, on May 27.

The author was a Summer 2016 CPR Institute summer intern and is a third-year LL.B. student from the Singapore Management University.