Friday, December 7, 2012

FYI: 4th Cir Holds Limited Discovery Did Not Waive Right to Arbitrate, Arbitration Clause in Separate Agreement Still Applied

Reversing a ruling by the lower court, the U.S. Court of Appeals for the Fourth Circuit recently held that the assignee of a retail installment sale contract did not waive its right to enforce an arbitration provision contained in a separate used-car purchase agreement.
The Court held that: (1) the purchase and financing transaction involved interstate commerce and thus required application of the Federal Arbitration Act; (2) the used-car purchase agreement should be interpreted together the RISC, despite an integration clause in the RISC; and (3) plaintiff consumer had suffered no actual prejudice as a result of the creditor's delay in moving to enforce the arbitration agreement after conducting limited discovery. 
A copy of the opinion is available at:
Plaintiff consumer ("Consumer") bought a used car from a dealer, executing a retail installment sale contract (the "RISC") to finance the purchase.   As part of the transaction, Consumer also executed a separate contract (the "Buyer's Order") containing the terms of sale and an agreement to arbitrate.  A limiting clause in the arbitration agreement provided that assignees of certain monetary claims may not compel arbitration.
The RISC did not include an arbitration provision, but contained an integration clause stating that the RISC constituted the entire agreement between the parties. 
The dealer assigned the RISC to defendant company ("Assignee") immediately after the sale.  A short time later, Consumer returned the car to the dealership, claiming that the car was defective.  Consumer had never made a payment on the car loan.  Assignee then repossessed the car, sold it at a loss, and sought to collect the unpaid loan balance from Consumer. 
Consumer filed a putative class action in state court against Assignee, alleging violations of Maryland consumer protection law based on unfair business practices and undisclosed finance charges.  Assignee removed the case to federal court and both parties engaged in limited discovery according to a mutually acceptable discovery plan. 
Waiting for a court decision applying the U.S. Supreme Court's ruling on mandatory class arbitration, Assignee moved six and a half months later to compel non-class arbitration of Consumer's claims against it.  See Stolt-Nielsen S.A. v. AnimalFeeds Int'l Corp., 559 U.S. __, 130 S. Ct. 1758, 1775 (2010)(holding that the Federal Arbitration Act does not permit a party to be compelled to submit to class arbitration unless there is a contractual basis for concluding that the party agreed to do so).  
The lower court denied Assignee's motion, ruling that the underlying loan transaction was governed by state law because it was a purely intrastate transaction and that, even though the Buyer's Order and the RISC formed an enforceable arbitration agreement governing Consumer's claims, Assignee had waived its right to compel arbitration due to the unjustified delay in filing its motion and because it had engaged in discovery.   Assignee appealed.
The Fourth Circuit reversed and remanded.
As you may recall, the FAA operates to enforce arbitration provisions included in "a contract evidencing a transaction involving interstate commerce."  9 U.S.C. § 2.  See also Whiteside v. Teltech Corp., 940 F.2d 99, 102 (4th Cir. 1991)(application of the FAA requires four elements:  "(1) the existence of a dispute between the parties, (2) a written agreement that includes an arbitration provision which purports to cover the dispute, (3) the relationship of the transaction, which is evidenced by the agreement, to interstate or foreign commerce, and (4) the failure, neglect or refusal of the defendant to arbitrate the dispute."). 
In addition, the FAA permits appellate review of orders that fall within the FAA's exception to the final judgment rule.  See 9 U.S.C. §§ 16(a)(1)(A)-(B) (providing for appeals from orders refusing to stay proceedings pending arbitration or orders denying a petition to require arbitration pursuant to an agreement between the parties); 9 U.S.C. § 3 (requiring federal court to stay proceedings pending completion of arbitration in accordance with an agreement if "the applicant for the stay is not in default in proceeding with such arbitration."); 9 U.S.C. § 4 (allowing party to petition federal court for order to compel arbitration pursuant to arbitration agreement).
In concluding that the transaction here involved interstate commerce, the Fourth Circuit ruled that the FAA applied to the transaction, because the funds for Consumer's car loan originated from a foreign state.  In so ruling, the Court noted, first, that the FAA does not require the party invoking the FAA to prove the interstate nature of the transaction and, second, that the FAA applies where "in the aggregate the economic activity in question would represent 'a general practice . .  . subject to federal control.'"  See Maxum Founds., Inc. v. Salus Corp., 779 F.2d 974, 978 n.4 (4th Cir. 1985); Citizens Bank v. Alafabco, Inc.,   539 U.S. 52, 56-57 (2003).  The Court of Appeals accordingly ruled that the lower court erred in declining to apply the FAA to the transaction.
Turning to the question whether Assignee's motion adequately invoked Section 3 or 4 of the FAA to create appellate jurisdiction, the Court relied on an earlier opinion to conclude that even though Assignee's motion did not specifically reference Section 3 or 4, the motion clearly sought enforcement of the arbitration agreement in the Buyer's Order and was thus immediately appealable.  See Wheeling Hosp. Inc., v. Health Plan of the Upper Ohio Valley, Inc., 683 F.3d 577 (4th Cir. 2012)(focusing on whether motion shows clear intention to seek enforcement of an arbitration clause rather than on adherence to a specific form or explicit reference to Section 3 or 4).
Next, the Fourth Circuit explored whether there was a valid arbitration agreement between the parties and whether Assignee was in fact in default of its right to enforce that agreement.  In so doing, the Court applied state-law contract-interpretation principles, ultimately concluding that the parties' intent controlled the effect of the RISC's integration clause.  Specifically, the Court agreed with the district court that the Buyer's Order and the RISC were intended to constitute a single transaction and should thus be interpreted together under Maryland law.  In so ruling, the Court noted that the Buyer's Order was expressly "conditioned upon approval of [the] retail installment sale contract and that it defined the "Agreement" as encompassing other documents made in connection with the Buyer's Order. 
Moreover, turning to a "carve-out" in the arbitration clause regarding assignees of the RISC, the Court rejected Consumer's argument that Assignee could not enforce the arbitration agreement because it sought to arbitrate a "purely monetary claim" as the assignee of that claim.  Ruling that the carve-out for assignees applied only to the forced arbitration of such monetary claims, the Court concluded that the carve-out did not pertain to assignees of the entire RISC itself.  As the Court explained, the carve-out "indicates that a person to whom an otherwise-qualifying monetary claim has been assigned cannot enforce arbitration.  [Assignee] is not the assignee of any monetary claim, but instead is the assignee of the entire agreement embodied in the RISC." Accordingly, the Court ruled that the arbitration provision in the Buyer's Order was enforceable by Assignee as assignee of the RISC. 
Finally, in analyzing whether Assignee waived its right to enforce the arbitration agreement due to its delay in moving to compel arbitration, the Court noted that Maryland arbitration law was inapplicable to this case and that Section 3's reference to a party "in default" losing its right to compel arbitration was not tantamount to a waiver of that right in light of the federal policy favoring arbitration.   The Court stressed that the opposing party must suffer actual prejudice before a litigant will be deemed to default on the right to invoke the FAA.  See Microstrategy , Inc. v. Lauricia, 268 F.3d 244, 249 (4th Cir. 2001).
Applying this test, the Fourth Circuit concluded that Consumer did not suffer actual prejudice in this case, because the six and a half-month delay was relatively short and Assignee had only engaged in minimal litigation activities before moving to compel arbitration and had not gained any advantage thereby.  In particular, the Court pointed out that Assignee had not filed any dispositive motions and that Consumer had also engaged in similar discovery activities.    The Court therefore ruled that participation in discovery was not sufficient to trigger default under the FAA.
Accordingly, because Consumer had failed to establish the prejudice necessary to finding that Assignee defaulted on its right to enforce the arbitration agreement under the FAA, the Fourth Circuit reversed and remanded with directions to refer the claims to arbitration.

Ralph T. Wutscher
McGinnis Wutscher LLP
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