The U.S. Court of Appeals for the Second Circuit recently confirm that, in the Second Circuit, an arbitration agreement is no longer binding where the intent of the parties was to arbitrate with only a specific arbitrator and that arbitrator is unavailable.
A copy of the opinion is available at: Link to Opinion
The borrower took out payday loans from an online payday lender. The payday lender relied on banks to serve as middlemen to debit the customer's account. Two banks each debited the borrower's account for one payday loan.
When the borrower applied for the loans, she signed an application that included an arbitration clause. The arbitration clause stated that any and all claims, disputes or controversies between the borrower and payday lender shall be resolved under the code of procedure section of a specifically-named arbitration forum.
The clause then identified the named arbitration forum's address, website, and telephone number. Additionally, the clause stated that the named arbitration forum would waive its fees if a borrower could not afford them. The other applications the borrower signed contained similar arbitration clauses.
The borrower filed a putative federal class action against the two banks in federal court, alleging violations of the federal Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. § 1962, and state law. In short, the borrower alleged that the banks unlawfully facilitated high-interest payday loans that have been outlawed in several states.
The banks moved to compel arbitration on the basis of the arbitration agreements even though they were not parties to those agreements. The banks argued that they were entitled to enforce the agreements against the plaintiff under principles of estoppel. The district court agreed and initially granted the banks' motion to compel arbitration and stayed the proceedings.
Subsequently, the borrower sent a letter to the named arbitration forum indicating her intent to arbitrate her claims. The named arbitration forum declined to arbitrate the claims as a result of a consent judgment with a state's attorney general not to arbitrate such claims.
The borrower returned to federal court and moved to vacate the district court's order compelling arbitration. The district court concluded that the language of the arbitration agreements reflected the parties' intent to arbitrate exclusively before the named arbitration forum and vacated its prior order and lifted its stay of the proceeding. The banks appealed.
On appeal, the Second Circuit first held that it had jurisdiction under the Federal Arbitration Act to review an order refusing a stay of any action. The Court determined that the district court's order appealed from was effectively one refusing a stay.
The Court then explained that the language of the Federal Arbitration Act reflects the overarching principle that arbitration is a matter of contract. Consistent with that text, courts must rigorously enforce arbitration agreements according to their terms, including terms that specify with whom the parties choose to arbitrate their disputes and the rules under which that arbitration will be conducted. Consequently, the Court continued, as with any contract, the intent of the parties controls and such intent is determined by looking at the language of the agreement.
In analyzing the present arbitration clause, the Second Circuit highlighted the agreement's language that disputes shall be resolved under the code of procedure of the named arbitration forum. Additionally, the Court noted that the agreement does not address how the parties should proceed in the event that the named arbitration forum is unable to accept the dispute.
In arriving in its decision, the Second Circuit found In re Salomon Inc. Shareholders' Derivative Litigation, 68 F.3d 554 (2d Cir. 1995) dispositive. There, the Second Circuit held that a court must decline to appoint substitute arbitrators where the parties have contractually agreed to have only one arbitrator arbitrate any disputes between them. Despite the federal policy favoring arbitration, the Court explained in Solomon that there is no further promise to arbitrate in another forum when the contractually agreed-upon arbitrator refuses to dispute the question.
Thus, under In re Salomon, the present question in this case is whether the language of the parties' agreement contemplates arbitration before only the named arbitration forum, or whether it contemplates the appointment of a substitute arbitrator should the named arbitrator forum become unavailable. The Court held that the present arbitration agreement in this case contains numerous indications that the parties contemplated one thing: arbitration before the named arbitration forum.
In support, the Second Circuit cited the arbitration's clause language that the disputes shall be resolved by the named arbitration forum. The arbitration clause also identified the named arbitration forum's code of procedure. Furthermore, the clause states that the named arbitration forum would pay the arbitration fees if a borrower could not pay them. Significant to the Second Circuit, the agreement made no provision for the appointment of a substitute arbitrator should the named arbitrator forum become unavailable.
The Court concluded that the matter was similar to In re Solomon because of the mandatory language, the pervasive references to the named arbitration forum in the agreement, and the absence of any indication that the parties would assent to arbitration before a substitute arbitrator if the named arbitration forum became unavailable.
The Second Circuit did not find the banks' argument relying on the Federal Arbitration Act's directive that a court shall designate a substitute arbitrator if there is a lapse in the naming of an arbitrator. The Court explained that the named arbitration forum's refusal to arbitrate the matter was not a lapse, because a lapse refers to a lapse in time or some other mechanical breakdown in the arbitrator selection process.
Last, the Court acknowledged that there was a difference of opinion among the federal courts of appeal on this issue. The Second Circuit did not favor one interpretation over the other, but simply explained that they were bound by In re Solomon.
The Second Circuit Court of Appeals affirmed the district court's order and remanded the case for further proceedings.
Ralph T. Wutscher
Maurice Wutscher LLP
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