The U.S. Court of Appeals for the Third Circuit recently confirmed that parties may contractually delegate questions of arbitrability to the arbitrator and reversed a trial court's order denying a debt buyer's motion to compel arbitration when there was a question about the validity of assignment of the underlying contract.
"Arbitration is a contractual obligation," the Third Circuit held. "Thus, parties to a contract may delegate questions of arbitrability to an arbitrator. If parties clearly and unmistakably make this choice, then district courts generally must send threshold questions of arbitrability to arbitration to comply with the parties' agreement."
A copy of opinion is available at: Link to Opinion
A non-bank finance company and a borrower entered into a loan contract that included a very broad arbitration agreement including "the enforceability, or the arbitrability of any Claim pursuant to this Agreement, including but not limited to the scope of this Agreement and any defenses to enforcement of the Note or this Agreement." The arbitration agreement also applied to any assignees or successors of the original parties.
Subsequent to the formation of the contract, the finance company assigned the contract to a debt buyer company, which attempted to collect the balance due from the borrower. At issue was the fact that the loan had an interest rate of 26.91% that would ordinarily run afoul of Pennsylvania's usury law. The finance company issued the loan under the Consumer Discount Company Act (CDCA) which creates an exception to Pennsylvania's usury limits. The finance company was licensed by Pennsylvania's Department of Banking to issue CDCA loans, but the debt buyer was not.
The borrower filed a class action lawsuit against the debt buyer arguing that the attempt to collect the loan was unlawful because the debt buyer did not have the requisite CDCA license and did not seek approval of the Pennsylvania Department of Banking to purchase his loan and the loans of the putative class.
The debt buyer filed a motion to compel arbitration that was originally denied by the trial court in order that the parties could engage in brief discovery to determine whether the debt buyer either had the requisite license or had obtained approval from the Pennsylvania Department of Banking. After the discovery revealed that the debt buyer did not in fact have either the license or the Department of Banking's blessing, the trial court held that the assignment from the finance company to the debt buyer was invalid and denied the debt buyer's motion to compel arbitration.
The Third Circuit had recently held that the question of arbitrability may be delegated to an arbitrator so long as the contract expressly provides for that delegation in MZM Constr. Co., Inc. v. New Jersey Bldg. Labs Statewide Benefit Funds, 974 F.3d 386, 392 (3d Cir. 2020). Here, the issue was whether the challenge to the legality of an assignment of a loan that is subject to an agreement to arbitrate can also challenge the formation of the arbitration agreement itself.
The Third Circuit rejected the borrower's preliminary argument that the debt buyer was not a "party" that could move to compel arbitration under the Federal Arbitration Act (FAA) because the assignment to the debt buyer was invalid. Rather, the Court held that "party" under the FAA referred to litigants and not parties to the agreement.
Moving on to the "threshold arbitrability question" the Third Circuit disagreed with the trial court's finding that it must answer the question of who decides whether the parties must arbitrate: the arbitrator or the court. The Court discussed the strong federal policy in favor of resolving disputes through arbitration and ensuring that courts will honor and enforce contractual provisions related to arbitration.
The trial court and the dissenting Third Circuit judges wanted to make the determination of whether there is an agreement to delegate questions of arbitrability to the arbitrator, but the Third Circuit majority held that this decision is for the arbitrator. There was no dispute that the borrower and the finance company agreed that arbitrability would be determined by the arbitrator. The trial court made the determination that the assignment to the debt buyer was invalid whereas the Third Circuit reasoned that such a determination would render the delegation provision in the arbitration agreement meaningless. The Third Circuit recognized that the arbitrator could later find that the assignment was invalid but also noted that this was not definite as there was a question as to whether the CDCA applied now that the loan was charged off.
On the issue of delegating arbitrability to the arbitrator the Third Circuit noted that a party would have to challenge the very formation of the arbitration agreement unless the delegation clause was being separately challenged. Here, the borrower argued that the challenge to the assignment constituted a challenge to the formation of the agreement to arbitrate but this argument was rejected by the Third Circuit as there was no dispute that the borrower entered into a valid arbitration agreement with the finance company and that the finance company subsequently assigned that agreement to the debt buyer. Thus, the challenge was really to the validity of the assignment and not the agreement.
The Appellate Court further reasoned that "because the parties clearly and unmistakably intended to delegate the issue of enforceability of the contract to an arbitrator, the challenge to the enforceability of the arbitration agreement must be decided by the arbitrator and not the court."
Ultimately, the arbitration agreement at issue was very broad and included "any Claim . . . includ[ing] . . . the arbitrability of any Claim . . . and any defenses to enforcement of the Note or this Agreement." The Third Circuit concluded that the arbitrator will determine these issues and that the District Court's opinion making that determination had to be reversed and thus remanded the case to the District Court with instructions to refer the matter to arbitration.
This case is significant for debt buyers and other assignees that have faced challenges from plaintiffs related to assignments in the face of motions to compel arbitration. So long as the contractual provision is clear and unmistakable (as it was here), courts in the Third Circuit will have to refer the question of arbitrability, including the alleged validity of the assignment, to an arbitrator.
Ralph T. Wutscher
Maurice Wutscher LLP
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