Justices Ponder State Ruling That Barred Arbitration

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By  Kevin McGowan

Oct. 6 — The Federal Arbitration Act requires reversal of a California state appeals court ruling that invalidated an arbitration agreement meant to resolve satellite television subscriber complaints, an attorney representing DirecTV, Inc.  argued to the U.S. Supreme Court Oct. 6 (DirecTV, Inc. v. Imburgia, U.S., No. 14-462, oral argument 10/6/15).

The justices are reviewing a California Court of Appeal  decision that affirmed the denial of arbitration to DirecTV on a court action by past subscribers challenging the company's imposition of early cancellation fees. Although the case arises in a consumer context, employers with arbitration pacts containing class action waivers are watching closely to see if the Supreme Court continues to enforce such agreements, as it did in AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (U.S. 2011) (81 DLR AA-1, 4/27/11).

Arguing for DirecTV, attorney Christopher Landau said even though contract interpretation ordinarily is a matter of state law, the FAA gives federal courts power to ensure state court decisions don't frustrate the federal policy favoring arbitration. The state court's “nonsensical” contract interpretation in this case would infringe that strong federal pro-arbitration stance, said Landau, who is with Kirkland & Ellis LLP in Washington.

But representing the subscriber class, attorney Thomas Goldstein said even if the state court incorrectly interpreted the arbitration pact, it relied on ordinary state rules of contract construction that don't implicate federal power under the FAA.

If the justices override the state court in this case, they are going to face “a wealth of challenges” to state law contract rulings that happen to touch arbitration clauses, warned Goldstein, who is with Goldstein & Russell in Bethesda, Md.

Contract Reference to ‘State Law' at Issu

A 2006 form agreement between DirecTV and its subscribers required arbitration of all contract disputes, and it forbade either party from combining claims in arbitration or joining in a class action.

But a proviso to Section 9, the arbitration clause, said if the “law of your state” banned class action waivers, then the entire arbitration provision was “unenforceable.” Section 10 of the agreement said the arbitration provision “shall be governed by the Federal Arbitration Act.”

When two past subscribers in 2008 sued DirecTV over the cancellation fee issue, the company didn't seek arbitration because the California courts at the time held class action waivers were unenforceable. But after the Supreme Court decided Concepcion, DirecTV moved to compel arbitration in the pending court case, which had been certified for class action.

A state trial court denied arbitration, reasoning the contract's reference to state law meant the parties had intended to follow California law that banned class action waivers. Under the agreement as written, the arbitration provision was invalidated because state law didn't allow class action waivers, the state court said. The California Court of Appeal affirmed the denial of arbitration, notwithstanding the ruling in Concepcion that the FAA preempted the California rule banning class action waivers.

Meanwhile, the U.S. Court of Appeals for the Ninth Circuit, construing the same DirecTV consumer contract, had ruled arbitration of subscribers' claims was required after Concepcion. The federal appeals court rejected as “nonsensical” the argument that the parties intended to rely on preempted state law regarding class action waivers (Murphy v. DirecTV, Inc., 742 F.3d 1218 (9th Cir. 2013)).

The justices in March granted DirecTV's petition to review the state appeals court decision (55 DLR AA-1, 3/23/15)

Boundary Question Repeatedly Raised

Under the Federal Arbitration Act, the interpretation of arbitration contracts is “not solely a matter of state law,” Landau said in his argument for DirecTV.

The Supreme Court in  Volt Information Sciences Inc. v. Board of Trustees of Leland Stanford Junior University. 489 U.S. 468 (1989), said that in applying general state law contract principles to arbitration pacts, courts must give “due regard” to the federal policy favoring arbitration, Landau said. In Volt, the court also said ambiguities in such agreements must be resolved in favor of arbitration, he said.

Ordinarily, contract interpretation is a matter of state law, but the federal question arises in the arbitration context when courts may act as a “check” on state law to ensure compliance with the FAA, Landau said.

Justice Samuel Alito asked where the line gets drawn between state contract matters outside the federal power to review and arbitration matters within the court's purview. During the argument, Justices Stephen Breyer, Anthony Kennedy, Elena Kagan and Sonia Sotomayor also raised the same question in various ways.

The Supreme Court's role is to do what Volt said federal courts must do, Landau replied.

If the court reviews the state law contract interpretation in this case, “we've got every arbitration case in the world” coming to the Supreme Court, Breyer said. “We would have federalized” a “huge area” of state contract law, he said. Perhaps the justices should just certify the case to the California Supreme Court for a definitive ruling on the state contract issues, Breyer said.

But Landau said even if the state supreme court interpreted the DirecTV contract, the federal question would remain whether that interpretation could be reconciled with the FAA's substantive policy favoring arbitration.

You still need a test to distinguish state law contract cases outside the Supreme Court's purview from those that implicate the court's power under the FAA, Justice Antonin Scalia said. Perhaps one trigger is a state court ruling that flouts standard contract interpretation principles, Scalia suggested.

The California appeals court admitted it didn't really know what the parties thought about federal preemption when the contract was formed in 2006, in part because DirecTV didn't seek to compel arbitration until after Concepcion was decided in 2011, three years after the former subscribers sued, Sotomayor said.

DirecTV didn't seek arbitration earlier because it would have been “futile” under California state law barring class action waivers, Landau replied. But once Concepcion said that the California rule was preempted by the FAA, DirecTV immediately sought arbitration, he said.

‘State Law' Not Frozen

Both parties contemplated that “state law” in their agreement referred to California law, so their intent was “clear” that if that law barred class action waivers, the entire arbitration agreement was invalidated, Justice Ruth Bader Ginsburg said.

But Landau disagreed that the parties meant California law as it existed in 2006, regardless of whether it subsequently was held preempted by the FAA.

“Nothing in the contract freezes this [state law reference] at a certain point in time,” Landau said. The arbitration pact says if “the law of your state would find this agreement to dispense with class action procedures unenforceable,” then the arbitration provision is unenforceable, Landau said. That verbiage indicates the parties didn't intend to remain stuck with the 2006 version of California law, he said.

Even assuming the California appeals court made “a really bad mistake” in interpreting the contract, nothing in its opinion indicates a judicial hostility to arbitration, Kagan said. The state court said ambiguities in form contracts should be construed against the party that drafted the contract, a principle that has been used “hundreds of times” by California courts in contract cases, Kagan said.

The state court may have correctly stated a rule of contract interpretation, but “there is no antecedent ambiguity” in the DirecTV contract, Landau replied.

Contract interpretation, even if erroneous, is a matter of state law, Landau acknowledged. But under the FAA, the federal courts' role is to ensure the state court “gave effect to the healthy federal policy favoring arbitration,” he said.

The “line drawn by Volt” has worked for almost 30 years, he said. In this case, it should be invoked to overturn a contract interpretation the Ninth Circuit rejected as “nonsensical,” Landau said.

What are the signs the state court in this case is “so far over the line?” Scalia asked.

The California appeals court “went out of its way” to find the arbitration agreement unenforceable, Landau replied. The state court ignored Section 10 of the agreement, which specifically references the FAA and said the federal arbitration law should govern the arbitration provision, Landau said. It therefore was “nonsensical” for the state court to say the contract's state law reference was unaffected by the FAA, he said.

The state court opinion was “unsatisfying” at best, but does that give the Supreme Court the power to intervene and reverse on a state law issue, Kagan asked. The DirecTV contract was poorly drafted, the state law reference was ambiguous and the state court probably “got the answer wrong,” Kagan said. “But ‘wrong' isn't what we do here,” she said.

‘Hostility' to Arbitration Shown?

Arguing for the former subscribers, Goldstein said the case is a “reprise” of  Oxford Health Plans LLC v. Sutter, 133 S. Ct. 2064 (U.S. 2013), which held an arbitrator permissibly read a contract to find the parties intended to allow class arbitration and said courts have very limited power to review an arbitrator's contract interpretation (111 DLR AA-1, 6/10/13).

Similarly, the state court applied ordinary contract principles to decide the parties' intent regarding the state law proviso on class action waivers, Goldstein said. The Supreme Court should tread with caution in reviewing state law contract determinations, he said.

Congress enacted the FAA in response to state courts exhibiting “hostility” to private arbitration agreements and refusing to enforce them, Chief Justice John Roberts said. Those courts adopted “special rules of interpretation” for arbitration agreements, different from other types of contracts, and that's what Congress expressly wanted to stop, Roberts said.

What could be “more hostile” to arbitration than a state court “dispensing” with the Supreme Court's opinion inConcepcion? Roberts asked.

There's no prior case in which the Supreme Court has overturned a state court ruling on the threshold issue of whether the parties had agreed to arbitrate, Goldstein replied.

But there's no question here the parties agreed to arbitrate, Scalia interjected.

“We're not saying you have to turn a blind eye to the idea” state courts may discriminate against arbitration, Goldstein said. But the state court here relied on ordinary contract principles to interpret the contract's “state law” reference to mean the California state law banning class waivers, prior to Concepcion, he said.

“This is not a doctrine to discriminate against arbitration,” Goldstein said. The argument that the state court “really got it wrong” in interpreting the contract isn't sufficient to raise a federal issue under the FAA, he said.

But the Supreme Court in Volt said “due regard” must be paid to the federal policy favoring arbitration and “ambiguities must be resolved” in favor of arbitration, Kennedy said.

That refers to ambiguities “in the scope of the agreement,” not to whether an agreement to arbitrate was formed, Goldstein said.

He cited Justice Clarence Thomas's opinion in  Granite Rock Co. v. International Brotherhood of Teamsters, 561 U.S. 287, 188 LRRM 2897 (2010), which said the issue of whether an arbitration agreement exists at all is a state law question, not a federal question.

Under Section 9 of the DirecTV agreement, the issue is whether any arbitration “at all” exists in California given the state law proviso, Goldstein said.

If the question is whether the parties have an arbitration agreement at all, that is for states to decide, Goldstein said.

There also is “no administrable line” by which DirecTV can distinguish the state court's decision in this case from other decisions applying generally applicable contract principles, Goldstein said. It's also “not true” the contract was wrongly interpreted, he said.

If we grant your argument, the states then “can do whatever they want” to invalidate arbitration agreements, Scalia said.

The state appeals court opinion doesn't say anything explicitly against arbitration but if it interprets the contract “in such a strange way,” is it effectively discriminating against arbitration? Alito asked.

That's the “wildly out of bounds situation” for contract interpretation but even that wouldn't trigger the Volt principle for federal intervention, Goldstein said.

Whether there's an agreement in the first place is “quite different” from questions about the agreement's meaning, Scalia said.

“There's no doubt there was an agreement” between DirecTV and its subscribers, Scalia said. “The only question is the meaning of the agreement.”

Fears of Evading Concepcion Are Unfounded

There's also a “good argument” the state court's interpretation “flies in the face” of Concepcion, Breyer said.

Even though he dissented in Concepcion, Breyer said he's concerned that affirming the state court ruling would raise the risk that state courts could “run around” the Supreme Court's decisions.

The California Supreme Court's recent decision in  Sanchez v. Valencia Holding Co., LLC, 2015 BL 247805 (Cal. 2015), which cited Concepcion to rule a class action waiver didn't violate state law, should put to rest any concerns the state courts are trying to evade Concepcion, Goldstein said.

Rather, there's a danger of a “boundless rule” allowing federal courts to reexamine every state court interpretation of contracts that include an arbitration clause, Goldstein said. The justices retain the option of not deciding the instant case at all, in the wake of the state supreme court decision in Sanchez, he said.

To contact the reporter on this story: Kevin McGowan in Washington at  kmcgowan@ban.com

To contact the editor responsible for this story: Susan J. McGolrick at  smcgolrick@bna.com