Invalid State Law No Bar to Arbitration, Justices Rule

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By Kevin McGowan

Dec. 14 — Satellite television consumers must individually arbitrate their disputes with DirecTV Inc. because the Federal Arbitration Act preempts the use of invalid state law to render the arbitration provision unenforceable, a divided U.S. Supreme Court ruled Dec. 14.

In a 6-3 decision that could also affect mandatory arbitration agreements in employment, the court said the California Court of Appeal violated the federal statute by applying special rules to an arbitration contract that the state wouldn't apply to contracts generally.

The decision certainly is relevant for agreements in the employment context as the Supreme Court makes no distinction between consumer and employment arbitration, Professor Alex Colvin of the Cornell University School of Industrial and Labor Relations in Ithaca, N.Y., told Bloomberg BNA Dec. 14.

In particular, the justices said the state court erred by ruling that the contract's reference to the “law of your state” referred to a California rule prohibiting class action waivers that the Supreme Court had invalidated in AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011) (81 DLR AA-1, 4/27/11).

Writing for the majority, Justice Stephen Breyer said the court wasn't interpreting the arbitration contract, which remains the province of state courts.

But the FAA bars state courts from placing arbitration contracts “on a different footing” from contracts generally, which is what the state court did in DirecTV's case, the court said.

In dissent, Justice Ruth Bader Ginsburg said the court incorrectly reads the DirecTV agreement in favor of “the powerful economic enterprises” that force arbitration and class action waivers onto consumers and employees.

Rather, applying the traditional contract law tenet of construing ambiguous terms against the drafter would mean the state court reasonably interpreted the DirecTV agreement to bar arbitration in California, Ginsburg said.

“I would take no further step to disarm consumers, leaving them without effective access to justice,” Ginsburg wrote, acknowledging the Supreme Court precedent in Concepcion. Justice Sonia Sotomayor joined in her dissent.

In a separate dissent, Justice Clarence Thomas would hold that the FAA doesn't apply to proceedings in state court.

Court's Ruling Not a Surprise

Advocates on both sides of the issue said the justices' reversal of the California Court of Appeal decision wasn't a surprise, given Concepcion and other recent Supreme Court rulings on arbitration.

The decision “reinforces” Supreme Court cases that “really give employers carte blanche” in enforcing class action waivers, Colvin said. State regulation of arbitration agreements generally is “preempted by the FAA” in the court's view, he said.

The “overall trend” in the Supreme Court is “knocking down” state law regulation of arbitration contract provisions, Colvin said. Given the court's other recent rulings, “this is not a surprising decision,” he said.

Perhaps the only surprises are that Breyer wrote the decision and that Justice Elena Kagan joined the majority, Colvin said.

Michael Droke, a management lawyer with Dorsey & Whitney in Seattle, said the decision's significance is that the court “strengthens what Concepcion said” and “allows employers to rely on class action waivers” in arbitration pacts.

In an ongoing battle between the Supreme Court and courts in California over enforcing arbitration pacts with class actions waivers, the court in DirecTV “unequivocally established its supremacy,” Droke told Bloomberg BNA Dec. 14.

Potential Impact on Pending Arbitration Case

Breyer's majority opinion was “a very straightforward application” of the principles established by Concepcion, said Rae Vann of Norris Tysse Lampley & Lakis in Washington, who is general counsel to the Equal Employment Advisory Council, an employers' organization.

Ginsburg's dissent “tries to create confusion” that really wasn't present, given that Concepcion rendered invalid the state law rule against waiving class actions on which the California Court of Appeal relied, Vann told Bloomberg BNA Dec. 14.

The “more interesting question” for employers is what impact the court's ruling might have on MHN Government Services, Inc. v. Zaborowski, No. 14-458, another arbitration case from California the court will hear later this term, Vann said.

The MHN case involves the denial of arbitration regarding employment claims based on a state law rule that prevented the arbitration provision from being separated from other allegedly invalid contract terms (190 DLR AA-1, 10/1/15).

The EEAC filed amicus briefs in both DirecTV and MHN, but the latter case might be the more significant for employers, Vann said.

In DirecTV, the state courts were “trying to do a complete end run” around Concepcion, Vann said. In the MHN case, the U.S. Court of Appeals for the Ninth Circuit similarly applied a state law rule exclusively to arbitration contracts to prevent arbitration, she said. The DirecTV decision suggests that the Federal Arbitration Act preempts such a state law focus, Vann said.

Based on DirecTV, it “seems more likely” the arbitration agreement in MHN would be upheld, Droke said. A “similar argument” against enforcement is being made by the workers contesting arbitration in MHN as was made by the consumers in DirecTV, he said.

Moving Away From Consent?

The majority's opinion in DirecTV is striking for its lack of attention to what the parties intended, said Professor Katherine Stone of the University of California-Los Angeles School of Law.

A “hallmark” of arbitration law is to enforce the agreement the parties consented to, Stone said. But the court's decision reads the exception in DirecTV's 2007 contract about not enforcing arbitration if the “law of your state” prohibits class action waivers completely out of context, Stone told Bloomberg BNA Dec. 14.

Reasonable options would be to read the provision as meaning the “law of your state” when the arbitration agreement was signed or when the dispute arose, Stone said. At both those times, in 2007 and 2008, the law of California prohibited class action waivers, she said.

But the Supreme Court instead ruled the “law of your state” provision should be interpreted as of the time DirecTV first sought arbitration, after Concepcion was decided and three years after the satellite TV consumers had sued in a California court with no objections from DirecTV.

Until now, a “strong prevailing theme” in arbitration law was to discern what the parties meant when they agreed to arbitrate, Stone said. Precedent established that parties by contract could choose among state laws or decide certain topics would or wouldn't be addressed in arbitration, she said.

But the court's decision casts doubt on what has been “a fundamental principle” of arbitration, that the private parties decide the scope of the process, Stone said.

Invalid State Law Is No Bar

After DirecTV sought arbitration of subscribers' California court challenge to early termination fees, a state trial court ruled no arbitration was warranted because of the contract's provision that arbitration wouldn't occur if the “law of your state” prohibited class action waivers.

The California Court of Appeal affirmed the denial of arbitration and the state supreme court declined to review the lower court decision.

The Supreme Court granted DirecTV's petition for review in March (55 DLR AA-1, 3/23/15) and heard oral argument Oct. 6 (193 DLR AA-1, 10/6/15).

Reversing the state appeals court, the Supreme Court said the DirecTV arbitration agreement wasn't ambiguous, so there was no need to construe the contract against its drafter

The state court ran afoul of the FAA because it applied rules of construction in the arbitration context that the state wouldn't apply to any other type of contract, Breyer wrote.

Although the federal law allows arbitration pacts to be invalidated on state-law grounds generally applicable to all contracts, the FAA prohibits singling out arbitration contracts for different treatment, the court said.

“After examining the grounds upon which the Court of Appeal rested its decision, we conclude that California courts would not interpret contracts other than arbitration contracts the same way,” Breyer wrote. “Rather, several considerations lead us to conclude that the court's interpretation of this arbitration contract is unique, restricted to that field.”

Nothing in the Court of Appeal's reasoning suggests a California court would reach the same interpretation of “law of your state” in any context other than arbitration, the court said.

The state appeals court didn't explain why parties might generally intend the words “law of your state” to encompass the “invalid law of your state,” Breyer wrote. “To the contrary, the contract refers to ‘state law' that makes the waiver of class arbitration ‘unenforceable,' while an invalid state law would not make a contractual provision unenforceable,” the court said.

“[W]e can find nothing in that [state appeals court] opinion (nor in any other California case) suggesting that California would generally interpret words such as ‘law of your state' to include state laws held invalid because they conflict with, say, federal labor statutes, federal pension statutes, federal antidiscrimination laws, the Equal Protection Clause, or the like,” Breyer wrote. “Even given our assumption that the Court of Appeal's conclusion is correct, its conclusion appears to reflect the subject matter at issue here (arbitration), rather than a general principle that would apply to contracts using similar language but involving state statutes invalidated by other federal law.”

The state court said it would interpret “ambiguous language” against DirecTV, the party that drafted it. But the Supreme Court reiterated that no ambiguity is involved.

“[W]ere the phrase ‘law of your state' ambiguous, surely some court would have construed that term to incorporate state laws invalidated by, for example, federal labor law, federal pension law, or federal civil rights law,” Breyer wrote. “Yet, we have found no such case.”

Allowing DirecTV to enforce the arbitration agreement “falls well within the confines (and goes no further than) present well-established law,” the court said.

“California's interpretation of the phrase ‘law of your state' does not place arbitration contracts ‘on equal footing with all other contracts,' ” Breyer wrote.

The state court failed to “give due regard” to the federal policy favoring arbitration, and its ruling therefore is preempted by the FAA, the court said.

Dissent Sees ‘Reasonable' Interpretation

In dissent, Ginsburg said the state appeals court permissibly interpreted an ambiguous form contract against the large company that drafted it.

“As I see it, the California court's interpretation of the ‘law of your state' provision is not only reasonable, it is entirely right,” she wrote.

For more than 25 years, the Supreme Court until now never reversed a state court decision on the grounds it misapplied state contract law when determining the meaning of a term in a particular arbitration pact, the dissent said.

“Today's decision is a dangerous first,” Ginsberg warned.

Christopher Landau of Kirkland & Ellis LLP in Washington represented DirecTV before the Supreme Court. Thomas C. Goldstein of Goldstein & Howe in Bethesda, Md., represented the subscribers.

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

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