Arbitration Clauses as Separate Binding Contracts | Nelson Mullins Riley & Scarborough LLP
This term, Supreme Court Justice Elena Kagan wrote a pair of opinions related to the arbitration. The first of these decisions, Badgerow v. Walters20-1143, 142 S. Ct. 1310 (2022) was released March 31, 2022, where Judge Kagan, writing for the 8/1 majority, held that a court must have an independent basis of federal jurisdiction to undertake a motion for confirmation or annulment of an arbitral award.
Under Section 4 of the Federal Arbitration Act (“FAA”), a district court may use a “look-through” approach to determine whether it has jurisdiction over the underlying substantive controversy in the examination of a request for compulsory arbitration, as adopted in Vaden vs. Discover Bank, 556 US 49 (2009). But the same approach is not available to parties seeking to uphold an arbitration award under FAA Sections 9 and 10. Under these sections, the court’s review must be limited to the claim itself.
In Badger, the parties filed a motion for confirmation of an arbitration award, which was affirmed by the District Court and affirmed by the Fifth Circuit Court of Appeals. Here, the arbitration was conducted prior to any federal trial in which a party sought to compel arbitration under Section 4. The Supreme Court reversed the lower courts, finding that the text of Sections 9 and 10 does not did not include the same provisions for judicial transparency. such as when a district court is seized of a request for confirmation of an award for which it had previously imposed arbitration. Where there is no prior federal lawsuit in which arbitration was forced, the claim itself must meet the jurisdictional requirements for a district court to consider it: diversity jurisdiction, question federal regarding the confirmation of the award itself or other cause of establishment of jurisdiction.
Then, on May 23, 2022, Judge Kagan, writing this time for a unanimous court in Morgan v. Sundance, Inc., 21-328, — S. Ct. —- (U.S. 23 May 2022), held that the long-standing arbitration-specific majority rule that a party may waive to its arbitration rights by litigate only when its conduct prejudiced the other party was inappropriate. The Court concluded that outside of arbitration, a “federal court assessing the waiver generally does not ask questions of harm. Waiver, we said, is the intentional surrender or relinquishment of a known right. Identifier. at 5 (quoting United States vs. Olano507 US 725, 733 (1993)).
And while the Court recognized that for many years there has been a general political consensus among the Circuits in favor of arbitration, this “does not authorize federal courts to invent special rules of procedure, preferring the arbitration”. Identifier. at 6. Instead, the Court clarified: “[t]he policy is to make arbitration agreements as binding as other contracts, but no more so. Identifier. (quoting PrimaPaint Corp. vs. Flood & Conklin Mfg. Co., 388 US 395, 404 no. 12 (1967)). “As a result, a court must hold a party to its arbitration contract as it would any other type. But a court cannot design new rules to favor arbitration over litigation. Identifier.
Kagan continues, “FAA Section 6 provides that any request under the . . . must be made and heard in the manner provided by law [meaning] apply the usual federal rules of procedure [and] a ban on the use of tailor-made rules. Identifier. at 7. A court should not and must not apply a novel or pro-arbitration analysis when considering a motion to compel arbitration.
Judge Kagan’s arbitration-focused views have pushed back against longstanding policy and procedure favoring arbitration over disputes in federal district courts and demands a return to strict adherence to FAA text.
For bankruptcy practitioners, arbitration clauses present a unique issue. Bankruptcy is unique in that it allows a debtor to assume or reject an enforceable contract under Section 365 of the Bankruptcy Code. This includes any contract containing an arbitration clause, as found in Highland Capital Mgmt vs Dondero (In D Highland Capital Management.), No. 19034054, 2021 WL 5769320 (Bankr. ND Tex. 3 Dec. 2021). In this case, the court held that the debtor’s rejection of a limited partnership agreement containing an arbitration clause constituted in fact the rejection of two enforceable contracts: the partnership agreement and, separately, the arbitration agreement. ID. at 7 O’clock.
The court’s analysis led to the conclusion that an arbitration clause in another agreement creates a separate and distinct enforceable contract from the main agreement. See id. to *6-7. While arbitration can survive breach of contract in general contract law, in bankruptcy the dismissal of a contract prevents specific enforcement – including arbitration – against the trustee. Identifier.
The Supreme Court clarifies that the enforcement of an arbitration agreement is limited to contractual interpretation and not to an overall policy favoring arbitration over litigation. In the event of bankruptcy, debtors have the unique ability to reject enforceable contracts, including separate arbitration agreements contained in other agreements. It follows, then, that bankruptcy courts must favorably consider a debtor’s rejection of an arbitration agreement as a binding contract when determining whether to compel a matter to arbitration.