The Federal Arbitration Act
October 24, 2023
In this issue of the Surety Today Blog, I will discuss the Federal Arbitration Act (“FAA”), an issue that I touched on last month in the Surety Today podcast. See 10/9/23, The Federal Arbitration Act and a Potential Surety Defense. Having a good understanding of the FAA is important for sureties so that you can defend against its use if a party is seeking to compel arbitration when you do not wish to arbitrate or if you want to compel arbitration utilizing the FAA.
The FAA was enacted in 1925 in response to widespread “judicial hostility” to arbitration agreements. See Hall Street Associates, L.L.C. v. Mattel, Inc., 552 U.S. 576, 581 (2008). This judicial hostility began long ago in the English courts and was followed in the American courts. Id.; Allied–Bruce Terminix Companies, Inc. v. Dobson, 513 U.S. 265, 270 (1995). Thus, one of the basic purposes of the FAA was to overcome the reluctance of the courts to enforce agreements to arbitrate. Allied–Bruce, supra. A second basic purpose of the FAA was to place arbitration agreements upon the same footing as any other contract. Id. at 270-71, 115 S.Ct. at 838. It has been repeatedly stated by the courts that through the FAA, Congress has declared a strong, liberal national policy favoring arbitration and that there is a strong presumption favoring enforcement of such agreements. Southland Corp. v. Keating, 465 U.S. 1, 10 (1984); see also Moses H. Cone Memorial Hospital v Mercury Constr. Corp. 460 US 1, 24 (1983).
However, it is important to note that in a unanimous decision authored by Justice Kagan just last year, in Morgan v. Sundance, Inc., 142 S. Ct. 1708, 1709–14, 212 L. Ed. 2d 753 (2022), the Supreme Court clarified the nature of the federal policy on arbitration. The Court stated that the FAA’s policy favoring arbitration “is merely an acknowledgment of the FAA’s commitment to overrule the judiciary’s longstanding refusal to enforce agreements to arbitrate and to place such agreements upon the same footing as other contracts.” Id., citing Granite Rock Co. v. Teamsters, 561 U.S. 287, 302 (2010). Further, the Court observed that “[t]he policy is to make ‘arbitration agreements as enforceable as other contracts, but not more so.’” Id., citing Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 404 (1967). The Court held “[a]ccordingly, a court must hold a party to its arbitration contract just as the court would to any other kind. But a court may not devise novel rules to favor arbitration over litigation.” See Dean Witter Reynolds Inc. v. Byrd, 470 U.S. 213, 218–221 (1985). “The federal policy is about treating arbitration contracts like all others, not about fostering arbitration.” Morgan, 142 S.Ct. at 1713-14; citing National Foundation for Cancer Research v. A. G. Edwards & Sons, Inc., 821 F.2d 772, 774 (D.C. Cir. 1987) (“The Supreme Court has made clear” that the FAA’s policy “is based upon the enforcement of contract, rather than a preference for arbitration as an alternative dispute resolution mechanism”).
The FAA “embodies Congress’ intent to provide for the enforcement of arbitration agreements within the full reach of the Commerce Clause.” Perry v. Thomas, 482 U.S. 483, 490 (1987); Frizzell Construction Company, Inc., v. Gatlinburg, L.L.C., 9 S.W.3d 79, 83 (Tenn. 1999), cert. denied, 530 U.S. 1238 (2000); see also Robert Lawrence Co. v. Devonshire Fabrics, Inc., 271 F.2d 402, 407 (2d Cir. 1959). In Prima Paint Corp., supra., the Supreme Court held that, the FAA creates a basis for federal substantive law under the Commerce Clause of the U.S. Constitution and that it is enforceable under the Supremacy Clause of the Constitution. However, the United States Supreme Court noted in Moses H. Cone Memorial Hospital, supra., “the FAA is something of an anomaly in the field of federal court jurisdiction, as it creates a body of federal substantive law establishing and regulating the duty to honor an agreement to arbitrate, yet it does not create any independent federal question jurisdiction.” Hursh v. DST Systems, Inc., 54 F.4th 561 (8th Cir. 2022). Thus, the FAA requires an independent jurisdictional basis over the parties’ dispute for access to a federal court. Vaden v. Discover Bank, 556 U.S. 49 (2009). So, you would need diversity or a federal question, like the Miller Act, to have jurisdiction under the FAA.
While the purpose of the FAA is to ensure enforceability of arbitration agreements according to their terms, the FAA does not force parties to arbitrate claims that they did not agree to arbitrate. Frizzell, 9 S.W.3d at 84; Nordeman v. Dish Network LLC, 525 F. Supp.3d 1080 (N.D. Cal. 2021). Arbitration under the FAA is a matter of consent, and as such, the parties are free to structure an arbitration agreement as they see fit. They can limit which issues will be arbitrated and specify the rules under which the arbitration will be conducted. Frizzell, 9 S.W.3d at 84. Indeed, the liberal policy in favor of arbitration generally does not apply to the threshold question of whether a valid agreement to arbitrate between the parties exists. Dye v. Tamko Building Products, Inc., 908 F.3d 675 (11th Cir. 2018). Of course, in the surety context, the question of whether there is an agreement to arbitrate is in many jurisdictions intertwined with the question of whether there is an arbitration provision in an underlying contract that has been incorporated by reference into the surety bond.
When parties have agreed to arbitration, the FAA ensures enforcement of that agreement. Moreover, “[a]s a matter of federal law, any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration. … To that end, ‘the heavy presumption of arbitrability requires that when the scope of the arbitration clause is open to question, a court must decide the question in favor of arbitration.’” American Recovery Corp. v. Computerized Thermal Imaging, Inc., 96 F.3d 88, 92 (4th Cir. 1996). However, the Supreme Court has stated “[o]f course, ‘[w]hile ambiguities in the language of the agreement should be resolved in favor of arbitration, we do not override the clear intent of the parties, or reach a result inconsistent with the plain text of the contract, simply because the policy favoring arbitration is implicated.’” EEOC v. Waffle House, Inc., 534 U.S. 279, 294 (2002).
The FAA is comprised of 16 sections set forth at 9 U.S.C.A. §1 et seq. The primary declarative Section of the FAA is Section 2, which provides in relevant part that a written provision in any contract “evidencing a transaction involving commerce” to settle by arbitration a controversy thereafter arising out of such contract or transaction, or an agreement in writing to submit to arbitration an existing controversy arising out of such a contract or transaction, “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” 9 U.S.C.A. § 2.
Section 1 of the FAA defines “commerce” as “commerce among the several States or with foreign nations, or in any Territory of the United States or in the District of Columbia, or between any such Territory and another . . .” 9 U.S.C.A. § 1. Section 3 of the FAA empowers the courts to stay any case that is pending in court until the arbitration is completed. Section 4 enables a party to an arbitration agreement to request that the court compel arbitration and sets forth procedures for conducting a hearing on the issue. Section 5 addresses appointment of arbitrators if the parties’ agreement does not address the issue. Section 9 provides for confirming an arbitration award and Sections 10 and 11 deal with vacating or modifying an arbitration award. The other Sections of the FAA deal with procedural issues, except that Section 16 addresses appeals from the various court actions relating to enforcement of the FAA.
When a party invokes the FAA and asks a federal court to stay a case and compel arbitration, the Court must determine whether the parties agreed to arbitrate the dispute at issue. Stout v. J.D. Byrider, 228 F.3d 709, 714 (6th Cir. 2000). Courts will engage in a four-step inquiry: (1) determine whether the parties agreed to arbitrate; (2) determine the scope of that agreement; (3) if federal statutory claims are asserted, the Court must consider whether Congress intended those claims to be non-arbitrable; and (4), if the Court concludes that some, but not all, of the claims in the action are subject to arbitration, it must determine whether to stay the remainder of the proceedings pending arbitration. Id.; Seeds v. Sterling Jewelers, Inc., No. 3:17-CV-718-CHB, 2018 WL 5892368, at *3 (W.D. Ky. Nov. 9, 2018). “[T]he party resisting arbitration bears the burden of proving that the claims at issue are unsuitable for arbitration.” Green Tree Financial Corp.-Alabama v. Randolph, 531 U.S. 79, 91 (2000).
As Section 2 of the FAA makes clear, one of the threshold issues on the applicability of the FAA is whether there is a “transaction involving interstate commerce.” As one court put it, “[b]efore the FAA can become applicable, there must be an agreement in writing providing for arbitration and the contract must evidence a ‘transaction involving interstate commerce.’” American Home Assur. Co. v. Vecco Concrete Const. Co., Inc. of Virginia, 629 F.2d 961 (4th Cir. 1980); Shearson Hayden Stone, Inc. v. Liang, 493 F. Supp. 104 (N.D.Ill.1980), aff. 653 F.2d 310 (Interstate commerce is necessary basis for application of the FAA). Many courts have observed that due to the liberal federal policy favoring arbitration agreements, the words “evidencing a transaction involving commerce” are to be construed broadly. Cecala v. Moore, 982 F. Supp. 609 (N.D. Ill. 1997). In deciding whether there is a transaction involving commerce governed by the FAA, the court will look to the terms of the contract, affidavits, and parties’ business operations. Ideal Unlimited Services Corp. v. Swift-Eckrich, Inc., 727 F. Supp. 75 (D.P.R. 1989). Basically, you should expect that the courts will generally try to bend over backwards to find some relationship to “commerce” so that the FAA will apply.
One of the unique features of the FAA is that it can give rise to federal preemption over conflicting state laws. While the FAA contains no express preemptive provision, nor does it reflect a congressional intent to occupy the entire field of arbitration, the liberal federal policy favoring arbitration and the purpose of the FAA has given rise to preemption.
In Southland Corp. v Keating, 465 US 1 (1984), the Supreme Court held that the substantive law created by the FAA was applicable in state courts as well as in federal courts. The Court stated “[i]n creating a substantive rule applicable in state as well as federal courts, Congress intended to foreclose state legislative attempts to undercut the enforceability of arbitration agreements.” 465 U.S. at 16. Because the FAA creates a substantive body of federal law to the full limit of the Commerce Clause, under the Supremacy Clause the FAA preempts inconsistent state laws.
Under the law of preemption, courts have held that state laws making arbitration agreements void or unenforceable, or revocable any time prior to the arbitral award, are preempted because they contravene the federal policy and purpose of the FAA. Similarly, State laws which make arbitration clauses invalid as adhesion contracts have been held preempted by the FAA. A state law which treated the incorporation by reference of arbitration agreements into contracts differently than the incorporation by reference of other provisions into contracts was held to be preempted by the FAA.
While preemption under the FAA exists, the FAA does not entirely displace state arbitration law. 9 U.S.C.A. § 1 et seq.; Nationwide Mut. Ins. Co. v. Liberty Mut. Ins. Co., 57 F. Supp. 3d 112 (D. Mass. 2014) and the mere fact that a contract affects interstate commerce, thus triggering the FAA, does not automatically preclude enforcement of state arbitration laws in general. Long v. BDP Intern., Inc., 919 F. Supp. 2d 832 (S.D. Tex. 2013). Rather, the FAA can preempt state law to the extent that such law “stands as an obstacle to accomplishment and execution of the full purposes and objectives of Congress” under the FAA. 9 U.S.C.A. § 2; Sakkab v. Luxottica Retail North America, Inc., 803 F.3d 425 (9th Cir. 2015). Stated differently, state rules specific to arbitration that interfere with the purposes of the FAA are subject to preemption under the Act. Brown v. MHN Government Services, Inc., 306 P.3d 948 (Wash. 2013). The converse is also true – state laws specific to arbitration that do not conflict with the FAA or its purpose are not preempted, nor are state laws affecting all contracts.
The final phrase of § 2 of the FAA permits arbitration agreements to be declared unenforceable “upon such grounds as exist at law or in equity for the revocation of any contract.” This saving clause permits arbitration clauses to be invalidated by generally applicable contract defenses, such as fraud, duress, waiver, unconscionability, or other such general contract defenses. However, the FAA does not permit defenses that apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue to invalidate an otherwise valid arbitration agreement. AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 339–40 (2011); Doctor’s Associates, Inc. v. Casarotto, 517 U.S. 681, 687 (1996); see also Perry, 482 U.S. at 492–493, n. 9.
Whether the FAA applies, whether preemption applies, whether the arbitration agreement is enforceable or a particular defense applies are very dense and complicated issue with many nuances and decisions going in many directions, so one must exercise caution when analyzing such FAA related issues.
If you have questions regarding the issues discussed in this post, please do not hesitate to contact Michael A. Stover, Esq. (email@example.com) or any member of the Surety and Fidelity Practice Group.
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