Enforceability of Arbitration Agreements That Restrict Statutorily-Mandated Rights: the Sharpening Split Among the Circuits By: Howard S

Enforceability of Arbitration Agreements that Restrict Statutorily-Mandated Rights: the Sharpening Split Among the Circuits By: Howard S. Suskin1 and Marek H. Badyna2

Increasingly, many arbitration Eighth Circuits have held that an Subsequently, in PacifiCare agreements include clauses that arbitration clause that is alleged Health Systems, Inc. v. Book,6 attempt to limit substantive rights to impermissibly preclude or limit the Court held that when there is and remedies that are otherwise statutorily authorized remedies is ambiguity about the scope of a afforded to parties by various still a valid agreement to arbitrate, remedies limitation in an arbitration federal and state statutes. For and that the arbitrator should decide agreement, an arbitrator must example, many employment, the availability of remedies along decide the issues of enforceability cable television subscriptions, with the other issues in the case. in the first instance. PacifiCare or residential mortgage loan This article examines the different addressed the question of whether contracts contain arbitration approaches courts have taken with parties could be compelled to clauses purporting to exclude or regard to the enforceability of such arbitrate claims arising under limit punitive or actual damages clauses. the Racketeer Influenced and Corrupt Organizations Act (RICO), otherwise available under Introduction applicable remedial statutes.3 notwithstanding the fact that The current split among the These clauses have been subject to the arbitration agreement’s bar circuits has its genesis in a trilogy varying degrees of judicial scrutiny, of punitive damages could be of U.S. Supreme Court opinions depending on the jurisdiction construed to limit the arbitrator’s that have touched upon, but not authority to award treble damages where the dispute is brought. resolved, the issue of enforceability under the RICO statute.7 The Court One particular issue as to which of arbitration clauses that preclude concluded that it was unclear the circuits are sharply divided is or limit statutorily authorized whether the arbitration agreement, whether courts should adjudicate remedies. which prohibited awards of “punitive the enforceability of an arbitration In Gilmer v. Interstate/Johnson damages,” actually would prevent clause before arbitration if the party Lane Corp.,4 the Supreme Court an arbitrator from awarding treble opposing arbitration contends that stated that “[b]y agreeing to damages under RICO.8 The parties’ public policy prohibits the waiver of arbitrate a statutory claim, a party agreement was also subject the party’s statutory rights that the does not forego the substantive to uncertainty surrounding the clause purports to effect. rights afforded by the statute; it parties’ intent with respect to the The First, Fifth, Sixth, Ninth, only submits to their resolution contractual term “punitive.”9 The Eleventh, and D.C. Circuits have in an arbitral, rather than judicial Court concluded that the case was held that in the first instance the forum.” The Court, however, did not not ripe for judicial determination, court, not the arbitrator, should analyze the issue of enforceability and that the arbitrator should decide the validity of an arbitration of the rights-restrictive agreements decide the issue of the agreement’s clause that allegedly offends in more detail, as the facts in Gilmer enforceability in the first instance.10 some statutory provision and did not involve limitations upon the The Court’s ruling, however, did not its underlying public policy. In types of relief that the arbitrator address the situation where there contrast, the Third, Seventh, and could award.5 was not any ambiguity affecting the

1 scope of remedial limitations in the agreements based upon their will deny the motion to compel arbitration agreement.11 remedial restrictions fall within the arbitration only where the invalid Most recently, in Buckeye category of gateway matters to be terms of the arbitration agreement 16 Check Cashing, Inc. v. Cardegna, decided by a court. Other circuits render the entire arbitration 20 the Supreme Court held that disagree, holding that challenges clause void. If all provisions a challenge to the validity of a to the adequacy of arbitration of the arbitration agreement contract as a whole, and not remedies have nothing to do with are enforceable, the court must specifically to the arbitration clause whether the parties agreed to compel arbitration. If, however, within it, must be resolved by the arbitrate, and that such challenges some or all of the provisions in the arbitrator in the first instance.12 must first be considered by the agreement are unenforceable, then 17 Buckeye involved a putative class arbitrator. the court must determine whether the unenforceable provisions action, in which plaintiffs challenged First, Fifth, Sixth, Ninth, are severable.21 If the offending the validity of the entire contract Eleventh, and D.C. Circuits between the parties, including the Adjudicate the Enforceability of provisions are severable from the arbitration provision. The Court Substantive Restrictions rest of the arbitration agreement, explained that federal courts in Arbitration Agreements the court must compel arbitration may adjudicate only challenges Prior to Arbitration according to the remaining, valid 22 that “go[ ] to the making of the The First, Fifth, Sixth, Ninth, terms of the parties’ agreement. agreement to arbitrate,”13 as the Eleventh, and D.C. Circuits have The Eleventh Circuit also Federal Arbitration Act does not held a court’s determination permits district courts to compel permit federal courts to consider of arbitrability encompasses arbitration without first passing on challenges to contracts generally. the issue of enforceability of the validity of remedial restrictions Thus, unless the challenge is to the substantive restrictions contained if the agreement contains an arbitration clause itself, the issue in the arbitration agreement that unambiguous severability of the contract’s validity is to be allegedly conflict with state or clause, and there is no doubt considered by the arbitrator in the federal statutes and public policy. that the dispute would wind up first instance.14 Under this approach, a trial court in the arbitration. A district court Despite its various can either invalidate the entire might then refrain from ruling pronouncements, the Supreme agreement to arbitrate and hear on the validity of the challenged Court has not yet resolved the merits of the case, or sever the restrictions and direct the parties definitively whether the issue of offending provisions and require to proceed to arbitration because enforceability of an arbitration arbitration under the remainder there is no longer any question as 18 clause that limits a party’s of the contract. The differences to whether the parties had a valid 23 substantive remedies must be in outcomes on the issue of agreement to arbitrate. resolved by the courts or left severability reflect variations among The decisions striking arbitration 19 for the arbitrators. The circuit different arbitration agreements. clauses in their entirety most often courts currently are split on this Under the approach taken involve agreements without a issue, reflecting a divergence in these circuits, when a party severability clause, and situations of views concerning the proper challenges the validity of an where the agreements are scope of judicial review regarding arbitration clause on the ground pervasively infected with illegality, the enforceability of arbitration that it contains unenforceable particularly if “the offensive agreements. The prevailing remedial restrictions, the court must provisions clearly represent an tendency among the circuits has first decide whether the restrictions attempt . . . to achieve though been to assign the issue to the are unenforceable because they arbitration what Congress has courts.15 The majority of circuits defeat the remedial purpose of expressly forbidden.”24 The hold that challenges to arbitration the state or federal statute. Courts decisions in which the courts

2 severed the offending provisions that purported to forfeit plaintiff’s provision is severable from the and compelled arbitration, on statutorily-mandated rights to remainder of the contract.35 In the other hand, typically involve exemplary damages, attorney’s general, the more one of the agreements with discrete, readily fees, and one-year statute of parties overreaches, the less a separable provisions.25 limitations.29 The court refused to court is likely to sever the offending sever the offending provisions, provisions and enforce the rest Clauses Foreclosing of the arbitration agreement. But Substantive Rights Might instead concluding that the Invalidate an Otherwise entire arbitration clause must be when the agreement contains Enforceable Agreement To eliminated as it clearly purported a severability clause and the Arbitrate to achieve through arbitration offending provisions are discrete and separable, a court is likely In several instances, the circuit what Congress has expressly 30 to sever the unenforceable part courts have invalidated entire forbidden. The court concluded and compel arbitration under the arbitration agreements that that severance is inappropriate remainder of the agreement.36 foreclosed statutory remedies. when the entire clause represents In Paladino v. Avnet Computer an integrated scheme to contravene For example, in Morrison v. Circuit Technologies, Inc., for example, public policy.31 City Stores, Inc, the Sixth Circuit the Eleventh Circuit invalidated Paladino and Graham Oil held that the arbitration agreement’s the entire agreement to arbitrate involved exceptional circumstances provisions restricting an employee’s because the arbitration clause that presented several allegedly right to compensatory and punitive impermissibly restricted plaintiff’s offending provisions. As the damages under Title VII were 26 37 statutory remedies under Title VII. Eleventh Circuit later explained, unenforceable but severable. The arbitration agreement in that “Paladino does not hold that any The court emphasized that Circuit case specified that “[t]he arbitrator remedial restriction contained in an City’s arbitration agreement, which limited plaintiff’s compensatory is authorized to award damages for arbitration agreement is necessarily and punitive damages under Title breach of contract only, and shall unenforceable or necessarily VII, contravened the remedial have no authority whatsoever to renders the agreement null and principles of the statute by make an award of other damages.” void in its entirety.”32 Instead, when Id. Because Title VII damages preventing full compensation for a party challenges the validity of an are not contract damages, the any harms caused by wrongful arbitration clause on the ground that Eleventh Circuit concluded that discrimination, and by eviscerating it contains unenforceable remedial this arbitration clause denied Congress’ intent to utilize punitive restrictions, the court must first the employee “the possibility of damages as a tool for combating determine whether those remedial meaningful relief in an arbitration discrimination.38 Nonetheless, restrictions are severable.33 proceeding.”27 As the court the court held that the offending explained, the arbitration agreement Judicial Determinations of provisions were severable from the defeated the statute’s remedial Severability of Allegedly arbitration agreement as a whole.39 purposes by insulating defendant Offending Provisions Likewise, in Jackson v. Cintas from Title VII damages and When the arbitration agreement Corp, the Eleventh Circuit upheld equitable relief a court could award, includes a severability provision, the trial court’s arbitration order and “the arbitrability of [statutory] courts will not lightly conclude severing the restrictions in the claims rests on the assumption that that a particular provision of an arbitration clause that purported to the arbitration clause permits relief arbitration agreement taints the limit the time in which the employee 28 equivalent to court remedies.” entire agreement.34 Indeed, in could bring statutory claims.40 Similarly, in Graham Oil Co. v. Buckeye, the Supreme Court held Similarly, in Kristian v. Comcast Arco Products, the Ninth Circuit that as a matter of substantive Corp., the First Circuit held that invalidated an arbitration clause federal arbitration law, an arbitration arbitration agreements prohibiting

3 recovery of treble damages as harassment, and retaliation in and fees to the prevailing party, applied to federal antitrust claims, violation of the Iowa Civil Rights was an unconscionable contract of attorney’s fees and costs, and Act. Plaintiff’s employment adhesion.54 the class arbitration bar were agreement contained an arbitration Indeed, when one of the invalid, and severed the offending clause, which limited the arbitrator’s contracting parties overreaches provisions from the arbitration authority to award punitive in limiting the counterparty’s 48 agreements as applied to antitrust damages. The employer moved to substantive rights, the entire 41 claims. With the offending compel arbitration. Plaintiff opposed arbitration agreement might provisions removed, the parties the motion to compel arbitration, fall under the doctrine of could proceed with the arbitration of contending that the punitive unconscionability, which the courts 42 the antitrust claims. damages limitation in the arbitration in all jurisdictions can adjudicate 49 agreement violated public policy. 55 Third, Seventh, and Eighth prior to arbitration. While it is The district court compelled Circuits Hold That Arbitrators, for the arbitrator to address the Not Courts, Should Adjudicate arbitration, holding that it is for the arguments concerning the waiver the Enforceability of arbitrator, not the court, to decide of statutory rights, a court must Substantive Restrictions in whether the waiver of punitive still ascertain whether the parties 50 Arbitration Agreements damages is unenforceable. entered into a valid agreement The Third, Seventh, and Eighth Despite the limited scope to arbitrate.56 In evaluating that Circuits hold that challenges to of judicial inquiry in the Third, issue, a court must look to state a provision restricting arbitration Seventh and Eighth Circuits, courts law principles.57 Under those rules, remedies must be determined by within these circuits still disfavor the court may find an agreement the arbitrator in the first instance.43 arbitration agreements that limit to arbitrate unenforceable Under this approach, the court’s the relief an arbitrator may award, based on generally applicable scope of review of an arbitration and these courts recognize that the contractual defenses, such as agreement is limited to the issues arbitrators have power to fashion unconscionability or fraud in the which are “essential to defining appropriate relief.51 For example, inducement of the arbitration the nature of the forum in which courts have allowed an arbitrator clause.58 And it is well-established the dispute will be decided.”44 to award the party relief even in that a court may adjudicate Once a court determines that a the face of contractual limitations, issues which go to the making valid agreement to arbitrate exists, and may rule that certain arbitration of the agreement to arbitrate.59 the arbitrator should decide all awards are unenforceable.52 The Considerations of public policy remaining issues.45 Questions narrow scope of the initial judicial and the loss of statutory rights are concerning public policy and review under the arbitration relevant, but not dispositive, in the remedies are outside the scope agreement does not foreclose a broader, multi-factor analysis of of that inquiry because these party from subsequently vindicating unconscionability.60 issues are considered not to affect legal rights because “[b]y agreeing In Alexander v. Anthony the validity of an agreement to to arbitrate a statutory claim, a party International, L.P., for example, the 46 arbitrate. does not forego the substantive Third Circuit found the agreement A recent decision within the rights afforded by the statute; it only to arbitrate unenforceable under Eighth Circuit, by the Southern submits to their resolution in an the doctrine of unconscionability 53 District of Iowa in Faust v. arbitral, rather than judicial forum.” because plaintiffs were not Command Center, Inc., provides In Bob Schulz Motors v. Kawasaki presented with any real opportunity a typical example of such limited Motors Corp. U.S.A., for instance, to negotiate the terms of the judicial review.47 In Faust, a former the Eighth Circuit confirmed the arbitration agreement; the employee sued her employer arbitrator’s ruling that the arbitration agreement provided one-sided time for sex discrimination, sexual provision, which awarded costs limitations and restrictions on the

4 relief available to plaintiffs, and the the existence, scope or validity of Action Litigation Law Practice and “loser pay” provisions for arbitrator’s the arbitration agreement.” Thus, Co-Chair of the firm’s Securities Litigation Law Practice. He has sub- fees and expenses unreasonably by incorporating Rule 8 into their stantial experience counseling and favored the defendant.61 The court agreement, the parties consented representing clients in arbitrations, concluded that those elements that the arbitrator would decide and is an arbitrator with the AAA, of illegality permeated the entire whether the arbitration clause is NYSE, NASD, CBOE and NFA. agreement to arbitrate, precluding valid. The court concluded that 2 Marek H. Badyna is a member of Jenner & Block LLP’s Litigation severance of the offending because the arbitrator is to decide Practice. provisions.62 the ultimate question of arbitrability, 3 See, e.g., Booker v. Robert Half there is no reason for the court to Parties Also Can Contractually Intern., Inc., 413 F.3d 77 (D.C. decide the subsidiary, antecedent Cir. 2005) (arbitration agreement Submit the Issue of Arbitrabil- questions regarding the validity of purporting to limit punitive damages ity to the Arbitrator and Avoid otherwise available under the D.C. the remedial restrictions, and the Antecedent Judicial Review statute); Hadnot v. Bay, Ltd., 344 court therefore directed the case to Even in jurisdictions where courts F.3d 474 (5th Cir. 2003) (arbitration arbitration.64 provision prohibiting punitive and typically adjudicate enforceability exemplary damages otherwise avail- of arbitration clauses in the face Conclusion able under Title VII of the Civil Rights Act); Kristian v. Comcast Corp, 446 of allegations that the clauses Until the Supreme Court deter- F.3d 25 (1st Cir. 2006) (cable televi- contravene public policy, parties mines whether the issue of validity sion subscriber agreements barring may avoid such adjudication by of an arbitration agreement that treble damages otherwise available specifically addressing this topic limits substantive remedies is to be under federal antitrust laws); Anders in their arbitration clauses. In v. Hometown Mortgage Services, resolved by the courts or left for the Inc., 346 F.3d 1024 (11th Cir. 2003) Terminix International Co. v. Palmer arbitrators, courts will continue to (arbitration agreement purporting to Ranch Limited Partnership, the proceed with varying degrees of re- limit punitive and treble damages, Eleventh Circuit allowed the parties view of such agreements. As a gen- penalties or attorney’s fees otherwise to contract around the default available under the Truth in Lending eral matter, however, agreements Act, and the Real Estate Settlement rule that requires antecedent limiting the relief that an arbitrator Procedures Act). enforceability assessment of may award are disfavored, and 4 500 U.S. 20, 26 (1991). the remedial restrictions in the the ultimate effectiveness of such 5 Id . at 32. In Gilmer, the Court re- arbitration agreement. The court restrictions is uncertain. Parties jected a general challenge to the ar- instructed that when parties drafting arbitration clauses there- bitrability of a claim brought under the Age Discrimination in Employment incorporate the Commercial fore should be mindful of the risk Act (ADEA). Id. at 23. The Court Arbitration Rules of the American that such clauses may be subject to concluded that the ADEA claim was Arbitration Association (AAA) into review and possible unenforceabil- subject to arbitration in the absence their arbitration agreement, a ity if the clauses encroach too far of showing that Congress intended to court does not have to decide the preclude a waiver of a judicial forum on substantive rights and remedies, in the text of the ADEA, its legislative antecedent question regarding the particularly in those jurisdictions history, or as a result of an “inherent validity of the arbitration clause, and where courts have demonstrated a conflict” between arbitration and the will order the parties to proceed to willingness to engage in this type underlying purposes of the statute. Id. at 27-29. arbitration, leaving it to the arbitrator of analysis in deciding a motion to 6 538 U.S. 401, 407 (2003). to decide whether the agreement compel arbitration. unlawfully deprives the party of 7 Id . at 402-03. any statutory rights.63 AAA Rule 8 Id . at 405-06. 8(a) provides that “[t]he arbitrator Endnotes 9 Id . at 406. shall have the power to rule on his 1 Howard S. Suskin is a partner in 10 Id. 406-07. or her own jurisdiction, including Jenner & Block LLP’s Chicago Office. 11 See, e.g., Kristian, supra note 3, at any objections with respect to He is the Chair of the firm’s Class 45 (PacifiCare does not apply where

5 “[t]here is nothing ambiguous about dino v. Avnet Computer Techs., Inc., at 807 (“Because the adequacy of the remedies-stripping provision at 134 F.3d 1054, 1057-60 (11th Cir. arbitration remedies has nothing to issue.”). 1998); Booker, supra note 3, at 79. do with whether the parties agreed See also Cole v. Burns Int’l Security 12 546 U.S. 440, 445-46 (2006); see to arbitrate or if the claims are within Services, 105 F.3d 1465, 1468 (D.C. also Pleasant v. Houston Works the scope of that agreement, these Cir. 1997). USA, No. 06-20824 (5th Cir. June challenges must first be considered 7, 2007) (district court properly 19 Booker, supra note 3, at 84-85. by the arbitrator”); Great Western Mortgage Corp. v. Peacock, 110 F.3d compelled arbitration where plaintiff 20 Terminix Int’l Co., LP v. Palmer conceded he agreed to arbitrate all 222, 232 (3d Cir. 1997) (“The avail- Ranch Ltd. P’ship, 432 F.3d 1327, ability of punitive damages is not employment disputes, and con- 1331 (11th Cir. 2005). tended generally that arbitration relevant to the nature of the forum clause was unenforceable due to the 21 Morrison, supra note 18, at 675. in which the complaint will be heard. Thus, availability of punitive dam- employer’s alleged breach of obliga- 22 Terminix, supra note 20, at 1331. tions under the entire Employment ages cannot enter into a decision to 23 Anders, supra note 3; Terminix, su- Dispute Resolution Program). compel arbitration.”). pra note 20, at 1332 (quoting Green 44 Larry’s United, supra note 43, at 13 546 U.S. at 445 (citing Prima Paint Tree Fin. Corp. v. Bazzle, 539 U.S. 1085; Great Western, supra note 43, Corp. v. Flood & Conklin Mfg. Co., 444, 452 (2003)). 388 U.S. 395, 403-04 (1967)). at 230. 24 Graham Oil, supra note 18, at 45 Great Western, supra note 43, at 14 Compare with State ex rel. Vincent v. 1248-49. Schneider, 194 S.W.3d 853, 857 n. 1 231. 25 Booker, supra note 3, at 84-85. (Mo. 2006) (Buckeye does not apply 46 Arkcom Digital Corp. v. Xerox Corp., where plaintiff challenges arbitration 26 Paladino, supra note 18, at 1062. 289 F.3d 536, 539 (8th Cir. 2002). clause directly and not the contract 27 Id. at 1062. 47 484 F. Supp. 2d 953 (S.D. Iowa as a whole). 28 Id. 2007). 15 See, e.g., Kristian, supra note 3, at 48 Id. at 954. 45-46 (rejecting inconsistent dicta 29 Graham Oil, supra note 18, at 1246. from MCI Telecomm. Corp. v. Matrix 30 Id. 49 Id. Communications Corp., 135 F.3d 31 Id. 50 Id. at 955. 27 (1st Cir. 1998), and holding that a court, not the arbitrator, should 32 Terminix, supra note 20, at 1331. 51Faber v. Menard, Inc., 367 F.3d 1048, 1052 (8th Cir. 2004). resolve claims of damages limitation 33 Id. which preclude plaintiffs’ federal anti- 52 Bailey v. Ameriquest Mortgage Co., 34 Morrison, supra note 18, at 675. trust claims). See also infra note 18. 346 F.3d 821, 822 (8th Cir. 2003). 35 Buckeye, supra note 12. 16 See, e.g., Kristian, supra, note 3, at 53 Gilmer, supra note 4; Mitsubishi 39 (citing Howsam v. Dean Wit- 36 Booker, supra note 3, at 85-86. Motors Corp. v. Soler Chrysler-Plym- ter Reynolds, Inc., 537 U.S. 79, 37 Morrison, supra note 18, at 670-75. outh, Inc., 473 U.S. 614, 628 (1985); 84 (2002)); Anders, supra note 3, Arkom Digital, supra note 46, at 538. at 1027 (citing Green Tree Finan- 38 Id. at 672. 54 Kawasaki Motors, supra note 43. cial Corp. v. Bazzle, 539 U.S. 444 39 Id. at 675. (2003)). 55 See, e.g., Alexander v. Anthony 40 425 F.3d 1313, 1317 (11th Cir. Int’l, L.P., 341 F.3d 256, 264 (3d Cir. 17 See, e.g., Hawkins v. Aid Ass’n for 2005). 2003). Lutherans, 338 F.3d 801, 807 (7th Cir. 2003). The Seventh Circuit also 41 Kristian, supra note 3, at 64. 56 Id. held that Gilmer only applies to 42 Id. 57 See, e.g., Doctor’s Assoc., Inc. v. federal statutory claims if Congress 43 Bob Schulz Motors, Inc. v. Kawasaki Casarotto, 517 U.S. 681, 687 (1996) has evinced its intention to preclude Motors Corp., U.S.A., 334 F.3d 721 (“generally applicable contract the waiver of statutory rights, and (8th Cir. 2002); Larry’s United Super, defenses, such as fraud, duress, or does not apply to state common-law Inc. v. Werries, 253 F.3d 1083, 1085 unconscionability, may be applied claims. Id. at 807. See also infra (8th Cir. 2001); Matrix, supra note to invalidate arbitration agreements note 43. 15, at 33 n. 12 (issue of validity of without contravening § 2 of the 18 Kristian, supra note 3, at 45-46; arbitration agreement foreclosing FAA”); Cap Gemini Ernst & Young, Hadnot, supra note 3; Morrison v. statutory remedies “must be brought U.S., L.L.C. v. Nackel, 346 F.3d Circuit City Stores, Inc., 317 F.3d to the arbitrator because it does not 360, 364 (2d Cir. 2003) (questions 646, 670-74 (6th Cir. 2003); Graham go to the arbitrability of the claims of contractual validity relating to the Oil Co. v. Arco Prods. Co., 43 F.3d but only to the nature of available unconscionability of the underlying 1244, 1247-48 (9th Cir. 1995); Pala- relief”); Hawkins, supra note 17, arbitration agreement must be re-

6 solved first, as a matter of state law, before compelling arbitration). 58 Prima Paint, supra note 13, at 403-04 (fraud in inducement); Alexander, supra note 55, at 265 (unconscionability). 59 Prima Paint, supra note 13, at 403-04. 60 Alexander, supra note 55, at 264-70; Cap Gemini, supra note 57 at 364. 61 Alexander, supra note 55, at 263. 62 Id. 63 Terminix, supra note 20, at 1333. 64 Id. at 1332-33.