Arbitrability of Mental Capacity Defenses Under the Federal Arbitration Act and C

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Arbitrability of Mental Capacity Defenses under the Federal Arbitration Act and California Law Resource type: Article Status: Law stated as at 23-Sep-2014 Jurisdictions: California, USA

This Article examines whether the Prima Paint rule applies to a mental capacity defense. Prima Paint holds that unless the challenge is to the arbitration clause itself, the arbitrator determines the issue of the contract's validity. While the law is not universally settled, federal and state court decisions have either held or suggested that if a person lacked the mental capacity to enter into an agreement, he should not be assumed to have agreed to arbitrate the issue of his mental capacity, and the mental capacity defense should be considered by the court in the first instance.

Fletcher W. Paddison and Erik M. Ideta, Troutman Sanders LLP, with Practical Law Litigation

Sources of US Arbitration Law

The Federal Arbitration Act (FAA) applies to all arbitrations arising from maritime transactions or to any other contract "involving commerce," which is defined broadly (see Practice Note, Understanding the Federal Arbitration Act). Courts have generally stated that the FAA pre-empts state law that conflicts either with its express provisions or its intent of promoting arbitration.

Parties may, however, contemplate enforcement of their arbitration agreement under state procedural statutory or common law (also referred to as arbitration law) (see Hall St. Associates, L.L.C. v. Mattel, Inc., 552 U.S. 576, 590 (2008)). In a California state court, a general choice of law provision will incorporate not only California's substantive law but also its arbitration law (see Cronus Investments, Inc. v. Concierge Servs., 35 Cal.4th 376, 387 (2005) and Mastick v. TD Ameritrade, Inc., 209 Cal.App.4th 1258, 1263-64 (2012)). However, Federal Courts in California have held the opposite (see Wolsey, Ltd. v. Foodmaker, Inc., 144 F.3d 1205, 1211-13 (9th Cir. 1998)). For more information, see Practice Note, Drafting Arbitration Agreements Calling for Arbitration in the US: Choice of Law.

The California Arbitration Act (CAA) is the state arbitration law of California (Cal. Code Civ. Pro. §§ 1280- 1294.2). The CAA applies to domestic arbitrations and is generally applicable to international arbitrations when the parties have chosen it in their arbitration agreement. California also has a separate statute applicable only to international arbitrations, the 1996 California International Arbitration and Conciliation Act (CIACA), which gives the California Superior Court jurisdiction over matters arising under the CIACA (Cal. Code Civ. Pro. §§ 1297.11-1297.432). For more information, see Practice Note, Choosing an Arbitral Seat in the US: California.

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Separability

A challenge to the validity of a contract as a whole, and not specifically to the arbitration clause within it, must go to the arbitrator, not the court. This is known as the separability doctrine. The US Supreme court has established two considerations regarding separability:

• As a matter of substantive federal arbitration law, an arbitration provision is severable from the remainder of the contract.

• Unless the challenge is to the arbitration clause itself, the arbitrator considers the issue of the contract's validity in the first instance.

(See Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, 445-46 (2006).)

Where an arbitral agreement contains a "delegation provision," a clause delegating the power to determine the enforceability of the arbitral agreement to the arbitrator, a court may step in to decide arbitrability only if a party makes a specific challenge to the delegation provision (see Rent-A-Center, West, Inc. v. Jackson, 561 U.S. 63, 73-75 (2010)). (See also Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 403. (1967).) In Prima Paint, a party claimed the agreement as a whole, not the arbitration clause itself, was procured by fraud. The claim of fraud in the inducement was, under those circumstances, to be decided by the arbitrator, not the court. For more information, see Practice Note, Jurisdictional issues in international arbitration: Separability.

California arbitration law also recognizes the separability doctrine (see Ericksen, Arbuthnot, McCarthy, Kearney & Walsh, Inc. v. 100 Oak St., 35 Cal. 3d 312, 323 (1983)). (See also Rosenthal v. Great Western Fin. Secs. Corp., 14 Cal. 4th 394, 415 (1996).)

Who Decides Whether a Dispute is Arbitrable?

Contracts Governed by the FAA To find out whether a party can be required to arbitrate a particular dispute, courts must determine:

• Whether a valid agreement to arbitrate exists.

• Whether a party to the agreement has failed or refuses to arbitrate.

(9 U.S.C. § 4.)

Questions of arbitrability are "presumptively to be decided by courts, not the arbitrators themselves" (Telenor Mobile Commc'ns AS v. Storm LLC, 584 F.3d 396, 406 (2d Cir. 2009)). Parties can, however, "agree to arbitrate 'gateway' questions of 'arbitrability,' such as whether the parties have agreed to arbitrate or whether their agreement covers a particular controversy" (Rent-A-Center, 561 U.S.at 68-69).

However, where it is disputed that the parties have entered into any arbitration agreement at all, courts will first determine that issue, even where the purported written agreement delegates issues of arbitrability to the

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arbitrator (see Nebraska Mach. Co. v. Cargotec Solutions, LLC, 13-2753, 2014 WL 3896179, n. 2 (8th Cir. Aug. 7, 2014)).

The Mental Capacity Defense

In Buckeye Check Cashing, the US Supreme Court noted in dicta that the separability doctrine may not apply to a mental capacity defense (546 U.S. at 444, n. 1, citing Spahr, 330 F.3d at 1266)). The distinction the Court drew was between challenges to a contract's validity, which are arbitrable, and challenges to a contract's formation, which generally are not (see SBRMCOA, LLC v. Bayside Resort, Inc., 707 F.3d 267, 274 (3d Cir. 2013), citing Buckeye Check Cashing).

Federal courts are split on whether mental capacity defenses are arbitrable under the FAA. In Primerica Life Insurance Co. v. Brown, the Fifth Circuit Court of Appeals held that the respondent could be compelled to arbitrate his lack of capacity defense (304 F.3d 469 (5th Cir. 2002)). Citing Prima Paint, the Fifth Circuit reasoned that because Brown's capacity defense was a "defense to his entire agreement with CitiFinancial and not a specific challenge to the arbitration clause," it was "part of the underlying dispute between the parties which, in light of Prima Paint and its progeny, must be submitted to the arbitrator."

However, in Spahr v. Secco, the Tenth Circuit reached the opposite conclusion (330 F.3d 1266 (10th Cir. 2003)). The court reasoned that plaintiff's mental incapacity defense naturally goes to both the entire contract and the agreement to arbitrate in the contract. The court distinguished a claim of fraud in the inducement, which can be directed at individual provisions in a contract, from a mental capacity challenge, which can be directed only at the entire contract.

More recently, in Amirmotazedi v. Viacom, Inc., the DC district court reasoned that the Buckeye Check Cashing footnote means that the Prima Paint rule does not necessarily apply to a mental capacity defense (768 F. Supp. 2d 256 (D.D.C. 2011)). Freed from the Prima Paint rule, the court found Spahr more persuasive than Primerica, which considered Prima Paint binding precedent in cases of mental capacity.

Practice Tip When contracting with a party who may suffer from diminished capacity, having the agreement signed by that party's agent may save the arbitration agreement. In a Fifth Circuit case, a nursing home admission agreement contained an arbitration clause. The incapacitated patient's mother signed the agreement on the patient's behalf. The patient was bound to arbitrate as a third-party beneficiary of the agreement because the agreement expressly named the patient as the resident receiving care and services from the nursing home (JP Morgan Chase & Co. v. Conegie ex rel. Lee, 492 F.3d 596, 600 (5th Cir. 2007)). Some state courts, however, have disagreed with this approach (see, for example, Coleman v. Mariner Health Care, Inc., 407 S.C. 346 (2014) and State ex rel. AMFM, LLC v. King, 230 W. Va. 471 (2013)).

Contracts Governed by the CAA

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California law also holds that in the absence of an indication of contrary intent, and where the arbitration clause is reasonably susceptible of such an interpretation, claims of fraud in the inducement of the contract (as distinguished from claims of fraud directed to the arbitration clause itself) are subject to arbitration (see Ericksen, 35 Cal. 3d at 323).

In Rosenthal v. Great Western Financial Securities Corp., plaintiffs alleged fraud in the "inception" of the contracts that contained the arbitration clauses (14 Cal. 4th 394, 408-10 (1996)). The court concluded that a party could not have intended to arbitrate disputes where the contract was wholly void. The Rosenthal court also assumed, without discussion, that the issue of mental capacity to make a contract was for the court and not the arbitrator to decide. In that case, the plaintiff's guardian ad litem stated that the plaintiff suffered from diminished understanding and was incapable of comprehending complicated monetary transactions. The Rosenthal court remanded the matter to the trial court to find facts and decide whether the plaintiff's alleged incapacity rendered the contract, including the arbitration clause, void.

In McKenzie v. Morgan Stanley & Co., the Fourth District Court of Appeal followed Rosenthal and held that the court, not the arbitrator, decides the mental capacity defense (D053946, 2009 WL 2618623 (Cal. Ct. App. Aug. 26, 2009)). As an unpublished decision, McKenzie is not binding law in California (see Cal. Rules of Court, rule 8.1115(a)). However, the rationale behind this decision and the language in Rosenthal strongly suggest that a court in California would hold that the mental capacity defense must be decided by the court and is not arbitrable.