A recent decision of the United States Supreme Court has resolved a disagreement among lower federal courts about the significance of arbitration provisions in contracts. In support of adopting such rules, nine of the eleven federal circuits previously cited the common refrain that the Federal Arbitration Act (FAA) created an overriding federal policy favoring arbitration. In a decision rebuffing these holdings, the Supreme Court explained that the FAA’s policy only makes arbitration agreements as enforceable as other contracts, but not more so, and does not permit federal courts to devise novel rules to favor arbitration over litigation.
This case, Morgan v. Sundance, Inc., arose out of a nationwide collective action by a former employee against their employer, Sundance, for violations of the Fair Labor Standards Act. Although the employment agreement at issue contained an arbitration agreement, Sundance initially defended itself against the employee’s suit as if no arbitration agreement existed. Only after eight months of litigation—during which Sundance moved to dismiss the employee’s suit (which the District Court denied), answered the complaint asserting 14 affirmative defenses, and engaged in joint mediation—did Sundance change course and move to stay the litigation and compel arbitration under Sections 3 and 4 of the FAA.
Responding to Sundance’s FAA motion, the employee contended that Sundance had waived its right to arbitrate by litigating for so long. In deciding the waiver issue, the lower federal courts applied Eighth Circuit precedent. Under that Circuit’s test, a party waives its right to arbitration if it knew of the right, acted inconsistently with that right, and prejudiced the other party by its inconsistent actions. This arbitration-specific waiver rule’s prejudice requirement is not a feature of federal waiver law, and the Eighth Circuit had adopted the requirement because of its understanding that there existed a federal policy favoring arbitration embodied in the FAA. Although the District Court found that Sundance’s actions had prejudiced the employee, the Eighth Circuit reversed because the parties had not yet begun formal discovery or contested any matters going to the merits. The Supreme Court granted certiorari to resolve a nine-to-two circuit split over whether prejudice is, in fact, a requirement to find a waiver of arbitration.
Assuming without deciding that federal waiver law, not state procedural law, applied to the case, the Court addressed the permissibility of arbitration-specific variants of federal procedural rules, including those concerning waiver. The Court explained that ordinary federal waiver law applicable to contractual rights generally requires a showing of an intentional relinquishment or abandonment of a known right. The Court then explained how nine Courts of Appeals—all but the Seventh and the District of Columbia Circuits—employed bespoke rules of waiver for arbitration requiring a showing of prejudice, which those courts justified by the “overriding federal policy favoring arbitration” rooted in the FAA.
Holding that these rules are impermissible, the Court explained that the Courts of Appeals employing this reasoning had overemphasized the import of the FAA. Specifically, the Court stated that the FAA was enacted “to overrule the judiciary’s longstanding refusal to enforce agreements to arbitrate and to place such agreements upon the same footing as other contracts.” That is, the FAA’s purpose was to make arbitration agreements as enforceable as other contracts, not to favor arbitration or the creation of arbitration-specific procedural rules. Accordingly, the Court unanimously vacated and remanded the Eighth Circuit’s decision, counseling that federal courts may not “devise novel rules to favor arbitration over litigation,” and instructing those courts to employ their ordinary procedural rules when addressing arbitration matters.
Although the importance of the Sundance decision will be born out over time, particularly given the scope of Sundance’s involvement in litigation prior to seeking to exercise its arbitration right, the case appears to push back on the decades-long trend of federal courts citing the FAA as a justification for giving arbitration cases special treatment. In particular, the Court’s assertion that the FAA’s policy merely is to place arbitration agreements on the same footing as other contracts stands as a rebuke to the oft-cited mantra that the FAA created a policy favoring arbitration. Thus, clients with disputes involving arbitration agreements should pay close attention to the shifting ground that this decision has engendered.