1983 U.S. Supreme Court arbitration-law case
1984 United States Supreme Court case
Southland Corp. v. Keating, 465 U.S. 1 (1984), is a United States Supreme Court decision concerning arbitration. It was originally brought by 7-Eleven franchisees in California state courts, alleging breach of contract by the chain's then parent corporation. Southland pointed to the arbitration clauses in their franchise agreements and said it required disputes to be resolved that way; the franchisees cited state franchising law voiding any clause in an agreement that required franchisees to waive their rights under that law. A 7-2 majority held that the Federal Arbitration Act (FAA) applied to contracts executed under state law.
Chief Justice Warren Burger wrote for the majority that it was clearly the intent of Congress in passing the FAA to encourage the use of arbitration as widely as possible, that it enacted "a national policy favoring arbitration." Justice Sandra Day O'Connor dissented, along with William Rehnquist, arguing that the legislative history of the FAA strongly suggested it was intended to apply only to contracts executed under federal law. In later years, Clarence Thomas would make those arguments the foundation of a series of dissents from cases concerning the application of the FAA to state law, even in cases for which O'Connor decided with the majority, citing "stare decisis".
The decision was a turning point in the use of arbitration in American contract law, as it was followed with other decisions limiting the authority of states to regulate arbitration. It has been described as "perhaps the most controversial case in the Supreme Court's history of arbitration jurisprudence." Its legal foundation has been examined and disputed, and some critics have found the FAA's legislative history directly contradicts the court's holding. One scholar has even found the decision an unconstitutional infringement of states' power over their own courts. Mandatory prebinding arbitration clauses became widespread, particularly in credit card agreements and other consumer services. Proponents of arbitration pointed to its success in reducing crowded court dockets, but consumer advocates charged that the arbitration process was biased in favor of large corporations and against consumers, many of whom were far poorer and legally unsophisticated. They would be joined in calling unsuccessfully for it to be overturned in a later case by 20 state attorneys general.
Background.
The plaintiffs, all 7-Eleven franchisees, filed suit individually in California Superior Court charging Southland with fraud, misrepresentation, breach of contract, breach of fiduciary duty and violations of disclosure provisions required in California's Franchise Investment Law (CFIL) between 1975 and 1977. Their actions were consolidated with another filed separately by Keating in Alameda County seeking class certification for all franchisees. Southland sought to compel arbitration per the franchise agreements. The Superior Court granted that request except for the CFIL claims, citing Section 31512 of that statute under which any contractual language that binds a franchisee to waive rights it grants was void. It neither saw it as conflicting with the FAA and nor ruled on the motion for class certification.
A state appeals court reversed that decision, reading the arbitration clause to require the arbitration of all claims under the contract, including those under the CFIL. If the CFIL's language created an exception, it was superseded by the federal law and thus unenforceable. It directed the trial court to begin hearing the class certification motion.
The plaintiffs appealed to the California Supreme Court. It ruled in their favor, seeing the CFIL as requiring adjudication of all claims brought under it, and not in conflict with the FAA. Again, the case was remanded to trial court with an instruction to begin hearing the class certification motion.
Existing arbitration law.
New York City merchants, who had embraced arbitration as a method of alternative dispute resolution in the early 20th century, persuaded Congress to pass the FAA in 1925. Until then many courts had been wary of the process, sometimes even refusing to accept it as binding. After they had persuaded New York to pass a state law allowing for the results of an arbitration to be considered binding on both parties, that statute became the model for the FAA.
For the first few decades after it was passed the FAA was understood to be applicable to contracts executed under federal law, specifically those concerning . The Supreme Court first considered a case related to it in "Wilko v. Swan", where a 7-2 majority found that the anti-waiver provisions of the Securities Act of 1933 voided an arbitration clause where securities fraud was alleged. The issue of a conflict with state law came up a few years later in "Bernhardt v. Polygraphic Co.", where the court, with only Harold Hitz Burton dissenting, had refused to allow a federal court to decide whether an arbitration clause was valid simply because one party to the dispute had moved to another state than the one in which the contract was originally executed. In 1959 the Second Circuit Court of Appeals suggested that the FAA applied to state court actions as well, when it ruled that disputes over not just the execution but the contract itself were arbitrable.
In the 1967 "Prima Paint" case the Court had opened the door to more widespread use of arbitration when it adopted the separability principle, compelling arbitration of a claim that a contract had been fraudulently induced. That held that any challenge to the validity of a contract with an arbitration clause must be heard by the arbitrator first unless the challenge is to the arbitration clause itself. It creates a legal fiction that two separate contracts exist.
The term before it heard Southland's appeal, a 6-3 court had, in "Moses H. Cone Memorial Hospital v. Mercury Construction Corp.", upheld an appellate decision that overturned a district court's stay of a federal action to compel arbitration pending the disposition of a parallel action in state court. The primary issue in that case had been the proper application of the "Colorado River" abstention doctrine and whether the lower court's decision was appealable. In passing, the opinion noted that "state courts, as much as federal courts, are obliged to grant stays of litigation under § 3 of the Arbitration Act... Congress can hardly have meant that an agreement to arbitrate can be enforced against a party who attempts to litigate an arbitrable dispute in federal court, but not against one who sues on the same dispute in state court."
Before the Court.
At oral argument in late 1983, Mark Spooner pointed to the "dictum" in "Cone" the previous term stating that the FAA applied to the states. He held firm despite being challenged on that reading. "[I]f Section 2 were read otherwise... [t]hat would lead to forum shopping and would destroy the predictability in interstate commercial dealings that is so important," he told the justices. "What Congress gives it can take away, but the states cannot take away what Congress has made valid and enforceable in a federal statute."
"[Q]uite apart from encouraging forum shopping, the conclusion if the Supreme Court of California's decision is upheld," responded John Wells, "the decision that Southland is asking for is the one that would encourage forum shopping." He noted that in securities law upheld in "Wilko", Congress had not only included an anti-waiver provision but also encouraged the states to pass parallel legislation, many of which included anti-waiver provisions of their own. If Southland's position were held applicable to those statutes, "[t]hat would result in the same claim that came into the federal court being not arbitrable but if it was brought in the state court under the state securities law it would be required to be arbitrated." He also noted that the contract simply gave the arbitrator jurisdiction over the instant dispute between the parties and did not specifically give the arbitrator power to enforce an award under the CFIL. "Arbitration is not a good place to enforce important rights set forward in a statute that is complicated."
Decision.
The Court postponed ruling on whether it had jurisdiction while it considered the merits of the case. In April 1984 it handed down its 7–2 decision. Chief Justice Warren Burger wrote for the majority, with John Paul Stevens concurring in part and dissenting in part. Sandra Day O'Connor's dissent was joined by William Rehnquist, who had himself written a pointed dissent in "Cone".
Majority.
"Contracts to arbitrate are not to be avoided by allowing one party to ignore the contract and resort to the courts," Burger wrote, explaining why the Court chose not to let the state litigation run its course before ruling on the core issue. "For us to delay review of a state judicial decision denying enforcement of the contract to arbitrate until the state court litigation has run its course would defeat the core purpose of a contract to arbitrate." However, the Court lacked jurisdiction to decide the class-certification question at that point in the action.
The next section of the opinion addressed the FAA's applicability to the states. "In enacting § 2 of the federal Act, Congress declared a national policy favoring arbitration and withdrew the power of the states to require a judicial forum for the resolution of claims which the contracting parties agreed to resolve by arbitration," Burger declared. There were only two statutory exemptions: that it was applicable only a written maritime contract or a contract "evidencing a transaction involving commerce" and that the arbitration agreements could be voided only "upon such grounds as exist at law or in equity for the revocation of any contract." "Cone" had found the FAA to be substantive law that Congress had power to pass under the Commerce Clause. In that case, "[we] expressly stated what was implicit in "Prima Paint", "i.e." that the substantive law the act created was applicable in both state and federal courts."
A third section addressed the legislative history in response to O'Connor's heavy reliance on it in her dissent. "Although [it] is not without ambiguities, there are strong indications that Congress had in mind something more than making arbitration agreements enforceable only in the federal courts." If the enforceability of arbitration agreements, which common law had long been skeptical of, were a problem only in federal court, he reasoned, Congress would have been less likely to take action. "To confine the scope of the Act to arbitrations sought to be enforced in federal courts would frustrate what we believe Congress intended to be a broad enactment appropriate in scope to meet the large problems Congress was addressing."
If, as O'Connor had argued, the FAA was merely procedural law, why would Congress have limited it to maritime and interstate transactions? "We therefore view the 'involving commerce' requirement in § 2, not as an inexplicable limitation on the power of the federal courts, but as a necessary qualification on a statute intended to apply in state and federal courts." O'Connor's interpretation would lead to forum shopping, Burger wrote:
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Stevens' concurrence.
"I am persuaded that the intervening developments in the law compel the conclusion that the Court has reached." Stevens began. "I am nevertheless troubled by one aspect of the case that seems to trouble none of my colleagues." He referred to the majority's contention that, had the case been brought in federal court as a diversity case analogous to "Prima Paint", the arbitration clause would have been enforceable.
Since the FAA allowed arbitration agreements to be voided under the same principles applicable to contracts generally but did not specifically enumerate what principles might be applicable, "hence it would appear that the judiciary must fashion the limitations as a matter of federal common law." Such a federal common law would likely draw on state precedent and law regarding contract, as indeed the lower federal courts already did when evaluating questions of whether a contract was properly formed in challenges to an arbitration clause. For that reason, he believed state public policy decisions regarding arbitration and its enforcement were entitled to more latitude than that afforded by the majority. A past Supreme Court, in "Paramount Famous Lasky Corp. v. United States", had voided arbitration agreements among parties where it found they served to restrain trade.
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Dissent.
O'Connor began by noting that the "courts of the United States" language the majority rested its decision on did not specify which courts and that the following two sections specifically refer to federal court. "Today, the Court takes the facial silence of