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‘Wholly groundless’ exception to arbitrability tossed as inconsistent with FAA, precedent

The “wholly groundless” exception to arbitrability, which certain federal appellate courts have ruled permits a court to decide the threshold question of arbitrability when the question was wholly groundless—even though the governing arbitration rules delegated arbitrability questions to the arbitrator—has been overruled by the U.S. Supreme Court. The dispute involved antitrust claims brought by one dental products distributor against another but, of course, has significant implications in the employment law context. The High Court, in the first opinion authored by recently confirmed Justice Kavanaugh, concluded that the wholly groundless exception was inconsistent with the Federal Arbitration Act (FAA) and the Court’s precedent. The case was remanded to the Fifth Circuit with the High Court expressing no view as to whether the contract at issue did in fact delegate the arbitrability question to the arbitrator, with the observation that the appellate court could address that issue, as well as any others that were properly preserved (Henry Schein, Inc. v. Archer & White Sales, Inc., January 8, 2019, Kavanaugh, B.).

Lower court proceedings. At issue before the Court was a Fifth Circuit decision that held the complaining distributor’s claims were not subject to mandatory arbitration. Archer and White Sales, a distributor of low-cost dental equipment, had alleged that Henry Schein, Inc., a leading distributor of dental equipment, conspired to terminate or reduce Archer and White’s distribution territory in response to its low prices by engaging in an illegal boycott in violation of the Sherman Act and state law. Archer and White requested damages, estimated to be in the “tens of millions of dollars,” and injunctive relief. The parties’ contract expressly incorporated the rules of the American Arbitration Association, which provide that arbitrators have the power to resolve arbitrability questions.

Although a federal magistrate judge granted the defendant companies’ motion to compel arbitration, a federal district court in Texas reversed. The district court held that the court should decide the question of arbitrability and that the dispute was not arbitrable because the plain language of the arbitration clause expressly excluded lawsuits including requests for injunctive relief. The defendants then appealed that decision to the Fifth Circuit.

In addressing the arbitrability issue, the appeals court conducted a two-step inquiry—the Douglas test—adopted in 2014 in Douglas v. Regions Bank. The Douglas test inquires: (1) whether the agreement between the parties “clearly and unmistakably” delegates the issue of arbitrability; and (2) whether there is a plausible argument for the arbitrability of the dispute, or whether the argument for including the claim within the scope of arbitration is “wholly groundless.” Undertaking the first step of the Douglas test and noting the parties’ competing arguments about the agreement’s relationship between the carve-out clause and the incorporation of American Arbitration Association Rules, the Fifth Circuit ultimately determined that the interaction between the two “is at best ambiguous.” As a result, the court asserted, “[w]e need not decide which reading to adopt here because Douglas provides us with another avenue to resolve this issue: the ‘wholly groundless’ inquiry” under the second step.

Fifth Circuit rationale. According to the Fifth Circuit, the second step of the Douglas test provides a “narrow escape valve” because if an assertion of arbitrability is deemed to be “wholly groundless,” a court “need not submit the issue of arbitrability to the arbitrator.” Consequently, the court found that there was no plausible argument that the arbitration clause applied to Archer and White’s action because the lawsuit sought injunctive relief. Rejecting the defendant companies’ argument that the plaintiff was able to avoid arbitration by merely including a claim for injunctive relief in its complaint, the court stressed that, despite policy considerations favoring arbitration, the plain meaning of the arbitration clause was paramount, and the clause clearly excluded actions seeking injunctive relief.

In light of disagreement in the federal circuit courts over whether the wholly groundless exception is consistent with the FAA, the Supreme Court granted Henry Schein’s petition for certiorari.

Wholly groundless exception. The Supreme Court has held that parties could agree not only to have an arbitrator decide the merits of a dispute, but also the “‘gateway’ questions of ‘arbitrability,’ such as whether the parties have agreed to arbitrate or whether their agreement covers a particular controversy.” Some courts of appeal, however, including the Fifth Circuit in this case, have reasoned that even when the contract delegates the threshold arbitrability question to an arbitrator, the wholly groundless exception permits courts to block frivolous attempts at arbitration. However, the unanimous Court ruled the “wholly groundless” exception is inconsistent with the text of the FAA and with Supreme Court precedent.

FAA is supreme. Courts must interpret the FAA as written and the Act requires courts to interpret the contract as written, the Court explained. “When the parties’ contract delegates the arbitrability question to an arbitrator, a court may not override the contract. In those circumstances, a court possesses no power to decide the arbitrability issue.” Such is the case even where the court believes that the argument the dispute should be arbitrated is wholly groundless, the High Court stated.

Supreme Court precedent, including AT&T Technologies, Inc. v. Communications Workers, has long established that a court may not “rule on the potential merits of the underlying” claim that is assigned by contract to an arbitrator, “even if it appears to the court to be frivolous. That principle applies with equal force to the threshold issue of arbitrability, the Court reasoned.

That ship has sailed. Archer and White advanced four main arguments in favor of the wholly groundless exception, all of which the Supreme Court found unpersuasive. First, it pointed to sections 3 and 4 of the FAA, which set out the Act’s mandate for a court to stay litigation and compel arbitration “upon being satisfied that the issue” is “referable to arbitration” under the “agreement.” Archer and White contended that those provisions require a court to always resolve questions of arbitrability and that an arbitrator never may do so. However, “that ship has sailed,” the High Court explained. The Supreme Court has consistently held that parties may delegate threshold arbitrability questions to the arbitrator.

Back-end judicial review. Second, Archer and White cited section 10 of the FAA, which provides for back-end judicial review of an arbitration decision if an arbitrator exceeds his or her powers. Archer and White reasoned that if a court can rule an underlying issue as not arbitrable at the back-end, it should also be able to do so at the front-end. To this, the Supreme Court explained that “Congress designed the Act in a specific way, and it is not our proper role to redesign the statute.” Further, the argument presumes that courts should also decide frivolous merits issues that have been delegated to an arbitrator, an argument the High Court already rejected in AT&T.

Waste of time and resources. Third, Archer and White argued as a policy matter that it would be a waste of time and resources to send wholly groundless arbitrability questions to an arbitrator. The High Court rejected that argument with the refrain that the FAA contains no “wholly groundless” exception, and it was not the Court’s role to engraft its own exceptions onto the statutory text. Moreover, the Court found it doubtful that the “wholly groundless” exception would save time and money systemically even if it might do so in some individual cases.

Frivolous motions to compel. Finally, Archer and White advanced the policy argument that the wholly groundless exception is necessary to deter frivolous motions to compel arbitration. To this, the Court reiterated that it could not rewrite the statute to accommodate policy concerns. It added that arbitrators can efficiently and quickly dispose of frivolous cases, along with, in some instances, impose fee-shifting and cost-shifting sanctions. In any event, the Court was unaware of any substantial problem caused by frivolous motions to compel arbitration in those Circuits that have not recognized the wholly groundless exception.

Expert insight. After reviewing the Court’s opinion, Jack Sullivan, a labor and employment partner at the international law firm Dorsey & Whitney, offered his insight: “Parties that sign arbitration agreements often specify the sort of disputes that should be decided by an arbitrator and the sort of disputes that may be brought in court. For example, some contracts stipulate that certain types of employment claims are to be decided in arbitration, even if other types of claims are to be decided in court.”

“But parties may disagree over whether a particular dispute falls within the category of claims that must be arbitrated or whether it is a claim that should remain in court. Before today’s decision, in many parts of the country, it wasn’t always clear whether that threshold question—is this a claim for arbitration, or is it for court?—should  itself be decided by a court or by an arbitrator. Today’s ruling provides a nationwide rule for litigants: If the contract gives an arbitrator the authority to decide the threshold question of where the dispute should be heard, then the contract should be followed,” Sullivan observed.