Last week, we linked to a brief comment that Prof. Szalai posted in Outsourcing Justice regarding a decision the US Court of Appeals for the Fourth Circuit issued at the end of October. In that decision, Goodwin v. Branch Banking & Trust Co., 2017 U.S. App. LEXIS 21629, the court applied West Virginia contract law to refuse to enforce an arbitration provision based on the unconscionableness of some of its provisions.  We also posted a short comment by Alvin Goldman (Professor of Law Emeritus, University of Kentucky, NAA Member) in which Prof. Goldman noted that while he agreed with Prof. Szalai’s praise of the Fourth Circuit’s decision, the praise might have been  premature “inasmuch as the Fourth Circuit did not adopt the principle as part of the federal law of arbitration.”  Below please find both a reply by Prof. Szalai, followed by a rejoinder by Prof. Goldman.  ArbitrationInfo thanks both of them for engaging in this interesting exchange.

Prof. Szalai’s response to Prof. Goldman:

“I fully agree with Prof. Goldman and appreciate his thoughtful comments; the Fourth Circuit’s holding was premised on state law.  However, as explained below, there is a hidden federal issue, and I still consider the Fourth Circuit’s result a positive outcome for vulnerable parties who may be faced with a take-it-or-leave-it arbitration clause containing harsh terms.  Here’s why:

1)  I view the development of arbitration law in America as consisting of several stages: pre-1920s; 1920s (with the adoption of modern arbitration laws during the 1920s) to about the 1980s; 1980s to about 2010, with judicial expansion of the FAA beyond its original intent beginning in the 1980s; and arguably a fourth stage, from 2010 to today where nothing stands in the way of the FAA’s broad preemptive powers.  I consider cases like Rent-A-Center (2010), Concepcion (2011), American Express (2013) as having ushered in a new stage of development of the FAA.  In this fourth stage, judicial review of arbitration agreements for fundamental fairness is shrinking or arguably even non-existent.  In Rent-A-Center, the Court approved of delegation clauses, and as a result, some courts today are no longer ruling on harsh provisions in arbitration clauses.  Judicial oversight of arbitration agreements, at least from the front-end in terms of compelling arbitration, has been lost through Rent-A-Center.  Furthermore, for decades, the effective vindication doctrine was well established in arbitration law and provided a legal standard for courts to review or monitor the fairness of arbitration agreements to ensure that parties could effectively vindicate their substantive rights.  However, in the American Express case in 2013, the Court undermined the effective vindication doctrine and labeled the doctrine as mere “dictum.”   In Concepcion, the Supreme Court set forth a vague, broad preemption test examining whether a state law presents an “obstacle” to the FAA’s objectives, or whether a state law has a “disproportionate impact” on arbitration or somehow interferes with a vague notion of the “fundamental attributes of arbitration,” which are not explicitly defined in the statute.  As a result of this broad preemption test from Concepcion, some courts are rejecting or questioning pre-Concepcion forms of state law defenses.  Based on the recent trifecta of Concepcion, American Express, and Rent-A-Center, the ability of courts to police or monitor arbitration agreements for fundamental fairness has shrunk or arguably even disappeared, which is problematic for consumer and employee agreements where bargaining power is often lacking and harsh terms can creep in.  (I argue in a forthcoming symposium piece with the UNLV law review that cases like Concepcion, American Express, and Rent-A-Center, although nominally applicable to all FAA cases, have a greater potential impact on cases involving vulnerable parties.)  In this post-2010 legal environment, it is harder than before to convince a court to invalidate an arbitration clause because of the doctrines from the trifecta of Concepcion, American Express, and Rent-A-Center.  Judicial invalidation of harsh arbitration agreements still occurs, but the post-2010 legal doctrines from the FAA make it harder to obtain invalidation.  Judicial review has been shrinking.  (There is a stronger need for arbitrators to fill in the gaps.  The Due Process Protocols were a positive step in the right direction.  However, these Protocols are not binding, and the Protocols are in need of beaucoup upgrades.)

Turning to this Fourth Circuit case of Goodwin v. Branch Banking, the counsel for the bank, in the appellate briefs to the Fourth Circuit, argued that the district court should have severed the harsh terms in the arbitration agreement, instead of invalidating the entire agreement.  The bank’s counsel explained that invalidation, as opposed to severance, was against the FAA’s strong policy in favor of arbitration.

A rational preemption argument could be made that severance is required in this case under Concepcion.  In other words, the state law at issue (preferring invalidation of entire agreements instead of severance of harsh terms) arguably is used to undermine arbitration, or has a “disproportionate impact” on arbitration, using the preemption language from Concepcion.  As a result, so the argument goes, Concepcion preempts this state law preferring invalidation over severance of harsh terms; thus, severance is the correct remedy in this case, contrary to the Fourth Circuit’s holding.  Take a look at the divided Ninth Circuit opinion in Zaborowski v. MHN Government Services, Inc., No. 13-15671 (9th Cir. Dec. 17, 2014), which addresses this precise issue.  The Supreme Court granted cert on this issue (does Concepcion preempt a court’s decision to invalidate an entire agreement, as opposed to severance of harsh terms) in the Zaborowski case.  However, the parties in Zaborowksi settled the case while the case was pending before the US Supreme Court.

In light of the preemption arguments from Concepcion (which the Fourth Circuit could have easily relied on to require severance of the harsh terms, but didn’t), I am very pleased with the Fourth Circuit’s result.  True, as Prof. Goldman indicates, the Fourth Circuit’s decision is ultimately based on state law.  However, I look at this case through an additional lens in the post-2010 environment: the avoidance of a very-real possibility of federal preemption under Concepcion.  The plaintiff narrowly avoided federal preemption here.  I am glad the Fourth Circuit did not apply the federal preemption arguments suggested by the bank’s counsel in the bank’s appellate briefs.  The case easily could have turned out the opposite way through application of federal preemption under Concepcion, where the Fourth Circuit would have ordered severance of harsh terms instead of invalidation of the entire agreement.

Although the Fourth Circuit case turned ultimately on state law, I am more relieved that Concepcion’s federal preemption bullet was dodged.  Dodging this federal preemption bullet from Concepcion, in my mind, creates good FAA law.  (I am sympathetic to Justice Thomas and his critique of Concepcion’s vague preemption test in his concurring opinion in Concepcion.)

2) Although the Fourth Circuit’s Goodwin case ultimately turns on state law (and the dodging of a federal preemption argument in the wake of Concepcion), I have been working on a new law review article demonstrating that as a matter of FEDERAL law, the correct remedy is judicial invalidation of an entire arbitration agreement containing harsh terms, instead of merely severing the harsh terms.  In other words, I am hoping that federal courts in the future, as a matter of federal law, will reach the same result as this Fourth Circuit Goodwin case.  This article, which should be finished in a few weeks in January 2018, relies heavily on historical arguments about the development of arbitration law, as well as the FAA’s text and purpose.

Prof. Goldman’s rejoinder

“We should all look forward to the publication of Prof. Szalai’s forthcoming article respecting the better approach for remedying situations in which arbitration provisions include conditions that are grounds that “exist at law or in equity for the revocation of any contract.” (9  U.S.C. § 2). I have no quarrel with the indicated forthcoming analysis. Rather, the proposed solution seems to me consistent with the wording of FAA § 2 which on its face says that in such situations the remedy is “revocation” of the arbitration provision.

Moreover, although I disagree with the Court’s legislative actions in going far beyond Congress’ purpose of promoting the availability of arbitration as a means of resolving commercial contract disputes, it seems to me that the Court’s discussion in Concepcion provides a basis for accepting as a matter of federal law the remedy advocated by Prof. Szalai. There, qoting from Dean Witter, the Court stated that the two goals of the Arbitration Act are enforcement of private agreements and encouragement of efficient and speedy dispute resolution. When arbitration agreements over-reach, they generate uncertainty and potential litigation, thereby impeding the efficiency and speed with which the parties are likely adhere to the procedure without judicial intervention. Those who draft such provisions are more likely to avoid creating an appearance of over-reaching if the sword of revocation hangs over them.”