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The Stakes are High in Supreme Court Arbitration Rights Case

published in Law360  | March 25, 2022

Whether employed in chess or a party’s litigation strategies, calculated risk-taking is necessary to obtain the desired result.

On March 21, in Morgan v. Sundance Inc., the U.S. Supreme Court heard oral arguments on whether a party’s litigation strategy to delay arbitration resulted in that party’s waiver to arbitrate the dispute, and whether an arbitration-specific requirement of prejudice to the opposing party must be demonstrated before a waiver defense is successfully asserted under the Federal Arbitration Act.

In chess, the rules of the game are clear, and the playing field leveled. Both players know what pieces the other holds and their exact placement on the board. The board is conspicuous, affording a bird’s-eye view of the accuracies and miscalculations resulting from each player’s move.

A player’s successes and failures rise and fall upon the short- and long-term strategies employed. Intentionality is critical; and an understanding of the body of rules and principles governing the players’ conduct is sure to increase the likelihood of success for one of the players.

Whether as a litigation strategy employed either in a garden-variety contract or arbitration agreement, Congress intended, and the Supreme Court directed, the rules of engagement to apply the same. In placing arbitration agreements on equal footing with other contracts, Congress enacted the FAA.

The express language of the FAA mandates courts to enforce arbitration agreements and the related defenses to the same extent that exists in law and equity as other contracts. In principle, the FAA is designed to achieve efficient, streamlined, expedient and cost-saving procedures in resolving disputes.

Thus, when parties agree to resolve their disputes through arbitration rather than in the courts, the courts are compelled to enforce the agreements and the applicable defenses. In short, arbitration is a matter of contract.

Waiver as a Contract Defense

Unlike other equitable doctrines, which require a showing of prejudice to the other side — e.g., laches and estoppel — waiver has generally been a unilateral concept. Under state contract law, a party’s intentional relinquishment or abandonment of a known right drives a court’s inquiry into whether waiver principles will render a provision or the entire agreement unenforceable.

The key to finding waiver rises and falls upon a party’s intentional act — whether expressed or implied from a party’s conduct, actions and circumstances surrounding the agreement. But when contracting parties expressly contract to arbitrate disputes, various federal courts diverge from the generally applicable contract defenses.

Some federal courts require a plaintiff to show it has been prejudiced before the court will conclude the defendant waived its right to arbitration. That arbitration-specific requirement knocks the FAA’s carefully drawn balance off kilter.

Distilling Morgan v. Sundance

Resolution of the imbalanced principles that previously undergirded the FAA will soon be addressed in the impending decision from the Supreme Court in Morgan v. Sundance.[1]

The Supreme Court recently heard oral arguments on whether the contract defense of waiver engrafts an additional showing of prejudice when the FAA is implicated. Also subsumed in the inquiry is whether a party must promptly assert its right to arbitrate.

For context, Robyn Morgan and Sundance entered into an employment agreement that included an arbitration clause. Morgan subsequently sued Sundance in the U.S. District Court for the Southern District of Iowa, based on various alleged violations of the Fair Labor Standards Act.

In response, Sundance unsuccessfully moved for dismissal and answered the complaint on the merits. Although Sundance raised 14 affirmative defenses, the right to arbitrate was not asserted.

Later, the parties participated in mediation, but no settlement agreement resulted. Then, almost eight months after the service of the complaint, Sundance moved to compel arbitration. Finding Morgan was prejudiced during the eight-month span of litigation, the Southern District of Iowa determined Sundance waived its right to arbitrate and denied the motion.

The U.S. Court of Appeals for the Eighth Circuit reversed and held that Morgan was not prejudiced by Sundance’s litigation strategy. And in the absence of prejudice, Sundance’s contractual right to arbitrate remained intact. The Supreme Court granted certiorari review.

During oral arguments, Chief Justice John Roberts and Justices Stephen Breyer, Sonia Sotomayor, Elena Kagan and Brett Kavanaugh expressed their respective concerns about a party’s delay in asserting one’s right to arbitrate. Collectively, the justices questioned whether delays born by a party’s litigation strategies were in contravention of the FAA’s rationale.

Finding the essence of the parties’ agreement was to avoid litigation, Justice Sotomayor took exception with Sundance’s failure to move for arbitration in its responsive pleadings. Justice Sotomayor opined Sundance’s “calculated” conduct signaled its intent to waive a speedy adjudication in arbitration, and instead litigate the dispute in the district court.

Justice Kavanaugh seemingly agreed. He focused on whether the filing of dispositive motions in the district court was the intentional relinquishment of a party’s right to arbitrate.

Viewing the issue from a slightly different angle, Justice Kagan questioned whether an actual distinction exists between a party’s actual breach of a contractual term versus a party’s affirmative actions taken inconsistent with the contractual terms. According to Justice Kagan, both violations seemingly resulted in wavier.

In unpacking the justices’ concerns, Sundance explained that the federal civil procedural rules prescribe the contents of the first responsive pleading, but notably absent is the requirement that a party raise arbitration as a defense. Similarly, the statutes do not specify the time for asserting one’s right to compel arbitration.

Sundance contends the line of demarcation should not be drawn at the responsive pleading stage but rather the stage where discovery becomes substantial. And according to Sundance, substantial discovery did not occur here. Further, a party’s decision to delay arbitration is neither sanctioned by nor prohibited under the FAA.

Justice Amy Coney Barrett wondered how a party’s decision to litigate in district court would not constitute a failure, neglect or refusal to arbitrate, as expressly delineated in the FAA’s default provision. That conduct alone would suffice as a wavier without a separate showing of prejudice to the other side. But Sundance disagreed.

By Sundance’s definition, those terms — failure, neglect or refusal — inherently require prejudice, while waiver does not. Further, a court must first find that a party neglected a legal duty before a court may conclude that negligence in fact occurred.

As to the issue of prejudice, Justices Sotomayor, Kavanaugh and Kagan intimated that the financial costs of motions practice alone might be sufficient to demonstrate prejudice. Morgan, however, urged the court to forgo any consideration of prejudice in analyzing the waiver defense under the FAA.

Justice Barrett seemingly deferred to the plain text of the parties’ agreement and noted the absence of a substantive provision that would deem a party’s right to arbitration waived if the party first chooses to litigate the action in the district courts.

In response, Morgan explained that agreements that omit a substantive arbitration or waiver provision are, nonetheless, waivable by the parties’ intentional conduct. So, to conclude that in the absence of such provision a waiver defense is unavailable, a party is likewise bereft of a similar defense that is expressly contemplated in the FAA.

Justice Barrett also found the principles of estoppel and laches, rather than waiver, aptly governed the parties’ dispute. She opined that, under those principles, a showing of prejudice would be required.

Morgan explained that laches is a doctrine that focuses mostly on the delay of asserting a right, not the inconsistent actions by the waiving party. And the element of prejudice is the feature that distinguishes estoppel and laches from waiver. Nevertheless, several jurisdictions have merged waiver with the estoppel and laches principles. And under the equal treatment theory, if arbitration is subject to the same generally applicable contract rules, that treatment would accord with the FAA. However, those jurisdictions do not apply those principles evenhandedly where the agreement to arbitrate is concerned.

Justices Breyer, Sotomayor and Kagan acknowledged the waiver defense is generally governed under the applicable state law framework. But troubling to the justices were the circuits’ varying definitions of prejudice. Justices Samuel Alito and Neil Gorsuch, on the other hand, questioned whether the general contract principles were truly an issue of state rather than federal law. The justices reasoned that the FAA directs the courts to treat motions to arbitrate like other motions lodged in federal courts and subject to the federal rules of civil procedure.

Morgan attempted to resolve the justices’ concerns by reconciling the application of state laws to substantive contract matters raised in state courts. But as a “gap filler,” Morgan posits, federal law would govern in determining procedures, e.g. venue, or the meaning of a provision under the FAA.

High Stakes

The stakes of the Supreme Court’s impending ruling are high for both parties. The waiver defense and the prompt assertion of one’s rights will be critical for contracting parties with a general arbitration clause.

A system designed to avoid costly and protracted court litigation may transform an efficient, neutral forum to resolve disputes into a sophisticated game. Common calculating moves — like filing dispositive motions, taking part in settlement discussions, or otherwise advancing through the various litigation stages — may result in costly and protracted litigation that would have been abated upon the prompt assertion of the right to arbitrate.

The impending ruling may engraft prejudice into the waiver defense and may determine how early in the proceedings a party must assert its right to arbitrate.

On the one hand, a party that employed miscalculated litigation strategies or obtained unfavorable results may be afforded a second bite at the apple by halting litigation midstream and compelling arbitration. On the other hand, the parties’ contracted right to arbitrate disputes may be forever barred if the right is not asserted early in the litigation.

The Final Move

Exactly how the Supreme Court will rule remains to be seen. But a ruling — either engrafting or excluding prejudice from the waiver analysis — and prescribing the time a party must assert its right to arbitrate will have rippling effects that transcend any subject matter involving an agreement to arbitrate.

One thing, however, is clear — as to the issues on appeal, the U.S. Supreme Court’s ruling will afford one party the checkmate.
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Kate N. Dodoo is of counsel at McAfee & Taft PC.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] Morgan v. Sundance, case number 21-328
This article originally appeared in Law360 on March 25, 2022. It is reprinted with permission of the publisher, Portfolio Media, Inc.