On February 26, 2013, a panel of the 4th Circuit Court of Appeals in Noohi v. Toll Bros., Inc., a putative class action alleging the wrongful retention of class members' earnest money deposits under the terms of their purchase and sale contracts, held that the arbitration provision contained in those agreements was unenforceable based on a requirement of state law. The Noohi Court specifically found that state law was not preempted by the Federal Arbitration Act ("FAA") in this instance, as it had been in the United States Supreme Court's decision in AT&T Mobility v. Concepcion, 131 S.Ct. 1740 (2011), with respect to California's judicial rule regarding the unconscionability of class arbitration waivers in consumer contracts. In so doing, the 4th Circuit has added fuel to the fire in the debate over how broadly to apply the Concepcion decision.
The state law requirement at issue in Noohi was the decision of the Maryland Supreme Court in Cheek v. United Healthcare of Mid-Atlantic, Inc., 835 A.2d 656 (Md. 2003), holding that for an arbitration provision to be enforceable the obligation to arbitrate must be mutual, and not just at the election of one of the parties to the agreement. Otherwise, the agreement to arbitrate fails for lack of consideration, even if the contract as a whole includes sufficient consideration to be enforceable by both parties. As described by the Noohi Court: "under Maryland law as articulated in Cheek [citation omitted], an arbitration provision is treated as a severable contract that must be supported by adequate consideration." Slip op. at 6.
Pursuant to the subject arbitration provision, only the plaintiff buyers ("Buyer") agreed "that any and all disputes with Seller . . . shall be resolved by binding arbitration," and expressly waived "the right to a proceeding in a court of law (including without limitation a trial by jury)." Slip op. at 16-18. The defendant seller did not expressly undertake a reciprocal obligation, although defendant argued that such mutuality was implicit from the arbitration provision read as a whole. Slip op. at 18-19. The Noohi Court "agree[d] with the district court that the provision binds only Plaintiffs to arbitration, and thus lacks mutuality of consideration." Slip op. at 19. The arbitration provision was silent as to whether arbitration could proceed on a classwide or only individual basis, and in light of the result reached by both the district court and the court of appeals, that issue was not addressed.
After addressing several other subsidiary issues, including its jurisdiction to hear the interlocutory appeal, slip op. at 6-9, and the applicability of Maryland law governing contract formation to determine "whether the parties agreed to arbitrate [the] matter," slip op. at 12, the Noohi Court got to what has to be considered the main act of this decision: whether "the Cheek rule is preempted by the FAA." Slip op. at 20. This question had not been addressed by the district court. Slip op. at 6. As noted above, the court of appeals answered this question in the negative, purporting to distinguish Concepcion, but hardly sounded convinced of its own rationale.
The 4th Circuit began by stating "the [Concepcion] Court's analysis focused on ways in which classwide procedures interfere with the informality of arbitration – one of its chief benefits – as well as on the increased risks to defendants." Slip op. at 21. The Noohi Court then summarily concluded that the Cheek rule does neither and that "[t]he primary concerns underlying Concepcion are therefore inapplicable here." The Noohi Court made no effort to explain, however, how it would not be more burdensome and risky for the defendant to be subjected to a class action lawsuit rather than the arbitration it bargained for, a point that seems intuitive.
The Noohi Court went on to acknowledge "that the
Court in Concepcion was also concerned with ensuring, in general
terms, that arbitration agreements are enforceable as written,
including 'with whom a party will arbitrate its
disputes.'" Slip op. at 21 (quoting
Concepcion, 131 S. Ct. at 1748-49, and Stolt-Nielsen S.A. v. AnimalFeeds Int'l
Corp., 130 S. Ct. 1758, 1773 (2010) (emphasis in
original)). The Noohi Court discounted this
precedent in the case before it, however, by noting:
"The Supreme Court has never held that the FAA preempts state
law rules requiring that arbitration provisions themselves contain
consideration (i.e., that they not be illusory), and it would
require a
substantial extension of existing precedent to do so
here." Slip op. at 21.
The more relevant point, however, is that federal law imposes no such requirement of mutual consideration within the arbitration provision itself as opposed to within the contract as a whole. To the contrary, federal law prohibits discrimination against provisions to arbitrate as compared to other contract provisions. As noted by the Noohi Court:
Perhaps [defendant's] strongest
contention is that the Cheek rule "imposes a
requirement
on arbitration clauses (mutuality within the clause itself) that
does not apply to other contract clauses." This
contention properly gives us pause. The Supreme Court has
long held that "[c]ourts may not
. . . invalidate arbitration agreements under state laws applicable
only to arbitration provisions." The Court has
explained that "[b]y enacting § 2, . . . Congress
precluded States from singling out arbitration provisions for
suspect status, requiring instead that such provisions be placed
'on the same footing as other contracts.'"
Slip op. at 21-22 (citations omitted); see also slip op. at 11 ("'This saving clause [in § 2 of the FAA] permits agreements to arbitrate to be invalidated by 'generally applicable contract defenses, such as fraud, duress, or unconscionability,' but not by defenses that apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue.' Concepcion, 131 S. Ct. at 1746 (citation omitted)" (emphasis added)).
The Noohi Court's tepid attempt "on closer inspection" to limit Concepcion and the scope of preemption under the FAA is not persuasive. As the Noohi Court admitted: "In a basic sense, the Cheek rule does single out an arbitration provision in a larger contract, and assess whether that provision binds both parties to arbitrate at least some claims." Slip op. at 22. The Noohi Court even argued that the Maryland rule could "just as readily be viewed as encouraging arbitration," slip op. at 22 (emphasis in original), when its effect in the case before it was exactly the opposite.
What really seemed to give the Noohi Court pause was "the gravity of the issue presented" and the fact that the appellant's wound struck the court as self-inflicted. The Noohi Court bluntly stated its reluctance "to overturn a decision of the high court of one of the 50 states – relying on our Constitution's Supremacy Clause," particularly where the defendant "could easily have avoided this serious constitutional question – one implicating federalism and state sovereignty, as well as the constitutional right to a jury trial – by adding just a few words to the arbitration provision, binding itself to arbitration in the way it now contends it intended all along." Slip op. at 23-24. As the Noohi Court concluded: "The Supreme Court may eventually hold that the FAA preempts such a rule," but "[t]his we decline to do."
Although the 4th Circuit's caution in this area is certainly not without reason, it muddies rather than clarifies the FAA preemption pond post-Concepcion. It will encourage further parsing of Concepcion's scope concerning which state law requirements impacting the arbitrability of class action claims are and are not preempted under the FAA. The seemingly bright line that state law requirements specifically targeting arbitration provisions are preempted just got a little blurrier, and may remain so until the Supreme Court weighs in on this topic again. Of course, the particular issue in the Noohi case – the mutuality of the arbitration provision – can be solved by drafting, but that will not be true in every instance where an arbitration clause is challenged under state law as illustrated by the Concepcion case itself. It remains important for the federal courts to guard the policies underlying the FAA from encroachments imposed by individual state law requirements, even when it means invoking the Supremacy Clause which the Noohi Court was expressly reluctant to do.
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