Insight Into Assigning Arbitrability

6/22/2009 Articles

Published on Law360.

Over the past decade, courts have wrestled with the question: who decides whether an arbitration agreement is valid and enforceable, the court or the arbitrator?  There is consensus that an arbitrator may decide an arbitration clause's scope if the agreement, "clearly and unmistakably" assign that issue to the arbitrator.[2]  The debate, however, has continued over the circular conundrum of whether the court or the arbitrator should decide the threshold issue of the arbitration clause's validity and legality.  Decisions cover challenges based on unconscionability,[3] whether arbitration costs amount to waiver of statutory non-waivable rights,[4] and whether a remedies limitation clause preventing a litigant from obtaining statutory relief (such as treble RICO damages) invalidates an arbitration agreement.[5]  Federal courts outside the Ninth Circuit have enforced clauses assigning such validity questions to the arbitrator,[6] but until recently, neither a federal court within the Ninth Circuit nor a California state court had directly decided the issue.  See, e.g., Bruni, 160 Cal. App. 4th at 1288 (stating, in dicta, that validity was for the arbitrator if the parties so agreed).  Recently a Central District of California decision for the first time enforced such a clause, sending the validity question to the arbitrator.

In Monex Deposit Co. v. Gilliam, Case No. SACV 09-287 (JVS)(RNBx), --- F. Supp. 2d ---, 2009 WL 1426252, at *2-3 (C.D. Cal., May 18, 2009), Judge James Selna held that the parties' arbitration agreement required them to arbitrate the legality and validity of their arbitration agreement.  In Gilliam, the court had preliminarily enjoined defendants, including former customers of the plaintiff precious metals dealer, from using a website to extort money from the company.  One defendant countersued on trading losses, alleging RICO and other claims.  The company moved to sever and arbitrate all counterclaims.  Defendant opposed arbitration only of the RICO claim, arguing that the arbitration agreement's remedies limitation was invalid insofar as it unlawfully prevented him from obtaining RICO treble damages and attorney fees.  The Gilliam court rejected defendant's challenge on several grounds, including that the arbitration agreement authorized the arbitrator to determine the agreement's validity.[7]  Id.

Relying on federal authorities,[8] and quoting Terminix, 432 F.3d at 1332-33, the Gilliam court agreed with the Eleventh Circuit that "the issue must go to the arbitrator, in part because of the contract's incorporation of an arbitration rule that ‘[t]he arbitrator shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope or validity of the arbitration agreement.'"  --- F. Supp. 2d ---, 2009 WL 1426252, at *3 (internal citations omitted).  The agreement before the court in Gilliam similarly provided that the arbitrator could decide disputes relating to "the . . . validity of this Agreement," and also incorporated JAMS rules to the same effect.  Thus, the court held, the parties agreed to assign the issue of the agreement's validity to the arbitrator in the first instance.

California state courts have not yet enforced such a clause.  But they have approved of Terminix and suggested that they would adopt its rationale in the appropriate case.  See, e.g., Bruni, 160 Cal. App. 4th at 1288 ("Terminix is not inconsistent with our view that, if the parties have agreed to arbitrate issues regarding the validity of the arbitration clause, a party that is claiming illegality can be compelled to arbitrate that defense.").[9]  Bruni stated that a court must look to the "precise nature of the claim that the party resisting arbitration is making" to determine whether the court or the arbitrator should adjudicate it.  Id. at 1287.  If the party resisting arbitration claims he never agreed to arbitrate - e.g., he claims that his signature on the agreement is a forgery or that he was deceived as to the nature of the document he signed (fraud in the factum) - then the court must decide the claim.  Id.  If, on the other hand, the party resisting arbitration does not dispute that he signed the agreement but instead asserts some other defense - e.g. illegality or fraud in the inducement - then the court must send that dispute to arbitration.  Id.

It should not matter under this line of cases what issue of validity is in dispute, whether a statutory damage limitation or unconscionability.  But there will often be questions of whether the parties did indeed agree to assign the validity questions to the arbitrator.[10]  It is here where the drafting party should pay attention to the arbitration clause's wording and the context in which the parties agree to it to ensure that they properly authorize the arbitrator to decide validity questions.  Generally, California courts have raised at least three concerns that may limit - though not ultimately prevent - them in their adoption of the Gilliam result.

First, California courts may not compel arbitration of an arbitration agreement's validity if the arbitration agreement is part of an adhesion contract.  See Ontiveros, 164 Cal. App. 4th at 505; see also Murphy v. Check ‘N Go of Cal., Inc., 156 Cal. App. 4th 138, 144 (2007).  Indeed, in Murphy, the arbitration agreement expressly required arbitration of "any assertion by you or us that this Agreement is substantively or procedurally unconscionable."  156 Cal.App. 4th at 144.  "[T]he language of the agreement," the court noted, "could not be clearer."  Id.  But still, it refused to compel arbitration of the plaintiff's unconscionability claim because it found that the agreement was part of an adhesion contract.  Id. 

The scope of this adhesion contract limitation, however, is unclear because both Ontiveros and Murphy involved mandatory pre-employment arbitration agreements forced on low-wage workers who subsequently claimed violation of state labor and anti-discrimination laws.  See Ontiveros, 164 Cal. App. 4th at 508; Murphy, 156 Cal. App. 4th at 144-45.  California courts are especially protective of this class of persons, but less so of consumers and other groups not triggering statutory policy issues of wide public concern.[11]  Whether state courts would order arbitration of an arbitration agreement's validity in other contexts remains to be seen.  The Gilliam court did.

Second, ordering arbitration of an arbitration agreement's validity may be improper bootstrapping to break the circularity conundrum of who, court or arbitrator, decides validity.  Bruni's answer, however, seems sufficient.  The reviewing court can determine, without making factual determinations, what type of challenge the party resisting arbitration is making to the arbitration agreement.  This information is usually found within the four-corners of the complaint.[12]  If there is no dispute that the resisting party knowingly signed the arbitration agreement - coerced or not - then the arbitrator must decide any challenges to the arbitration agreement's validity.

Third, very few courts have queried whether allowing the arbitrator to determine the validity of an arbitration agreement creates a conflict of interest, or the appearance of a conflict or impropriety, for the arbitrator.[13]  One would expect this not to be a serious challenge to the parties' agreement.  First, Congress and the California state legislature were presumably well aware that an arbitrator often has the ability to end early, or not to end, an arbitration by way of a motion to dismiss.  But such decisions, with possible loss of revenues upon dismissal, have not caused the legislatures or courts to be concerned about arbitrators' conflicts or appearance of conflict.  This debate therefore would seem to be over.  Second, there are ethical, reputation and pragmatic restraints on such self-serving conduct.  If nothing else, arbitrators are aware that attorneys can control arbitrator selection, and bad reputations do not help.  

The Gilliam case begins to fill in a gap that California decisions have acknowledged.  And, as Gilliam notes, other jurisdictions have already adopted the rule that, where the parties clearly and unmistakably assign arbitrability of an arbitration agreement's validity to the arbitrator, the court must enforce that agreement.  California law is consistent with this approach.  It remains only for California state courts so to hold.


[1] Neil Goteiner is a trial partner at Farella Braun + Martel LLP, where  Frank Riebli and Scott Andrews are trial associates.  The authors represent Monex Deposit Company in three of the cases referenced in this article:  Cronin v. Monex Deposit Co., No. SACV 08-1297 DOC (MLGx), 2009 WL 412023, at *5 (C.D. Cal., Feb. 17, 2009), Monex Deposit Co. v. Gilliam, Case No. SACV 09-287 (JVS)(RNBx), --- F. Supp. 2d ---, 2009 WL 1426252, at *2-3 (C.D. Cal., May 18, 2009), and Parada v. Superior Court (Monex Deposit Co.), No. G041339, currently pending before the California Court of Appeals, Fourth District, Third Division.

[2] See First Options of Chi., Inc. v. Kaplan, 514 U.S. 938, 944-45 (1995); Dream Theater, Inc. v. Dream Theater, 124 Cal. App. 4th 547, 557 (2004).  Courts have held that both broad language in an arbitration agreement describing the scope of arbitrable disputes, and the express incorporation of private party arbitration rules which themselves give the arbitrator authority to determine the scope of disputes within the clause constitute "clear and unmistakable" evidence that the parties intended the arbitrator to determine "arbitrability."  See Drews Distrib., Inc. v. Silicon Gaming, Inc., 245 F.3d 347, 350 (4th Cir. 2001) (broad language re scope); Fleet Tire Serv. of N. Little Rock v. Oliver Rubber Co., 118 F.3d 619, 621 (8th Cir. 1997) (same); Zink v. Merrill Lynch Pierce Fenner & Smith, Inc., 13 F.3d 330, 332 (10th Cir. 1993) (same); Cronin v. Monex Deposit Co., No. SACV 08-1297 DOC (MLGx), 2009 WL 412023, at *5 (C.D. Cal., Feb. 17, 2009) (same); Packeteer, Inc. v. Valencia Sys., Inc., No. C-06-07342 RMW, 2007 WL 707501, at *2 (N.D. Cal., Mar. 6, 2007) (private party arbitration rules); Poponin v. Virtual Pro, Inc., No. C 06-4019 PJH, 2006 WL 2691418, at *9 (N.D. Cal., Sept. 20, 2006) (same); Dream Theater, 124 Cal. App. 4th at 557 (same). 

[3] E.g., Bruni v. Didion, 160 Cal. App. 4th 1272, 1290 (2008).

[4] E.g., Green Tree Fin. Corp. v. Randolph, 531 U.S. 79, 90-91 (2000); Armendariz v. Found. Health Psychcare Serv., Inc., 24 Cal. 4th 83, 100-01 (2000).

[5] E.g., Terminix Int'l Co., LP, v. Palmer Ranch Ltd. P'ship, 432 F.3d 1327, 1332-33 (11th Cir. 2005). 

[6] Awuah v. Coverall N. Am., Inc., 554 F.3d 7, 11 (1st Cir. 2009) ("[T]he validity of an arbitration clause is itself a matter for the arbitrator where the agreement so provides."); Terminix, 432 F.3d at 1332-33; Contec Corp. v. Remote Solution, Co., 398 F.3d 205, 208 (2d Cir. 2005); Bailey v. Ameriquest Mortgage Co., 346 F.3d 821, 822 (8th Cir. 2003).

[7] The arbitration agreement at issue in Gilliam provided that "[t]he parties agree that any and all disputes, claims or controversies arising out of or relating to any transaction between them or to the breach, termination, enforcement, interpretation or validity of this Agreement . . . shall be subject to the terms of the Federal Arbitration Act and shall be submitted to final and binding arbitration before JAMS."  The agreement further provided that "the arbitration shall be conducted in accordance with the provisions of JAMS Comprehensive Arbitration Rules and Procedures," and then directed the parties to JAMS's website to find a copy of those rules.  JAMS rules provided in turn that "[j]urisdictional and arbitrability disputes, including disputes over the . . . validity, interpretation or scope of the agreement under which Arbitration is sought ... shall be submitted to and ruled on by the Arbitrator.  The Arbitrator has the authority to determine jurisdiction and arbitrability issues as a preliminary matter."  JAMS Comprehensive Arbitration Rules and Procedures11(c).  

[8] The Monex account agreement containing the arbitration clause had a California choice of law provision.

[9] Accord, Ontiveros v. DHL Express (USA) Inc., 164 Cal. App. 4th 494, 507-08 (2008) (noting Bruni's discussion of arbitrability and following Bruni's rationale); Murphy v. Check ‘N Go of Cal., Inc., 156 Cal. App. 4th 138, 144 (2007) (discussed below and noting an agreement to have the arbitrator decide unconscionability issues); Sanchez v. W. Pizza Enter., Inc., 172 Cal. App. 4th 154, 166 (2009) (citing Bruni and noting that "[s]ome opinions by the Courts of Appeal have suggested, without holding, that the enforceability of an arbitration agreement is a question for the arbitrator to decide if the arbitration agreement ‘clearly and unmistakably' so provides."). 

[10] In Bruni, plaintiffs claimed the arbitration agreement was unconscionable because it was concealed in a separate booklet they did not see at the time they signed what they thought was an application through a third party for a warranty on their new homes.  160 Cal. App. 4th at 1279.  Thus, even though they styled their claim as "unconscionability," the "nature of their claim" was that they had never knowingly agreed to arbitrate, so the court decided their claim.  And in Sanchez, the court decided unconscionability "because the arbitration agreement here does not clearly state that the arbitrator will decide whether the arbitration agreement is enforceable."  172 Cal. App. 4th at 166.

[11] See Armendariz, 24 Cal. 4th at 100-01, and Guiterrez, 114 Cal. App. 4th at 97.  Where California courts shift all arbitration-specific forum costs to the employer regardless of the employee's ability to pay, see Armendariz, 24 Cal. 4th at 111-113, federal courts require a party resisting arbitration on the ground that it is prohibitively expensive to show he cannot afford the forum fees, and will allow the arbitrator to make the initial determination with the employee having access to the trial court if the employee is unhappy with the arbitrator's decision.  See Green Tree, 531 U.S. at 97.

[12] See, e.g., Nagrampa v. MailCoups, Inc., 469 F.3d 1257, 1266 (9th Cir. 2006).

[13]See Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 416 (1967) ("The only advantage of submitting the issue of fraud to arbitration is for the arbitrators.  Their compensation corresponds to the volume of arbitration they perform."); Ontiveros, 164 Cal. App. 4th at 506-07 (finding in the employment context that, because employers are repeat players, "an arbitrator who finds an arbitration agreement unconscionable would not only have nothing further to arbitrate, but could also reasonably expect to obtain less business in the future, at least from the provider in question").     

A panel of the Fourth Appellate District for the California Court of Appeal raised this conflict issue in a May 21, 2009 argument in Parada v. Superior Court (Monex Deposit Co.), No. G041339.  The writ panel queried whether, because an arbitrator's income is tied to the amount of time he spends on a case, having the arbitrator decide the agreement validity issue posed a conflict of interest.  The arbitration agreements at issue in Parada and Gilliam are identical with respect to their assignment to the arbitrator of disputes over the arbitration agreement's validity.

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