- Leshaw Law - http://leshawlaw.com -

4-25-13 – Supreme Court Holds That Only Arbitrator And Not State Court Can Make Determination That Contract With Arbitration Clause Is “Null And Void And Against Public Policy”

Posted By Peter Leshaw On April 25, 2013 @ 2:55 pm In Newsletter | Comments Disabled

SUPREME COURT HOLDS THAT
ONLY ARBITRATOR AND NOT
STATE COURT CAN MAKE DETERMINATION
THAT CONTRACT WITH ARBITRATION CLAUSE
IS “NULL AND VOID AND AGAINST PUBLIC POLICY”

In Nitro-Lift Technologies, L.L.C. v. Howard,[1] the Supreme Court was faced with a chicken and egg issue:  whether an arbitration provision can be invoked to prevent judicial review of a contract when the arbitration provision is in a contract alleged to be null and void in its entirety.  In a broadly worded decision potentially having significant ramifications with respect to arbitration of bankruptcy disputes, the Supreme Court held that the Federal Arbitration Act prohibits a state court from determining whether a contract is “null and void and against public policy” when the contract contains an enforceable arbitration provision.

Background

Nitro-Lift entered into employment agreements with two of its employees.  Those agreements also contained confidentiality and non-compete provisions as well as a provision which required arbitration of “[a]ny dispute, difference or unresolved question between Nitro-Lift and the Employee. . .”

After termination of their employment with Nitro-Lift, the employees went to work for a competitor of Nitro-Lift.

Procedural History

Nitro-Lift filed a demand for arbitration, claiming that the employees had breached their non-competition agreements.  The employees responded to Nitro-Lift’s arbitration demand by filing a complaint in Oklahoma state court asking the court to declare the “noncompetition agreements null and void and enjoin their enforcement” based on an Oklahoma statute that prohibited enforcement of certain non-competition agreements. The trial court dismissed the complaint, concluding that the contracts contained valid arbitration clauses, thus requiring that an arbitrator rather than a court should resolve the dispute.

Based on its “exhaustive overview of the United States Supreme Court decisions construing the Federal Arbitration Act” the Oklahoma Supreme Court reversed the trial court, holding that “the existence of an arbitration agreement in an employment contract does not prohibit judicial review of the underlying agreement.”  Based on this conclusion, the Oklahoma Supreme Court went on to hold that that “noncompetition agreements were ‘void and unenforceable as against Oklahoma’s public policy.’”

In reaching this decision, the Oklahoma Supreme Court relied in part on its conclusion that the Oklahoma statute “addressing the validity of covenants not to compete, must govern over the more general statute [the Federal Arbitration Act] favoring arbitration.”

The Supreme Court’s Decision

The Supreme Court vacated the decision of the Oklahoma Supreme Court relying on the Federal Arbitration Act and the “national policy favoring arbitration” and on the Constitution’s Supremacy Clause:

And when parties commit to arbitrate contractual disputes, it is a mainstay of the [Federal Arbitration] Act’s substantive law that attacks on the validity of the contract, as distinct from attacks on the validity of the arbitration clause itself, are to be resolved “by the arbitrator in the first instance, not by a federal or state court.”  For these purposes, an “arbitration provision is severable from the remainder of the contract” and its validity is subject to initial court determination; but the validity of the remainder of the contract (if the arbitration provision is valid) is for the arbitrator to decide.

Relying on the Constitution’s Supremacy Clause, the Court went on to reject the conclusion of the Oklahoma Supreme Court that the “more specific” Oklahoma statute governed over the more general Federal Arbitration Act:

But the ancient interpretive principle that the specific governs the general (generalia specialibus non derogant) applies only to conflict between laws of equal dignity.

The Court finally concluded, relying on its own precedence, that “when state law prohibits outright the arbitration of a particular type of claim, the analysis is straightforward:  The conflicting rule is displaced by the FAA.”

Analysis and Potential Impact on Arbitration of Bankruptcy Disputes

The Supreme Court thus made it clear that a contract containing an arbitration clause is severable such that a court may determine whether the arbitration provision itself is enforceable.  If the court determines that the arbitration clause is enforceable, it is up to the arbitrator to resolve the substantive dispute, potentially including whether the contract itself is enforceable.

Bankruptcy and appellate courts are divided on the issue of which bankruptcy disputes may be subject to mandatory arbitration.  For example, the Second Circuit has permitted arbitration of a stay relief violation[2] – a core proceeding – after the bankruptcy case had been closed.  A bankruptcy court in New Jersey recently held that a dispute over a violation of the automatic stay is subject to mandatory arbitration in a case that had not yet been closed,[3] while a district court in the Southern District of New York recently affirmed a bankruptcy court decision holding that a dispute over property of the estate was not subject to mandatory arbitration because the interests of the Bankruptcy Code outweighed the interests of the Federal Arbitration Act.[4]  In a similar vein, a bankruptcy court in the Southern District of New York declined to enforce an arbitration provision in the Hostess Brands case in a dispute over whether a pre-bankruptcy collateral agreement was breached in connection with the debtor’s request to use cash collateral.[5]  Another bankruptcy court in the Southern District of New York did, however, permit arbitration of a fraudulent transfer claim.[6]

It remains to be seen whether a court, relying on Nitro-Lift, might hold that where there is an enforceable agreement to arbitrate a dispute, it is the arbitrator rather than the bankruptcy court that should decide whether the dispute is subject to judicial review or should be decided by the arbitrator.



[1] 568 U.S. __ (2012).

[2] MBNA America Bank, N.A. v. Hill, 436 F.3d 104, 108 (2d Cir. 2006).

[3] MicroBilt Corp. v. Fidelity National Information Services, Inc., 2012 WL 6137610 (Bankr. D. N.J. Dec. 11, 2012).

[4] Kraken Investments Ltd. v. Jacobs, 11-06133 (S.D.N.Y. July 10, 2012).

[5] In re Hostess Brands, Inc., 2013 WL 82914 (Bankr. S.D.N.Y. Jan. 7, 2013).

[6] In re Cardali, 2010 WL 4791801 (Bankr. S.D.N.Y. Nov. 18, 2010).


Article printed from Leshaw Law: http://leshawlaw.com

URL to article: http://leshawlaw.com/2013/04/supreme-court-holds-arbitrator-state-court-determination-contract-arbitration-clause-null-void-public-policy/

Copyright © 2013 Leshaw Law. All rights reserved.