Arbitration

The submission of a dispute to an unbiased third person designated by the parties to the controversy, who agree in advance to comply with the award—a decision to be issued after a hearing at which both parties have an opportunity to be heard.

Buckeye Check Cashing, Inc. v. Cardegna

Commercial lenders, like many other businesses, typically require borrowers to sign an agreement that includes a provision mandating arbitration if there is a dispute. The question has arisen whether an unhappy borrower may go to court and seek to void the entire contract or whether the legality of the contract must be submitted to the arbitrator for resolution. The U.S. Supreme Court, in Buckeye Check Cashing, Inc. v. Cardegna, __U.S.__, 126 S.Ct. 1204, 163 L.Ed.2d 1038 (2006), ruled that in a state court proceeding, the Federal Arbitration Act (FAA) mandates that the arbitrator consider whether the contract is void for illegality.

John Cardegna and another Florida plaintiff entered into deferred-payment transactions with Buckeye Check Cashing. Buckeye operates what is known as a "fast money service." Cardegna borrowed $337 from Buckeye, which required him to write a check for the sum of the borrowed money plus a processing fee. The check would be cashed after Cardegna's next payday, giving him the opportunity to have the money on hand. Cardegna kept renewing his loan each time it came due. By the time he filed suit, Cardegna owed Buckeye around $1000. Cardegna's state lawsuit alleged that the processing fee amounted to criminal usury and that the lending agreement he signed was criminal on its face and should be voided.

Buckeye filed a motion to compel arbitration, submitting a copy of the lending agreement to the court that contained two pertinent provisions. The first provision stated that Cardegna agreed to submit to binding arbitration if "a dispute of any kind arises out of this Agreement." The second provision stated that if there was a dispute about the "validity, enforceability, or scope of this Arbitration Provision or the entire Agreement," the parties agreed to settle it through arbitration. This section also provided that the arbitration agreement was governed by the FAA. The Florida trial court denied Buckeye's motion, finding that a court of law rather than an arbitrator should determine whether the contract was illegal and void. The Florida Court of Appeals reversed this decision, ruling that because Cardegna had not challenged the arbitration provision itself, claiming instead that the entire contract was void, the agreement to arbitrate was enforceable. The arbitrator would decide the legality of the contract. The Florida Supreme Court reversed the appeals court, concluding that to allow the arbitration to go forward in an allegedly unlawful contract "could breathe life into a contract that not only violates state law, but is also criminal in nature."

The U.S. Supreme Court, in a 7-1 decision (newly confirmed Justice Samuel Alito did not participate in the case), overturned the Florida Supreme Court ruling. Justice Antonin Scalia, writing for the majority, noted that Congress had passed the FAA to "overcome judicial resistance to arbitration." The act placed arbitration agreements on equal footing with other contracts. Arbitration agreements have been challenged in two ways. The first challenges the validity of the agreement to arbitrate, while the second challenges the contract as a whole. Attacks on the contract are based either on a claim that affects the entire agreement or on a claim that the illegality of one contract provision makes the entire contract invalid. In the present case the entire contract was challenged as invalid because of the usurious finance charge.

Justice Scalia cited an earlier case, Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 87 S.Ct. 1801, 18 L.Ed.2d 1270 (1967), as precedent. That case involved a federal lawsuit claiming that a contract was induced by fraud and whether a federal judge or an arbitrator should resolve the issue. The Court held that if the claim is fraud in the inducement of the arbitration provision itself, then the federal court must handle the matter. However, the FAA did not permit the federal courts to consider claims of fraud in the inducement of the contract generally. In addition, an arbitration provision was severable from other provisions of a contract, meaning that it could remain in effect even if other provisions were ruled invalid. In a 1984 case the Court went further and stated that the FAA created a body of law that applies to both federal and state courts, rejecting the possibility of a state court barring the enforcement of FAA provisions. Based on these rulings, Justice Scalia found that Cardegna's challenge of the entire agreement meant that an arbitrator would have to consider this claim.

The Court rejected Cardegna's argument that the severability rule did not apply to state court cases because the FAA provisions involved in Prima Paint applied only to federal courts. Justice Scalia interpreted that decision to be based on another section of the act that states that arbitration agreements must be treated like all other contracts, whether in state or federal court. Prima Paint's holding relied on "Congress' broad power to fashion substantive rules under the Commerce Clause." Therefore, the FAA was not limited only to federal court jurisdiction. Whether a "challenge is brought in federal or state court, a challenge to the validity of the contract as a whole, and not specifically to the arbitration clause, must go to the arbitrator."

Justice Clarence Thomas, in a dissenting opinion, contended that the FAA does not apply to state court proceedings. Therefore, the FAA could not "be the basis for displacing a state law that prohibits enforcement of an arbitration clause contained in a contract that is unenforceable under state law."