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SCOTUS Finds California’s Contract Interpretation Skills Lacking In New Arbitration Decision

Just under the wire, SCOTUS released an arbitration opinion today, ensuring that 2015 would continue the string of years with cases interpreting the Federal Arbitration Act.  In DIRECTV v. Imburgia, the Supreme Court found that California’s interpretation of an arbitration clause was preempted by the FAA.  DIRECTV is a 6-3 decision, with Justice Kagan (who vociferously dissented in Italian Colors) joining the majority, and it appears to make it even harder for courts to apply state contract doctrines to find arbitration agreements unenforceable.

The issue in DIRECTV was primarily how to interpret the poison pill in the parties’ arbitration agreement, which stated that if the “law of your state” made the waiver of class arbitration unenforceable, then the entire arbitration agreement was unenforceable.  The California Court of Appeal found the phrase’s meaning ambiguous, but relied on two doctrines of contract interpretation to conclude that it referred to California’s contract law, without consideration of any federal preemption.  In other words, it meant California law before, or without respect to, Concepcion, which found California’s refusal to enforce class action waivers was preempted by the FAA.  Therefore, the California court used the poison pill to blow up the arbitration agreement altogether.  The California Supreme Court denied review, but SCOTUS took up the case.  (And disposed of it quickly — the argument was just about two months ago.)

Justice Breyer wrote the decision for the majority.  He focused heavily on the states’ obligation to abide by federal law and the Court’s interpretation of those federal laws.  Recognizing that interpreting contracts is “ordinarily a matter of state law,” the Court framed this case as an issue of whether California’s interpretation of “law of your state” to mean “invalid California law” “is consistent with the [FAA].”  As usual, the way the Court frames the issue gives away the ending.  Indeed, the Court goes on to essentially accuse the California Court of Appeals of being results-oriented.  (The dissent calls this “demeaning”)  The Court “conclude[s] that California courts would not interpret contracts other than arbitration contracts the same way.”  Why? Because, the opinion argues, state law normally means “valid” state law, and California criminal pleas are presumed to incorporate the state’s ability to amend the law, and SCOTUS’ esteemed law clerks could not find any California case that interpreted “law of your state” to mean state laws that had been preempted by any federal statute.  Finally, the majority addressed one of the two doctrines relied on by the California court: contra proferentem , which allows ambiguous terms to be construed against the drafter.  The Court found the doctrine does not apply in this case, because the phrase is not ambiguous, and in any case using the doctrine here was stretching it too far: “the reach of the canon construing contract language against the drafter must have limits”.

There are two dissents.  Justice Thomas dissented, as usual, because he believes the FAA does not apply in state court.  Justice Ginsburg (joined by Sotomayor) dissented because she will “take no further step to disarm consumers, leaving them without effective access to justice.”  Her dissent largely focuses on the appropriate use of the contra proferentem doctrine in this case.  But she also points out that this is the first time in 25 years that SCOTUS has “reversed a state-court decision on the ground that the state court misapplied state contract law.”  (The recipient of the reversal 25 years ago, in Volt Information Sciences, was also California.)  She points out that parties can agree on any law to apply to their arbitration, so providing for pre-Concepcion law in California is not beyond the pale.  And finally, Justice Ginsburg engages in a broader attack on the state of arbitration law, citing the recent NYTimes series and articles by Prof. Resnik to argue that the Court’s interpretation of the FAA no longer has any connection to the legislative intent behind the statute and goes too far in “insulat[ing] powerful economic interests from liability for violations of consumer protection laws.”

Here are some first-day impressions:

  • The Court should not have taken this case.  The majority seems to anticipate that reaction by noting that the Ninth Circuit reached the opposite result from the California Court of Appeals on how to interpret this version of DIRECTV’s poison pill.  But, that could have resolved over time.  And even if it didn’t, I doubt there are many arbitration agreements out there with this uniquely worded poison pill, so this particular elucidation on its meaning does not help very many parties.  This is pure and simple error-correction, which SCOTUS generally avoids.
  • Plus, California has largely turned the corner; its recent arbitration jurisprudence is generally in line with the FAA.  So, there is no reason to continue focusing exclusively on California in SCOTUS’ game of arbitration whack-a-mole.
  • What broader impacts might there be?  Well, one is that future state courts will have to think carefully before construing ambiguous language against the drafter in the context of an arbitration clause.  Another is that transactional attorneys should re-think any use of the phrase “law of your state” or any variations thereof.
  • But the most significant impact is that this decision calls into question any state’s ability to defend their arbitration decisions.  The preemption test articulated in  Concepcion was imprecise and has been hard for lower courts to apply.  (When does a state rule really stand as “an obstacle” to the Congressional intent behind the FAA?  Almost every contract defense is an obstacle of some sort.  But the language of Concepcion does not help distinguish between run-of-the-mill obstacles and true preemption.)  In this first post-Concepcion example of how the highest court in the land interprets that test, it seems to require that a state anti-arbitration ruling meet an impossible burden: show us cases in which you (the state) have done exactly the same thing, with the same phrase, in a non-arbitration context.  A lot of the phrases and clauses used in arbitration agreements are unique, there may not be a perfect comparison to draw on in non-arbitration decisions from the same state’s courts.  This decision, if read broadly, may provide precedential authority to overturn almost any state court’s invalidation of an arbitration agreement.  Which brings me back to point number one — this case was improvidently granted.