Legal Commentary

Scope of Judicial Review of Mandatory Arbitration Agreements

U.S. Court of Appeals for the Ninth Circuit is set to issue an opinion with potentially far-reaching implications for contractual arbitration.  The question before the en banc 9th Circuit in Nagrampa v. Mailcoups is who decides the question of whether an agreement to arbitration is unenforceable because it is a part of a contract of adhesion - the courts or the abitrator.

Earlier this year, the three-judge panel of the 9th Circuit held that the question is to be resolved by the arbitrator,  Nagrampa v. Mailcoups, Inc., 401 F.3d 1029 (9th Cir. 2005).  The Court (O'Scannlain, Bea, and Cowen) relied on lesser-known Warren era precedent, Prima Paint Corp. v. Flood & Conclin Mfg. Co., 388 U.S. 395 (1967), which held that pursuant to the Federal Arbitration Act, federal courts can only adjudicate challenges to the validity of the specific arbitration clause.   Any challenge to the general validity of the contract itself is to be resolved by the arbitrator.  Applying that principle, the Nagrampa court held that the plaintiff's claim that the entire contract (including the arb. provision) was an uneforceable contract of adhesion was not a challenge to the validity of the arbitration clause, and thus could not be decided by the courts.  The enbanc court has now de-published this opinion.

Law.com reports that based on the questions at oral argument by the en banc panel, the Court appears to be leaning toward a conclusion that judges are still ultimate arbiters of whether a mandatory arbitration agreement is fair.  In my opinion, while such a conclusion would probably be a corrrect interpretation of the Arbitration Act, it could not be squared with Prima Paint. 

To be sure, Prima Paint majority  seems to be a poor interpretation of the Arbitration Act.  Section 4 of the Act allows the courts to hear cases in which making of the agreement for arbitration is not an issue.  The Prima Paint majority narrowly interprets this provision as limited to making of the arbitration clause.  To me, this makes no sense: on what basis did the Court sever an arbitration clause from the rest of the agreement?  Similarly, it makes no sense to have judges decide one aspect of unconsionability, and arbitrators another.  Also, allowing arbitrators to rule on contract formation fairness issues would do nothing to take advantages of what arbitrators do best: provide expertise in day-to-day performance of contract and quickly resolve cases.  Instead, arbitrators would be required to decide legal issues on which they are hardly better experts than judges.  Finally, to have an arbitrator decide the issue of whether a mandatory arbitration agrement is fair raises due process concerns -- an arbitrator would hardly be a neutral arbiter in that situation.

In light of these apparent problems, it is not surprising that as pointed out by Justice Black's dissent in Prima Paint, the congressional intent in enacting the Arbitration Act was to have the courts enforce agreements to arbitrate "unless the court, not the arbitrator, finds grounds in law or in equity for the revocation of any contract."  (388 U.S. at p. 412.)   Indeed, if there is no valid contract, there is nothing to arbitrate.

But despite its many problems, Prima Paint remains good law and I do not see how 9th Circuit could get around it.  If the court has no jurisdiction to hear that the entire contract was fraudulently induced, by logical implication, it cannot hear a challenge that the entire contract is a contract of adhesion.  As I read the Nagrampa opinion, the contract of adhesion challenge is directed at the entire agreement, not just the arbitration clause.

So, one way or the other, the case might well end up before the U.S. Supreme Court.  It would not surprise me to see the high court abandon Prima Paint severability approach and hold that the courts should decide all challenges to fairness of the mandatory arbitration agreement (whether directed to the arbitration clause or the entire contract). 

As usual, thanks to How Appealing for the tip about this interesting case.

UPDATE:  here is the post at the Aribtration Blog about this case, along with the link to the audio transcript for en banc oral argument.

Cash rebate and Truth-in-Lending Act

Virachack v. University Ford is a surprisingly interesting opinion about a subject as boring as the Truth-in-Lending Act, cash rebates, and hidden finance charges.  The issue here is whether a $2,000 rebate offered to customers paying cash or credit obtained on their own, but not to customers buying it through the dealership's preferred APR rate, is a hidden finance charge that should have been disclosed under the Truth-in-Lending Act.  I believe Judge Flethercher's dissent gets the better of Judge Noonan's majority, as a matter of both law and policy.

The facts are simple.  The plaintiffs bought a new Ford Explorer (God knows why!) and obtained financing for part for the purchase price through the defendant's dealership at the promotional 0.9 % interest rate.  What the plaintiffs did not know (and folks at University Ford did not tell them) was that at the time, Ford was offering a $2,000 factory rebate to customers paying cash or credit at other than the promotional 0.9 rate offered by the defendant.  The sales contract contained a very good explanation of all the costs and prices applicable to this transaction, but did not include the information about the $2,000 rebate possibility.

The applicable authorities, as described by the 9th Circuit, are as follows.  The Truth-in-Lending Act ("TILA") itself defines a finance charge as a charge imposed directly or indirectly for the use of credit.  A Federal Reserve Bank regulation interpreting TILA (12 C.F.R., sec. 226.4) defines the term "finance charge" in a similar manner, i.e., as a discount for using cash not extended to customers using credit.  A staff interpretation of that regulation further explains that in order to determine whether a discount is a "finance charge" that requires disclosure, the court looks at a particular credit transaction and compares the price paid with the price that was paid by a cash customer.  If there is a difference, the rebate is a "finance charge" and must be disclosed. 

The majority opinion gets sidetracked by two facts.  One - legal definitions aside, it cannot conclude that a cash-rebate (discount) can be considered a charge.  Two - it thinks the plaintiffs got a good deal on the car by getting financing at 0.9 %, so it deems their lawsuit a request for a windfall.  Neither of these points seems well-taken.  While a cash rebate is not a charge in an abstract dictionary sense, according to the TILA and the interpretive regulation, it is a charge in a sense that it is a cost of using the defendant's preferred credit arrangement.  Furthermore, whether the plaintiffs got "a good deal" (in Judge Noonan's opinion) is irrelevant  - the point is that they never got to make that choice.  [Editorial Note - I would also say that this point is very debatable - some people may well prefer to pay cash to reduce the overall amount of money paid and they would be very much interested in the additional $2,000 incentive]

On the other hand, Judge Fletcher is right, both as a matter of law and as a matter of being consistent with the purposes of TILA.  Under the statutory and regulatory definitions of the term "finance charge," the rebate was a finance charge requiring disclosure because it was a cost of using the defendant's preferred credit.  Also, the purpose of TILA to promote informed use of credit through meaningful disclosure of credit terms.  Here, any meaningful disclosure of the terms of the deal required the defendant to inform the plaintiffs of both sides of the coin (preferred financing vs. cash rebate if cash is used).