When a party contests the enforceability of an agreement containing an arbitration clause, should the issue be determined by an arbitrator or a court? The United States Supreme Court recently addressed this issue in Buckeye Check Cashing, Inc. v. Cardegna. The Court held that when a party challenges the validity of the contract containing the arbitration clause as a whole, and not specifically the arbitration clause within it, the issue is to be determined by an arbitrator, not a court. The Court’s decision should bring some certainty to an issue that had resulted in a lack of uniformity in the courts.

Buckeye Alleged Agreement Containing Arbitration Clause Violates Florida Laws

In Buckeye, a customer of a check-cashing store brought a putative class action suit in Florida state court alleging that the interest rates charged by the store on various deferred payment transactions, under which the store would provide cash to customers in exchange for a personal check in the amount of the cash plus a finance charge, were usurious.

As part of the transaction, the customer entered into an agreement providing for arbitration of disputes. Buckeye moved to compel arbitration. The plaintiff argued that the agreement was illegal and void because it violated various Florida lending and consumer protection laws.

The trial court denied the motion to compel arbitration, holding that a court, not an arbitrator, should resolve the claim that the contract was illegal and void. The appellate court reversed, holding that because the plaintiff did not challenge the arbitration clause itself, but instead claimed the entire agreement was void, the agreement to arbitrate was enforceable, and the issue of the contract’s legality was to be determined by the arbitrator. That decision was reversed by the Florida Supreme Court, which held that enforcing an arbitration agreement in a contract challenged as unlawful would violate Florida public policy and contract law.

But US Supreme Court Held That Arbitration Clause Was Enforceable

The case was appealed to the United States Supreme Court, which reversed the decision of the Florida Supreme Court. Looking to its own precedent, the United States Supreme Court stated that its prior decisions in Prima Paint Corp. v. Flood & Conklin Mfg. Co. and Southland Corp. v. Keating established three propositions: (1) as a matter of substantive federal arbitration law, an arbitration clause is severable from the remainder of the contract; (2) unless the challenge is to the arbitration clause itself, the issue of the contract's validity is considered by the arbitrator; and (3) this arbitration law applies in both state and federal courts. Applying those rules, the United States Supreme Court held that because the plaintiff challenged the agreement as a whole, but not the arbitration clause, the arbitration clause was enforceable separate from the remainder of the contract, and the challenge to the agreement was to be heard by an arbitrator, not a court.

In reaching the opposite conclusion, the Florida Supreme Court had found that the case was distinguishable from Prima Paint because that case involved a claim of fraud in the inducement which, if proven true, would have rendered the underlying contract merely voidable; whereas, in the present case the agreement would be rendered void from the outset if it were found to violate Florida’s usury laws, and all of the provisions of the agreement, including the arbitration clause, would be nullified. It held that Florida public policy and contract law did not permit severable parts of a contract to be enforced if the contract was found to be void under Florida law. The Florida Supreme Court noted that many other courts have likewise distinguished Prima Paint and declined to extend its holding to cases where a party claims that a contract was void from its inception.

The United States Supreme Court rejected this reasoning, finding that it did not matter whether the challenge to the contract would render it void or voidable, and enforceability of the arbitration clause should not turn on Florida public policy and contract law.

Whether State or Federal Level, Challenge Must Go to Arbitrator

The United States Supreme Court also rejected the plaintiff’s argument that the Prima Paint severability rule does not apply in state court. The Court found that Section 2 of the Federal Arbitration Act (the FAA), the section of the FAA that the Court has in the past applied to state court proceedings, is not limited to "contracts" that are valid; it also applies to contracts that later prove to be void. The Court held that regardless of whether the 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 the arbitrator.

The United States Supreme Court acknowledged that its decision permits a court to enforce an arbitration agreement in a contract that an arbitrator later finds to be void, but it also noted that the opposite result would allow a court to deny effect to an arbitration agreement in a contract that the court later finds to be perfectly enforceable. The Court stated that Prima Paint resolved this conundrum in favor of separate enforceability of arbitration clauses.

Decision Should Resolve Uncertainty When Franchisees Seek to Avoid Arbitration Clauses Based on Challenge to Overall Agreement

The United States Supreme Court’s decision in Buckeye should resolve the uncertainty and lack of uniformity involved in cases where a franchisee seeks to avoid an arbitration clause by claiming that the franchise agreement containing the clause is unenforceable. As a result of this decision, franchisors should be more confident that the arbitration clause will be enforced and the matter will be referred to arbitration. If, however, the franchisee’s challenge is to the arbitration clause itself, as opposed to the whole contract, that issue will be determined by the court.

Please call us if you have any questions about this case or any of the issues it raises.

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