United States: Supreme Court Holds Federal Arbitration Act Preemption Applies To Contract Formation Rules

Last Updated: May 22 2017
Article by Thaddeus Ewald

Last week, the U.S. Supreme Court rejected the Kentucky Supreme Court's use of a clear-statement rule to require that powers of attorney specifically authorize a representative to enter into an arbitration agreement, finding that the rule violated the Federal Arbitration Act's ("FAA") equal treatment principle. The plaintiffs in two consolidated cases were the wife and daughter of individuals who lived and died at a Kindred Nursing Centers facility. They each held powers of attorney with broad authority to manage their family members' affairs. When each plaintiff signed the necessary paperwork to move their family member into the Kindred facility, they signed binding arbitration agreements.

The present dispute arose from a lower court action in which the plaintiffs sued Kindred over allegations that substandard care caused their family members' deaths. Kindred moved to dismiss the suits on the basis of the arbitration agreements, the lower courts denied those motions, and the Kentucky Supreme Court affirmed. The state's highest court found that one plaintiff's (Wellner) power of attorney was not broad enough to permit her to enter into an arbitration agreement on behalf of her husband, but that the other plaintiff's (Clark) power of attorney was sufficiently broad. However, the Kentucky court invalidated both arbitration agreements based upon a so-called clear-statement rule—that a power of attorney must specifically state that the representative has the power to enter into an arbitration agreement lest the individual's "sacred" right of access to the courts and to trial by jury be violated. This rule complied with FAA's demands that arbitration agreements be treated equally, the court explained, because it would apply to arbitration and other contracts implicating "fundamental constitutional rights."

Justice Kagan authored an opinion for seven justices that squarely rejected the Kentucky Supreme Court's reliance on the clear-statement rule, holding that it failed to put arbitration agreements on "an equal plane" with other contracts. The FAA includes an equal treatment principle that courts may invalidate arbitration agreements based upon generally applicable contract defenses, but not on legal rules singling out arbitration. The Supreme Court found that the clear-statement rule did exactly what its prior precedent (Concepcion) barred: it adopted a legal rule turning on the distinctive, primary characteristic of an arbitration agreement—the waiver of the right of access to the court and to a jury trial.

The Supreme Court dismissed the Kentucky court's attempt to sidestep the equal treatment principle by suggesting the clear-statement rule could apply to other fundamental constitutional rights, referring to the hypothetical examples as "patently objectionable and utterly fanciful contracts."  The Court stated that adopting the respondents' view "would make it trivially easy for States to undermine the Act—indeed, to wholly defeat it."

Importantly, the Supreme Court rejected an argument by respondents attempting to salvage the clear-statement rule by characterizing it as only affecting contract formation, and thus, outside of the FAA's purview. In rejecting that characterization, the Court relied upon the FAA's text as well as case law. By its terms, the FAA states arbitration agreements be treated as "valid, irrevocable, and enforceable," thus covering the initial "valid[ity]" of arbitration contracts." The Court explained that its discussion of duress in Concepcion, a doctrine involving unfair dealing at the contract formation stage, would not make sense if the FAA did not apply to the contract formation stage. Furthermore, if respondents were correct, states could easily make an end-run around it by declaring everyone incompetent to sign arbitration agreements—a rule only affecting contract formation.

In dispensing with the consolidated cases, the Court reversed and ordered enforcement of Clark's arbitration agreement because the Kentucky court had invalidated that agreement only based on the clear-statement rule. On the other hand, the Court vacated and remanded Wellner's case for the state court to determine whether its interpretation of the power of attorney was independent of the clear-statement rule.

Kindred Nursing Ctrs. Ltd. P'ship v. Clark, No. 16-32 (USSC May 15, 2017).

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