We wrote twice recently on the growing controversy surrounding mandatory arbitration clauses and class action waivers which are increasingly included by financial services companies in consumer credit card contracts. In those Alerts– written in May 2008 and March 2009 – we discussed opinions from the Second and Third Circuits which, although they did not invalidate the contract provisions at issue, made it easier for plaintiffs seeking to invalidate mandatory arbitration clauses and class action waivers to prevail. See Homa v. American Express Co. et al, ____ F.3d ____ (3d Cir. Feb. 24, 2009); Ross v. Bank of America, N.A., 524 F.3d 217 (2d Cir. 2008).
Now, the United States Supreme Court has similarly ruled in favor of a credit cardholder who seeks to avoid enforcement of a mandatory arbitration clause in federal court. On March 9, 2009, in Vaden v. Discover Bank, 556 U.S. ____ (2009), the Supreme Court "sharply restrict[ed] the ability of federal courts to enforce agreements to arbitrate" by refusing to extend federal jurisdiction under Section 4 of the Federal Arbitration Act to cases where federal issues arise only in a counterclaim. Vaden dissent, slip op. at 2 (Roberts, C. J. dissenting). In an opinion authored by Justice Ginsburg, and joined by Justices Souter, Kennedy, Thomas, and Scalia, the Court held that "a federal court may 'look through' a § 4 petition to determine whether it is predicated on an action that 'arises under' federal law; in keeping with the well-pleaded complaint rule..., however, a federal court may not entertain a § 4 petition on the contents, actual or hypothetical, of a counterclaim." Id. at 11.
The procedural posture of this case had an important impact on its outcome. An affiliate of Discover Bank filed a complaint in a Maryland state court, solely under state law, to recover past-due charges from a credit cardholder, Betty Vaden. Ms. Vaden counterclaimed that Discover's charges violated state law. Based on an arbitration clause in its cardholder agreement with Vaden, Discover then filed a petition in federal court to compel arbitration under section 4 of the Federal Arbitration Act. Discover argued that the federal District Court had jurisdiction under the Act – as set out in section 4 – because Vaden's counterclaim was completely preempted by federal law. The District Court agreed and ordered arbitration. On appeal, the Fourth Circuit affirmed, agreeing that the underlying dispute presented a federal question based on federal preemption. The Supreme Court reversed.
The Court held that the federal court lacks jurisdiction based on the plain language of section 4 and the well-established parameters of federal jurisdiction set out in the "well-pleaded complaint rule." Section 4 authorizes a district court to entertain a petition to compel arbitration if that court would have jurisdiction, "save for [the arbitration] agreement," over "a suit arising out of the controversy between the parties." 9 U.S.C. § 4. However, reasoned the Court, federal jurisdiction cannot "rest upon an actual or anticipated counterclaim." Slip. op at 9 (citing Holmes Group, Inc. v. Vornado Air Circulation Systems, Inc., 535 U.S. 826 (2002)) (well-pleaded complaint rule excludes counterclaims, even when compulsory, from federal jurisdiction). Thus, the Court determined that "a completely preempted counterclaim remains a counterclaim and thus does not provide a key capable of opening a federal court's door." Slip op. at 16.
In a partial concurrence and partial dissent, Chief Justice Roberts, joined by Justices Stevens, Breyer, and Alito, agreed with Justice Ginsburg that district courts should be able to "look through" the section 4 petition at the underlying dispute. Vaden dissent, slip op. at 1 (Roberts. C. J. dissenting). However, the Chief Justice continued, section 4 should apply to allow arbitration in federal court where the basis for federal jurisdiction is made clear in the section 4 petition, regardless of the posture of the underlying dispute.
Vaden is a case primarily about federal jurisdiction and not creditors' rights. However, the majority opinion evidences concern for the credit cardholder who did not initiate the suit and suggests that the mandatory arbitration clause is unfair to her. "Vaden's preference for court adjudication is unsurprising. The arbitration clause, framed by Discover, prohibited presentation of 'any claims as a representative member of a class.'" Slip op. at 3 n.2. The Court also pointed out that Discover did not attempt to invoke its arbitration clause until faced with Vaden's counterclaims, and that Discover had chosen the state court forum for its original lawsuit. In contrast, the Court continued, Vaden, "framed her counterclaims under state law and clearly preferred the Maryland forum." Id. at 18.
Thus, given this concern, it is not surprising that the Supreme Court chose the Vaden case to reiterate the parameters of federal jurisdiction in favor of a credit cardholder who seeks to avoid enforcement of a mandatory arbitration clause in federal court.
For more information about the pending Arbitration Fairness Act of 2009, read our Alert.
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