Supremes: There Can Still be an Arbitration Foul Without Harm

Supremes:  There Can Still be an Arbitration Foul Without Harm

It isn’t always true that no harm means no foul. 

Changing Course

Consider this.  A former employee sues his or her former employer, in a class action.  The employer defends in federal court.  There is motion to dismiss and even a mediation.  Eight months later, the employer defendant, apparently tired of the court action, points out there is an arbitration clause and moves to stay court proceedings and send the case to arbitration. 

The trial court applies the law many circuit courts have fashioned especially for arbitration: a party waives its contractual right to arbitration if it knew of the right, acted inconsistently with that right, and prejudiced the other party by its inconsistent actions.  The trial court finds the test is met and denies the motion. It observes that time and resources were wasted on a motion and a mediation.  You can imagine the court is a little miffed after spending time and energy on the case and having the defendant basically say, “Never mind judge, we quit.  Seems like things may go better for us in arbitration.”  

On appeal — no prejudice no waiver

The Eighth Circuit disagrees.  No discovery has begun, and the court has yet to decide any substantive matters going to the merits, it reasons.  It finds no prejudice.  Off to arbitration the case goes.

No bespoke arbitration rules

That’s about where things stood when the Supreme Court took the matter up in the case of Morgan v. Sundance, No. 21–328 (May 23, 2022).  The parties argued plenty of issues, but Justice Kagan, writing for the Court, focused on just one: may courts create arbitration-specific variants of federal procedural  rules, like those concerning waiver, based on the FAA’s policy favoring arbitration?  The Court decided they cannot.  So, it ruled that, “the Eighth Circuit was wrong to condition a waiver of the right to arbitrate on a showing of prejudice.”

The Court began by noting that courts generally do not require prejudice before finding waiver. Rather, a contractual waiver normally is effective without proof of detrimental reliance. But the courts have created  “a bespoke rule of waiver for arbitration” that requires proof of prejudice before waiver is found.” 

The source of the special rule is the federal policy favoring arbitration.  But this, said the Court, has gone too far.  The policy is an acknowledgment of the FAA’s commitment to overrule the judiciary’s longstanding refusal to enforce agreements to arbitrate and to “place such agreements upon the same footing as other contracts.”  But the policy is to make “arbitration agreements as enforceable as other contracts, but not more so.”

In short, the courts have for decades been using the wrong rule to decide whether or not a party has waived its right to arbitrate.   So, the Court sent the case back to the Eighth Circuit to decide a narrower issue:  Did the defendant “knowingly relinquish the right to arbitrate by acting inconsistently with that right?”

 For now, assume it’s “use it or lose it”

It seems as though the question on remand should be an easy call.  Now that prejudice is out of the test, it seems likely the test will be met.  Presumably, the trial court, in finding the test was met – including the prejudice requirement, also found knowing relinquishment of the right to arbitrate.

This decision makes sense.  It always seemed wrong to let a party just quit the game and try a new field of play when the going gets rough in court.  But since these cases usually turned on the prejudice element, it will be interesting to see at what point the waiver is effective.  Will it be as soon as a party defends in court at all without invoking an arbitration clause?  If not, how far can things get?  Time will tell.

In the meantime, if you have an arbitration clause, your assumption should probably be” use it or lose it.”