Prevent Waiver of Your Right to Arbitrate

If your business includes arbitration clauses in its contracts with customers or employees, a recent US Supreme Court decision provides a practical lesson in enforcing your arbitration rights.

For a Supreme Court that often cannot agree on the day of the week, a 9-0 unanimous decision in Morgan v. Sundance, Inc. provided absolute certainty on a narrow issue and a broader issue.

The narrow lesson: A party to an arbitration agreement must invoke its right to arbitration immediately when a dispute arises, rather than participating in litigation in court and later trying to enforce the arbitration clause.

The Broader Lesson: The Federal Arbitration Act requires courts to enforce arbitration clauses the same way courts enforce any other contract term, but does not actually promote arbitration by letting courts enforce rules. which make arbitration clauses more enforceable than other types of contractual clauses.

Background

Sundance, Inc. operates Taco Bell franchises and requires employees to arbitrate certain employment-related disputes. Plaintiff Robyn Morgan signed the arbitration agreement included in her employment application, but later filed a federal class action lawsuit alleging the company was not paying employees for all of the overtime they worked.

Rather than immediately seek dismissal of the lawsuit and forced arbitration, Sundance first filed an unsuccessful motion to dismiss on grounds unrelated to binding arbitration. She then filed a legal response, without even mentioning the arbitration agreement. Sundance only offered to suspend the lawsuit and compel arbitration after seven months of litigation in court.

Morgan argued that Sundance waived its right to arbitrate by litigate in court for months. The United States Court of Appeals and Court of Appeals for the Eighth Circuit applied the test that the Eighth Circuit had previously adopted when a party waives its right to arbitration. This test required both showing that the party invoking arbitration acted in a manner inconsistent with that right and proving that the other party suffered prejudice as a result. The trial court ruled that Morgan suffered damages, but the Eighth Circuit disagreed, finding that Sundance could still demand arbitration because the parties had not yet commenced discovery in the litigation or contested issues on the merits, so no prejudice to Morgan had occurred.

The Supreme Court decision

But the Supreme Court backtracked, ruling that Sundance had waived its right to arbitrate and the Eighth Circuit’s Arbitration Waiver Test had set its foot on the ground: a ruling on whether a party attempting to invoke arbitration clauses had waived its contractual right to arbitration should focus on the conduct of the party invoking the arbitration clause, not on the harm the other party suffers as a result. Why? Because the Federal Arbitration Act requires courts to enforce arbitration clauses the same as other contract terms, but does not say that courts should actually favor arbitration. In fact, the Act contains no requirement that the conduct of the party seeking to compel arbitration has caused prejudice to the opposing party.

Notably, all federal appeals courts except the U.S. Courts of Appeals for the Seventh Circuit of Chicago and the District of Columbia had also adopted the same (now incorrect) test the Eighth Circuit used to determine whether a party had waived its arbitration rights.

Lessons Learned: 1) If your business wants to take advantage of the potential time and cost savings that arbitration offers versus litigation, then don’t wait to invoke your arbitration rights; and 2) the Federal Arbitration Act does not allow courts to favor arbitration over litigation – it requires courts to make arbitration clauses just as enforceable as any other contractual clause.

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