law-challenging-arbitration | arbitration-non-signatories | arbitration cases | arbitration mandamus | Federal Arbitration Act FAA |
enforceability void agreement | unconscionable contract
CHALLENGES TO ARBITRATION AGREEMENTS | WHO DECIDES THE ISSUE? -
COURT OR ARBITRATOR?
There are two types of challenges to an arbitration provision: (1) a specific challenge to the validity of the
arbitration agreement or clause, and (2) a broader challenge to the entire contract, either on a ground that
directly affects the entire agreement, or on the ground that one of the contract’s provisions is illegal and
renders the whole contract invalid. Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, 444 (2006).
SOURCE: In re Labatt Food Service, LP, No. 07-0419 (Tex. 2009)(Johnson)
(arbitration mandamus granted, arbitration of wrongful death claim by nonsubscribers compelled)
A court may determine the first type of challenge, but a challenge to the validity of the contract as a whole,
and not specifically to the arbitration clause, must go to the arbitrator. Id. at 448-49; see Prima Paint, 388 U.S.
at 403-04 (claim of fraud in the inducement of arbitration clause itself may be adjudicated by court, but court
may not consider claim of fraud in the inducement of the contract generally); Forest Oil Corp. v. McAllen, 268
S.W.3d 51, 56 (Tex. 2008) (“[T]he party opposing arbitration must show that the fraud relates to the
arbitration clause specifically, not to the broader contract in which it appears.”); Perry Homes v. Cull, 258 S.W.
3d 580, 589 (Tex. 2008) (“[A]rbitrators generally must decide defenses that apply to the whole contract, while
courts decide defenses relating solely to the arbitration clause.”); In re Merrill Lynch, 235 S.W.3d at 190 & n.
12 (noting that a defense relating to the parties’ entire contract rather than the arbitration clause alone is a
question for the arbitrators); In re FirstMerit Bank, 52 S.W.3d at 756 (noting that the defenses of
unconscionability, duress, fraudulent inducement, and revocation must specifically relate to the arbitration part
of a contract and not the contract as a whole if they are to defeat arbitration, and that validity of an arbitration
provision is a separate issue from validity of the whole contract).
We recently considered the first type of challenge in In re Poly-America, L.P., 262 S.W.3d 337 (Tex. 2008).
There, Johnny Luna and his employer, Poly-America, entered into a five-page-long arbitration agreement. Id.
at 345, 360. After Luna was fired, he sued for retaliatory discharge and sought a declaratory judgment that
the arbitration agreement was unenforceable because it contained provisions that violated public policy and
were unconscionable. Id. at 345. One of his arguments was that provisions prohibiting the arbitrator from
awarding punitive damages or ordering reinstatement violated Labor Code provisions authorizing such relief.
Id. at 352. We determined that those provisions were unconscionable and void, but they were severable and
did not invalidate the rest of the agreement to arbitrate. Id. at 359-60. We stated that “where a particular
waiver of substantive remedies or other provision of a contract is unconscionable—independent of the
agreement to arbitrate—it will be unenforceable even though included in an agreement to arbitrate.” Id. at 349.
But that statement must be read in context of the case as it was presented to us. We were considering only
provisions that were part of the arbitration agreement. There was no challenge to an invalid or illegal provision
outside of the arbitration agreement because the entire contract at issue was an arbitration agreement.
Because we were considering the various challenged provisions only as they were part of the arbitration
agreement itself, the Court could properly adjudicate Luna’s challenge. Buckeye, 546 U.S. at 444; Prima
Paint, 388 U.S. at 409. At oral argument in this case, Labatt urged the Court to similarly sever the indemnity
clause if we found it violated Labor Code section 406.033(e). But as we explain below, we do not reach the
issue of whether the indemnity clause is void because it is a question for the arbitrator.
The case now before us presents a challenge of the second type that we refer to above: a broad challenge to
the entire contract on the ground that one of the contract’s provisions is illegal and renders the whole contract
invalid, but not specifically challenging the arbitration clause. The Supreme Court addressed a similar
challenge in Buckeye. 546 U.S. 440. There, Buckeye Check Cashing operated a deferred deposit service by
which its customers obtained cash in exchange for the customer’s check in the amount received plus a finance
charge. Id. at 442. For each transaction, Buckeye’s customers signed a “Deferred Deposit and Disclosure
Agreement,” which included an arbitration clause. Id. Buckeye customers brought a class action suit in Florida
state court. Id. at 443. They alleged the finance charges in the agreement violated Florida lending and
consumer protection laws. Id. Buckeye moved to compel arbitration, but the plaintiffs argued the contract as a
whole, including the arbitration clause, was rendered invalid by the usurious finance charges. Id. The trial
court denied the motion to compel, holding that the court rather than an arbitrator should resolve the claim
that a contract is void and illegal. Id. The Florida Supreme Court affirmed, but the United States Supreme
Court reversed. Id. at 449. The United States Supreme 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 to the arbitrator.” Id.
Like the plaintiffs in Buckeye, the beneficiaries in this case challenge the contract on the ground that an illegal
clause renders the whole contract void. The beneficiaries challenge the arbitration clause only in the sense
that they also challenge all parts of the agreement because the parts comprise the whole. But, unless a
challenge is to the arbitration clause or arbitration agreement itself, as it was in In re Poly-America, the
question of a contract’s validity is for the arbitrator and not the courts. Accordingly, the beneficiaries’
challenge to the validity of the agreement must be determined by the arbitrator, and we do not address it.
Buckeye, 546 U.S. at 445-46; In re Merrill Lynch, 235 S.W.3d at 190 & n.12; In re FirstMerit Bank, 52 S.W.3d
at 756, 758.
Because of our disposition of the case, we do not address Labatt’s alternative argument that the FAA
preempts Labor Code section 406.033(e) to the extent the state statute would prevent or restrict enforcement
of the arbitration provision. See In re Bison Bldg. Materials, Ltd., Nos. 01-07-00003-CV, 01-07-00029-CV,
2008 WL 2548568, at *8 (Tex. App.—Houston [1st Dist.] June 26, 2008, orig. proceeding) (mem. op.); In re
Border Steel, Inc., 229 S.W.3d 825, 831-32 (Tex. App.—El Paso 2007, orig. proceeding); In re R & R Pers.
Specialists of Tyler, Inc., 146 S.W.3d 699, 703-04 (Tex. App.—Tyler 2004, orig. proceeding).