From Lexology, Peter J. Gallagher discusses a recent case in which an arbitration agreement was not enforceable because it required arbitration in an “illusory forum.” Arbitration clauses are an important part of any independent contractor agreement because it is a less expensive way for independent contractors to resolve disputes and it protects the company from class action lawsuits. Pete writes:
This one may seem obvious, but, in MacDonald v. Cashcall, Inc., the U.S. Court of Appeals for the Third Circuit held that a contractual arbitration provision that calls for arbitration in an “illusory forum” is not enforceable. So, if you were thinking about trying to compel arbitration in Wakanda or before the Jedi Council, better think twice.
In MacDonald, plaintiff entered into a loan agreement with a entity known as Western Sky in connection with a $5,000 loan. The loan agreement stated that it was “subject solely to the jurisdiction of the Cheyenne River Sioux Tribe,” and “governed by the . . . laws of the Cheyenne River Sioux Tribe.” It also contained an arbitration provision requiring that any disputes arising out of the agreement be “conducted by the Cheyenne River Sioux Tribal Nation by an authorized representative in accordance with its consumer dispute rules and the terms of [the agreement].” But the agreement also provided that either party, after demanding arbitration, could select an arbitrator from the American Arbitration Association (“AAA”) or Judicial Arbitration and Mediation Services (“JAMS”) to administer the arbitration, and, if it did, “the arbitration [would] be governed by the chosen arbitration organization’s rules and procedures” to the extent that they did not contradict the “law of the Cheyenne River Sioux Tribe.” The agreement also contained a severability clause, providing that, if any provision of the agreement was deemed invalid, the remaining provisions would remain in effect.
Although plaintiff originally borrowed $5,000, “[h]e was charged a $75 origination fee and a 116.73% annual interest rate over the seven-year term of the loan, resulting in a $35,994.28 finance charge.” After paying approximately $15,493 on the loan, which included $38.50 in principal, $15,256.65 in interest, and $197.85 in fees, plaintiff filed a putative class action lawsuit against defendants, asserting federal RICO claims and state law claims for usury and consumer fraud. Defendants moved to compel arbitration. The district court denied the motion, holding that the loan agreement’s “express disavowal of federal and state law rendered the arbitration agreement invalid as an unenforceable prospective waiver of statutory rights.” Defendants appealed.
The Third Circuit affirmed the district court, but for slightly different reasons. It held that the “arbitral forum provided for in the [agreement was] nonexistent.” Therefore the provision itself was unenforceable, and the Third Circuit did not have to reach the district court’s conclusion that the provision was an impermissible prospective waiver of plaintiff’s federal and state rights.
Somewhat surprisingly, nobody seems to dispute that no “tribal arbitral forum” before the Cheyenne River Sioux Tribal Nation (“CRST”) exists. As the Third Circuit observed, several other courts of appeal concluded that it does not, and defendants in McDonald never “contested [the conclusion] that CRST arbitration is unavailable.” Instead, defendants argued that the loan agreement provided for an actual, available arbitral forum by allowing either party to the loan agreement to choose a AAA or JAMS arbitrator, “without relying on a CRST representative or CRST consumer dispute rules.” The Third Circuit disagreed.
The court noted that the agreement only allows the parties to choose a AAA or JAMS arbitrator to “administer the arbitration.” Under both AAA and JAMS rules, however, the role of the arbitration administrator is to manage the administrative aspects of the arbitration, not to decide the merits of the case. Therefore, the Third Circuit held, the “plain language of the [agreement] belies [d]efendants’ argument that it provides an available arbitral forum.”
The Third Circuit further held that this conclusion was consistent with the loan agreement’s forum selection clause, which required that any arbitration “be conducted by the Cheyenne River Sioux Tribal Nation by an authorized representative.” Allowing AAA or JAMS to administer an arbitration, but having a CRST representative actually conduct the arbitration would be consistent with this clause. According to the Third Circuit, the opposite wold not be true: “To construe the Choice of Arbitrator provision to allow arbitration by someone other than a CRST representative would be irreconcilable with the forum selection clause’s requirement that a CRST representative conduct the arbitration.” Accordingly, this provision did not create an available arbitral forum.
Finally, the Third Circuit rejected defendants’ argument that the severability clause in the loan agreement allowed “invalid provisions, such as the selection of an illusory forum, to be severed,” and the remaining portions of the arbitration clause to be enforced. The Third Circuit observed that, under New Jersey law, courts will only sever language from an agreement “where doing so would not defeat the central purpose of the contract.” It then held that the “CRST arbitration provision was an integral, not ancillary, part of the parties’ agreement to arbitrate.” The loan agreement referenced the Cheyenne River Sioux Tribal Nation or its rules in most paragraphs of the loan agreement that discussed arbitration. “These references reflect[ed] that the primary purpose of the [l]oan [a]greement was to arbitrate disputes subject to CRST oversight and its laws.” Accordingly, this provision could not be severed from the loan agreement. Because this provision was unenforceable and because it could not be severed from the agreement, the Third Circuit held that the entire arbitration provision in the loan agreement was unenforceable, and the district court was correct in denying defendants’ motion to compel arbitration.