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Supreme Court Upholds Arbitration as Proper Forum for Challenges to Validity of Agreements with Arbitration Clauses

The United States Supreme Court has held that in cases arising under the Federal Arbitration Act (“FAA”), where a party challenges the enforceability of a contract that contains an arbitration clause, the arbitrator designated under the agreement must determine the validity of the agreement. State laws giving primary jurisdiction under such circumstances to another forum, whether judicial or administrative, are pre-empted by the FAA, the Court stated in its February 20 ruling. Preston v. Ferrer, 552 U.S. __ (2008).

In Preston, an entertainment attorney initiated an arbitration proceeding against a television performer to recover the fees to which he claimed he was entitled under their contract. The attorney invoked the parties’ agreement to arbitrate any dispute relating to the terms of the contract or the breach, validity, or legality thereof in accordance with the rules of the American Arbitration Association (AAA). The performer, however, sued in California state court seeking to stay the arbitration on the basis the contract was invalid and unenforceable under the California Talent Agencies Act (TAA), because the attorney acted as an unlicensed talent agent, which violated the TAA. The TAA gives the California Labor Commissioner exclusive jurisdiction to resolve such a dispute. In response, the attorney filed a motion in state court to compel arbitration. The California courts found state law controlling and refused to enforce the arbitration agreement because state law vested the Labor Commissioner with exclusive jurisdiction over the dispute.

The Supreme Court reversed, holding that when a contract contains an arbitration provision, any challenge to the validity of the contract as a whole must be considered by the arbitrator, not a court or an administrative agency. In contrast, state law governs where the challenge is only to the enforceability of the arbitration provisions.

The Court’s decision also rejected the entertainer’s argument that the TAA was compatible with the FAA because arbitration would merely be postponed. The Court found that the arbitration would likely be long delayed and that such delay would contravene Congress’ intent to “move the parties to an arbitrable dispute out of court and into arbitration as quickly and easily as possible.” The Court said the best way to harmonize the contract’s adoption of the AAA’s rules and its choice of California law was to use California law to interpret the parties’ substantive rights and obligations, but not to allow California law to limit the arbitrator’s authority.

Practically, this decision limits employees’ ability to challenge in court the enforceability of contracts which contain arbitration agreements. Employees thus should not be able to assert contract defenses in response to an employer’s efforts to compel binding arbitration. Employers, however, should still ensure that the arbitration provisions in their employment agreements are consistent with applicable state law requirements. Jackson Lewis attorneys are experienced in assisting employers in developing a variety of alternative dispute resolution programs, including arbitration agreements.