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BUSINESS LAW UPDATE: Enforceability of an Arbitration Agreement When the Specified Arbitrator Has Agreed to Cease Administering and Participating in All Consumer Arbitration

Posted by Gale Burns on Mon, Mar 26, 2012 @ 15:03 PM

March 27, 2012

Charlene Hicks, Senior Attorney, National Legal Research Group

The always thorny topic of mandatory arbitration provisions in consumer sales contracts has recently developed a new layer of legal complexity.  Prior to July 2009, many businesses routinely inserted into their consumer sales contracts arbitration clauses that required consumers' complaints to be resolved through binding arbitration administered exclusively by the National Arbitration Forum ("NAF").  At that time, the NAF was the largest administrator of consumer arbitrations in the United States.  A 2009 investigation of the NAF conducted by the Minnesota Attorney General, however, revealed that the supposedly neutral body of the NAF actually held a strong anticonsumer bias.  See Arbitration or "Arbitrary":  The Misuse of Mandatory Arbitration to Collect Consumer Debts:  Hearing Before the H. Domestic Policy Subcomm. of Comm. on Oversight & Gov't Reform, 111th Cong. 3-5 (July 22, 2009).  The NAF routinely "represented to corporations that it would appoint anti-consumer arbitrators and discontinue referrals to arbitrators who decided cases in favor of consumers."  Khan v. Dell, Inc., No. 10-3655, 2012 WL 163899, at *8 (3d Cir. filed Jan. 20, 2012) (Sloviter, J., dissenting).  The NAF's "various deceptive practices" had the effect of unfairly disadvantaging consumers in the arbitral forum.  Id. at *2 (majority opinion).  As a result of the Minnesota Attorney General's investigation, the NAF entered into a consent judgment wherein it agreed to cease administering and participating in all consumer arbitrations.

Because the NAF is no longer available to serve as an arbitral forum in consumer disputes, consumers in recent cases have moved the courts for orders setting aside mandatory arbitration clauses that name the NAF as the exclusive arbitrator of the consumers' complaints.  Courts confronted with this issue have reached differing conclusions as to whether the unavailability of the NAF to serve as arbitrator of consumer-related disputes renders the entire arbitration clause unenforceable.

The current, unsettled status of the law in this regard was well documented by the Third Circuit Court of Appeals in Khan.  In that case, Khan, a consumer, filed a putative class action on behalf of himself and other similarly situated purchasers and lessees of a certain Dell computer model that he claimed had been defectively designed.  Khan purchased his computer for $1,200 directly from Dell's website.  To complete the purchase, Khan was required to click a box that stated:  "I AGREE to Dell's Terms and Conditions of Sale."  Id. at *1.  The Terms and Conditions of Sale contained an arbitration clause that provided that any claim or dispute between the parties relating to the computer purchase

SHALL BE RESOLVED EXCLUSIVELY AND FINALLY BY BINDING ARBITRATION ADMINISTERED BY THE NATIONAL ARBITRATION FORUM (NAF) under its Code of Procedure then in effect. . . . This transaction involves interstate commerce, and this provision shall be governed by the Federal Arbitration Act[,] 9 U.S.C. sec. 1B16 (FAA).

Id. (citation omitted).

At the time Khan filed his lawsuit, the consent judgment entered into by the NAF barred the NAF from arbitrating Khan's complaint.  Even so, Dell moved to compel arbitration on the ground that the arbitration provision in the sales contract was binding and covered all of Khan's claims.  Khan objected by arguing that the arbitration provision was unenforceable because the NAF was no longer permitted to conduct consumer arbitrations, and that the NAF's designation as the arbitral forum was integral to the arbitration provision.  Id.

Finding that the contract language indicated that the parties had intended to arbitrate exclusively before a particular arbitrator that was no longer available, the district court denied Dell's motion to compel.  Id.  In addition, the district court refused to appoint a substitute arbitrator, finding that it could not compel the parties to submit to an arbitral forum to which they had not agreed.  Id.

On appeal, the Third Circuit reversed.  The majority opinion emphasized that the case was governed by the Federal Arbitration Act ("FAA") and that the courts have recognized a strong federal policy favoring arbitration.  Id. at *4.  Section 5 of the FAA provides a mechanism for substituting an arbitrator when the designated arbitrator is unavailable.  Federal case law has established that the applicability of this FAA section turns upon "whether the designation of the arbitrator was 'integral' to the arbitration provision or was merely an ancillary consideration."  Id.  In other words, "'the failure of the chosen [arbitral] forum'" will preclude any type of arbitration from proceeding if the parties' choice of arbitrator was "'an integral part of the agreement to arbitrate, rather than an "ancillary logistical concern."'"  Id. (quoting Brown v. ITT Consumer Fin. Corp., 211 F.3d 1217, 1222 (11th Cir. 2000)).  For this to occur, the Khan majority stated that "the parties must have unambiguously expressed their intent not to arbitrate their dispute in the event that the designated arbitral forum is unavailable."  Id.

In light of this articulated standard, the Khan majority then went on to analyze the language of the arbitration provision contained in Dell's sales contract.  In this regard, the majority found the contract language to be ambiguous.  Id. at *5.  The word "exclusively" could be interpreted to modify "binding arbitration," "the national arbitration forum," or both.  Hence, the contract did not clearly indicate what the parties should do in the event that the NAF was unavailable to conduct the arbitration.

Other courts considering similar arbitration provisions have reached differing conclusions as to their meaning.  Some courts have determined that the word "exclusively" modifies "binding arbitration" and therefore demonstrates "an intent to arbitrate that trump[s] the designation of a particular arbitrator who [i]s no longer available."  Id.; see, e.g., Brown, 211 F.3d at 1222; Adler v. Dell, Inc., No. 08-cv-13170, 2009 WL 4580739, at *3 (E.D. Mich. Dec. 3, 2009) (slip copy).  In contrast, other courts have ruled that the designation of the NAF as the arbitral forum was integral to the agreement to arbitrate and that the appointment of a substitute arbitrator would amount to an impermissible reworking of the contract.  See, e.g., Carideo v. Dell, Inc., No. C06-1772JLR, 2009 WL 3485933, at *6 (W.D. Wash. Oct. 26, 2009) (unpublished).

In Khan, the Third Circuit determined that "[a]lthough courts are divided on the issue, . . . the liberal federal policy in favor of arbitration counsels us to favor the Brown line of cases."  2012 WL 163899, at *6.  In effect, given the strong public policy in favor of arbitration as a means of dispute resolution, the Khan majority decided to resolve the ambiguity in the contract language in favor of arbitration.  This conclusion was further substantiated by the fact that the arbitration provision in Dell's sales contract expressly referred to the FAA.

A strong dissenting opinion was issued by Judge Sloviter.  Id. at *7 (Sloviter, J., dissenting).  According to Judge Sloviter, the majority gave "mere lip service" to the fundamental principle that arbitration is a matter of contract.  Id.  The plain text of the arbitration provision at issue clearly indicated that Dell's selection of the NAF as arbitrator was integral to the agreement.  It followed that the unavailability of the NAF to serve as arbitrator wholly precluded arbitration of Khan's claims.

Judge Sloviter further emphasized the importance of the NAF as the chosen arbitral forum.  It was significant that Dell, in drafting the sales contract, had intentionally chosen the NAF, a known anticonsumer group, as the exclusive forum in which to resolve consumer complaints regarding Dell's computers.  Thus, Judge Sloviter concluded:  "Even assuming that in the usual case, substitution of a neutral arbitrator would be an acceptable alternative, it is evident that this is not an ordinary case and we should affirm the District Court's denial of Dell's motion."  Id. at *9.

The tensions inherent in any contractual dispute pitting individual consumers against a large business such as Dell are magnified by the presence of an arbitration clause such as the one at issue in Khan.  Although the Third Circuit's majority opinion applied sound principles of contract analysis in ruling that a substitute arbitrator should be appointed to resolve the dispute between Khan and Dell in accordance with the procedure set forth in the FAA, it would seem equally reasonable for the court to have relied on the equitable considerations emphasized in Judge Sloviter's dissent to set aside the arbitration clause.  In any event, given the revelations concerning the NAF's unfair and deceptive practices toward consumers, it is likely that consumers will continue to seek judicial relief from arbitration provisions naming the NAF as the exclusive forum in which consumers' complaints are to be resolved.  Counsel representing either party to such a dispute would be well advised to stay abreast of emerging legal developments on this issue.

Topics: legal research, Charlene Hicks, business law, consumer sales contracts, National Arbitration Forum (NAF), NAF's strong anticonsumer bias and deceptive p, no longer administers consumer arbitrations, Kahn v. Dell, increasing judicial relief being sought in contrac, mandatory arbitration provisions

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