Recently, the U.S. Supreme Court has ruled that, unlike petitions to compel arbitration, petitions to confirm or vacate an arbitration award cannot be brought in federal court simply because the underlying dispute involves a federal question. The Supreme Court also heard oral argument on whether a showing of actual prejudice is necessary to argue waiver of an arbitration claim.

Is a showing of actual prejudice necessary for waiver of arbitration?
On March 21, the Supreme Court heard oral argument in Morgan v. Sundance. The case was brought by Robyn Morgan who worked at a Taco Bell franchise owned and operated by Sundance, Inc. Morgan signed an application for employment that contained a mandatory arbitration provision, which required arbitration of all disputes. Morgan complains that Sundance used a business method known as “hours shifting,” ensuring that no employee logged more than 40 hours in any given week, regardless of the number of hours the employee actually worked and that Sundance instructed employees to clock out, but continue working. Morgan alleged that Sundance prevented employees at its more than 150 Taco Bell franchises from ever collecting overtime pay for hours actually worked.

Morgan filed a nationwide class action under the Fair Labor Standards Act (FLSA) against Sundance in the U.S. District Court for the Southern District of Iowa. The court denied Sundance’s motion to dismiss based on a prior pending class action, (the “Wood” case) and Sundance filed an answer asserting 14 affirmative defenses but made no mention of the agreement to arbitrate.

In April 2019, Morgan and the Wood plaintiffs conduced a joint mediation with Sundance. Sundance provided Morgan with discovery including payroll data for class members and thousands of pages of emails from Sundance’s management. The mediation resulted in the settlement of the Wood claims, but not of Morgan’s claims. Six months after filings its motion to dismiss, Sundance invoked the arbitration provision in Morgan’s application for employment and moved to compel arbitration of her FLSA claims.

Morgan argued that Sundance had waived its right to compel arbitration by engaging in litigation with Morgan and the district court agreed. On appeal, a divided U.S. Court of Appeals for the Eighth Circuit panel reversed, ruling that Sundance had not waived its right to compel arbitration. The majority’s decision turned on whether Morgan had shown prejudice as a result of Sundance’s action.The dissent noted that prejudice was a “debatable prerequisite” for finding waiver of an arbitration agreement, and that Morgan had shown prejudice through her “waste [of] time and money engaging in a fruitless mediation based on an inaccurate premise that the case would be litigated in federal court.”

The Supreme Court accepted the case because of a split in the circuit court decisions on whether arbitration cases requires a showing of prejudice to establish waiver; should arbitration clauses be treated like an ordinary contract where actual prejudice is not necessary, and should a demonstration of prejudice be required because public policy favors arbitration. The Seventh and D.C. circuits do not require a showing of prejudice. The Tenth Circuit considers prejudice a factor, and the First, Second, Third, Fourth, Fifth, Sixth, Eighth, Ninth and Eleventh circuits require a showing of prejudice necessary to find waiver. The Morgan case is important because a requirement to show prejudice will reaffirm the public policy favoring arbitration. If decided otherwise, more diligence will be required in asserting the right to arbitrate.

The Supreme Court limits federal jurisdiction for confirming or setting aside awards. 
The Supreme Court’s 8-1 decision in Badgerowv. Walters, (U.S. March 31, 2022), holds that motions to confirm or vacate arbitration awards will now be able to be brought in federal court—rather than in state court—only if there is diversity of citizenship between the parties to the dispute or the application itself (as opposed to the underlying dispute) involves a federal question. The decision also marks a triumph of the “textualist” approach to statutory interpretation, even among members of the court’s so-called “liberal” wing, as opposed to a more policy-oriented approach.

The Supreme Court addressed the issue of federal jurisdiction over motions to compel arbitration under Section 4 of the Federal Arbitration Act (FAA) more than a decade ago in Vaden v. Discover Bank, 556 U.S. 49 (2009), adopting the so-called “look through” approach. Under this approach, “a federal court may ‘look through’ a Section 4 petition to determine whether it is predicated on an action that ‘arises under’ federal law.”

The court noted that, under Section 4 of the FAA—which governs application to compel arbitration—that statute provides that a party to an arbitration agreement may petition for an order to compel arbitration in a “U.S. district court which, save for [the arbitration] agreement, would have jurisdiction” over “the controversy between the parties.” The Badgerow court quoted Vadenas saying that it was that text that “drives our conclusion that a federal court should determine its jurisdiction by ‘looking through’ a Section 4 petition to the underlying substantive controversy”—to see, for example, if that dispute “‘arises under’ federal law.”

In contrast, the Badgerow court noted Section 8 and 9 of the FAA—the provisions concerning petitions to confirm or vacate awards—“contain none of the statutory language on which Vadenrelied.  Most notably, those provisions do not have Section 4’s ”save for” clause. They do not instruct a court to imagine a world without an arbitration agreement, and to ask whether it would then have jurisdiction over the parties’ dispute. Indeed, Sections 9 and 10 do not mention the court’s subject-matter jurisdiction at all.”

Accordingly, Justice Elena Kagan’s majority opinion ruled that, “under ordinary principles of statutory construction, the look-through method for assessing jurisdiction should not apply … We have no warrant to redline the FAA, importing Section 4’s consequential language into provisions containing nothing like it. Congress could have replicated Section 4’s look through instruction in Sections 9 and 10. Or for that matter, it could have drafted a global look-through provision, applying the approach throughout the FAA. But Congress did neither. And its decision governs.”

The only dissenter from Kagan’s opinion was Justice Stephen Breyer, a mainstay of the court’s “liberal” wing who has announced his retirement when the court takes its summer recess. In his dissent, Breyer, wrote that, when interpreting a statute, “it is often helpful to consider not simply the statute’s literal words, but also the statute’s purposes and the likely consequences of our interpretation.” He went on the discuss certain policy concerns that he believed counseled in favor of the “look through” approach, including consistency with the interpretation of Section 4. The majority opinion disagreed with those policy concerns, but ruled that, in any event, “even the most formidable policy arguments cannot overcome a clear statutory directive.”

As a practical matter, the court’s decision means that, going forward, applications for confirm or vacate arbitration awards can be brought in federal—rather than state—court only when there is diversity of citizenship between the parties—that is, the plaintiff and defendant are residents of different states—or there is some other basis for federal jurisdiction on the face of the complaint, such as admiralty. The mere fact that the underlying dispute in the arbitration involves a federal claim or question will not be sufficient to establish federal jurisdiction. Some practitioners believe that state courts tend to be more willing to vacate arbitration awards than federal courts are. It remains to be seen whether state courts will live up to that reputation as more and more applications to confirm or vacate awards are brought in state courts in the wake of Badgerow.

Reprinted with permission from the April 21, 2022 issue of The Legal Intelligencer© 2022 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.