OPINION ANALYSIS

Courts may not “make up” new procedural rules to favor arbitration

In a series of decisions, the Supreme Court has insisted that the Federal Arbitration Act requires courts to put arbitration contracts on “equal footing” with other kinds of contracts. These decisions have often favored companies seeking to enforce arbitration agreements, rejecting rules that give employees or consumers a way out from contract clauses requiring them to arbitrate their disputes on an individual basis. But Monday’s unanimous decision in Morgan v. Sundance clarifies that the equal-footing rule works both ways. In an opinion by Justice Elena Kagan, the court rejected a court-created, arbitration-specific rule that benefitted defendants that began to litigate a case in court, only to reverse course and demand arbitration after a delay.

This case arose from Robyn Morgan’s employment at a Taco Bell franchise owned by Sundance, Inc. Believing that Sundance had illegally failed to pay overtime, Morgan filed a lawsuit on behalf of herself and other employees who were similarly affected by Sundance’s pay practices. Initially, Sundance litigated Morgan’s lawsuit; over the course of about eight months, it moved to dismiss the case on procedural grounds, filed an answer to the complaint, and attempted mediation. After these efforts to resolve the case failed, Sundance moved to compel individual arbitration, relying on an arbitration clause printed in the job application form that Morgan submitted when she applied to work for Sundance.

If Sundance had sought to compel arbitration at the beginning of the case, it likely would have gotten its way. But Morgan argued that the company’s delay constituted a waiver of its right to enforce the arbitration agreement. The lower courts resolved this question by applying a test used by a majority of federal appellate courts to resolve situations in which a plaintiff argues that the defendant has lost its right to demand arbitration by waiting too long. That test asked whether the company knew of its right to arbitrate, whether it acted inconsistently with that right, and whether the plaintiff was prejudiced by the delay. The last requirement — a demonstration of prejudice — was unique to arbitration; as Kagan put it, “usually, a federal court deciding whether a litigant has waived a right does not ask if its actions caused harm.”

Sundance undoubtedly knew of its right to demand arbitration when it began to litigate the case. In the trial court, it explained that it had waited because it feared that the language of its arbitration clause would allow Morgan to arbitrate on a collective basis; it reversed course after the Supreme Court dispelled that fear in Lamps Plus v. Varela, which was decided shortly after Morgan’s and Sundance’s unsuccessful attempt to mediate. Accordingly, the district court refused to send the case to arbitration based on its conclusion that Morgan was prejudiced by Sundance’s delay. However, the U.S. Court of Appeals for the 8th Circuit thought Morgan was not prejudiced by the delay, and reversed the district court.

In earlier cases, the court has linked its equal-footing rule to what it has termed the FAA’s “liberal federal policy favoring arbitration.” In this case, Sundance argued that the pro-arbitration policy should trump the equal-footing rule, freeing courts to apply pro-arbitration rules that they did not apply in other contexts. However, the Supreme Court rejected that contention, with Kagan writing that “a court must hold a party to its arbitration contract just as the court would to any other kind.” Further, she continued, “a court may not devise novel rules to favor arbitration over litigation. … [F]ederal policy is about treating arbitration contracts like all others, not about fostering arbitration.”

This decision leaves open several important questions. Among them are which contract-law doctrines are the rights ones to apply — waiver, forfeiture, or perhaps something else — and whether courts should rely on state or federal law in applying those doctrines. That the court did not resolve these questions is unsurprising, given that several justices expressed trepidation about wading into the nuances of contract law during oral argument. But this means that on remand, the 8th Circuit will have to determine which rules govern when a defendant waits to invoke a contractual right, and then apply those rules to determine the effect of Sundance’s delay.

To be clear, Morgan does not undo any of the court’s previous pro-arbitration decisions, of which there have been many in recent decades. In a sense, it is telling that Sundance’s doubts about its own arbitration clause were resolved by one of those decisions, leading to the company’s belated demand that Morgan resolve her wage-and-hour dispute in individual arbitration. Still, Monday’s decision is significant for its holding that courts go too far when they create new rules to favor arbitration.