Employer Arbitration Agreement Pointers From 2 Rulings
By Kirsten Grossman (October 13, 2020) published as a Guest Article by Law360 Expert Analysis
On Sept. 11 and 14, respectively, the New Jersey Supreme Court and U.S. Court of Appeals for the Third Circuit decided two significant cases relating to the enforceability of arbitration provisions in
the employment context.
Although the decisions address separate issues, both reaffirm the strong federal policy favoring arbitration agreements codified in the Federal Arbitration Act, while they attempt to clarify the conundrum of when a
court versus an arbitrator determines — as the Third Circuit put it — “the arbitrability of arbitrability.”[1]
In Flanzmen v. Jenny Craig Inc.,[2] the New Jersey Supreme Court addressed the enforceability of an individual employee’s arbitration agreement where it failed to identify an arbitrator, an arbitration organization to conduct the arbitration, or the process for the parties to select an arbitrator.[3] The New Jersey Appellate Division relied heavily on a 2016 appellate division decision[4] to hold that the agreement’s failure to identify an arbitral forum — such as the American Arbitration Association — was fatal and
rendered the agreement unenforceable.[5]
The New Jersey Supreme Court disagreed and reversed.[6] The court first addressed the threshold issue of whether the “agreement to arbitrate all, or any portion, of [the] dispute is ‘the product of mutual assent.'”[7]
The court observed that, like the Federal Arbitration Act, the New Jersey Arbitration Act,[8] in addition to “enunciat[ing] the same policies favoring arbitration,” also contains a procedure by which the court, upon application by a party, can appoint the arbitrator.[9] The court determined there was no basis to invalidate the parties’ otherwise clear and unmistakable agreement to arbitrate where this default provision provided an alternate mechanism to appoint an arbitrator when the agreement is silent.[10]
Although the court noted that the inclusion of the contemplated arbitration process would have “enhance[d] the clarity” of the agreement, the agreement met the requirements to be enforceable under New Jersey contract law.[11]
The Third Circuit would address the same threshold issue of mutual assent three days later. However, the Third Circuit’s analysis involved a far more convoluted — and mind-bending — procedural context. The question presented in MZM Construction Co. Inc. v. New Jersey Building Laborers’ Statewide Benefit Funds[12] was whether the court or arbitrator decides if an agreement to arbitrate exists.
In MZM Construction, the arbitration agreement at issue referenced another agreement that included an arbitration provision empowering an arbitrator to decide whether an agreement to arbitrate exists. In other words, the dispute involved an alleged agreement within an agreement.
The plaintiff, MZM’s president, signed a short-form agreement, or SFA, with the New Jersey Building Laborers’ Statewide Benefit Funds in 2002.[13] The SFA consisted of a single page. It did not contain any other substantive provisions, but incorporated by reference (but did not attach) a lengthy collective bargaining agreement and its unsigned successor CBA dated 2002.[14]
MZM’s president later testified that she had felt pressured to sign the SFA by a threatened work stoppage on a project at the Newark Liberty International Airport, and she believed (and was told by the union) that the SFA only applied to the airport project.[15] The record contained no evidence that MZM’s president ever saw the unsigned 2002 CBA.
A dispute arose years later over the amount of MZM’s contributions to the defendant funds between 2001 and 2018.[16] The defendant funds audited MZM’s books, identified a significant shortfall, and claimed MZM owed approximately $230,000 in contributions.[17]
The defendant funds based their claim on the signed SFA, which incorporated the unsigned 2002 CBA.[18] It also invoked a provision in the 2002 CBA permitting it to arbitrate its collection dispute with MZM.[19] MZM filed a petition in the U.S. District Court for the District of New Jersey to enjoin the arbitration and for declaratory judgment that it was not bound by the unsigned 2002 CBA.[20] The defendant funds moved to dismiss and opposed the application for injunction.[21]
The issue before the district court was whether the court or an arbitrator should decide the threshold issue of whether an agreement to arbitrate exists.[22] The district court determined that since MZM had alleged “fraud in the execution” of the alleged agreement as opposed to “fraud in the inducement,” the court — not an arbitrator — should determine the initial question of whether an agreement to arbitrate existed.[23]
The district court granted a preliminary injunction to preserve the status quo, later enjoined the arbitration, denied the motion to dismiss, and ordered expedited discovery on the issue of arbitrability.[24] The defendant funds appealed.[25]
The Third Circuit began its analysis by acknowledging the “strong federal policy in favor of compelling arbitration over litigation” and observing that the district court had not ruled on the merits of MZM’s arbitrability claim.[26] It stated that requiring the parties to litigate the arbitrability issue in court may deny the defendant funds the right to arbitrate that issue.[27] To determine whether that was proper, the Third Circuit was required to unwind years of U.S. Supreme Court and Third Circuit jurisprudence on the issue.
The court began its analysis with the severability principle enunciated by the U.S. Supreme Court in 1967 in Prima Paint Corp. v. Flood & Conklin Manufacturing Co. Under the severability principle, an arbitration clause is deemed severable and independently enforceable from the rest of the contract in which it is contained (the container contract).
The severability principle provides that a party cannot avoid arbitration by merely challenging the container contract. Rather, the party must specifically challenge the arbitration clause itself.[28] As a result of Prima Paint, “a claim of fraud in the inducement of the arbitration clause is for the court to decide, but a claim of fraud in the inducement of the container contract is for the arbitrator.”[29]
The Third Circuit subsequently held in Sandvik AB v. Advent International Corp. in 2000 that if the formation or existence of the container contract is at issue, the court must decide fraud-in-the-execution issues unless there is a clear and unmistakable delegation of that authority to the arbitrator. This principle is known as competence-competence or arbitrating arbitrability.[30]
In 2010, the U.S. Supreme Court in Rent-A-Center West Inc. v. Jackson held that parties could accomplish this allocation by including a delegation provision in the agreement that clearly vests the arbitrator(s) with exclusive authority to decide arbitrability.[31]
It is the intersection of the severability doctrine and arbitrating arbitrability principle in MZM Construction that led the Third Circuit to the complex and mind-bending question: Does the court or arbitrator determine the arbitrability dispute if the formation of the container contract is challenged, but the container contract itself includes a delegation provision authorizing the arbitrator to decide the issue?[32]
The defendant funds argued that because MZM challenged the validity of both the SFA and the 2002 CBA (the container contract), but failed to specifically challenge the delegation provision (the agreement to arbitrate arbitrability), the issue should be decided by the arbitrator(s).[33] MZM argued that its fraud-in-the-execution challenge to the validity of the entire agreement — the SFA incorporating the 2002 CBA, which included both the arbitration and delegation provisions — required the court to decide the arbitrability
issue.[34]
The Third Circuit agreed with MZM and the district court that the decision belonged with the court. It determined that Sandvik compelled this conclusion, which was also consistent with Rent-A-Center.[35]
In so holding, the Third Circuit reaffirmed its holding in Sandvik that that severability doctrine simply does not apply when the issue is whether the parties mutually assented to the container contract.[36] As the court noted, “[i]t can hardly be said that contracting parties clearly and unmistakably agreed to have an arbitrator decide the existence of an arbitration agreement when one of the parties has put the existence of that very agreement in dispute.”[37]
The court further noted that the U.S. Courts of Appeals for the Fourth, Fifth, Sixth and Eighth Circuits have come to the same conclusion: Courts retain authority to decide the question of mutual assent to a contract containing or incorporating a delegation provision.[38]
The interplay of MZM Construction and Flanzmen offer several important lessons.
First, before signing any agreements, a party must read and understand the agreement and all documents attached or incorporated by reference. While this seems like common sense, following that basic guidance here likely would have saved the parties in MZM an expensive litigation regarding a nonsubstantive threshold issue.
Moreover, while the Third Circuit held that the arbitrability issue was for the court, this does not mean the court is where the case will ultimately proceed. The district court may conclude that MZM assented to arbitration and compel the matter to arbitration.
Second, before signing, parties to an arbitration agreement must be sure they understand the benefits — and potential downsides — of arbitration with respect to all types of disputes that could potentially be arbitrated under the terms of that agreement to avoid buyer’s remorse. In many of the cases in which parties challenge arbitrability, those challenges appear to arise out of a dissatisfaction with the arbitration venue, which should have merited more consideration before the agreement was signed, not after a dispute arose.
Parties should never assume that they can simply get out of an arbitration provision later by challenging it in court.
Finally, when it comes to arbitration provisions, more is more. The arbitration provision should be as detailed as possible and designate an arbitration forum as well as a backup forum, and clearly designate whether the issue of arbitrability is delegated to the arbitrator.
Kirsten McCaw Grossman is head of the restrictive covenant practice group at NukkFreeman & Cerra PC.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] 9 U.S.C. § 1 et seq.
[2] — A.3d — (2020), 2020 WL 5491899 (September 11, 2020).
[3] Id. at *3.
[4] Kleine v. Emeritus at Emerson, 445 N.J. Super. 545 (App. Div. 2016). In Kleine, New
Jersey’s Appellate Division invalidated an arbitration agreement because the parties’
designated arbitration forum, the AAA, had announced prior to the execution of the
agreement that it would no longer handle the types of disputes at issue unless the parties
agreed post-dispute. Id. at 552.
[5] Id. at *11.
[6] Id. at *11-12.
[7] Id. at *10.
[8] N.J. Stat. Ann. §§ 2A:23B-11, 2A:23B-15.
[9] Id. at *8-9.
[10] Id. at *9-10 (citing Atalese v. U.S. Legal Services Group, L.P., 219 N.J. 430, 443, 99
A.3d 306 (2014)).
[11] Id. at *12.
[12] — F.3d —, 2020 WL 5509703 (3d Cir. September 14, 2020).
[13] Id. at *1.
[14] Id.
[15] Id. at *2. MZM’s President testified that the local union representative told her that the
SFA was a “single project” agreement which she needed to sign because the union had
“nothing on record” for the Newark Airport job. Id. MZM’s President further claimed that the
union never told her it needed a “statewide CBA” and that the union was aware that MZM
was an “open shop.” Id.
[16] Id.
[17] Id. at *2.
[18] Id.
[19] Id.
[20] Id. MZM claimed it never saw the CBA or the 2002 CBA but rather relied upon the
union representatives characterization of the SFA when signing it. Id.
[21] Id. at *3.
[22] Id.
[23] Id.
[24] Id.
[25] The Defendant Funds also moved for reconsideration and an order enforcing the
arbitration agreement based on “newly discovered evidence,” which the District Court
denied. Id. at *3.
[26] Id. at *5.
[27] Id. at *4.
[28] Id. (citing Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 403-06, 87 S.
Ct. 1801, 18 L.Ed.2d 1270 (1967).
[29] Id. (citing Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 403-04, 87 S.
Ct. 1801, 18 L.Ed.2d 1270 (1967).
[30] Id. at *6-*7 (citing Sandvik AB v. Advent Int’l Corp., 220 F.3d 99, 104 (3d Cir.
2000), China Minmetals Materials Imp. & Exp. Co. v. Chi Mei Corp., 334 F.3d 274, 281, 287
(3d Cir. 2003) and Sandvik, 220 F.3d at 111 (quotation omitted)).
[31] Id. at *7 (citing Rent-A-Ctr., W., Inc. v. Jackson, 561 U.S. 63, 68-69, 72, 130 S.Ct.
2772, 177 L.Ed.2d 403 (2010)).
[32] Id. at *8.
[33] Id.
[34] Id. at *9.
[35] Id.
[36] Id.
[37] Id. at *10 (citing Rent-A-Ctr., W., Inc. v. Jackson, 561 U.S. 63, 69, n.1, 130 S.Ct.
2772, 177 L.Ed.2d 403 (2010)).
[38] Id.