The Federal Arbitration Act (“FAA”) guarantees the enforceability of private agreements to arbitrate, but guarantees a federal forum to compel arbitration only some of the time. State courts are bound to give effect to the FAA in enforcing agreements to arbitrate, and limitations on federal subject matter jurisdiction often will require that they do so.
Section 4 of the FAA provides for a civil action whose sole purpose is to obtain an order to compel a recalcitrant party to arbitrate. No court action concerning the underlying dispute need be pending; the Section 4 petition is an independent proceeding. It permits such an action to be
brought by a party to an arbitration agreement against another party to the same agreement who has “fail[ed], refus[ed], or neglect[ed]” to arbitrate a dispute between the parties that is covered by their arbitration agreement.
But Section 4 contains an important limitation: It may only be invoked to get relief in a federal district court if “save for [the arbitration] agreement” that court would have federal subject matter jurisdiction of “a suit arising out of a controversy between the parties.”
Application of Section 4 — and especially the requirement for federal jurisdiction based on a hypothetical suit on the merits that has not been commenced in federal court — has vexed and divided federal courts for many years. On March 9, 2009, the Supreme Court of the United States in Vaden v. Discover Bank, 2009 U.S. LEXIS 1781, 173 L.Ed. 2d 206 , eliminated some of this confusion, at least for cases where the parties are already involved in state court litigation over the ostensibly arbitrable controversy.
The Court, in an opinion by Justice Ginsburg joined by four other justices, held that: (1) the federal court considering its subject matter jurisdiction over a Section 4 petition should “look through” (or past) the controversy over arbitrability as described in the petition, to determine if the actual merits controversy involves a question of federal law, and (2) where a state court litigation is already pending, whether such a “federal question” would be presented in “a suit concerning the subject matter of the controversy between the parties” must be determined according to the standards for remove to federal court of a pending state court suit: i.e. the question of federal law must appear from the well-pleaded allegations of plaintiff’s state court complaint, not from the defendant’s answer or counterclaims.
It was the first point that prompted the Supreme Court to review the case. Federal Courts of Appeals had reached different outcomes on whether the District Court could “look through” the Section 4 petition to the actual underlying controversy for the purpose of ascertaining whether subject matter jurisdiction exists. On this point the Court was unanimous in holding that the “look through” approach is correct. But the complaint-versus-counterclaim conundrum turns out to have been the more interesting and controversial issue – and while it is not explicit in the Court’s opinions, the underlying tension appears to be over the role state courts should be permitted to play in enforcing agreements to arbitrate that are governed by the FAA.
The Vaden case began as an ordinary state court/state law lawsuit in Maryland by Discover, to recover unpaid credit card charges. The amount in dispute was below the $75,000 minimum for federal diversity jurisdiction. The customer asserted purported class action counterclaims for violations of Maryland’s credit laws. Discover then elected to arbitrate only the counterclaims, and filed in federal court a petition under Section 4 to compel arbitration. In support of the requirement of federal jurisdiction over the underlying dispute, Discover correctly alleged that the counterclaim was governed exclusively by federal banking law, and that Maryland’s credit laws were pre-empted.
The District Court held that courts considering Section 4 petitions to compel arbitration should “look through” the petition’s description of the controversy to determine the actual controversy. But the District Court held, and the Fourth Circuit agreed, that the relevant “controversy” for federal jurisdiction analysis is only the singular dispute that the Section 4 petitioner seeks to arbitrate, even if the “controversy” pending in the state court was commenced based on state law claims made by the party seeking to compel arbitration.
On the latter point, the Court, by a narrow 5-4 margin, held that where the controversy has already spawned litigation in a state court, the controversy must be viewed, for purposes of subject matter jurisdiction to adjudicate under the FAA, the same way as if removal of that action had been sought for adjudication of the merits: the state court plaintiff’s pleaded allegations are dispositive, and the counterclaim is irrelevant. In a phrase most succinctly capturing its holding, the majority opinion states: “Under the well-pleaded complaint rule, a completely preempted counterclaim remains a counterclaim and thus does not provide a key capable of opening a federal court’s door.” 2009 U.S. LEXIS 1781 at *34. It is important to note, however, that the Court’s holding is not limited to cases where an action is already pending. More broadly stated, the Court’s holding is that the District Court must consider not the merely the controversy a Section 4 petitioner seeks to arbitrate, but the entire controversy between the parties. Where state court litigation is already pending, however, the question of what federal claims the Section 4 petitioner might assert as a plaintiff becomes what federal claims did the state court plaintiff actually assert in the state court complaint.
Chief Justice Roberts, joined by three members of the Court, wrote in dissent from the second branch of the Court’s holding. For the dissenters, the words “a suit arising out of the controversy” calls for assessment of hypothetical jurisdiction over the particular dispute petitioner desires to arbitrate, even if an actual suit is already pending based on claims the petitioner does not seek to arbitrate. In the dissenters’ view, the majority’s approach unduly limits the federal court’s role in enforcing arbitration agreements. The majority opinion, in contrast, applies the words of the statute to the case presented: the “controversy between the parties” in this context necessarily included all claims in the state court action, and thus the question of hypothetical subject matter jurisdiction was the same as whether the state court case could be removed to the federal court. What seems to be implicit in the dissenters’ position is that the justification for applying “well-pleaded complaint” rule, i.e. to limit the federal court workload by limiting access, is not as compelling under the FAA, where the federal court’s role is mainly to decide whether to compel arbitration or to enforce an award.
The majority observed that Plaintiff had recourse in the Maryland courts to compel arbitration, and that the command of Section 2 of the FAA that private arbitration agreements shall be enforced is fully applicable in state courts (even though the procedure prescribed by the state, not
section 4 of the FAA, would govern the proceeding). The dissent reflects, on the other hand, a concern based on experience that state courts are not as uniformly and consistently vigilant as federal courts in enforcing agreements to arbitrate.
The Court’s decision in Vaden is mainly significant for domestic arbitration. It serves as a reminder that the “domestic” FAA is not a jurisdiction-giving statute, and that state courts play an important role in the enforcement of arbitration agreements and awards to which the FAA applies. As to awards, federal jurisdiction depends not only on the existence of a federal question in the arbitration, or diversity of citizenship of the parties, but also that there be language in the arbitration agreement whereby the parties consent to confirmation of the award in the federal district court.
Section 4 petitions are relatively rare in relation to international arbitrations. Most international arbitration rules provide that the tribunal may proceed to enter an award even if a respondent fails to appear, so long as there is adequate notice of the proceedings and the Claimant proves its case. For this reason, the international arbitration claimant generally is not “a party aggrieved” (in the words of Section 4) by the adverse party’s refusal to participate. Further, if the arbitration-dodging party to an agreement governed by the New York Convention has already started an action in a U S. Court, relief to compel arbitration and stay or dismiss the action is available under Article II (3) of the New York Convention and Section 206 of the FAA. Section 206 simply provides for a motion to compel arbitration, and does not require as does Section 4 that the movant be “aggrieved by a failure, neglect, or refusal” of the adverse party to proceed to arbitration.
Thus, there is little that Section 4 can accomplish in a New York Convention case that cannot be accomplished through Section 206 alone. Some litigants have conceived of a Section 4 petition to compel arbitration as the equivalent of a request for an anti-suit injunction to stop foreign litigation of an arbitrable dispute. But the courts have rejected this, and limited Section 4 relief to an affirmative direction to arbitrate, without corresponding directions to discontinue parallel
Thus, the Vaden decision may be received by international arbitration practitioners as an item of “domestic” FAA arcana. But there are many cases where the applicability of the New York Convention is uncertain, notably when two or more U. S. parties are involved, their citizenship
is non-diverse or not completely diverse, and the Convention applies only if the underlying transactions involve some “substantial” foreign or international element. Indeed, two U.S. parties might proceed to arbitrate under ICDR or ICC international arbitration rules, only to learn at the enforcement stage that for federal jurisdiction purposes there is doubt about whether the cases arises under the New York Convention.
For parties who must, or may have to, look to Section 4 for a federal forum to compel arbitration, the lesson of Vaden is small but significant: an initial decision to litigate an arbitrable claim in a state court will likely mean that a decision to change course and seek to compel arbitration of all or part of the case is likely to remain a matter for state court determination. This in turn brings into play a host of uncertainties about enforcement of the FAA in courts often more familiar with their own state arbitration statutes and often lacking clear jurisprudence on the interplay of state and federal arbitration law.
For foreign arbitration practitioners viewing the U. S. arbitration law landscape from afar, the uncertainty resulting from overlapping state and federal jurisdiction, and inconsistent state and federal arbitration law, is a defining attribute of American arbitration law. The Vaden decision will likely serve to reinforce this perception.