Last week’s decision by the US Ninth Circuit Court of Appeals that incorporation of the UNCITRAL Rules in an arbitration clause is considered as a matter of federal arbitration law to be a clear and unmistakable delegation to the arbitrators of exclusive power to decide the scope of arbitrable issues — [Oracle America, Inc. v. Myriad Group A.G., 2013 WL 3839668 (9th Cir. July 26, 2013)] — may at first blush appear to be uneventful news, at least for practitioners who do not practice in the 9th Circuit or often frequent its federal district courts to pursue or resist arbitration. The view from 37,000 feet — good for admiring California’s High Sierras, less ideal for appreciating its federal arbitration jurisprudence — might be that this is only an instance of another appellate court leaping on a bandwagon already occupied by most of its “sister” federal appellate circuits. But this case had some curious elements that the Court did not address.

Greatly simplified, this case involved an IP license for a Swiss company to make use of Java software, one of Oracle’s major products.  But the arbitration clause in the license was also a litigation clause. It said that all disputes under the license shall be arbitrated, except that either party could opt to litigate a dispute relating to that party’s “Intellectual Property Rights.” And it said that in a case eligible for litigation, if litigation were elected the court’s jurisdiction would be exclusive.

The clause provided for arbitration under the UNCITRAL Rules, and those Rules of course provide that arbitral tribunals have power to rule on issues of their own jurisdiction. I have referred, in recent posts, to the principle that the adoption of such rules delegates arbitrability to the arbitrators as the Incorporation-by Reference Principle. I will continue to use that shorthand here. Dutifully, your Commentator reviewed all the Incorporation-by-Reference Principle First Options “arbitration of arbitrability” case law cited in the Ninth Circuit’s decision. Not one of the arbitration clauses involved in those cases was this type of hybrid arbitrate-unless-you-litigate formulation. So, the Ninth Circuit might have analyzed in its opinion, but did not, what were the reasonable expectations of the parties as to the forum in which arbitrability would be determined if Oracle filed a trademark/copyright infringement suit in federal court, as it did, and if Oracle alleged, as it did, that the action fell within the express elective litigation carve-out for disputes involving its IP rights.

This case highlights how very little the Incorporation-by-Reference Principle has to do with the actual intentions of the parties. The courts have embraced the Principle largely without analyzing why the parties’ adoption of an arbitration rule of compétence-compétence that empowers arbitrators to decide jurisdiction must necessarily divest a court of such power. That position is a matter of interpretation, which is really to say it is a matter of federal pro-arbitration policy. A main tenet of federal arbitration law is that any doubts about the scope of arbitrable issues are to be resolved in favor of arbitration.  Thus, if an adopted arbitral compétence-compétence rule like UNCITRAL Rule 23(1) (2010) makes arbitrability arbitrable, any doubts about whether that Rule makes the Tribunal’s jurisdiction over arbitrability exclusive are to be resolved in favor of exclusivity.  But this means that what the US federal courts are treating as “clear and unmistakable evidence” is partly evidence and partly presumption — or, stated another way, the “evidence” is only “clear and unmistakable” because of a policy-based rule of construction in the absence of which one would be hard-pressed to characterize such compétence-compétence rules as conferring exclusive arbitrability jurisdiction on arbitrators.

Further, even though most courts have not so stated expressly, a critical contextual element of the Incorporation-by-Reference Principle is that the arbitration clause broadly commits all disputes between the parties to arbitration without material exception. When the contract does not expressly sanction any entrée to a judicial forum for merits adjudication, there is considerable appeal to the position that the arbitral compétence-compétence rule, in context, represents an exclusive forum choice for arbitrability disputes.

Given these dimensions of the Incorporation-by-Reference Principle, it is curious that the Ninth Circuit panel did not spend any energy on the question of whether the express litigation carve-out in the arbitration clause had any significance as evidence of the parties’ intentions. The fact that the panel did not do so does not necessarily mean that the panel’s decision is unsound. It does however confirm our understanding that the Incorporation-by-Reference Principle, as an implementation of the First Options “clear and unmistakable evidence” test, is not genuinely a rule of evidence or a barometer of the intentions of the parties, but a policy-based pro-arbitration federal common law rule on the allocation of power between courts and arbitrators. It may well be a good thing for there to be such a rule. But if we admit that the rule is policy-driven, then we might also hope that the US Supreme Court in a proper case would hold that First Options is a precedent that has outlived its useful life and should be supplanted by express rules of construction, emanating from the FAA, for deciding on the allocation of arbitrability jurisdiction between courts and arbitrators.

Tonight Arbitration Commentaries brings its readers the annual Midsummer Night’s Dream post. In tonight’s dream, an arbitration clause drifts in and out of view through an undulant layer of fog. In a fleeting moment of legibility, we see that the clause provides for arbitration under the UNCITRAL Rules in New York. Before we can read further to see if any appointing authority is designated, the dense misty curtain envelops the page anew. But a voice, resounding and echoing, instructs us: ” NOOOOOOO……”

The scene shifts. Two pinstripe-clad figures, one in gray, one in blue, appear on the steps of a forbidding massive edifice marked by the letters “PCA.”  In time, a white-clad monk-like form, hooded and faceless, appears at an open window on a upper floor, and unfurls a white sheet marked in red white and blue letters “SDNY.”

Could this be?  Could it one day come to pass that the US District Court in Manhattan would be designated by the Permanent Court of Arbitration as the appointing authority in an international case under the UNCITRAL Rules? Please indulge this fantasy a moment longer, as there is method to this madness.

Chapters One and Two of the Federal Arbitration Act contain provisions for judicial power to appoint arbitrators. But there are material differences. Chapter Two, implementing the New York Convention, simply provides in Section 206 that a court having jurisdiction, in an action or proceeding that falls under the Convention, may appoint arbitrators in accordance with the provisions of the agreement. So if the Secretary General of the Permanent Court of Arbitration, upon application of a party in a case under the UNCITRAL Rules that (from an FAA Chapter Two perspective) falls under the Convention, did designate a US federal district court as the appointing authority, there would be no jurisdictional obstacle to the court’s fulfillment of the mission. That would not be the case under Chapter One, Section 5 of the FAA. That original domestic arbitration enactment from 1925 envisioned a judicial role in the appointment of arbitrators only in default — if the parties did not specify a method of appointment, or if the agreed method became unworkable such that the parties’ intent to arbitrate would be stymied unless the court lent assistance.

That difference is worth understanding, because the limited judicial role in appointments under FAA Chapter One underlies a well-developed body of federal jurisprudence holding that the federal courts will not intervene in an ongoing arbitration to remove and replace an arbitrator on grounds of bias or lack of independence.  US courts have read Section 5 in combination with Section 10(a)(2) which permits the court to vacate an award based upon the “evident partiality” of an arbitrator, to require the conclusion that a party has no judicial redress for arbitrator bias during the arbitration, but only the right to seek annulment of the award. The courts have injected a policy component into the statutory analysis, reasoning that multiple challenges to consecutively-appointed arbitrators might be employed as a tactic to paralyze the arbitration process. For a very recent installment of this jurisprudence, read the opinion of a Boston federal judge in National Casualty Co. v. OneBeacon American Ins. Co.,  2013 WL 3335022 (D. Mass. July 1, 2013). [Also read a case discovered by your Commentator after this post was written: PK Time Group, LLC v. Robert, 2013 WL 3833084 (S.D.N.Y. July 23, 2013)]. In National Casualty, a reinsurance case, the parties had  agreed upon a rather convoluted process to break a deadlock on selection of the presiding arbitrator that involved each party-appointee submitting a list of candidates that would be ranked by the other. But having not selected an institutional provider of arbitration rules, they had no private mechanism for challenge. The court, citing the line of cases discussed here, refused to take on that role, and thus denied an application to strike one presiding arbitrator candidate from the list.

This judicial position of abstention has not caused much outcry because most arbitration in the US is administered by private organizations like the AAA whose rules provide a challenge process. And the abstention position is in part the legacy of the pre-2004 era of arbitrator ethics in the US, when the party-appointed arbitrator was presumed to be partisan. Courts understandably had little appetite to be involved in sorting out tolerable and intolerable partisanship. And at a time in history when more domestic arbitrations were one-day events with minimal discovery, the costs of new proceedings in the rare instances when an arbitrator was found, post-award, to have been unacceptably biased, were not so great as to evoke much organized consternation.

But that was then. Today it seems rather regrettable that parties facing multiple years of proceedings and millions of dollars in attorney and arbitrator fees should have to complete the case before a tribunal that includes a biased arbitrator if they have not agreed to use rules that include a challenge process.

This post will not elaborate further the arbitration policy case for discarding the current doctrine. The modest point made here is that none of this doctrine appears to have been developed or applied in international cases falling under the Convention and FAA Chapter Two. [The Court in the newer PK Time Group case, above-mentioned in brackets, failed to acknowledge that the case fell under the Convention, and failed to analyze it under FAA Chapter Two, as the case evidently reached federal court upon removal from New York state court on the basis of diversity.] At the very least, in a case such as the one in my Midsummer Night’s Dream, where the UNCITRAL Rules are used including Article 13(4) providing that the appointing authority shall rule on any challenges based on an arbitrator’s alleged lack of independence or impartiality, there would seem to be no compelling reason for the court to decline to entertain such an application. And indeed by entertaining that application the court would be enforcing the parties’ agreement according to its terms. Courts could and should distinguish the FAA case law on the basis that it was not developed in cases under the Convention and Chapter Two. Further, courts carrying out a mandate as appointing authority that is derivative of the parties’ agreement should be reluctant to construe Section 10(a)(2) as an implied prohibition on addressing “evident partiality” during the course of the proceedings. After all, in the context of Chapter Two, Section 10(a)(2) applies only to the extent it is not in conflict with Chapter Two, and an application of that Section to render unenforceable an agreement of the parties to have the appointing authority rule on arbitrator challenges would be just such a conflict.

A Sweet Dream on a mid-summer night.

In the Concepcion case in 2011 [AT&T Mobility LLC v. Concepcion, 131 S.Ct. 1740], five Justices of the Supreme Court of the United States agreed that the FAA pre-empts a rule of state law that makes an arbitration agreement unconscionable if the agreement prohibits class arbitration.  The actual implications of Concepcion for class arbitration remain murky, as the Supreme Court’s other recent decisions relating to class arbitration have been context-specific. Thus in Stolt-Nielsen the Court’s decision (5-3) was “anti-” class arbitration [Stolt-Nielsen S.A. v. Animalfeeds International Corp., 559 U.S. 662 (2010)], because the tribunal had no basis in the contract to order it (the parties having stipulated that they had no agreement about class arbitration). But in Oxford Health Plans (8-0) [Oxford Health Plans LLC v. Sutter, 133 S.Ct. 2064 (Jun. 10, 2013)] the Court’s decision was “pro-” class arbitration because the arbitrator was, rightly or wrongly, construing the contract in deciding that it permitted class arbitration. And in American Express (5-4) [American Express Co. v. Italian Colors Restaurant, 133 S.Ct. 2304 (Jun. 20, 2013)], once more the decision was “anti-” class arbitration, this time because the majority was unconvinced that a class proceedings waiver so seriously inhibited private civil enforcement of the antitrust laws as be a violation of public policy.

Into this summer stew we must now blend a new decision of a panel in the U.S. Ninth Circuit Court of Appeals (including, sitting by designation, the trial judge in the Stolt-Nielsen case), concerning FAA pre-emption (or not) of state law rules that treat as unconscionable clauses in consumer contracts that purport to waive “fundamental” rights including, but not limited to, the right to a trial by jury. (Mortensen v. Bresnan Communications LLC, 2013 WL 3491415 (9th Cir., July 15, 2013)).  At issue in Mortensen was the arbitration clause in a consumer contract for broadband internet service. The clause required all claimants to be named, and prohibited both class proceedings or consolidation. But plaintiffs’ challenge to the clause was not specific to the class and consolidation barriers.  Instead, plaintiffs invoked a Montana state law doctrine of the unconscionability of consumer contracts of adhesion. The essence of the Montana doctrine was that any clause in an adhesive consumer contract that purports to deprive a consumer of a fundamental right or a reasonable expectation will be ineffective unless the proposed deprivation is separately and fully explained before the contract is signed.

The U.S. District Court in Montana denied the motion to compel arbitration, holding that application of Montana’s rule was within the “savings” clause of FAA Section 2 (i.e. that arbitration agreements shall be valid “save upon such grounds as exist in law or in equity for the revocation of any contract”). In this decision, the Ninth Circuit held that Concepcion‘s reasoning required enforcement of the arbitration clause and federal pre-emption of the Montana rule. The Mortensen Court’s distillation of the holding in Concepcion is that when a state law unconscionability rule has a negative impact on enforceability of arbitration agreements, and that impact is disproportionate to the impact on other agreements, the rule is pre-empted by the FAA even if it is facially neutral in its application to arbitration agreements and other agreements. The Ninth Circuit panel’s interpretation of Concepcion — reading that decision as an extension of FAA pre-emption to state law rules of unconscionability that have a disproportionate anti-enforcement impact on arbitration agreements —  was seen by the panel as critical to the outcome. That is so because the panel did not think the Montana rule depended on the unique nature of arbitration agreements. In the panel’s view, the Montana rule as stated by Montana’s courts might apply to a wide variety of matters about which a consumer might have “reasonable expectations,” but in fact the Montana rule had evolved in cases where parties challenged arbitration clauses. So another look at what Concepcion actually held seems in order, having in mind that there are at least four judges on the Court, the dissenters, who may have an interest in taking up Mortensen or a case like it to define more precisely the border between FAA pre-emption and state law unconscionability/public policy in a consumer contract setting.

The Mortensen panel focused its attention on a passage in Concepcion wherein the Supreme Court had (i) posited that Section 2’s “savings” clause does not “save” state law unconscionability rules that “rely on the uniqueness of an arbitration agreement,” (ii) illustrated this point by reference to hypothetical state rules treating as unconscionable those arbitration agreements that do not provide for judicially monitored discovery or use of the Federal Rules of Evidence, and (iii) observed that such rules could not be defended as an application of a general policy against exculpatory clauses, because “[i]n practice…the rule would have a disproportionate impact on arbitration agreements.” 131 S. Ct. at 1747. The critical sentence in Concepcion, however, and arguably the essence of its holding, comes a few paragraphs later, when the Court states: “Requiring the availability of classwide arbitration interferes with fundamental attributes of arbitration and thus creates a scheme inconsistent with the FAA.” Id. at 1748. And the most sensible reading of Concepcion, despite the majority’s much-criticized attacks on the competence of arbitrators to manage and efficiently resolve complex high-value class actions, is that the “fundamental attribute” interfered with by California’s unconscionability rule was not bi-lateral arbitration between two contracting parties, but the ability of the parties to decide whether or not to arbitrate only according to that bi-lateral model.  “Disproportionate impact” does not appear to be the guiding principle in the Concepcion decision.

So viewing Concepcion, one might ask two questions about the Ninth Circuit’s decision in Mortensen? Was the outcome mandated by Concepcion, as the panel believed it was? And was the outcome correct in any event? On the first question, it is significant that the Montana rule had nothing to do with the design of the arbitration process. The Montana rule was only about the indicia of contractual consent in adhesive consumer contracts. As such, it seems that Concepcion was not directly on point. The problem with the Montana rule, however, is that it was what one might call a wolf in sheep’s clothing. Montana’s courts, motivated by antagonism to take-it-or-leave-it arbitration clauses in adhesive contracts between companies and consumers, fashioned a common law rule about contractual assent that was facially neutral as between arbitration and other “fundamental rights” or “reasonable expectations,” but had as its specific objective to eradicate the formation of an arbitration agreement through a consumer’s giving assent merely by accepting the purchased product or service. The undressed wolf, i.e. the Montana rule, is the sort of traditional anti-arbitration state law rule that the Supreme Court has found pre-empted in many pre-Concepcion cases. It was little more than a thinly-veiled rule that arbitration is unconscionable because it deprives consumers of the right to a trial by jury. Thus, it appears that the outcome in Mortensen is correct.

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New York lawyers reading this post should be alerted to a similar issue that may eventually come before New York’s courts. Part 137 of the Rules of the Chief Administrator of the New York Courts provide for arbitration of attorney-client fee disputes mainly at the election of the client and subject to judicial de novo review if the client is unsatisfied with the outcome. Part 137 also purports to specify disclosure requirements imposed upon an attorney if the attorney wishes to make an agreement with the client for binding arbitration of fee disputes other than Part 137 arbitration. In particular the attorney must specifically inform the client of the right to arbitrate under Part 137 and provide to the client a copy of the Part 137 arbitration procedures. If the FAA applies to the attorney-client engagement agreement’s arbitration clause, does Part 137 (like the Montana rule) establish a special anti-arbitration rule for client assent that is pre-empted by the FAA?  Arguably it does, as it constitutes an unacceptable interference with the rights of attorney and client to agree to resolve fee disputes through ordinary commercial arbitration.