SC Lawyer, March 2012, #3. The Outrageous Conduct Exception to Arbitration Clauses.

• Author: By James L. ("Lee" Floyd III and Brian Comer

South Carolina BAR Journal

2012.

SC Lawyer, March 2012, #3.

The Outrageous Conduct Exception to Arbitration Clauses

South Carolina LawyerMarch 2012The Outrageous Conduct Exception to Arbitration ClausesBy James L. ("Lee" Floyd III and Brian ComerThe perceived burdens and benefits of arbitration remain subject to intense debate. Regardless of whether a practitioner views arbitration as a fair and efficient means of resolving disputes or as a mechanism that deprives litigants of the right to a jury trial, it is important to remain knowledgeable of recent developments concerning the enforcement of arbitration agreements. Increasing burdens on courts and scarce judicial resources led federal and state legislators to codify a public policy favoring the enforcement of arbitration agreements. See Federal Arbitration Act, 9 U.S.C. 1-16 (2011); South Carolina Uniform Arbitration Act, S.C Code Ann. 15-48-10 to -240 (1978).

Despite this clear policy, the presence of a valid arbitration clause and a dispute within its provisions does not always mean the matter will go to arbitration. In 2007, the S.C. Supreme Court recognized what can be referred to as the "outrageous conduct" exception to the enforcement of arbitration clauses. Aiken v. World Finance Corp. of S.C., 373 S.C. 144, 151, 644 S.E.2d 705, 709 (2007).

The basic exception is fairly simple: a S.C. court should "refuse to interpret any arbitration agreement as applying to outrageous torts that are unforeseeable to a reasonable consumer in the context of normal business dealings." Id. While simple to state, the true breadth of this exception is less clear.

This article provides a brief overview of the Court's decision in Aiken and some observations on several recent cases that interpret and apply the outrageous conduct exception under South Carolina law.

The adoption of the outrageous conduct "rule:" Aiken v. World Finance Corp. of S.C.

In Aiken, the Court considered whether to enforce an arbitration clause where the conduct alleged by the Complaint was particularly egregious. Aiken had entered into a series of consumer loans with the defendants. Two years after Aiken had paid off his final loan with the defendants, employees of the defendants used Aiken's personal information to take out other loans in his name and embezzle the proceeds. 373 S.C. at 147, 644 S.E.2d at 707. Each of the loan agreements contained a conspicuous and broadly-worded arbitration clause. The arbitration clause encompassed any and all disputes, controversies or claims relating to any loan agreement or any prior or future dealings between the parties. Id.

Aiken's Complaint asserted multiple tort law claims, including actions for outrage, unfair trade practices and other negligence based claims. Defendants answered and also moved to compel arbitration. The trial court denied defendants' motion. It concluded Aiken's claims arose from conduct independent from the loan agreement because the misconduct did not take place until after Aiken had satisfied his last loan. Therefore, the arbitration clause did not encompass Aiken's claims.

On appeal, the Aiken Court recites the basic law that state and federal law favors arbitration and that arbitration agreements are subject to the same rules as other contracts. These rules limit arbitration clauses to only those disputes the parties agreed to submit to arbitration. The Aiken Court addressed whether the arbitration clause at issue included the claims pursuant to the "significant relationship" test applicable to "broad" arbitration clauses.

A broad arbitration clause is one that purports to encompass disputes that arise out of or relate to the contract between the parties. To be enforced, a significant relationship must exist "between the asserted claims and the contract in which the arbitration clause is contained." Id. at 149, 644 S.E.2d at 708. The Court held the link between the tort claims and the parties' prior dealings-that the contracts permitted the employees to access Aiken's personal information-was not significant. Id. at 150, 644 S.E.2d at 708. The Court expounded that "but for" causation scenarios will not be sufficient to satisfy this test.

The finding that no significant relationship existed, alone, was sufficient to determine whether the arbitration clause encompassed Aiken's claims. However, the Aiken Court went on to expressly adopt the outrageous conduct exception to arbitration clauses: "Because even the most broadly-worded arbitration agreements still have limits founded in general principles of contract law, this Court will refuse to interpret any arbitration agreement as applying to outrageous torts that are unforeseeable to a reasonable consumer in the context of normal business dealings." Id. at 151, 644 S.E.2d at 709. The Court then held the theft of Aiken's personal information was sufficiently outrageous to be unforeseeable at the time of the loan agreements. Therefore, those claims were not subject to arbitration under the agreement.

The Aiken Court then provided limited guidance to the breadth and application of the rule. It disclaimed that arbitration clauses would still encompass certain intentional torts where the gravamen of the allegations are a breach of the underlying contract. Id. at 152, 644 S.E.2d at 709 (suggesting the arbitration clause would apply to claims such as breach of fiduciary duty or misappropriation of trade secrets). The Court further explained its holding as "only seek[ing] to distinguish those outrageous torts, which although factually related to the performance of the contract, are legally distinct from the contractual relationship between the parties." Id. The Court also warned its decision should not be construed as an assault on the policies favoring arbitration but as promoting a public policy supporting "the procurement of arbitration in a commercially reasonable manner." Id. at 152, 644 S.E.2d at 709.

The Aiken Court described its decision as establishing a "more definitive rule" for applying the significant relationship test. Id. at 151, 644 S.E2d at 709. However, subsequent decisions applying and expanding the rule suggest that "outrageous conduct" is actually an independent exception to enforcing arbitration clauses.

Cases interpreting and applying the outrageous conduct rule: Has the rule transformed into an independent exception to arbitration clauses?

South Carolina's Court of Appeals and Supreme Court have issued a number of opinions implicating Aiken's outrageous conduct rule. These decisions are instructive, and in some cases, arguably expand the rule's application to the point that it encroaches upon the long-standing, statutory policies favoring arbitration.

Since Aiken, the S.C. Supreme Court has held a broad arbitration clause will not encompass claims under the South Carolina Unfair Trade Practices Act (SCUTPA) and fraud claims where the alleged conduct underlying the claims was deemed sufficiently outrageous to fall outside the arbitration clause. Partain v. Upstate Auto. Grp., 386 S.C. 488, 493, 689 S.E.2d 602, 604-05 (2010).

In Partain, the gravamen of the alleged misconduct was that an automobile dealership pulled a "bait and switch," telling Partain he was purchasing one used vehicle while delivering a different vehicle. Interestingly, the Partain Court held this misconduct fell within the arbitration clause and did not even apply the significant relationship test (as that finding made that analysis unnecessary). Id. at 492, 689 S.E.2d at 604 ("Because we find that the factual allegations underlying Partain's claim are encompassed by the terms of the arbitration clause, we need not reach the 'significant relationship' question."). The Court then held the arbitration clause did not apply because the illegal and outrageous actions alleged were unforeseeable to a reasonable consumer and could not have been the type of dispute Partain agreed to submit to arbitration. Id. at 493-94, 689 S.E.2d at 605.

The Court explained: "Partain cannot be held to have contemplated that, in signing the arbitration clause, he was agreeing to arbitrate claims arising from allegedly fraudulent conduct."

Id. at 494, 689 S.E.2d at 605 (emphasis added). Despite the breadth of the foregoing statement that arbitration clauses will not apply to allegations of fraudulent conduct, the Partain Court attempted to curtail the wide-reaching implications of its statement. It emphasized its decision was not "providing an 'end-run' around arbitration clauses" by simply "presenting a claim as a tort." Id. (emphasis added). However, whether this statement truly limits the outrageous conduct exception is debatable. While simply alleging a tort will not fall outside the arbitration clause, Partain supports the position that an arbitration clause cannot (as a matter of law) apply to a complaint alleging fraudulent conduct and unfair trade practices.

Six months after Partain, the Court seemed to reduce the breadth of the outrageous conduct exception through its decision in Timmons v. Starkey, 389 S.C. 375, 378, 698 S.E.2d 809, 810-11 (2010). While encountering facts strikingly similar to those in Aiken, the Court held an arbitration clause in contracts for investment service accounts encompassed claims that a UBS employee misappropriated funds from her account. Significantly, the UBS employee was also the plaintiff's daughter, and plaintiff had signed a durable power of attorney naming her daughter as her attorney-in-fact.

The Timmons Court's analysis is distinguishable from Aiken. Here the Court focused on whether UBS's failure to prevent the misappropriation of plaintiff's funds was outrageous conduct, rather than on the alleged theft from the account. Cf. 373 S.C. at 151, 644 S.E.2d at 709 ("[W]e find the theft of Aiken's personal information by World Finance employees to be outrageous conduct that Aiken could not possibly have foreseen when he agreed to do business with World Finance." (emphasis added)). Viewed through this framework, the Court focused on the fact the daughter was authorized to transfer funds in her capacity as plaintiff's attorney-in-fact and refrained from finding UBS engaged in illegal or outrageous conduct. Id. at 378, 698 S.E.2d at 810-11. While this decision arguably cautions against expanding the scope of the outrageous conduct exception, the unique factual scenario presented likely reduces its precedential value.

There is also authority refusing to apply the outrageous conduct exception where the allegations of the complaint, alone, do not require categorizing the alleged misconduct as outrageous or illegal. MCE Auto., Inc. v. Wetherald, No. 6:10-cv-00409-JMC, 2010 WL 5257233, at *4 (D.S.C. Dec. 17, 2010).

In MCE Automotive, the Court compelled arbitration of a suit premised on allegations that the defendant took advantage of a vulnerable adult through a series of transactions before the adult was found legally incompetent. Presumably the misconduct, if proven, would have been deemed outrageous. Yet the Court found the exception inapplicable because determining whether the alleged misconduct was "illegal and outrageous first requires a determination of Ms. Kaufman's mental capacity to contract." Id. at *4 (internal quotation marks omitted). Without a specific challenge to the arbitration clause, the Court refused to assess this issue.

It is noteworthy that the absence of the adult's legal competence to contract at the time of the transactions seems to be inherent in the alleged misconduct. Therefore, assessing whether the alleged misconduct was outrageous would presumably focus on the nature of the alleged misconduct and require analyzing the issue before compelling arbitration.

A recent decision by the Court of Appeals, Wachovia Bank v. Blackburn, 394 S.C. 579, 716 S.E.2d 454 (Ct. App. Aug. 24, 2011), showed a renewed expansion of the outrageous conduct rule beyond arbitration clauses and into contractual clauses waiving a right to a jury trial. Id. at 589-90, 716 S.E.2d at 459. This expansion seems particularly appropriate in this context. Unlike arbitration clauses, jury trial waivers have traditionally been strictly construed as involving a substantial right and lack the support of state and federal statutes favoring their enforcement. Id. at 585, 716 S.E.2d at 457-58.

The decisions since Aiken can seem difficult to logically reconcile. However, they make it clear that whether the outrageous conduct exception precludes enforcing an arbitration clause will depend upon a highly fact-specific inquiry. The alleged conduct, and not the labels on the causes of action, will determine the rule's application.

These decisions also make it clear that the rule or exception is easily stated, but its interpretation and application have been more difficult. Presently, there is no specific standard or test for evaluating what alleged misconduct will rise to the level of outrageous conduct. The present jurisprudence seems to encourage exaggerated pleadings of misconduct, illegal acts and fraudulent conduct if a party seeks to avoid arbitration.

Conclusion

Under Aiken v. World Finance Corp. of S.C., it is clear that South Carolina law and public policy prohibit interpreting any arbitration clause to apply to outrageous torts that are unforeseeable to a reasonable consumer in the context of normal business dealings. It was announced as a definitive rule for applying the substantial relationship test to broad arbitration clauses. Yet subsequent decisions seem to sufficiently expand the rule's application to make it more properly recognized as an independent exception to the enforcement of arbitration clauses.

The principle of contract law that a party is only bound to the terms agreed to supports finding disputes premised on outrageous and illegal conduct are beyond the contractual agreement to arbitrate. However, refusing to enforce arbitration agreements expressly applicable to any and all claims between the parties that arise from the transaction seems contrary to the plain language of such agreements. It also seems dangerously close to constituting an "end run" around the statutory policy in favor of enforcing arbitration agreements. Either way, the issue is likely to frequently be presented to trial courts and will require a significant expenditure of the scarce judicial resources that arbitration is supposed to avoid.

Lee Floyd is an attorney at Collins Lacy, P.C. in Columbia, practicing in insurance coverage, products liability, commercial transportation and professional negligence. Brian Comer also practices in products liability and professional negligence at Collins Lacy.