The Brave New World of Arbitration

AuthorDiane P. Wood
PositionCircuit Judge, U.S. Court of Appeals for the Seventh Circuit; Senior Lecturer in Law, The University of Chicago Law School; B.A. 1971, J.D. 1975, The University of Texas at Austin. All views expressed in this article are personal.
Pages383-412

Page 383

Once, long ago, arbitration was a method of dispute resolution that the courts viewed with skepticism. Those days now are only a distant memory. In 1925, Congress laid the groundwork for change when it passed the Federal Arbitration Act.1 At first, outside the realms of organized industrial relations and international commercial transactions, little seemed different. It was not even clear to what extent the new federal policy on arbitration applied only to the federal courts, and to what extent it affected state courts and state law as well. In 1964, in Prima Paint Corp. v. Flood & Conklin Mfg. Co.,2 the Supreme Court signaled that a new and favorable day had dawned for arbitration. Perhaps this was because the pressure of exploding dockets was beginning to make itself felt; perhaps legal philosophers who had long urged the use of more harmonious methods of dispute resolution were making headway; perhaps, as class actions were becoming popular in the wake of the 1966 amendment to Federal Rule of Civil Procedure 23 and as discovery was becoming an expensive burden, people were looking for ways to simplify litigation.

Whatever the reason, there can be no denying that from Prima Paint through the 2001 decision in Circuit City Stores, Inc. v. Adams,3 the Court has systematically dismantled the remaining legal constraints that stood in the way of the recognition of agreements to arbitrate, the enforcement of such agreements, and the enforcement of the resulting arbitral awards. It has federalized the law of arbitration to a degree astonishing to those who have thought of the Rehnquist Court as the new expositor of states' rights and federalism. It has expanded the availability of arbitration far beyond the law merchant and collective bargaining to all parts of the non-criminal legal world, so that it now encompasses, in addition to those traditional subjects, practically all statutory claims, constitutional claims, consumer claims, and employee claims. The Court has turned away efforts to place limits on what it takes to form a pre-dispute contract for arbitration and has found voluntary Page 384 consent to arbitration even if the contract was presented on a take-it-or-leaveit basis, even if actual notice of the arbitration clause is doubtful, and even if there were marked disparities in bargaining power between the parties.

It would be too much to say that a backlash has developed to the apparent triumph of arbitration. But doubts are springing up that a one-size-fits-all arbitral regime is optimal. Recent court decisions refusing to enforce some kinds of arbitration agreements and some arbitral awards display a new caution and concern for public policies that may be suffering as arbitration sweeps across the legal landscape. In today's talk, I would like briefly to review the key Supreme Court decisions that have brought us to where we are today, and then turn to the new issues that those decisions have brought to the fore and the skeptical undercurrents that can be detected in the courts. I conclude that arbitration in the United States today is still a work-in-progress. Some recalibration of the system is necessary and desirable if we are to reach a socially acceptable balance between dispute resolution in the public institutions known as courts and private dispute resolution that should be entitled to public enforcement.

  1. Supreme Court Landmarks .

    While the topic of arbitration arose from time to time in Supreme Court decisions after the passage of the Arbitration Act in 1925, for the most part the cases involved either industrial relations (especially in the railroad industry, where the Railway Labor Act has long required a special form of mediation and arbitration) or highly specialized areas, such as disputes between states or admiralty cases. One interesting exception to that pattern, however, arose in Hardware Dealers' Mut. Fire Ins. Co. v. Glidden Co.,4 a case involving the constitutionality of a Minnesota statute that required arbitration of the question of amount of loss in all fire insurance policies written in that state. The Supreme Court upheld the state law over a challenge based on the due process and equal protection clauses of the Fourteenth Amendment. It acknowledged that the arbitration process might not have been strictly voluntary, because it was imposed by statute. Nevertheless, it went on to say that "the procedure by which rights may be enforced and wrongs remedied is peculiarly a subject of state regulation and control."5 The state rationally might have singled out amount of loss as a topic well suited to arbitration procedures because of the frequency of disputes on that point, the need for speedy determinations, and the special utility of expert knowledge. The opinion concluded as follows:

    "Granted, as we now hold, that the state, in the present circumstances, has power to prescribe a summary method of ascertaining the amount of loss, the Page 385 requirements of the Fourteenth Amendment, so far as now invoked, are satisfied if the substitute remedy is substantial and efficient."6

    The Court also added that the state was free to choose any kind of remedy "provided its choice is not unreasonable or arbitrary, and the procedure it adopts satisfies the constitutional requirements of reasonable notice and opportunity to be heard."7 The Hardware Dealers case thus stands as an early example of a hospitable reception of arbitration as a method of dispute resolution, albeit one with some important qualifications that may not have lost their relevance.

    The next important case, Wilko v. Swan,8 was decided in 1953. It posed the question whether an arbitration agreement between a securities brokerage firm and one of its customers was enforceable. The Supreme Court said "no", on the ground that the agreement to arbitrate amounted to a waiver of rights conferred by the Securities Act of 1933 and thus was void under section 14 of that Act. The Court recognized that the United States Arbitration Act "establish[ed] by statute the desirability of arbitration as an alternative to the complications of litigation,"9 but it thought that the mere existence of the arbitration statute did not resolve the question of the way it related to section 14 of the Securities Act. It rejected the respondent's argument that "arbitration [was] merely a form of trial to be used in lieu of a trial at law,"10for several reasons. First, it thought that section 14 reflected the view of Congress that buyers and sellers of securities would typically occupy unequal bargaining positions and have asymmetrical access to information. Second, waiver of a judicial forum deprives the buyer of more options than it does the seller. Third, there is no assurance in arbitration that the arbitrators would be properly instructed in the law or that they would apply the law correctly. The latter point was especially troublesome because section 10 of the Arbitration Act, as the Court noted, provides for such a narrow range of review that mistakes would go uncorrected. Finally, and most broadly, the Court intimated (while reserving the point) that the right to select a forum might be a substantive right in itself and that an agreement restricting that choice might thwart the express purpose of the statute.

    The next major arbitration case in the Supreme Court, Prima Paint,11 arose out of a more conventional arbitral dispute: whether one party had performed as required under a simple consulting services contract. The Page 386 contract contained a broad arbitration clause that required arbitration under the rules of the American Arbitration Association over "[a]ny controversy or claim arising out of or relating to this Agreement, or the breach thereof. . . ."12The wrinkle was that one party, Prima Paint, argued that the other party, Flood & Conklin, had committed fraud in the inducement of the agreement that contained the arbitration clause. Prima Paint took the position that a charge of fraud in the inducement had to be resolved by the court before any arbitration of the underlying claim could go forward. The Supreme Court disagreed. It held that section 4 of the Federal Arbitration Act (FAA) required a court to order arbitration to proceed once it was satisfied that the making of the agreement to arbitrate was not at issue. In so holding, it distinguished sharply between a challenge to the formation of the contract "generally" (which is all that Prima Paint was asserting) and challenges to the formation of the agreement to arbitrate within the contract: "We hold, therefore, that in passing upon a § 3 application for a stay while the parties arbitrate, a federal court may consider only issues relating to the making and performance of the agreement to arbitrate."13

    This rule, the Court went on to state, was a rule of federal law, enacted under the "incontestable federal foundations of 'control over interstate commerce and over admiralty.'"14 It therefore made no difference that the case before it was a diversity case. The federal court was bound to apply the FAA, and in the absence of any challenge to the making of the contract generally, it was required to stay the litigation so that the arbitration could proceed. Any other questions about fraud in the inducement generally could be presented to the arbitrator.

    While the tone of Prima Paint was indisputably more favorable toward arbitration than had been the case in Wilko, that difference might have been explained by the respective subject matters at hand: statutory claims, in Wilko, versus private law, in Prima Paint. Perhaps that explanation was accurate at the time. But in the next key case, the Court took a cautious step toward opening the door to the arbitration of statutory claims.

    That case was Scherk v. Alberto-Culver Co.,15 which seemed like a reprise of Wilko v. Swan with two potentially important differences: first, the claim arose under section 10(b) of the...

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