In Between a Rock and a Hard Place

by Mary Hodges

In Between a Rock and a Hard Place – State Courts’ Public Policy v. the United States Supreme Court’s strict interpretation of the FAA

Previously, my colleague, David Cosgrove, wrote a blog about the United States Supreme Court’s (“USSC”) denial of certiorari of the Missouri Supreme Court’s application of AT&T Mobility, LLC v. Concepcion, 131 S. Ct. 1740 (2011) after the USSC vacated a previous Missouri Supreme Court decision invalidating a class arbitration waiver (which essentially invalidated the arbitration clause). Conception stands for the proposition that a state cannot bar class action waivers by finding an arbitration clause unconscionable on the basis of the class action waiver alone.

Recently, however, the USSC took a stab at the Oklahoma Supreme Court for ignoring arbitration precedent. It is clear that the USSC and federal courts are staunch advocates of the Federal Arbitration Act (“FAA”). As David noted in his blog, arbitration jurisprudence between federal and state courts seems to resemble a “chaotic game of cat and mouse.” Often times, this is because state courts have their own public policy considerations (such as protecting its consumers) that may conflict with the FAA. Furthermore, attorneys frequently challenge arbitration because the contractual agreement requiring arbitration often strips their clients of remedies that would otherwise be available in court.

In Nitro-Lift Technologies, LLC v. Eddie Lee Howard et al., 568 U.S. ___ (2012) (“Nitro-Lift”), the USSC noted that state courts, rather than federal courts, are more often called upon to interpret the FAA and therefore it is “a matter of great importance…that state supreme courts adhere to a correct interpretation of the legislation.”

The dispute in Nitro-Lift involved an alleged breach of a confidentiality and non-compete agreement between Nitro-Lift Technologies (“Nitro”) and two former employees, Eddie Howard and Shane Schneider (collectively referred to as “Respondents”). The contracts between Nitro and Respondents contained an arbitration clause for any disputes or conflicts arising between the parties.

The non-compete clauses in question operated for a period of two years and prohibited employees from accepting employment with any oil or gas entity located in the United States which generates five percent (5%) of its gross revenues from nitrogen generation. The same clause prevented the employees from owning or even participating in a similar business; from being a director, officer, representative, partner, or consultant in any business engaging in nitrogen generation; loaning money to a like enterprise; or selling or leasing equipment to any person or business which has any significant portion of its business as nitrogen generation, whether or not the equipment is related to that particular portion of the business.

After Respondents terminated their employment with Nitro, they began working for one of Nitro’s competitors. Upon being served with a demand for arbitration by Nitro, Respondents filed suit in an Oklahoma district court requesting the court to declare the non-competition agreements null and void. The district court dismissed the complaint in favor of arbitration.

The case was appealed to the Oklahoma Supreme Court where Nitro cited several USSC cases in support of the FAA’s application to both state and federal courts. Unhappy with Nitro’s extremely restrictive non-compete covenant, the Oklahoma Supreme Court arguably ignored USSC precedent to find that “the existence of an arbitration agreement in an employment contract does not prohibit judicial review of the underlying agreement.” Howard v. Nitro-Lite Technologies, LLC, 273 P.3d 20, 27 (Okla. 2011)(“Howard”).

While finding that the non-compete agreement was invalid and against Oklahoma’s public policy, the Oklahoma Supreme Court never addressed the issue of whether the arbitration clause was invalid; nor did it disagree with the district court’s finding that the arbitration clause was valid. Rather, the Oklahoma Supreme Court stated that its decision to nullify the non-compete agreement rested on adequate state grounds. In response, the USSC held:

[T]he Oklahoma Supreme Court must abide by the FAA, which is ‘the supreme Law of the Land,’ U.S. Const., Art. VI, cl. 2, and by the opinions of this Court interpreting that law. It is this Court’s responsibility to say what a statute means, and once the Court has spoken, it is the duty of other courts to respect that understanding of the governing rule of law…. Hence, it is for the arbitrator to decide in the first instance whether the covenants not to compete are valid as a matter of applicable state law.

After reading the USSC’s decision in Nitro-Lite, I was surprised that the USSC passed on the chance to scold the Missouri Supreme Court the way it did Oklahoma and remind them who’s in charge. However, after comparing the state court opinions in Howard and Brewer v. Missouri Title Loans, 346 S.W.3d 486 (2012) (“Brewer II”) it became more clear. In Brewer II there was a question as to the validity of the arbitration agreement as a whole while in Howard the Oklahoma Supreme Court never even questioned the validity of the arbitration agreement.

To give a little history, Brewer v. Missouri Title Loans, Inc., 323 S.W.3d 18 (Mo. banc 2010) (“Brewer”), concerned a contract and promissory note between Beverly Brewer and Missouri Title Loans for a $2,215 loan which was secured by her vehicle. The loan had an annual percentage rate of 300% and provided that the company could seek judicial or self-help remedies to obtain possession of the collateral upon default of the loan. The agreement between the parties contained an arbitration clause as well as a class arbitration waiver. Therefore, upon any default the title company could use the assistance of the courts but Ms. Brewer would be forced to arbitrate any claims against the title company. Ms. Brewer made two payments of $1,000 towards her loan and her loan principal was only reduced by 6 cents.

The trial court found the class arbitration waiver unconscionable and unenforceable, ordering the claim to proceed to arbitration to determine if the claim was suitable for class arbitration. The Missouri Supreme Court found that simply finding the class arbitration waiver unconscionable and unenforceable would not remedy the underlying issue of the economic impracticality of individual arbitration claims because previous USSC precedent stated that expresses affirmative consent to class arbitration claims is required before class arbitration can be compelled. See Stolt–Nielsen v. AnimalFeeds International Corp., ––– U.S. ––––, 130 S. Ct. 1758 (2010).

Finding itself stuck between a rock and a hard place, the Missouri Supreme Court held that “this difficulty could be avoided only by permitting litigation of this matter as part of a class action, and as there is no affirmative agreement to class arbitration, the class action must proceed in court.” Brewer, 323 S.W.3d at 21. Therefore, the Missouri Supreme Court affirmed the trial court’s decision finding the class arbitration waiver unenforceable but reversed the decision to require the arbitrator to determine the appropriateness of a class arbitration.

On remand from the USSC, and after being instructed to apply Conception, the Missouri Supreme Court appeared to circumvent the FAA by finding contractual grounds to declare the arbitration clause unconscionable. The Missouri Supreme Court majority opinion did this by artfully and carefully distinguishing Conception from Brewer II. In Conception, the arbitration clause contained several benefits to consumers who filed individual arbitrations while in Brewer II the restrictions in the agreement made it nearly impossible for customers to vindicate their claims through arbitration. The Oklahoma Supreme Court, however, was not so tactful in Howard because it was presented with clear and controlling USSC precedent that likely could not be distinguished the way Conception could from Brewer II and there was no question whether the arbitration provision was enforceable. Essentially, the Howard decision far too blatantly ignored the Supremacy Clause.

Indeed, the counsel in both Brewer and Howard were right for challenging the restrictive and one-sided nature of these contracts. However, attorneys challenging arbitration by filing claims in court will have to consider whether the challenge concerns the arbitration clause itself, or other provisions in the contract, i.e. non-compete clauses. If the latter, the challenge will likely be unsuccessful and the arbitrator will be called upon to determine the enforceability of the contract provisions.