Supreme Court Reviews the Role of Prejudice to a Party in Determining Arbitration Waiver

By Russ Bleemer

This morning’s U.S. Supreme Court arbitration arguments in Morgan v. Sundance Inc., No. 21-328, reviewed what appeared to be a simple case of whether a plaintiff needs to show prejudice as a pivotal factor in claiming that a defendant has waived its right to arbitration.

But it wasn’t so simple. The arguments ranged over multiple possible standards for including the factor, as well as how to do so if it stays.

The question of whether the Federal Arbitration Act supports prejudice as a factor in waiving the right to arbitration stood next to evaluating the defendant’s actions for waiver in the arguments, with the petitioner soon attacking whether prejudice should be a part of the determination.

The solution likely will be anything but simple. Today expansive arguments lasted nearly an hour and a half–wiith just two attorneys–showed the Court wrestling with the need and content of a prejudice evaluation that has split the circuits. The Eighth U.S. Circuit Court of Appeals decision on review today had held that “[a] party waives its right to arbitration if it: (1) knew of an existing right to arbitration; (2) acted inconsistently with that right; and (3) prejudiced the other party by these inconsistent acts.”

In its summary ahead of the question presented, the Supreme Court noted that eight other federal courts of appeals and most state supreme include the requirement that the waiving party’s inconsistent acts caused prejudice in the waiver analysis, while three federal courts of appeal, and at least four state supreme courts “do not include prejudice as an essential element of proving waiver of the right to arbitrate.

With nearly everyone in the courtroom stressing the need for a simple evaluation, both sides missed opportunities to offer one. Karla Gilbride, co-Director of the Access to Justice Project at Washington, D.C., a nonprofit public interest law firm Public Justice, and attorney for petitioner Robyn Morgan, compellingly noted that the prejudice requirement was “atextual” and “all over the place.”

But she didn’t draw a bright line by noting that employees would be prejudiced by expending time or money on cases where employers delayed their arbitration requests until after they took litigation steps.

Former U.S. Solicitor General Paul D. Clement, a partner in the Washington office of Kirkland & Ellis, facing Justice Neil Gorsuch’s option that the Court eschew a Federal Arbitration Act analysis and send the case back to the lower court for a pure Iowa state law analysis, said that if that path is taken, the Court instead of offering a ruling, should dismiss Morgan entirely as improvidently granted.

And the Court wasn’t helping the advocates by invoking layers of state contract law doctrines, federal statutes, and case interpretations in order to establish a standard for evaluating waiver and whether to include prejudice.

Every member of the Court had pointed questions for the advocates in today’s arguments. Justice Clarence Thomas didn’t participate, however; the Court announced Sunday that he had been hospitalized with an infection, but it noted this morning that he would participate in the case based on the filings and the arguments’ transcript.

Petitioner attorney Gilbride opened, with an argument that centered around the case issue of whether the the Eighth Circuit ruling favored arbitration, in violation of AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 339 (2011), and FAA Sec. 2, which says that arbitration contracts are “valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.”

She maintained that the prejudice requirement has become specific to arbitration. She said there was a lot of discussion in the briefs about waiver and default, but the Eighth Circuit should have applied generally applicable Iowa law. Then, she explained, if it found waiver, the court would still have to assess if the actions of employer Sundance, which owns Taco Bell franchises, were in default of proceeding.

“So whether Sundance’s actions constituted default is a secondary question,” said Gilbride, “not a replacement for the first-order waiver inquiry.”

Gilbride was moving from her FAA Sec. 2 analysis to FAA Sec. 3, and urging the Court to adopt a two-step analysis for evaluating waiving a right to arbitration. She was countering an argument made by Paul Clement in his Court briefs, who maintained that FAA Sec. 3 could be dispositive.

FAA Sec. 3 deals with motions to stay proceedings in favor of arbitration:

If any suit or proceeding be brought in any of the courts of the United States upon any issue referable to arbitration under an agreement in writing for such arbitration, the court in which such suit is pending, upon being satisfied that the issue involved in such suit or proceeding is referable to arbitration under such an agreement, shall on application of one of the parties stay the trial of the action until such arbitration has been had in accordance with the terms of the agreement, providing the applicant for the stay is not in default in proceeding with such arbitration.

“Prejudice,” declared Gilbride, “has no part to play in either of these inquiries.”

Under initial questioning from Chief Justice John G. Roberts Jr. and Justice Elena Kagan, Gilbride offered that the Court could remand for analysis of Iowa’s generally applicable waiver doctrines, but instead the Eighth Circuit looked at federal law and erroneously required prejudice. See Morgan v. Sundance Inc., 992 F.3d 711 (8th Cir. 2021) (available at https://bit.ly/3nqL7sJ). She conceded that prejudice could be a part of the state contract law, and that each case needed individual determination at the trial court level.

At the same time, she noted that there could be a statutory default under federal law in FAA Sec. 3.

Justice Samuel A. Alito Jr. pressed Gilbride on how state law would affect the analysis if it in some way provided something different for arbitration cases than for other contract cases. She warned that arbitration-specific standards wouldn’t likely survive in analyzing three hypothetical Alito treatments of state law.

Justice Sonia Sotomayor told Gilbride her analysis was confusing, with the FAA Sec. 3 default meshing with FAA Sec. 4 on federal court jurisdiction over parties who refuse to honor arbitration agreements for purposes of compelling the process. Sotomayor appeared uncomfortable with the need to find a federal law default standard under Sec. 3 after finding the state law waiver standard needed for Sec. 2 in Gilbride’s sequential analysis proposal.

Sotomayor summarized, noting, “Some of my colleagues are troubled by the fact that states differ in how they define waiver. I am troubled by the fact that the circuits define prejudice in different ways.”

At that point, Gilbride offered a bright-line standard. She noted that the requirement is “atextual” and not applied uniformly. “A presumption that a party should raise their defense of arbitration . . . by the time they file their first responsive pleading, by the time of their answer . . . before their answer if they file a motion,” she said, “that would be presumptively enough to get someone not to be in default in proceeding.”

The analysis Gilbride proposed, countered Chief Justice Roberts, will “increase the complexity and delay in arbitration proceedings. . . . [It is] creating a whole new battleground before you even get to arbitration about whether or not there’s been . . waiver under state law. It seems quite contrary to the policy behind the FAA.”

Gilbride quickly countered that the prejudice requirement “actually increases delay and increases the sort of skirmishing in court . . . before anyone resorts to the arbitral forum that the FAA was designed eliminate.

In response to a comment by Justice Stephen G. Breyer that delay cases are fact intensive, Public Justice’s Karla Gilbride insisted that the analysis isn’t “any more complicated than questions about . . . who is bound by the contract or whether a particular dispute fall within the terms of the contract. . . . State courts and federal courts applying state law answer those questions . . . within the parameters of the FAA all the time . . . without anything seeming to have ground to a halt.”

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Sundance’s Paul Clement said that his client wasn’t in default under FAA Sec. 3, because there was no violation of a contract or a law. “[U]under all relevant state law doctrines, one has to show prejudice before a contractual right is lost because you litigated or waited too long to assert it,” he said at the outset, adding, “The most straightforward way to affirm the decision below is to apply Section 3 and its stay absent default direction.”

Client Sundance, Clement explained, moved under FAA Sec. 3 to stay the litigation, and “it is not in violation of any contractual deadline, any court rule, or any other legal obligation.”

He said the problem wasn’t a waiver by the respondent of its right to arbitrate. “[W]hat is at issue is simply not asserting a right soon enough,” he said.

Chief Justice Roberts was skeptical, asking, “Waiver plays no role in regard–evaluating that situation at all?”

Clement said that in the absence of filing deadlines, courts will assess a variety of factors–including prejudice to the other side.

Justice Neil Gorsuch pressed him on assessing a waiver in the absence of an intentional act, and Clement said that the lower court really meant a forefeiture.

At that point, Gorsuch suggested it would make sense to send the case back for that state law analysis stating that the Eighth Circuit made a mistake using a federal law analysis. That’s when Clement said that the Court should dismiss the case instead.

“The Eighth Circuit wasn’t saying this is absolutely waiver and ‘that’s why we’re applying this three-factor test,’” explained Clement.

The circuit court, he continued, “applied the three-factor test presumably as–if you go back in their case law . . .– as a gloss on the [FAA Sec. 3] statutory phrase ‘in default.’ And [the appeals panel] said, as a general matter, ‘This is when it’s too late to invoke your right to arbitrate, and we have a three-factor test, and the plaintiff in this case fails under the third factor.’ Importantly, [the Eighth Circuit] didn’t even definitively resolve the second factor [acting inconsistently with the right to arbitration], which is the only thing that actually even goes to an inconsistency that possibly could get to an implied waiver. And there’s not a hint in the decision that they thought they were talking about the explicit waiver that your question alludes to.”

Clement emphasized under tough questioning from Justices Breyer and Kagan that there was no dispute about the arbitration agreement’s existence, and attempts to resolve state law issues preliminarily under such circumstances belong with arbitrators, at one point invoking to Breyer the opinion the justice wrote on arbitrator versus court determinations in Howsam v. Dean Witter Reynolds Inc., 537 U.S. 79 (2002) (available at https://bit.ly/2yiejeh).

“The arbitration agreement is valid,” said Clement. “Nobody questions that.”

Justice Brett Kavanaugh asked whether the failure to raise the arbitration defense to a court action in the first responsive pleading could be a review standard for waiver, but Clement rejected it. He said it wasn’t fair to his client. “[If you want to write an opinion in my client’s favor and suggest to the rules committee that they amend the rules to give clear notice to parties, then I could live with that.”

Clement followed up when Kavanaugh pressed further to note that the line drawn by courts generally isn’t the first responsive pleading, but when there already has been extensive discovery.

Kagan returned to Clement’s point that missing a deadline would satisfy FAA Sec. 3’s requirement that a stay wouldn’t be issued if the party asking for the stay was in default. “Where does this federal common law rule come from as to what counts as default?” she asked.

“It’s a gloss on the statutory phrase ‘in default,’” responded the former solicitor general, “and I think everybody agrees ‘default’ means you violated a legal obligation.”

Justice Sotomayor recounted Sundance’s moves in the matter, and maintained that the company intentionally waived arbitration to see how it would do in litigation, and then reversed course. Clement resisted, but noted also countered that the strategy was sound and adhered to its arbitration contract.

He responded:

I think what the parties bargained for here was not just arbitration but bilateral arbitration. And when the other side decides not just to violate the arbitration agreement but to seek a nationwide collective action, I think my client is perfectly within its rights, and it’s what I would advise my client to do under the circumstances[–]don’t make a motion to compel arbitration because you might get a motion to compel nationwide collective arbitration, and pretty much every defendant on the planet agrees that’s the worst of both worlds. So you wait.

Sotomayor said that Sundance should have raised that objection in its motion to compel.

“I suppose we could have,” responded Kirkland’s Paul Clement, “and with the benefit of that additional advice, maybe that’s what I’d tell my clients to do. But I’d still say, OK, at worst, we failed to make a motion. At worst, we’re in the realm of forfeiture, and we still have the ability to make this motion under [FAA] Sec. 3.”

The case is expected to be decided before the Court’s current term ends in June. The audio of Supreme Court oral arguments, as well as transcripts, can be found here. For more background on Morgan, see Russ Bleemer, “The Supreme Court’s Six-Pack Is Set to Refine Arbitration Practice,” 40 Alternatives 17 (February 2022) (available here), and Mark Kantor, “U.S. Supreme Court Adds an Arbitration Issue: Is Proof of Prejudice Needed to Defeat a Motion to Compel?” CPR Speaks (Nov. 15, 2021) (available here).

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The author edits Alternatives to the High Cost of Litigation for CPR at altnewsletter.com.

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