One of the fundamental legal questions a business should tackle is whether it prefers to adjudicate disputes in litigation or arbitration. Whichever way a company decides (and it can vary based on the type of dispute), the choice should be reflected in the business’s contracts.
However, rules favoring arbitration have sometimes allowed companies to dip their toes into litigation to try to achieve an early favorable result before insisting that the court dismiss the matter in favor of arbitration.
A recent ruling by the United States Supreme Court, however, may have closed this loophole.
Morgan v. Sundance, Inc.
In Morgan v. Sundance, Inc., Robyn Morgan had signed an employment contract requiring arbitration of any dispute concerning her employment with Sundance, Inc. Despite this, Morgan brought suit in a collective action against Sundance in federal court for alleged violations of the Fair Labor Standards Act.
Sundance moved to dismiss the suit on the basis that it was duplicative of a collection action previously brought by other employees. When its dismissal motion was denied, Sundance answered Morgan’s complaint and participated in an early mediation before deciding (eight months into litigation) to move to stay the litigation and compel arbitration.
The district court denied Sundance’s motion, but the U.S. Court of Appeals for the Eighth Circuit reversed, applying the test adopted by that circuit (and eight others) that a party waives its right to arbitration if it acts inconsistently with that right and prejudices the other party by its acts. Leaning heavily on the federal policy favoring arbitration, a split panel found that Morgan had not shown sufficient prejudice, and held that the dispute must be arbitrated.
The U.S. Supreme Court reversed. In a short but important opinion, the Court explained that the federal policy favoring arbitration does not give courts license to invent rules that apply only to arbitration and skew the analysis in favor of the conclusion that the dispute must be arbitrated. As a general matter, waiver is an intentional relinquishment of a known right, and prejudice is not part of the calculation. The nine appeals courts that had grafted a prejudice requirement onto the waiver analysis in the context of arbitration agreements had erred by a creating a waiver rule that was unique to arbitration and was designed to favor the arbitration of disputes.
The Court explained that arbitration agreements are just like any other contract, and should not be given special treatment. Prior language from the Court discussing a federal policy favoring arbitration was a reaction to a history of courts favoring the judicial resolution of disputes at the expense of arbitration.
The point of that message, according to the Court in Sundance, was to level the playing field and overcome that historical bias, but not to tilt the field the other way toward arbitration. Waiver is waiver, whether in the arbitration context or otherwise, so courts should not be adding a prejudice requirement to the wavier analysis when it comes to whether a party waived the right to arbitration.
What the Decision Means: Choose One
What does this mean for businesses evaluating arbitration versus litigation?
In short, it means that companies must pick one of the two and stick to it. Under the former prejudice analysis, a company could sometimes get away with litigating for a short time while reserving its right to insist on arbitration later.
This could be very advantageous to the business. For instance, a company could (like Sundance did) file a motion to dismiss and see if it could resolve the case at the pleading stage, seeking arbitration only if the motion to dismiss was denied. Given that many standard arbitration rules disfavor or prohibit dismissal motions, this allowed companies to have the best of both worlds – gaining the ability to seek a quick victory in court on a motion to dismiss while still having the ability to adjudicate the merits in arbitration. The Supreme Court in Sundance appears to have shut down this ability to have a little of both.
Even before the Supreme Court’s opinion, cautious counsel would advise that Sundance was playing with fire when it litigated for eight months before seeking to compel arbitration. After the ruling, what Sundance did would be more akin to jumping directly into a bonfire. The import of Sundance is that businesses no longer can litigate for a bit and then seek to rely on arbitration-friendly rules if they want later to insist on arbitration.
An Opened Door
While Sundance closes the door on a hybrid litigation/arbitration strategy (and perhaps marks a tide-shift when it comes to the Supreme Court’s attitude toward arbitration), there are options a company can pursue if it wants the benefit of both robust procedural motions and confidential arbitration.
For instance, businesses can create a custom arbitration procedure that expressly permits motions to dismiss (perhaps with even more “teeth” than the Twombly/Iqbal standard). Too often, companies opt in to an established set of rules without giving careful thought to whether those rules will be beneficial when a dispute arises. Arbitration gives contract parties the ability to write their own ticket, but the downside is that you actually have to write it.
The Supreme Court’s decision in Sundance presents an obstacle to parties trying to get around poorly thought-out arbitration clauses or playing both sides of the litigation/arbitration field. Thus, the onus is on businesses to think through and carefully draft a dispute-resolution procedure if they want to control their own destiny.
This article was originally published on the State Bar of Wisconsin’s Business Law Blog. Visit the State Bar sections or the Business Law Section webpages to learn more about the benefits of section membership.