In one of its first business law opinions of the current term, the U.S. Supreme Court reminded state courts that they have an obligation to follow the Federal Arbitration Act. The Court’s per curium opinion in Nitro-Lift Technologies v. Howardhighlights that the FAA is the law of the land, even though state courts may disfavor it.
The Supreme Court specifically noted, "State courts rather than federal courts are most frequently called upon to apply the [Federal Arbitration Act,] including the Act’s national policy favoring arbitration. It is a matter of great importance, therefore, that state supreme courts adhere to a correct interpretation of the legislation."
The case involved a confidentiality and noncompetition agreement between petitioner Nitro-Lift Technologies, L.L.C. and two of its former employees. The agreement contained an arbitration provision stating that any dispute between the parties must be resolved through arbitration.
After the two employees went to work for a competitor, Nitro-Lift filed an arbitration claim citing breach of contract. The employees countered by filing a lawsuit in state court seeking to have the entire employment agreement deemed unenforceable under state law. The court ordered the case to arbitration, finding that any dispute as to the contracts’ enforceability was a question for the arbitrator.
However, the Oklahoma Supreme Court reversed, holding that the “existence of an arbitration agreement in an employment contract does not prohibit judicial review of the underlying agreement.” It further found that the enforceability of a noncompetition agreement was purely a matter of state law for state-court determination and invalidated the agreement.
The U.S. Supreme Court disagreed, finding that the state court usurped the arbitrator’s role. “By declaring the noncompetition agreements in two employment contracts null and void, rather than leaving that determination to the arbitrator in the first instance, the state court ignored a basic tenet of the Act’s substantive arbitration law,” the Court ruled.
As the Court further explained, “When parties commit to arbitrate contractual disputes, it is a mainstay of the Act’s substantive law that attacks on the validity of the contract, as distinct from attacks on the validity of the arbitration clause itself, are to be resolved ‘by the arbitrator in the first instance, not by a federal or state court.’”
As this case highlights, employers and other businesses that include arbitration provisions in their agreements should be prepared to live with the consequences of their enforcement, as state courts will have very little leeway to issue decisions on the contract’s underlying enforceability once the arbitration provision is triggered.
If you have any questions about this case or would like to discuss the arbitration provisions in your contracts, please contact me, Michael Cifelli, or the Scarinci Hollenbeck attorney with whom you work.