Vaden v. Discover Bank (07-773)

Oral argument: Oct. 6, 2008

Appealed from: United States Court of Appeals, Fourth Circuit (June 13, 2007)

ARBITRATION, FEDERAL ARBITRATION ACT, FEDERAL QUESTION, CONSUMER ARBITRATION

Under the Federal Arbitration Act(“FAA”), a party to a private arbitration agreement may petition a court to compel arbitration. However, the FAA only applies if federal law is implicated. A credit card agreement between Discover Bank and Betty Vaden contained an arbitration provision obligating cardmembers to arbitrate any disputes arising under the agreement. Discover Bank’s affiliate eventually sued Vaden in state court when she failed to make payments, and Vaden counterclaimed under state law. Discover Bank then petitioned the U.S. District Court of Maryland to compel arbitration under Section 4 of the FAA. The district court granted the petition, but the Fourth Circuit remanded, holding that the district court could only compel arbitration if the underlying dispute presented a federal question. The district court found that a federal question existed in the underlying dispute. On appeal, the Fourth Circuit affirmed the district court’s finding that it had jurisdiction because federal banking law preempted Vaden’s state law claims. Vaden argues that the Fourth Circuit’s holding conflicts with other circuits that hold that the petition itself must present a federal question.

The Supreme Court’s decision will resolve a circuit split on whether a federal court has subject matter jurisdiction over Section 4 FAA petitions where jurisdiction is based solely on the complaint for the underlying dispute. If the Court affirms the Fourth Circuit, parties may be able to invoke the FAA to compel arbitration when a federal question arises only in a counter-claim, even though the federal court would not have jurisdiction over the underlying dispute.

· [Question(s) presented]

· [Issue(s)]

· [Facts]

· [Discussion]

· [Analysis]

Questions presented

1. Whether a suit seeking to enforce a state-law arbitration obligation brought under Section 4 of the Federal Arbitration Act, 9 U.S.C. § 4, “aris[es] under” federal law, see 28 U.S.C. § 1331, when the petition to compel itself raises no federal question but the dispute sought to be arbitrated—a dispute that the federal court is not asked to and cannot reach— involves federal law.

2. If so, whether a “completely preempted” state-law counterclaim in an underlying state-court dispute can supply subject matter jurisdiction.

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Issue

When a party petitions a court to compel arbitration under Section 4 of the FAA, should that court be able look at the facts of the underlying the dispute to find subject matter jurisdiction?

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Facts

Betty Vaden became a Discover cardmember in 1990. Although Discover Bank issued Vaden her credit card, it contracted many services such as collecting on delinquent accounts to Discover Financial Services (“DFS”). See Discover Bank; Discover Financial Services, Inc. v. Vaden, 489 F.3d 594 (4th Cir. 2007) (hereinafter Vaden II). In June 1999, Discover Bank sent Vaden a Platinum card. The following month Discover Bank sent Vaden a “Notice of Amendment to Discover Platinum Cardmember Agreement.” Among its terms was a provision requiring Platinum cardmembers and Discover Bank to arbitrate any disputes, if either party elected arbitration. See Vaden II, 489 F.3d at 597.

Congress passed the Federal Arbitration Act (“FAA”) in 1925 to aid parties to private arbitration agreements who sought judicial enforcement of the agreement but faced courts who were hostile to arbitration. See Brief for the Petitioner at 2. In Moses H. Cone Memorial Hospital v. Mercury Construction Corp.,the Supreme Court held that the FAA does not create an independent basis for subject matter jurisdiction. See Moses H. Cone Mem’l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 25 n. 32 (1983). Under Moses, a district court may not compel arbitration under the FAA unless the court has jurisdiction under 28 U.S.C. § 1331, which grants federal courts jurisdiction over cases “arising under” federal laws. See Brief for the Respondents at 17.

In July 2003, DFS sued Vaden in Maryland state court for failure to make payments on credit card debt. Vaden filed class action counterclaims for breach of contract and violation of state statues regulating lending, based on Maryland state law. In response, DFS and Discover Bank (“Discover”) filed a petition with the U.S. District Court of Maryland to compel Vaden to submit her counterclaims to arbitration. See Vaden II, 489 F.3d at 598. In the petition, Discover relied on the arbitration provision in the cardmember agreement and Section 4 of the FAA. Discover alleged that the district court had subject matter jurisdiction because certain of Vaden’s state law counterclaims were completely preempted by federal banking law. The district court granted the petition to compel arbitration without addressing the issue of subject matter jurisdiction. See id.

On appeal, the Fourth Circuit vacated the decision and remanded, instructing the district court to determine whether it had subject matter jurisdiction. See Discover Bank, Discover Financial Services, Inc. v. Vaden, 396 F.3d 366 (4th Cir. 2005) (hereinafter Vaden I). After analyzing the language of Section 4 of the FAA, the Fourth Circuit adopted the “look-through” approach followed by the Eleventh Circuit in Tamiami Partners, Ltd. v. Miccosukee Tribe. See Vaden I, 396 F.3d at 368–70. This approach allows a court to find grounds for subject matter jurisdiction by “looking through” the petition to compel arbitration to the underlying dispute. Specifically, the Fourth Circuit ordered the district court to decide whether Vaden’s state law counterclaims were completely preempted by federal law, in which case, federal jurisdiction would exist. See Vaden I, 396 F.3d at 373.

On remand, the district court found that Discover Bank was the party in interest rather than DFS, the defendant named in Vaden’s counterclaim. See Vaden II, 489 F.3d at 598. The court then held that federal banking law completely preempted Vaden’s state law claims, because Discover Bank is a federally insured bank and is governed by federal law. Consequently, it found that it had jurisdiction over the petition to compel arbitration under 28 U.S.C. § 1331, which grants federal courts jurisdiction over any case “arising under” federal law. The court also held that Vaden had received and accepted the arbitration agreement. See id.

Vaden appealed the decision, arguing that Discover Bank lacked standing to file the petition because DFS was the true party in interest and that the arbitration agreement was invalid. See Vaden II, 489 F.3d at 598. The Fourth Circuit affirmed the district court’s holding (2-1). Id.at 606.The majority reiterated that the district court could “look through” to the underlying dispute to determine whether there was a federal question, and that in this case, federal law preempted the state law counterclaims. See id. at 599. The dissenting justice argued that complete preemption was a doctrine that applied in removing complaints filed in state court to federal court, and could not apply to counterclaims such as Vaden’s. See id. at 612 (Goodwin, J., dissenting).

The Supreme Court granted certiorari to decide the issue of whether federal courts may look beyond the Section 4 petition to the facts of the underlying dispute, in order to determine whether they would have jurisdiction independent of the petition to compel arbitration. See Vaden II, 489 F.3d 594, cert. granted, 76 U.S.L.W. 3496 (March 17, 2008) (No. 07-773).

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Discussion

The decision in this case will resolve a circuit split over whether federal courts may exercise look-through jurisdiction and will define the scope of federal courts’ power to compel arbitration under the Federal Arbitration Act (“FAA”). Section 4 of the FAA permits a federal court to compel arbitration as long as it finds that the parties had a valid arbitration agreement, and one of the parties failed to comply. See Vaden II, 489 F.3d 594, 598. The Second, Fifth, Sixth, and Seventh Circuits hold that a Section 4 petition does not “arise under” federal law, even if the underlying dispute involves a federal question. See Christopher Sullivan, Emerging Issues Law Center – Jurisdiction – Motion to Compel Arbitration, June 18, 2008. In Vaden, the Fourth Circuit joined the Eleventh Circuit in permitting courts to hear FAA petitions if the underlying dispute presents a federal question. See id.

I. Will Prohibiting District Courts from “Looking Through” Nullify Section 4?

Discover argues that prohibiting look-through jurisdiction will severely undermine the FAA by precluding jurisdiction in many cases. Discover believes that a reversal of the Fourth Circuit would reduce federal courts’ jurisdiction over Section 4 petitions to “obscure circumstances” such as incidents on federal lands. See Brief for the Respondents at 23–24. This could eviscerate the FAA’s underlying policy of encouraging arbitration, particularly because state courts do not always treat the FAA as binding. These courts may fail to enforce arbitration agreements on various grounds, especially against consumers fighting mandatory arbitration with companies. See id. at 36; Brief of the Chamber of Commerce of the United States and CTIA – The Wireless Association® as Amici Curiae in Support of Respondents at 17 (tracing state court decisions in Montana, California, West Virginia and Pennsylvania). The fear is that without the FAA, parties will have difficulty vindicating their contractual right to arbitration. See Brief of Chamber of Commerceat 2; Lou Whiteman, Arbitration’s Fall from Grace, Law.com, July 13, 2006.

Vaden argues that Discover overstates the danger that prohibiting “look through” assessments will nullify Section 4. Cases in which a petition itself would raise federal questions include cases where federal law preempts (takes the place of) an area of law so that the arbitration agreement itself is deemed to arise under federal law. See Brief for the Petitioner at 29. Other cases might arise where federal law requires arbitration, or Congress stated that any arbitration would be under federal law. See id. These parameters describe a smaller, but not insignificant, subset of cases.

II. Procedural Issues Raised by “Look Through” Assessments of Underlying Disputes

Vaden focuses on the procedural complications of look-through assessments. If courts could compel arbitration based on a state law counterclaim, plaintiffs may be able to abusively use the FAA to switch between federal and state court to decide the issue of arbitration, and would unnecessarily split the proceedings. See Brief for Petitioner at 51. Cintas Corp., which is a party in a Ninth Circuit case involving issues similar to Vaden, points out that banning looking through would lead to inequity, since jurisdiction would depend on whether the party seeking to compel arbitration was the one who filed the suit. See Brief of Amicus Curiae Cintas Corporation in Support of Respondent at 20.

III. Impact on Federal and State Court Systems

The Supreme Court’s decision will also have consequences for the statutory jurisdiction of courts hearing Section 4 petitions. According to Discover, prohibiting looking through creates the awkward result of rolling back district courts’ jurisdiction by foreclosing jurisdiction in diversity cases. See Brief for Respondents at 24. Many disputes, particularly disputes between customers and companies, only involve claims for breach of contract, tort, or other state law claims. See Barry Meier, In Fine Print, Customers Lose Ability to Sue, New York Times, March 10, 1997. In these cases, federal jurisdiction must be based on diversity. See 28 U.S.C. § 1332. Without the ability to find jurisdiction by considering the underlying dispute, courts would be unable to hear many Section 4 petitions even though the court would have had diversity jurisdiction over that dispute. See Brief for Respondents at 37.

If the Supreme Court does allow looking through, courts may face the opposite problem. An affirmation may “radically expand the class of removable cases,” and ignore the independence of state governments. See Petition for Writ of Certiorari at 30. (quoting Holmes Group, Inc. v. Vornado Air Circulation Sys., Inc., 535 U.S. 826, 832 (2002)). Vaden argues that looking through is contrary to a state’s interest in hearing cases involving state law. Federal courts would be able to assert jurisdiction based on a hypothetical lawsuit, even where the parties are involved in state litigation beyond the federal court’s jurisdiction. See Reply Brief of Petitioner at 6. The opposite problem could affect federal courts, which might be overwhelmed by cases that would have been filed in state court. Federal courts will spend much time and effort resolving questions and issues that are outside the narrow issue of whether the arbitration agreement is enforceable. See Brief for Petitioner at 45. Moreover, if the court compels arbitration, the arbitrator will revisit the same issues to make a decision – a highly redundant process. See id. at 44.

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Analysis

I. The Federal Arbitration Act and Federal Jurisdiction

Congress passed the Federal Arbitration Act (“FAA”) in 1925 to counteract hostile courts that refused to enforce arbitration agreements because they viewed arbitration as an unfair forum lacking procedural safeguards available to litigants in court. See Brief for Petitioner at 2–3. The FAA put arbitration agreements on the same footing as other contracts by allowing parties to petition courts to compel arbitration. See id. at 4.

Federal courts must have jurisdiction to hear a FAA petition, but the statute itself grants no jurisdiction. See Brief for Petitioner at 4. Although Article III of the Constitution gives federal courts potential jurisdiction over “all cases, in law and equity, arising under this Constitution, the laws of the United States, and treaties made,” Congress has the power to regulate and limit federal courts’ jurisdiction through statute. See LII Wex: Jurisdiction.

Section 4 of the FAA states that district courts may hear FAA petitions if the court “save for such [arbitration] agreement, would have jurisdiction under title 28, in a civil action… or in admiralty of the subject matter of a suit arising out of the controversy between the parties…” See 9 U.S.C. § 4; LII Wex: Jurisdiction. Title 28 contains Congress’ two major statutory grants of jurisdiction: “subject matter jurisdiction” and “diversity jurisdiction.” 28 U.S.C. §§ 13311332. Under 28 U.S.C. § 1331, subject matter jurisdiction exists when the federal court must apply or interpret federal law in order to decide the case. Another ground for jurisdiction is diversity of citizenship among parties, but claims must satisfy a minimum dollar amount before federal jurisdiction will exist. See 28 U.S.C. § 1332; LII Wex: Jurisdiction. Under the “look through” approach, a federal court may look beyond the Section 4 petition to compel arbitration that is filed in federal court, to the facts and circumstances of the dispute that the parties would have litigated in court. See Vaden I, 396 F.3d at 368.

II. Does Looking Through Exceed Congress’ Grant of Federal Question Jurisdiction?

Vaden argues that the district court’s exercise of jurisdiction exceeded 28 U.S.C. § 1331. According to Vaden, this statute only gives federal courts jurisdiction over cases where the dispute itself is about the interpretation or effect of a federal law. See Brief for Petitioner at 15–16. Vaden points to Supreme Court interpretations of Section 4, which limit courts to deciding whether there was an arbitration agreement, and do not permit courts to decide issues in the underlying dispute or have ongoing jurisdiction over non-arbitrable disputes. See id. at 17. She reasons that if the federal court is not free to decide underlying issues, the fact that there is a federal question in the underlying case cannot be a basis for jurisdiction. See id. at 18. Expanding Section 4 jurisdiction pushes the jurisdiction of federal courts to their Article III bounds and works as an implicit repeal of Congress’ narrower grant of jurisdiction in 28 U.S.C. § 1331. See id. at 21, 28. The expanded jurisdiction violates the traditional reluctance by courts to expand jurisdiction without an explicit directive from Congress. See id. at 37.

Discover argues that the plain language of the Section 4 does not merely permit looking through, but requires a court to examine the underlying dispute. It concludes that the statutory language indicates that when courts determine jurisdiction, they should consider the issues in the hypothetical lawsuit that would have occurred if not for the arbitration agreement. See Brief for Respondents at 15. Discover argues that the FAA grants no independent jurisdiction, in contrast to Vaden’s argument that under the Supreme Court’s decision in Moses H. Cone Memorial Hospital v. Mercury Construction Corp. and subsequent cases, Section 4 does not address jurisdiction at all. See id. at 36. Instead, Discover relies on Moses H. Cone to support its claim that “the subject matter of the suit arising out of the controversy” means the court must evaluate issues in the underlying dispute to find jurisdiction. See id. at 18.

Discover contends that look-through would not expand federal question jurisdiction beyond Congress’ limits, because a court would determine whether it has federal question jurisdiction over the underlying dispute with reference to established standards. See Brief for Respondents at 21. Discover argues that prohibiting looking through would curtail diversity jurisdiction in some situations, since the court would not be able to examine the amount in controversy. See id. Discover notes that the FAA would not be unique in allowing a district court to look through to an underlying dispute; the Supreme Court recognized that under the Declaratory Judgment Act federal courts can obtain original jurisdiction by evaluating the lawsuit that would have been brought. See Brief for Respondents at 19 (citing Franchise Tax Bd. v. Constr. Laborers Vacation Trust, 463 U.S. 1 (1983)).

Vaden argues that the FAA is not analogous to the Declaratory Judgment Act. She notes that in declaratory judgment cases where federal courts found jurisdiction based on the underlying dispute, the courts already had jurisdiction because the plaintiff had a federal law claim. See Brief for Petitioner at 19. Vaden further notes that, unlike a petition brought under Section 4, the resolution of a Declaratory Judgment complaint “necessarily depends on the resolution of a substantial question of federal law.” See Brief for Petitioner at 20 (quoting Comm. State Bank v. Strong, 485 F.3d 597, 633 (11th Cir. 2007) (Marcus, J., concurring) vacated, reh’g en banc granted, 508 F.3d 576 (11th Cir. Sept. 10, 2007)).

III. Is Look-Through Consistent with the Historical Purpose of Section 4?

Vaden argues that the Court must interpret Section 4 in its historical context, while Discover treats the issue as one of statutory interpretation. The Second Circuit adopted the “ouster doctrine” approach, adopted in Westmoreland Capital Corp. v. Findlay. See Brief for Petitioner at 26. Under the ouster doctrine, courts held that the agreement itself “ousted” courts from their jurisdiction and prevented judicial enforcement of the arbitration agreement. See id. at 21. Vaden argues that the Section 4 language was intended to prevent application of ouster doctrine by making clear that the federal court could order performance of the agreement. See id. at 26. “[S]ave for this agreement” was intended to clarify that the courts should ignore the agreement in determining their own jurisdiction (and thus leave courts unable to resort to the ouster doctrine, which was based on the arbitration agreement). See Brief for Petitioner at 26, 32–34. Vaden argues that Title 28 does not mean all grounds for jurisdiction in Title 28 because at the time the reference was put in, the arbitrability of federal questions was disputed. See id. at 28–30. Vaden also argues that “controversy” refers to the arbitration agreement, not the underlying dispute,becauseCongress wanted to make clear that ouster did not apply, and consequently instructed courts to examine their subject matter jurisdiction over the suit. See id. at 36.

Discover portrays Vaden’s argument as an attempt to avoid the plain language meaning of the statute. It argues that Vaden’s interpretation of “save for the agreement” needlessly introduces ambiguity, in violation of statutory interpretation doctrines that dictate that the “plain meaning” of an unambiguous statute controls. See Brief for Respondents at 28. Discover argues that the phrase is a reference to the fact that Section 4 only allows courts to compel arbitration when the agreement to arbitrate is itself not in dispute. See id. at 27. Discover also argues that Vaden’s interpretation of Section 4 would result in friction with other parts of the FAA; including redundancy with Section 2, which explicitly addresses the problem of judicial hostility; and conflict with Section 3, which would lack the same jurisdiction grant that Vaden finds in Section 4. See id. at 29. Discover rejects Vaden’s historical interpretation, contending that Congress was concerned that courts would refuse to compel arbitration because they did not want deprive themselves of jurisdiction over cases. See id. at 30. Discover argues that the “save for such agreement” is meant to direct courts to the underlying suit for the distinct purpose of determining whether they have jurisdiction over the FAA petition. See Brief for Respondents at 31. Discover also rejects Vaden’s argument that “controversy” means the controversy over whether the agreement to arbitrate is enforceable, since that would eliminate jurisdiction in all but a few cases. See id. at 32.

IV. If Look-Through is Permissible, May Courts Look-Through to a Preempted Counterclaim?

The parties dispute whether allowing jurisdiction based on counterclaims violates the “well-pleaded complaint” rule, a rule of federal procedure that requires that all facts establishing jurisdiction to appear on the face of the plaintiff’s complaint. See Well-Pleaded Complaint Rule, Glossary, Lawyers.com. In Holmes Group v. Vornado Air Circulation Systems, Inc., the Supreme Court held that a federal counterclaim was not a claim “arising under” federal law as required by Article III, because it did not satisfy the well-pleaded complaint rule. See Holmes Group v. Vornado Air Circulations Sys., Inc., 535 U.S. 826, 830 (2002); Brief for Petitioner at 46–47. However, under the doctrine of complete preemption, a state law claim can form the basis for federal question, if the state law that would decide the question is in an area of law that is wholly preempted by federal law. See Brief for Petitioner at 48.

Vaden argues that the Holmes Group complete preemption rule only applies to turn a state law complaint into a federal question when the well-pleaded complaint rule is satisfied. See Brief for Petitioner at 48. The Fourth Circuit read Holmes Group too expansively, leading to a holding that would prevent jurisdiction based on a federal counterclaim because it violated the well-pled complaint rule, but allow jurisdiction in the far more attenuated case of a state law counterclaim converted by preemption. See id. at 49. Vaden points out that this approach violates the basic rule that plaintiffs cannot remove their own proceeding to federal court, and infringes on state courts’ rights to decide issues over which they have jurisdiction. See id. at 51.

Discover argues that Holmes Group does not apply because it would require pending litigation to exist before a district court could entertain a petition to compel arbitration. Such a result would undermine the language of Section 4, which has no requirement of a pre-existing lawsuit. See Brief for Respondents at 42. It would also undermine the policy of encouraging courts to enforce arbitration agreements which animates the FAA. If the Court denied jurisdiction simply because the preempted claim was a counterclaim, it would mean that a party’s federal right to compel arbitration would depend on the procedural posture of the case. See id. at 43. The result is not contrary to the policy behind the well pleaded complaint rule, which is to prevent removal to federal court against the plaintiff’s wishes and prevent opportunistic changing of venue. Here, Discover is the one filing the suit, and there is no opportunism because it would not be able to assert the petition in state court. See id. at 46.

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Conclusion

In this case, the Supreme Court will resolve a circuit split over the use of “look through” jurisdiction. Certain circuits allow federal courts to “look through” the petitioner for arbitration and find jurisdiction over FAA petitions based on the underlying dispute, while others hold that federal jurisdiction can not be grounded on a federal question in the underlying dispute. The Supreme Court’s decision is important because it will determine to what extent parties seeking to enforce mandatory arbitration agreements can rely on the FAA to seek vindication of their rights in court. This question is especially relevant as arbitration clauses have become common in standardized agreements in recent years.

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Authors

Prepared by: Deepa Sarkar

Edited by: Lauren Buechner

Additional Sources

· Brief for the Financial Services Roundtable, the Consumer Bankers Association, the American Financial Services Association, the American Bankers Association, and the Maryland Bankers Association in Support of Respondent

· Brief for Law Professors in Support of Respondent

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