Appealed from: Florida Supreme Court (Jan. 20, 2005)
Oral argument: Nov. 29, 2005
ARBITRATION, PAYDAY Loan INDUSTRY, THE FEDERAL ARBITRATION ACT, SEVERABILITY, usury, VOID AB INITIO, Predatory lending
Buckeye Check Cashing, a service provider in the payday loan industry, agreed to loan money to John Cardegna. The loan agreement contained an arbitration clause that compelled the parties to use arbitration, and not the courts, in case of dispute. Cardegna brought a class action lawsuit against Buckeye for allegedly charging interest rates higher than Florida usury law allows. Buckeye responded by filing a motion to compel arbitration pursuant to the arbitration clause. Cardegna resisted arbitration, maintaining that the arbitration clause was part of an illegal contract and therefore void ab initio—the clause had never come into existence as a matter of law. The issue before the Court is thus whether a court or an arbitrator should determine whether the underlying contract is void for illegality before enforcing the arbitration clause. The outcome will depend on whether the Supreme Court believes the separability doctrine applies to such contracts. If the Court affirms and holds that Cardegna's claims should be decided by the courts, the payday industry and its consumers, businesses that use arbitration clauses, and the policies behind the Federal Arbitration Act may suffer. If the Court instead decides that the claims should be sent to arbitration, low-income consumers, consumer protection regulation, and the integrity of the judicial system as a whole may be negatively affected.
Whether the Florida Supreme Court erred by holding, consistent with the Alabama Supreme Court but in direct conflict with six federal courts of appeals, that the Federal Arbitration Act allows a party to avoid arbitration by claiming that the underlying contract containing an arbitration clause (but not the arbitration clause itself) is void for illegality.
Whether a court or an arbitrator should resolve an allegation that a contract is void for illegality when that contract contains an arbitration clause.
John Cardegna needed money. Cardegna v. Buckeye Check Cashing, 894 So.2d 860, 861 (Fla. 2005), cert. granted, 125 S.Ct. 2937 (2005). But traditional lenders considered Cardegna to be a "high risk." See id. He therefore turned to the payday industry, which offers short-term, high-fee loans to consumers who cannot find credit in traditional markets. See Brief Amicus Curiae of AARP in Support of Respondents at 3. Payday loan agreements often include a clause referring the parties to arbitration in case of a dispute. See Brief of Amicus Curiae Community Financial Services Association of America in Support of Petitioner at 1–2. Arbitration, a form of alternative dispute resolution, is a simplified version of a trial where a neutral third party is appointed to hear arguments and make a binding decision. See id. Because arbitration involves no discovery and simplified rules of evidence, disputes can be settled more quickly and cheaply than litigation. See id.
Buckeye Check Cashing ("Buckeye"), a service provider in the payday industry, loaned money to Cardegna. See Cardegna, 894 So. 2d. at 861. The loan agreement contained an arbitration clause which provided that "[a]ny claim, dispute, or controversy . . . arising from or relating to this Agreement . . . shall be resolved . . . by binding arbitration." See id.
Cardegna brought a class action lawsuit against Buckeye for allegedly charging interest rates higher than Florida usury law allows. See id. Buckeye responded by filing a motion to compel arbitration pursuant to the arbitration clause. See id. Cardegna resisted arbitration, maintaining that the arbitration clause was part of an illegal contract and was therefore void ab initio, or had never come into existence as a matter of law. See id.
The district court reversed the lower court's decision and held that Cardegna's challenge to the underlying contract's validity had to be resolved by an arbitrator, not a trial court. See id. at 862. The Florida Supreme Court disagreed. It held that, "where a party sufficiently alleges that a contract is void for violation of Florida's usury laws, the Florida courts . . . must first determine the contract's legality before a party may be required to submit to arbitration under a provision of the contract." Id. at 865.
In order to reverse, the Florida Supreme Court distinguished Prima Paint v. Flood & Conklin Manufacturing, a case which held that, where a contract contains an arbitration provision, arbitrators—rather than federal courts—decide claims that the entire contract was fraudulently induced. See 388 U.S. 395, 402 (1967). The court explained that the allegations in Prima Paint were submitted to arbitration because, if true, they would have rendered the contract merely voidable rather than void from the outset. See Cardegna, 894 So. 2d. at 863. Buckeye's loan agreement, the majority contended, would have been void from the outset if it had violated Florida's usury laws. See id. If the agreement was void from the outset all of its provisions, including the arbitration clause, would be nullified as well. See id. As a result, any claims arising out of the agreement would have to be decided by the courts. See id.
The dissent pointed out that the majority's holding was in direct conflict with "no fewer than three federal courts of appeals"—all of which had confronted the precise issue presented in this case and found that arbitration applied. See id. at 870 (Cantero, J., dissenting).
The use of these arbitration agreements in employment and consumer contracts has grown steadily as employers and businesses have sought to avoid the time and costs involved in submitting disputes to the judicial system. The Federal Arbitration Act ("FAA") seeks to ensure the validity and enforcement of arbitration agreements in any "maritime transaction or a contract evidencing a transaction involving commerce." 9 U.S.C. ? 1 (2000).
Implications if the Court Affirms
If the Supreme Court affirms the Florida Supreme Court's decision and holds that a court must first determine whether an underlying contract is illegal and void before enforcing an arbitration clause contained in the contract, (1) the payday industry and its consumers, (2) businesses that use arbitration clauses, and (3) the policies behind the FAA may suffer.
First, arbitration clauses allow payday firms to resolve disputes in a low cost, quick, and efficient manner. See Brief of Amicus Curiae Community Financial Services Association of America in Support of Petitioner at 1–2. If unable to rely upon arbitration clauses in payday advance agreements, payday providers would be denied these beneficial procedures and would have to raise prices to accommodate litigation costs. They may also have less of an incentive to lend money to these "high risk" customers. See id. at 3. As a result, consumers of the payday industry will face higher costs in a potentially reduced market of providers. Consumers will also have to pay the higher costs of litigation if they decide to pursue a claim against the provider.
Second, if forced to resolve claims in court, and not through efficient and cheaper arbitration, businesses in general would face higher transaction costs. See Brief of Amici Curiae Florida Bankers Association and American Bankers Association in Support of Petitioner at 3.
Third, claims of this sort could quickly multiply, and the resulting proliferation of pre-arbitration litigation would undermine the national policy favoring efficient resolution of disputes through arbitration and effectuating the parties' autonomy in choosing arbitration. See Brief for the Chamber of Commerce of the United States of America and the American Financial Services Association as Amici Curiae in Support of Petitioner at 15. The Florida Supreme Court's approach would also effectively emasculate arbitration agreements by allowing plaintiffs to avoid them simply by challenging the underlying contract as illegal. See Brief for Petitioner at 20.
Implications if the Court Reverses
But the Supreme Court may reverse and decide that the FAA preempts state law and thus requires Florida state courts to enforce arbitration clauses without first determining whether the overall agreement is illegal. See Brief for Respondents at 1. Such a reversal may hurt (1) low-income consumers, (2) consumer protection regulation, and (3) the integrity of the judicial system.
First, low-income consumers, whom mainstream lenders consider "high risk," often cannot find credit in the traditional market and must rely on high-cost lenders and nontraditional sources of credit. See Brief Amicus Curiae of AARP in Support of Respondents at 3. The American Association of Retired Persons ("the AARP") argues that the growth of this fringe banking sector, which specifically targets the consumers most vulnerable to predatory practices and least able to protect themselves from abuse, results in a strong need for court supervision. See id. at 16–17. Organizations like the AARP argue that courts are better suited protecting these at-risk investors by providing consumers with the full range of redress available. See id.
Second, the state's regulatory authority in the consumer protection arena could be weakened if predatory lenders are allowed to circumvent the state courts. See Joshua R. Welsh, Comment, Has Expansion of the Federal Arbitration Act Gone Too Far?: Enforcing Arbitration Clauses in Void Ab Initio Contracts, 86 Marq. L. Rev. 581, 610 (2002).
Third, if courts do not first resolve a contract's legality, courts as institutions may lose their integrity, dignity, and reputations. See Brief of Law Professors in Support as Amici Curiae in Support of Respondents at 18. If arbitration applied, an arbitrator could rule on a contract that, if found void, would not have given him the authority to arbitrate in the first place. If this was permitted, the judicial system would have essentially enforced an illegal contract and, in effect, "len[t] its aid to a man who founds his cause of action upon an . . . illegal act." See id. (quoting Holman v. Johnson, 1 Cowp. 341, 343, 98 Eng. Rep. 1120, 1121 (King's Bench 1775).
Cardegna filed a lawsuit in state court claiming that Buckeye made illegal usurious loans. Buckeye responded by filing a motion to compel arbitration pursuant to an arbitration clause in their loan agreement. The Supreme Court has agreed to hear this case to determine whether an arbitrator or a court should decide if a contract containing an arbitration clause is illegal.
Does the FAA Apply?
This determination turns on whether the FAA applies. If the FAA applies, then an arbitrator will decide the contract's legality; if not, then the courts will decide. To decide if the FAA applies, the Court will consider Sections 1, 2, and 4 of the FAA.
Does Section 1 Apply?
First, to be covered by the FAA, an agreement must be a "contract evidencing a transaction involving commerce." 9 U.S.C. ? 1 (2000). In The Citizens Bank v. Alafabco, 539 U.S. 52 (2003), the Supreme Court held that state courts must examine the overall economic activity of the businesses involved, not just the specific contract between the parties, to determine whether an arbitration agreement is subject to the FAA. See id. at 57. The Court in Alafabco also held that the FAA has broad application, making it likely that the FAA will cover more arbitration agreements. See id. at 56. Because of this broad applicability and because financial loans are considered commercial, Section 1 should apply.
Does Section 4 Apply?
Section 4 applies when a federal court is asked to compel arbitration in a case in which it otherwise has jurisdiction. See 9 U.S.C. ? 4 (2000); Brief of Law Professors in Support as Amici Curiae in Support of Respondents at 4. Section 4 therefore applies because the Supreme Court is a federal court with jurisdiction over the case.
Does Section 2 Apply?
Cardegna claims that a reading of the FAA in its entirety shows that the threshold question regarding the applicability of the FAA is whether a contract was formed in the first place. See Brief of Law Professors in Support as Amici Curiae in Support of Respondents at 5. Section 2 of the FAA makes enforceable written arbitration clauses in "a contract evidencing a transaction involving commerce." 9 U.S.C. ? 2. Cardegna points out that, under generally applicable principles of Florida law—and that of most other jurisdictions—an agreement to perform a criminal act does not form a contract. See Brief for Respondent at 8 (emphasis added). Because Cardegna's allegation that Buckeye charges usurious interest rates goes to the existence and formation of the contract in the first instance, Cardegna argues that it is an issue a court must resolve before the FAA comes into play. See id.
On the other hand, Buckeye argues that Cardegna's claims should be submitted to arbitration. Buckeye argues that the "separability doctrine" applies, meaning that a challenge to the validity of the underlying contract is severable from a challenge to the validity of the arbitration clause. See Brief for Petitioner at 1. Buckeye argues that, unless a party challenges its assent or agreement to arbitration, any challenge to the validity of the underlying contract must be presented to the arbitrator pursuant to the arbitration clause. See id. at 10. Because Cardegna challenges the underlying contract—and not his assent to arbitration—Buckeye argues that Section 2 applies, and an arbitrator must therefore hear the case. See id.
The Supreme Court's decision will reflect its view on whether the "separability doctrine" applies to claims that the underlying contract containing an arbitration clause is void for illegality. If the Court affirms and holds that Cardegna's claims should be decided by the courts, the payday industry and its consumers, businesses that use arbitration clauses, and the policies behind the Federal Arbitration Act may suffer. If the Court instead decides that the claims should be sent to arbitration, low-income consumers, consumer protection regulation, and the integrity of the judicial system as a whole may be negatively affected.
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