THE AMERICAN REVIEW OF INTERNATIONAL ARBITRATION. Vol. 20 No. 2

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1 THE AMERICAN REVIEW OF INTERNATIONAL ARBITRATION Vol. 20 No. 2

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3 THE RULES GOVERNING WHO DECIDES JURISDICTIONAL ISSUES: FIRST OPTIONS v. KAPLAN REVISITED Steven H. Reisberg* I. INTRODUCTION This article addresses one of the fundamental issues at the core of arbitration jurisprudence: Who the court or the arbitrator is to decide whether a person is required to arbitrate a particular dispute? As will be shown, the rules that govern the who is to decide question once were well defined. Today, however, there exists significant confusion as to how a court is to decide which forum, the court or the arbitrator, has the jurisdiction to decide this threshold issue. The current confusion can be traced directly to the Supreme Court s decision in First Options of Chicago, Inc. v. Kaplan. 1 One goal of this article is to identify the well-defined legal rules that once governed the analysis of this threshold question. This article will also show how the use by the Supreme Court of the term arbitrability in First Options has introduced significant confusion into the law of arbitration and obscured these once-clear governing rules. Whether a party is required to submit a particular dispute to arbitration may contain within it two completely distinct legal issues. First, a party may be objecting to arbitration on the ground that no valid, enforceable arbitration agreement exists between the parties. Second, and alternatively, a party may be arguing that the particular dispute does not fall within the scope of the arbitration agreement. The distinction between these two objections to arbitration is critical, because each is governed by its own separate set of legal rules that govern who, meaning which forum the court or the arbitrator is to adjudicate such objection to arbitration. Courts repeatedly recognize that the issue of who has the jurisdiction to decide the question of arbitrability is a threshold issue. However, the use of the term arbitrability in the framing of this question has introduced and is the source of substantial confusion. This is because the term arbitrability, as used by courts and commentators alike, can refer to both of the two above-noted very different objections to arbitration. If there is no valid and enforceable arbitration agreement between the parties, then neither can be required to arbitrate the dispute. Courts use the phrase the question of arbitrability to refer to such arguments challenging the existence, validity or enforceability of an arbitration * Steven H. Reisberg is a partner at Willkie Farr & Gallagher LLP. Special thanks to Emma-Ann Deacon, Esq. and Joshua Nahum, Esq. for their assistance with the preparation of this article. Steven H. Reisberg U.S. 938 (1995). See Alan Scott Rau, The Arbitrability Question Itself, 10 AM. REV. INT L ARB. 287, 289 (1999) ( There are certainly defects in craftsmanship in Kaplan but it is nevertheless bemusing that so many judges and scholars have tied themselves into knots trying to make sense of it. ). The American Review of International Arbitration (ARIA), v20/no 2, , copyright 2010 JurisNet LLC

4 160 THE AMERICAN REVIEW OF INTERNATIONAL ARBITRATION [Vol. 20 agreement. But the term arbitrability is also used to refer to an objection asserting that the specific dispute is not within the scope of the arbitration clause. This is an issue about the interpretation of the terms of the arbitration agreement. Importantly, such a scope objection does not question the existence, validity or enforceability of the arbitration agreement itself. Parties in a given case, of course, may assert both types of objection. The use of the same term arbitrability to refer to these two very different types of objections to arbitration would not be a problem if the same rules of decision applied to each. But that is not the case. These two fundamentally different questions are governed by their own separate sets of legal rules that determine who, the court or the arbitrator, is to decide the issue on the merits. Use of the single term arbitrability hides all this from view. As will be shown below, the rules that govern who (court or arbitrator) has the responsibility to address each of these two threshold issues are clearly identifiable from the case law. The rules are small in number and are different for each of these two types of objections. An express recognition and articulation of these rules can clarify the analysis to be used when deciding which forum has the authority to rule on a party s objection that (i) it is not bound by an arbitration agreement or (ii) the particular dispute is not one within the scope of the subjects it has agreed to resolve by arbitration. This article examines the current state of the law on these issues, including conflicts between the various courts, and provides what hopefully will be some practical guidance for courts and practitioners alike as to how these issues should be resolved. II. THE LEGAL RULES GOVERNING THE ALLOCATION OF JURISDICTION BETWEEN THE COURTS AND ARBITRAL TRIBUNALS In a trio of cases, the Supreme Court set forth certain fundamental principles of our arbitration jurisprudence: John Wiley & Sons, Inc. v. Livingston, 2 Prima Paint Corp. v. Flood & Conklin Mfg. Co., 3 and AT&T Technologies, Inc. v. Communications Workers of America. 4 An examination of these cases is important because the principles established therein allow for the identification of a clear set of traditional rules for determining who is to resolve jurisdictional challenges to an arbitration. As will be shown below, a return to these fundamental rules will clear away the confusion caused by First Options. These three Court decisions make it clear that there are two different fundamental threshold questions that a court must address in every arbitration case. These are: (1) Did the parties enter into a contractually valid arbitration agreement? and (2) Does the specific dispute fall within the scope of the arbitration agreement? The first question covers challenges to the existence, U.S. 543 (1964). 388 U.S. 395 (1967). 475 U.S. 643 (1986).

5 2009] THE RULES GOVERNING WHO DECIDES JURISDICTIONAL ISSUES 161 validity or enforceability of the arbitration agreement. The second question, which is based on the assumption that a valid arbitration agreement has been found to exist, concerns the scope of the subject matter that the parties have agreed is to be resolved by arbitration. Most importantly, these Court decisions make it clear that each question is subject to different rules as to the issue of who the court or the arbitrator has the jurisdiction to rule on the merits of the issues. A. The Existence of an Arbitration Agreement In John Wiley & Sons Inc. v. Livingston, 5 John Wiley & Sons, Inc. ( Wiley ) had acquired Interscience Publishers, Inc. ( Interscience ), with the result that Interscience ceased doing business as a separate entity. At the time of the merger, Interscience had about 80 employees, approximately 40 of whom were represented by a union (the Union ) pursuant to a collective bargaining agreement (the Agreement ). The Agreement did not contain any express provision making it binding on successors of Interscience, but it did contain an arbitration clause. 6 Wiley was the much larger company employing about 300 employees, none of whom were represented by a union. The Union contended that the Agreement was binding on Wiley, and one week before the expiration date of the Agreement, the Union commenced an action to compel arbitration of certain disputes relating to the 40 former Interscience employees represented by the Union. Wiley contended that it was not subject to arbitration because it was not a signatory to the Agreement and that, in any event, the merger terminated the collective bargaining agreement. 7 The Court stated the issue with clarity: The threshold question in this controversy is who shall decide whether the arbitration provisions of the collective bargaining agreement survived the Wiley-Interscience merger, so as to be operative against Wiley. 8 In other words, [h]ere, the question is whether Wiley, which did not itself sign the collective bargaining agreement on which the Union s claim to arbitration depends, is bound at all by the agreement s arbitration provision. 9 The Court was equally clear in stating the answer: Past cases leave no doubt that the threshold issue of whether a non-signatory is bound by an arbitration clause is for the courts, not the arbitrators. 10 As the Court explained, U.S. 543 (1964). Id. at Id. at Id. at 546 (emphasis added). 9 Id. at Id. at 546. The Court noted that the decision by the Court of Appeals below was not clear on this point, as at one point the Court of Appeals decision indicated that the question of whether Wiley was obligated to arbitrate was for the arbitrators. Id. at 547 n.1.

6 162 THE AMERICAN REVIEW OF INTERNATIONAL ARBITRATION [Vol. 20 this must be the case because the duty to arbitrate being of contractual origin, a compulsory submission to arbitration cannot precede judicial determination that the collective bargaining agreement does in fact create such a duty. 11 Thus, just as an employer has no obligation to arbitrate issues which it has not agreed to arbitrate, so a fortiori, it cannot be compelled to arbitrate if an arbitration clause does not bind it at all. 12 B. The Severability of the Arbitration Agreement Prima Paint Corp. v. Flood & Conklin Mfg. Co. 13 establishes, among other things, the severability of the arbitration agreement from the contract as a whole. Prima Paint Corporation ( Prima Paint ) and Flood & Conklin Manufacturing Company ( F & C ) had entered into a consulting agreement, following the purchase by Prima Paint of F & C s paint business. The consulting agreement contained a broad arbitration clause, which read in part: Any controversy or claim arising out of or relating to this Agreement, or the breach thereof, shall be settled by arbitration in the City of New York, in accordance with the rules then obtaining of the American Arbitration Association After Prima Paint failed to make a payment due under the consulting agreement, F & C served a notice of intent to arbitrate. 15 Prima Paint, in response, filed suit in District Court seeking: (i) rescission of the Consulting Agreement on the basis of alleged fraudulent inducement; and (ii) an order enjoining F & C from proceeding with the arbitration. 16 The Court stated that the question before it was whether a claim of fraud in the inducement of the entire contract is to be resolved by the federal court, or whether the matter is to be referred to the arbitrators. 17 The Court held that Congress has provided an explicit answer and [t]hat answer is to be found in 4 of the [Federal Arbitration] Act. 18 Section 4 of the Federal Arbitration Act (the FAA ) provides, in part: A party aggrieved by the alleged failure, neglect, or refusal of another to arbitrate under a written agreement for arbitration may petition any United States district court... for an order directing that such arbitration proceed.... The court shall hear the parties, and upon being satisfied that the making of the agreement for arbitration or the failure to comply therewith is not in issue, the court shall make 11 Id. at Id U.S. 395 (1967). 14 Id. at Id. 16 Id. at Id. at 402. The Court of Appeals had held that a claim of fraud in the inducement of the contract generally as opposed to the arbitration clause itself is for the arbitrators and not for the courts. Id. at Id. at 403.

7 2009] THE RULES GOVERNING WHO DECIDES JURISDICTIONAL ISSUES 163 an order directing the parties to proceed to arbitration in accordance with the terms of the agreement.... If the making of the arbitration agreement or the failure, neglect, or refusal to perform the same be in issue, the court shall proceed summarily to the trial thereof. If no jury trial be demanded by the party alleged to be in default, or if the matter in dispute is within admiralty jurisdiction, the court shall hear and determine such issue.... If the jury find that an agreement for arbitration was made in writing and that there is a default in proceeding thereunder, the court shall make an order summarily directing the parties to proceed with the arbitration in accordance with the terms thereof. 19 The Court stated that under Section 4 of the FAA, 20 the federal court is instructed to order arbitration to proceed once it is satisfied that the making of the agreement for arbitration or the failure to comply [with the arbitration agreement] is not in issue. 21 The Court noted that Section 4 restricted the issues that the district court may resolve prior to ordering arbitration, to those that challenge the making of the agreement for arbitration. The Court explained: Accordingly, if the claim is fraud in the inducement of the arbitration clause itself an issue which goes to the making of the agreement to arbitrate the federal court may proceed to adjudicate it. But the statutory language does not permit the federal court to consider claims of fraud in the inducement of the contract generally. 22 In so holding, the Court further held that this rule was a matter of federal law, applicable to all contracts within the coverage of the FAA. 23 This rule of federal law recognizes that the arbitration clause is to be treated as separate and severable from the contract as a whole. Accordingly, under the FAA, a court prior to the arbitration may consider only issues relating to the making and performance of the agreement to arbitrate. 24 As the arbitration provision is severable and can be considered independently from the contract as a whole, this means that under federal law a court does not have jurisdiction to rule on a claim of fraud in the inducement of the entire contract, unless the claim is made that the fraud was directed to the arbitration clause itself U.S.C. 4 (2009) (emphasis added). 9 U.S.C. 1 et seq. 21 Prima Paint, 388 U.S. at Id. at (footnote omitted). 23 Id. at See Southland Corp. v. Keating, 465 U.S. 1, (1984); Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, (2006) (Prima Paint and Southland established that as a matter of substantive federal arbitration law, an arbitration provision is severable from the remainder of the contract and this arbitration law applies in state as well as federal courts ). 24 Prima Paint, 388 U.S. at Id. at

8 164 THE AMERICAN REVIEW OF INTERNATIONAL ARBITRATION [Vol. 20 C. The Scope of the Arbitration Agreement AT&T Technologies, Inc. v. Communications Workers of America 26 addresses the issue of how the courts are to handle the question of whether a particular dispute falls within the scope of the subjects the parties had agreed would be subject to arbitration. There was no dispute about whether AT&T Technologies, Inc. ( AT&T ) was a signatory to and bound by the collective bargaining agreement. It was accepted that AT&T and the Communications Workers of America (the Union ) were parties to a collective bargaining agreement, which contained an arbitration clause. 27 There was no challenge to the existence, validity or enforceability of the agreement to arbitrate. In AT&T, Article 8 of the collective bargaining agreement provided that differences arising with respect to the interpretation of this contract or the performance of any obligation hereunder are to be referred to a mutually agreeable arbitrator. 28 However, Article 8 further provided that it (Article 8) does not cover disputes which are expressly excluded from arbitration by other provisions of this contract. 29 Notably, Article 9 of the agreement stated that certain management functions of AT&T, including, among other things, the hiring and placement of employees and the termination of employment, were not subject to the provisions of the arbitration clause. 30 Finally, Article 20 of the agreement stated that when lack of work necessitated layoffs, there was a particular order in which employees were to be laid off. 31 The Union filed an arbitration claim challenging AT&T s decision to lay off 79 installers. The Union claimed the planned layoffs violated Article 20 of the agreement because there was no lack of work necessitating the layoffs. 32 AT&T argued it could not be compelled to arbitrate such a claim because Article 9 of the agreement made it clear that the Company s decision to lay off workers was a subject excluded from the arbitration clause. Thus, the issue before the Court was whether this particular dispute fell within the scope of the parties agreement to arbitrate. The Court stated that the principles necessary to decide this case are not new, noting that they could be gleaned from the series of cases known as the Steelworkers Trilogy U.S. 643 (1986). Id. at Id. at Id. 30 Id. 31 Id. at 645 n Id. at Id. at 648. These cases are United Steelworkers of America v. American Manufacturing Co., 363 U.S. 564 (1960); United Steelworkers of America v. Warrior & Gulf Navigation Co., 363 U.S. 574 (1960); and United Steelworkers of America v. Enterprise Wheel & Car Corp., 363 U.S. 593 (1960). In each of the Steelworker Trilogy cases, there was no dispute about the formation, existence, validity or enforceability of the

9 2009] THE RULES GOVERNING WHO DECIDES JURISDICTIONAL ISSUES 165 The Court in AT&T then set forth four general principles or rules, which have been reaffirmed in numerous subsequent cases. 1. The first principle is that arbitration is a matter of contract and a party cannot be required to submit to arbitration any dispute which he has not agreed so to submit. This axiom recognizes the fact that arbitrators derive their authority to resolve disputes only because the parties have agreed in advance to submit such grievances to arbitration The second rule, which follows inexorably from the first, is that the question of arbitrability whether a collective-bargaining agreement creates a duty for the parties to arbitrate the particular grievance is undeniably an issue for judicial determination. Unless the parties clearly and unmistakably provide otherwise, the question of whether the parties agreed to arbitrate [a particular grievance] is to be decided by the court, not the arbitrator. 35 It is contended that this exception to judicial determination applies only to the issue of whether the parties agreed to arbitrate a particular grievance. It is only the issue of scope, not the existence of an arbitration agreement, that the parties can decide to assign to the arbitration. 3. The third principle is that in deciding whether the parties have agreed to submit a particular grievance to arbitration, a court is not to rule on the potential merits of the underlying claims. 36 The merit of the grievance is to be decided, not by the court asked to order arbitration, but as the parties have agreed, by the arbitrator The fourth rule is that the court, in determining whether an issue is within the scope of an arbitration clause, should apply a presumption that the dispute is one the parties had agreed to arbitrate. This presumption of arbitrability (which is applied to the issue of the scope of the arbitration clause), the Court stated, is particularly applicable where the clause is as broad as the one employed in this case, which provides for arbitration of any differences arising with respect to the interpretation of this contract or the performance of any obligation hereunder This presumption, however, may be rebutted, but only if it may be said with positive assurance that the arbitration clause is not susceptible of an interpretation that covers the asserted dispute. 39 arbitration agreement. Instead, the issue was whether a particular dispute was within the scope of the arbitration agreement. 34 AT&T, 475 U.S. at (citation omitted). 35 Id. at 649 (emphasis added). 36 Id. 37 Id. at Id. at Id.

10 166 THE AMERICAN REVIEW OF INTERNATIONAL ARBITRATION [Vol. 20 The Court in AT&T, in applying these four rules to the facts before it, held that it is evident that the Seventh Circuit erred in ordering the parties to arbitrate the arbitrability question. 40 But it is critical to note that by arbitrability question, the Court was referring to whether or not the particular dispute fell within the scope of the arbitration agreement. There was no challenge in AT&T to the existence or the making of an arbitration agreement between the parties. The Court held that it was for the court, not the arbitrators, to determine whether the parties intended to arbitrate grievances concerning layoffs predicated on a lack of work determination by the Company. 41 In other words, the Court held that it is for the courts to decide the threshold question of whether this particular dispute is subject to the arbitration clause. 42 As this was an issue that should have been decided by the District Court and reviewed by the Court of Appeals, the case was remanded. 43 D. The Rationale Behind These Rules These Court decisions established that there are two different threshold issues that may arise in an arbitration case. If the objection is a challenge to the existence of a valid arbitration agreement, then this objection must without exception be decided by the courts. 44 If the objection, however, focuses on whether the specific dispute falls within the scope of the arbitration agreement, then this issue is presumptively for the court to decide, but subject to an important exception: whether a specific dispute falls within the scope of an arbitration agreement may be assigned by the parties in their arbitration agreement to the arbitrator for determination, where the parties clearly and unmistakably have so provided. 45 This framework for distinguishing between these two threshold issues was firmly embedded in the law of arbitration. 46 Unfortunately, confusion has arisen 40 Id. at Id. 42 Id. at Id. at Id. at Id. at See, e.g., Trippe Mfg. Co. v. Niles Audio Corp., 401 F.3d 529, 532 (3d Cir. 2005) ( A motion to compel arbitration calls for a two-step inquiry into (1) whether a valid agreement to arbitrate exists and (2) whether the particular dispute falls within the scope of that agreement ) (citations omitted). Accord: Cap Gemini Ernst & Young, U.S., L.L.C. v. Nackel, 346 F.3d 360, 365 (2d Cir. 2003) ( [T]he district court must first determine two threshold issues that are governed by state rather than federal law: (1) Did the parties enter into a contractually valid arbitration agreement? and (2) If so, does the parties dispute fall within the scope of the arbitration agreement? ); Sherer v. Green Tree Servicing LLC, 548 F.3d 379, 381 (5th Cir. 2008) ( First, we ask if the party has agreed to arbitrate the dispute.... That first step itself contains two questions: (1) is there a valid agreement to arbitrate the claims and (2) does the dispute in question fall within the

11 2009] THE RULES GOVERNING WHO DECIDES JURISDICTIONAL ISSUES 167 in the law of arbitration because the courts in their struggle to apply First Options have drifted away from this fundamental analytical framework. 1. The Reason Why the Court, and Not the Arbitrator, Must Always Decide Any Challenge to Whether a Valid and Enforceable Arbitration Agreement Exists Between the Parties The rule that any challenge to the existence of a binding arbitration agreement may not, under any circumstances, be referred by the court to the arbitrators for decision 47 is dictated by the rules set forth in the Court s decisions in Wiley, Prima Paint and AT&T for two independent reasons. First, this result is required because of the application of the fundamental arbitration law principle that the duty to arbitrate being of contractual origin, a compulsory submission to arbitration cannot precede judicial determination that the [arbitration] agreement does in fact create such a duty. 48 That the court must decide if a party is bound by an arbitration agreement before it can compel a party to arbitration also is a matter of clear logic. As the Court in Wiley explained, a person cannot be compelled to arbitrate if an arbitration clause does not bind it at all. 49 Where the validity of the arbitration contract itself is challenged, such contract cannot serve as the basis for giving any power to the arbitrator. This has been recognized by several courts of appeal. As the Third Circuit explained in China Minmetals, [a]fter all, a contract cannot give an arbitral body any power, much scope of that arbitration agreement. ) (citations omitted); Drexel Burnham Lambert, Inc. v. Mancino, 1991 U.S. App. LEXIS 30181, at *5 (6th Cir. Dec. 19, 1991) ( [A] court s review is limited to two issues: (1) whether an express written agreement to arbitrate the subject matter of the present dispute exists between the parties, and (2) if so, whether the agreement to arbitrate has been breached ); Faber v. Menard, Inc., 367 F.3d 1048, 1052 (8th Cir. 2004) ( We have made clear that when reviewing an arbitration clause, we ask only (1) whether there is a valid arbitration agreement and (2) whether the particular dispute falls within the terms of that agreement ); Cox v. Ocean View Hotel Corp., 533 F.3d 1114, 1119 (9th Cir. 2008) ( [T]he FAA limits courts involvement to determining (1) whether a valid agreement to arbitrate exists and, if it does, (2) whether the agreement encompasses the dispute at issue ) (quotations and citations omitted). 47 After the dispute has arisen a party may elect to have this issue decided by the arbitrators. This is one reason why the principle of kompetenz-kompetenz expressly recognized in the rules of many arbitral organizations is important. See William W. Park, Determining Arbitral Jurisdiction: Allocation of Tasks Between Courts and Arbitrators, 8 AM. REV. INT L ARB. 133, 140 (1997). However, in this situation the court is enforcing the parties separate and undisputed post-dispute agreement to submit the issue to the arbitrator. Absent such post-dispute express consent, a party is entitled to a judicial adjudication of this issue. See China Minmetals Materials Imp. & Exp. Co. v. Chi Mei Corp., 334 F.3d 274, (3d Cir. 2003). 48 Wiley, 376 U.S. at Id.

12 168 THE AMERICAN REVIEW OF INTERNATIONAL ARBITRATION [Vol. 20 less the power to determine its own jurisdiction, if the parties never entered into it. 50 Similarly, in Sphere Drake Insurance Ltd. v. All American Insurance Co., 51 the Seventh Circuit explained that a person who has not consented (or authorized an agent to do so on his behalf) can t be packed off to a private forum. Courts have jurisdiction to determine their jurisdiction not only out of necessity... but also because their authority depends on statutes rather than the parties permission. Arbitrators lack a comparable authority to determine their own authority because there is a noncircular alternative (the judiciary) and because the parties do control the existence and limits of an arbitrator s power. No contract, no power. 52 In Sandvik AB v. Advent International Corp., 53 for example, Advent contended that the agent who signed the agreement on its behalf lacked authority to do so. The Third Circuit held that this was an issue for the court, because [e]ven under the severability doctrine, there may be no arbitration if the agreement to arbitrate is nonexistent. 54 [B]ecause an arbitrator s jurisdiction is rooted in the agreement of the parties, a party who contests the making of a contract containing an arbitration provision cannot be compelled to arbitrate the threshold issue of the existence of an agreement to arbitrate. Only a court can make that decision. 55 The issue cannot be deferred by the court to the arbitrator because [t]here would however be a severe problem of bootstrapping if a party to a contract could be forced to arbitrate the question whether he had been coerced or deceived into agreeing to arbitrate disputes arising under the contract. 56 In short, no contract, no power. The second reason why the court, and not an arbitrator, must decide this challenge by a party to arbitration is that such result is required by statute, specifically the FAA. As the Court held in Prima Paint, the FAA requires that a court prior to ordering a party to arbitration must be satisfied that the making of F.3d at F.3d 587 (7th Cir. 2001). 52 Id. at F.3d 99 (3d Cir. 2000). 54 Id. at Three Valleys Mun. Water Dist. v. E.F. Hutton & Co., 925 F.2d 1136, (9th Cir. 1991) (citation and footnote omitted) 56 Matterhorn, Inc. v. NCR Corp., 763 F.2d 866, 869 (7th Cir. 1985). See William W. Park, The Arbitrator s Jurisdiction to Determine Jurisdiction, in INTERNATIONAL ARBITRATION 2006: BACK TO BASICS?, ICCA CONGRESS SERIES NO. 13 at 130 (Albert Jan van den Berg ed., 2007) ( A contract clause purporting to give arbitrators power to determine their own authority does not, in itself, insulate from judicial review a decision to add a party that never agreed to arbitrate. The mere narration or recital of the arbitrator s power on a printed form cannot be confused with a genuine grant of authority. The suggestion that arbitrators can determine their own jurisdiction [in such situations] brings to mind the picture of Baron Münchhausen pulling himself up by his own pigtail. ).

13 2009] THE RULES GOVERNING WHO DECIDES JURISDICTIONAL ISSUES 169 the agreement for arbitration... is not in issue. 57 Section 4 requires that where the making of the agreement for arbitration is disputed the court shall proceed summarily to the trial thereof. Indeed, Section 4 provides that the person asserting such challenge has the right to have that issue tried before a jury. 58 This issue of the making of the agreement for arbitration includes any challenge to the existence, validity or enforceability of the arbitration agreement. This conclusion that any challenge to the existence, validity or enforceability of the arbitration agreement is a challenge to the making of the agreement for arbitration within the scope of Section 4 is required by Section 2 of the FAA. Section 2 addresses the Validity, irrevocability and enforcement of agreements to arbitrate and provides, in part, as follows: A written provision in any maritime transaction or a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction... shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract. 59 A claim of fraud in the inducement of an arbitration clause was found to be an issue concerning the making of the agreement for arbitration. In Prima Paint, the Court held that a claim [of] fraud in the inducement of the arbitration clause itself is an issue which goes to the making of the agreement to arbitrate, and so the federal court may proceed to adjudicate it. 60 Fraud in the inducement of the arbitration clause is an example of save upon such grounds as exist at law or in equity for the revocation of any contract. 61 That the meaning of the term agreement as used in Section 4 ( upon being satisfied that the making of the agreement for arbitration... is not in issue ) should be interpreted with reference to Section 2 of the FAA, is also supported by the Court s recent decision in Arthur Anderson LLP v. Carlisle, 62 where the court relied on the meaning of the term agreement in Section 2 in defining the meaning of agreement referred to in Section 3 of the FAA. In other words, in order to invoke the power of the FAA to compel a party to arbitrate a dispute, a court must be sure that there is no issue as to the making of the agreement to arbitrate. Agreements to arbitrate under the FAA do not include contracts that may be revoked upon such grounds as exist at law or in equity for the revocation of any contract. 63 As the Court held in Southland Corp. v. 57 See 9 U.S.C. 4; Prima Paint, 388 U.S. at See 9 U.S.C. 4 ( Where such an issue is raised, the party alleged to be in default may... demand a jury trial of such issue ) U.S.C. 2 (emphasis added) U.S. at U.S.C S. Ct (2009) U.S.C. 2.

14 170 THE AMERICAN REVIEW OF INTERNATIONAL ARBITRATION [Vol. 20 Keating, 64 [w]e discern only two limitations on the enforceability of arbitration provisions governed by the Federal Arbitration Act: they must be part of a written... contract... and such clauses may be revoked upon grounds as exist at law or in equity for the revocation of any contract The Rules and Reasons Governing Why a Dispute About the Scope of an Arbitration Agreement Is Presumptively for the Court, but May Be Assigned by the Parties to the Arbitrator for Decision The second threshold issue is whether the particular dispute between the parties is within the scope of the arbitration obligation. This question does not address whether there is a valid, binding and enforceable arbitration agreement between the parties. In fact, the question presumes that such inquiry has already been resolved. 66 Importantly, because this second threshold question presumes that an arbitration agreement exists, it can be made subject to a different set of rules. The Court has identified rules that are to be used to determine who is to decide whether a particular dispute falls within the scope of an arbitration agreement. 67 The first rule is that whether an arbitration agreement creates a duty for the parties to arbitrate the particular grievance is undeniably an issue for judicial determination. 68 This rule follows from the fundamental principle that arbitration is a matter of contract and a party cannot be required to submit to arbitration any dispute which he has not agreed to so submit. 69 This axiom recognizes the fact that arbitrators derive their authority to resolve disputes only because the parties have agreed in advance to submit such grievances to arbitration. 70 This first rule is subject to an important exception. The foundation for the exception is that a dispute about scope does not challenge the existence of an arbitration agreement. In other words, the parties are disputing only the identity of the grievances that are to be submitted to arbitration. The issue thus becomes U.S. at Quoting 9 U.S.C See Wiley, 376 U.S. at 547 ( The duty to arbitrate being of contractual origin, a compulsory submission to arbitration cannot precede judicial determination that the collective bargaining agreement does in fact create such a duty. Thus, just as an employer had no obligation to arbitrate issues which it has not agreed to arbitrate, so a fortiori, it cannot be compelled to arbitrate if an arbitration clause does not bind it at all. ) (emphasis added). 67 Because the FAA creates a body of federal substantive law, each of these rules is applicable in state and federal courts. Southland, 465 U.S. at AT&T, 475 U.S. at 649 (emphasis added) Id. at 648. Id. at

15 2009] THE RULES GOVERNING WHO DECIDES JURISDICTIONAL ISSUES 171 what the scope is of the authority that the parties have bestowed upon the arbitrators. This exception gives rise to the second rule. As the Court stated in AT&T: Unless the parties clearly and unmistakably provide otherwise, the question of whether the parties agreed to arbitrate [a particular grievance] is to be decided by the court, not the arbitrator. 71 Put the other way, the second rule is that where the court finds that parties have clearly and unmistakably provided the arbitrators with the authority to determine whether a particular issue is within the scope of the arbitration agreement, then that issue is to be decided by the arbitrators. This second rule recognizes that because a binding arbitration agreement has already been found to exist, there now is a legally binding document in which arbitrators have been given some power by the parties. Therefore, it is now possible to ask what the parties clearly and unmistakably have agreed should be decided by the arbitrators. In short, the question of whether the parties have clearly and unmistakably provided otherwise, can now be posed either because the court has separately determined or the parties have conceded that there is a binding arbitration agreement. In the absence of a court determination that there is a binding arbitration agreement, there is no agreement for a court to examine in order to find any clear and unmistakable statement of the parties intent. The third rule is that any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration. 72 This rule is a reflection of the strong federal policy favoring arbitration. 73 As the Court explained: The Arbitration Act establishes that, as a matter of federal law, any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration, whether the problem at hand is the construction of the contract language itself or an allegation of waiver, delay, or a like defense to arbitrability. 74 A fourth rule concerns the retained power of the court. Even where the court has determined that the parties have clearly and unmistakably agreed that any question as to the scope of the arbitration agreement should be decided by the arbitrators, the court retains the power to decide this issue. This retained power is to be used in only one narrow circumstance: the court may decline to order that the dispute about the scope of an arbitration clause be determined by the arbitrator if and only if it may be said with positive assurance that the arbitration clause is not susceptible of an interpretation that covers the asserted dispute. 75 As the Federal Circuit held in Qualcomm Inc. v. Nokia Corp., 76 where a court has concluded that the parties to the agreement did clearly and unmistakably Id. at 649. Moses H. Cone Mem l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, (1983). Id. at 24-25; see Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20, 24 (1991). Moses H. Cone, 460 U.S. at AT&T, 475 U.S. at F.3d 1366, 1371 (Fed. Cir. 2006).

16 172 THE AMERICAN REVIEW OF INTERNATIONAL ARBITRATION [Vol. 20 intend to delegate the power to decide arbitrability to an arbitrator, then the court should perform a second, more limited inquiry to determine whether the assertion of arbitrability is wholly groundless. Where the court, after performing such second, more limited inquiry can say with positive assurance that the arbitration clause is not susceptible to an interpretation that covers the asserted dispute, it need not refer the matter to the arbitrator. 77 As the Federal Circuit explained: We believe that the wholly groundless inquiry serves to prevent a party from asserting any claim at all, no matter how divorced from the parties agreement to force an arbitration. 78 E. A Summary of the Fundamental Arbitration Rules That Govern the Analysis of Whether a Party Is Required to Submit a Dispute to Arbitration A clear set of rules can be derived from the Supreme Court decisions as to how a court is to approach and evaluate a case where a party raises an objection to the arbitration. These rules, which constitute a paradigm of arbitral jurisprudence, are as follows: 1. There are two threshold issues that a court must decide in connection with any case that has an arbitration clause. Question 1: Did the parties enter into a valid, binding and enforceable arbitration agreement? Question 2: If so, does the specific dispute fall within the scope of that arbitration agreement? 2. The first question of whether the parties are bound by an agreement to arbitrate is a matter to be decided by the court in all cases and without exception. We will discuss below the types of challenges that are considered to go to the existence of a binding arbitration agreement. 3. The second question of whether the specific dispute falls within the scope of the subjects that the parties agreed were to be resolved by arbitration is, as a general rule, to be decided by the court (but this general rule is subject to an important exception). 4. When the court is making the decision as to the scope of the arbitration clause, any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration. 79 This is because of the strong federal 77 See Woodcrest Nursing Home v. Local 144, 788 F.2d 894, 898 (2d Cir. 1986); Concourse Village Inv. v. Local 32E, Serv. Employees Int l Union, 822 F.2d 302, 304 (2d Cir. 1987) (same). 78 Qualcomm, 466 F.3d at 1373 n.5; see Dream Theatre, Inc. v. Dream Theater, 21 Cal. Rptr. 3d 322, 326 (Cal. Ct. App. 2004) ( wholly groundless ). 79 Moses H. Cone, 460 U.S. at

17 2009] THE RULES GOVERNING WHO DECIDES JURISDICTIONAL ISSUES 173 policy favoring arbitration. This is a matter of the federal substantive law under the FAA and is applicable in state and federal courts The general rule that a court is to decide whether a dispute falls within the scope of the arbitration clause is subject to an important exception. The arbitrator, and not the court, will decide the question of whether a specific dispute falls within the scope of the arbitration clause if the court finds that the parties themselves have clearly and unmistakably assigned this as an issue to be decided by the arbitrator. 81 The ability to find such clear and unmistakable evidence of intent presupposes that the court has already determined, or it has been conceded, that a binding arbitration agreement exists between the parties. 6. Finally, the court need not refer to the arbitrator a question as to the scope of an arbitration clause even where the court has found clear and unmistakable evidence of the parties intent to do so if the court can say with positive assurance that the arbitration clause is not susceptible of an interpretation that covers the asserted dispute. 82 In other words, the court need not refer this issue to the arbitrators for decision where the assertion that a specific dispute is within the scope of the arbitration clause is wholly groundless. 83 It is important to note that the terms arbitrability or the question of arbitrability are never used in any of these statements of the fundamental laws of arbitration. This is because the term arbitrability masks the crucial distinction between objections that challenge whether a valid arbitration agreement exists, and objections that challenge whether a specific dispute falls within the scope of the arbitration agreement. As noted above, the rules of decision as to how to answer these questions are not the same. The use of the term the question of arbitrability is to be avoided because its ambiguity obscures recognition that there are, in fact, two separate and independent questions, each of which is governed by its own set of decisional rules. III. THE SERIOUS PROBLEMS CREATED BY THE MISINTERPRETATION OF FIRST OPTIONS v. KAPLAN The current confusion over how courts should decide which objections to arbitration are to be decided by the court and which may be decided by the arbitrator is directly traceable to First Options of Chicago, Inc. v. Kaplan. 84 The facts of First Options concern the Kaplans challenge to the existence of any See Southland, 465 U.S. at AT&T, 475 U.S. at 649. Id. at 650; see Concourse Village, 822 F.3d at 304. See Qualcomm, 466 F.3d at U.S. 938 (1995).

18 174 THE AMERICAN REVIEW OF INTERNATIONAL ARBITRATION [Vol. 20 arbitration agreement between themselves and First Options of Chicago. However, there are extensive dicta in First Options that discuss how a court is to resolve challenges to the scope of an arbitration clause. The unfortunate use of the term arbitrability 85 in the First Options decision masks the critical distinction between the two. As a result, since First Options as will be shown many courts have applied rules governing objections to the scope of an arbitration clause to cases where the objection is to the existence of an arbitration agreement, with unfortunate results. The First Options Decision First Options arose from a dispute between First Options of Chicago, Inc. ( First Options ) and MK Investments Inc. ( MKI ), which was owned by Manuel and Carol Kaplan. 86 The dispute centered on a workout arrangement for debts owed by MKI and the Kaplans to First Options which were embodied in four separate documents, whose signatories were not the same. Only one of the four documents contained an arbitration clause. At one point, First Options exercised certain rights against MKI and demanded immediate payment of the entire MKI debt, and insisted that the Kaplans personally pay any deficiency. 87 When these demands went unsatisfied, First Options filed a demand for arbitration against both MKI and the Kaplans with the Philadelphia Stock Exchange. MKI, which had signed the only document that contained an arbitration clause, accepted arbitration. The Kaplans, however, who had not personally signed that document, denied that their dispute with First Options was subject to any arbitration agreement. 88 The Kaplans filed written objections with the arbitration panel to that effect. The arbitrators ruled in favor of First Options, overruling the Kaplans objections to arbitration. 89 The Court in First Options began its analysis by noting that there were three separate types of disagreements between the parties present in the case. 90 First, the Kaplans and First Options disagree about whether the Kaplans are personally liable for MKI s debt to First Options. That disagreement makes up the merits of the dispute. 91 Second, the Kaplans and First Options disagree about whether they agreed to arbitrate the merits. 92 The Court characterizes this second 85 Rau, supra note 1, at 308 ( Now, arbitrability is a word that might well be banned from our vocabulary entirely.... Its use is particularly confusing in First Options). 86 First Options, 514 U.S. at Id. at Id. at Id. 90 Id. at Id. 92 Id.

19 2009] THE RULES GOVERNING WHO DECIDES JURISDICTIONAL ISSUES 175 disagreement as one about the arbitrability of the dispute. 93 Third, the Kaplans and First Options disagree about who should have the primary power to decide the second matter. 94 In other words: which forum a court or the arbitrator has the power to decide the issue of arbitrability? 95 The Court s decision addresses only this third question. The issue of forum is critical because, as the Court noted, who court or arbitrator has the primary authority to decide whether a party has agreed to arbitrate can make a critical difference to a party resisting arbitration. 96 This is because, as the Court explained, if a party has not agreed to arbitrate it will normally have a right to a court s decision about the merits of its dispute. 97 On the other hand, if a party has agreed to arbitration, then while that party still can ask a court to review the arbitrator s decision the court will set that decision aside only in very unusual circumstances. 98 In other words, the choice of forum has a major effect on the standard of review. As the Court later noted, courts grant arbitrators considerable leeway when reviewing most arbitration decisions. 99 The Court in First Options began from the fundamental principle that because arbitration is simply a matter of contract between the parties; it is a way to resolve those disputes but only those disputes that the parties have agreed to submit to arbitration. 100 Accordingly, the Court stated that if the parties agreed to submit the matter of arbitrability to the arbitrators, then the court should give considerable leeway to the arbitrator, setting aside his or her decision only in certain narrow circumstances. 101 On the other hand, if the answer to that question is no, then the court should decide that question just as it would decide any other question that the parties did not submit to arbitration, namely, independently. 102 In sum, the Court concluded that a court must defer to an arbitrator s arbitrability decision when the parties submitted that matter to arbitration Id. Importantly, by phrasing this second question in such way, what is overlooked is that the question contains within it two independent questions: First, did the Kaplans enter into any arbitration agreement with First Options? Second, is the particular dispute one that falls within the scope of that arbitration agreement? This example highlights the importance of courts returning to and consistently using the traditional two threshold question form of analysis. 94 Id. 95 Id. 96 Id. at Id. 98 Id. 99 Id. at Id. at Id. 102 Id. 103 Id.

20 176 THE AMERICAN REVIEW OF INTERNATIONAL ARBITRATION [Vol. 20 On the facts of the case, the Court held that the Kaplans did not agree to arbitrate arbitrability here. 104 This holding is clearly correct, as it appears undisputed that the only agreement that the Kaplans signed in their personal capacity with First Options did not contain an arbitration provision. 105 The Court also rejected First Options s arguments that the Kaplans be found to have waived any objection to arbitration because (i) they failed to file a court proceeding to stay the arbitration; (ii) they submitted a written memorandum on the issue to the arbitrators (in which they also objected to the arbitrators jurisdiction); or (iii) the FAA requires a presumption that the Kaplans agreed to be bound, which the Court rejected as legally erroneous. 106 The reason that the First Options decision has become such a source of confusion is that the Court did not approach the case by using the established two threshold question framework in its analysis. In other words, the Court in its decision did not ask: (1) is there a dispute about whether an arbitration agreement exists between the parties and (2) if so, does this particular dispute fall within the scope of the arbitration agreement. Instead, the Court stated the issue before it as the determination of who should have the primary power to decide about the arbitrability of the dispute. 107 This characterization of the issue is a mistake. This is because the term arbitrability can apply to either an objection challenging the existence of an arbitration agreement or an objection based on the scope of an arbitration agreement. The same problem was repeated when the Court phrased the issue before it as how a court should decide whether the parties have agreed to submit the arbitrability issue to arbitration. 108 As a result, the Court s conclusion that a court must defer to an arbitrator s arbitrability decision when the parties submitted that matter to arbitration simply repeats the ambiguity. 109 This ambiguity permeates the entire decision in First Options. In fact, a particularly dangerous misinterpretation of First Options arises from the Court s later discussion (which is not part of the holding of the case), in which the Court states that it now wants to say a word about how a court should decide whether the parties have agreed to submit the arbitrability issue to arbitration. 110 What is clear is that, from this point on, what the Court is addressing are the rules governing disputes about the scope of an arbitration clause. A review of the Court s dicta following a word about how a court should decide whether the 104 Id. at Id. at 941. See Kaplan v. First Options of Chicago, Inc., 19 F.3d 1503, 1507 (3d Cir. 1994), aff d, 514 U.S. 938 (1995) ( Individually, Mr. and Mrs. Kaplan signed only the Letter Agreement. It did not have an arbitration clause. ) U.S. at Id. at Id. at Id. at 943 (emphasis added). 110 Id. at 944.