Fourth Circuit Holds Arbitration Clause Unenforceable When Contract Also Disavows Federal and State Substantive Law

While not a construction dispute, the Fourth Circuit’s decision in Hayes v. Delbert Services Corp., 2016 WL 386016, __ F.3d __ (4th Cir. 2/2/16), gives insight to the limits to a court’s willingness to enforce arbitration clauses that also include a waiver of substantive rights. 

Hayes concerned a putative class action against Delbert Services Corporation (“Delbert”), the servicing agent for the loans at issue, in which the plaintiffs claimed that Delbert’s unfair debt collection practices violated federal law.  The lender was Western Sky Financial, LLC (“Western Sky”), an online lender owned by a member of the Cheyenne River Sioux Tribe and located on the Cheyenne River Indian Reservation in South Dakota.  Delbert sought to compel arbitration in response to the plaintiffs’ claims. 

The loan agreements required resolution of all disputes through arbitration, but at the same time disavowed the applicability of any federal or state laws to the dispute, stating that the agreement was “subject solely to the exclusive laws and jurisdiction of the Cheyenne River Sioux Tribe” and that “[n]either this Agreement nor Lender is subject to the laws of any state of the United States of America”.   Id. at *1-*2.

The district court upheld the arbitration clause, but the Fourth Circuit disagreed:

We both respect and appreciate the support of Congress and the Supreme Court for an arbitration procedure that reduces the costs and delays of civil litigation.  Our review of the record leads us to conclude, however, that the arbitration agreement in this case is unenforceable.  The agreement purportedly fashions a system of alternative dispute resolution while simultaneously rendering that system all but impotent through a categorical rejection of the requirements of state and federal law.  The FAA does not protect the sort of arbitration agreement that unambiguously forbids an arbitrator from even applying the applicable law.

Id. at *1.

The Fourth Circuit further noted that while parties can raise certain rights as part of an arbitration agreement, such as the right to a jury trial, “a party may not underhandedly convert a choice of law clause into a choice of no law clause¼”.  Id. at *8.

While the circumstances of Hayes are unique, it does provide guidance that, if an arbitration clause also effectively eliminates wholesale the federal or state substantive law that would otherwise apply to a dispute, the clause might be held unenforceable.

For reference, a copy of the Hayes decision is linked here.