The following article analyzes the more recent and influential federal court cases concerning waiver of contractual arbitration rights. Matthew Forsythe focuses on the factual considerations that circuit courts have found significant in their decisions regarding arbitration waiver issues, and offers a review of the standards the courts have applied in these cases.
When contracting parties include an arbitration provision in their contract, it is obviously not their intention that disputes arising out of, or relating to, that agreement will ultimately wind up before a judge or jury in civil court. Even though parties to such arbitration agreements do not intend to litigate, their subsequent actions, or the steps taken by their legal counsel, may lead them directly into the public forum that contractually they have attempted to avoid.
The following article offers a summary of recent and influential federal court cases when a party has waived its contractual right to arbitrate. It looks at what factual considerations circuit courts deemed significant in their decisions regarding waiver, and the standards that each court applied in its review. Although the attempt has been to provide some insight into how courts address waiver of arbitration rights, this article is not intended to be an exhaustive treatise on the subject, a practitioner's guide, or hornbook entry. Rather, it outlines the prevailing general trends in federal law and compares the varying tests and analyses used by federal appellate courts over the last 10 years or so.
Presumption Favoring Arbitration
In several of the federal circuits' landmark cases addressing the issue of waiver of a party's right to arbitrate disputes, the courts' initial point of departure has been to recognize and reaffirm the strong federal policy in favor of arbitration when contracting parties have selected it for the resolution of their disputes. The lineage of "the old judicial hostility to arbitration" has ended, and this modern trend represents a sea change in the way federal courts now view arbitration.1 Gone are the days when the English judges opposed any innovation that would deprive them of their jurisdiction.2 Today, federal policy strongly favors arbitration as an alternative dispute resolution forum.3
In this regard, many of the cases discussed below have pointed to the fact that "[i]n enacting the Federal Arbitration Act, Congress declared a national policy in favor of arbitration."4 This "national policy" and subsequent Supreme Court rulings mandate that federal courts widely recognize "Congress's clear intent, in the Arbitration Act, to move the parties to an arbitrable dispute out of court and into arbitration as quickly and easily as possible."5 Justice Brennan summarized the Supreme Court's opinion concerning this policy by stating:
[t]he 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.6 As a general rule, therefore, the federal courts have interpreted this federal policy favoring arbitration as a presumption that must be overcome initially in any argument in which waiver of the right to arbitrate is asserted. Decisions rendered in numerous federal cases illustrate clearly this inference in favor of arbitration. For example:
1. Accordingly, we indulge a presumption against finding waiver.7
2. Given this presumption in favor of arbitrability, waiver of arbitration is not to be lightly inferred.8
3. Further, when the contract's arbitration clause is a broad one, the strong presumption in favor of arbitrability applies with even greater force.9
With this presumption as a backdrop, the following cases demonstrate how federal courts have scrutinized the facts involved, and the procedural steps taken by the parties invoking arbitration to determine if, by their own actions, this initial presumption has been rebutted, and whether such parties have waived their contractual right to arbitrate. In the last 10 years, the bulk of federal case law precedent results from litigation occurring in the 1st, 2nd, 5th, 7th, and 9th Circuit Courts of Appeals. This article includes cases primarily from those jurisdictions. The relevant holdings of other federal circuits are included only in summary and without any explanation of the facts and procedural steps involved.
Court of Appeals for the 1st Circuit
The 1st Circuit's most recent case involving waiver of arbitration is Menorah Insurance Co. v. INX Reinsurance Corp.10 In this case, Menorah, an Israeli company, and INX, a Puerto Rican corporation, agreed that their business disputes would be resolved by a party-appointed arbitration panel. Menorah made a claim to INX for $750,000 and sought arbitration under the parties' agreement. INX responded that it would not arbitrate. In Sept. 1992, Menorah filed suit in Tel Aviv. INX did not respond or defend itself in this action, and a judgment was entered against it. In Sept. 1993, Menorah moved to enforce the judgment. Invoking the arbitration agreement for the first time in the course of the litigation, INX filed a motion to dismiss. Upon denial of its motion, INX removed the case to federal district court. The district court held that INX waived its right to demand arbitration, and INX appealed.
Upon extensive review of these facts, the 1st Circuit found an "implicit waiver" stemming from "INX's entire course of conduct."11 Analogous to the 2nd Circuit's treatment of prejudice as an essential element of waiver, the 1st Circuit held that: "[i]t has been the rule in this Circuit that in order for plaintiffs to prevail on their claim of waiver, they must show prejudice."12 Summarizing the court's general disdain for INX's conduct and attempts to invoke the arbitration agreement after years of litigation involving the courts of two different countries, Judge Lynch poignantly wrote:
Neither efficiency nor economy are served by adopting INX's arguments. The scenario here -in which a party knowingly opts out of the arbitration for which it has contracted (even if driven by looming insolvency), sits on its hands while a default judgment is entered against it after service, refuses to pay, requires an enforcement action be filed against it, and only then cries "arbitration"-undermines both the certainty and predictability which arbitration agreements are meant to foster.13
Court of Appeals for the 2nd Circuit
Given the location, population density, and economic diversity of the area included in the 2nd Circuit, its law contains more cases concerning waiver of arbitration than any other federal circuit. This circuit's decisions are far-reaching and are afforded considerable deference even by courts not bound by its precedent. For this reason, relatively more cases from this jurisdiction are included here than any other.
On Aug. 19, 1991, the United States Court of Appeals, 2nd Circuit, decided a case entitled Kramer v. Hammond.14 In this case, Hammond entered into two agreements with a number of California inventors and investors to license and market a medical device known as the lithotripter. Its creators designed the instrument to break up kidney stones with sound waves thereby avoiding more intrusive surgical procedures. The agreement contained an arbitration provision.
The parties' dispute arose from Hammond's charge that Kramer, the attorney for the group of inventors, and others had "entered into a conspiracy and an agreement to fool, cheat, and manipulate"15 Hammond and to reduce his rights in the business. Based on these allegations, Hammond filed suit in both South Carolina and New York state courts. Only after litigating issues to the highest state courts of New York and South Carolina and petitioning the U.S. Supreme Court for a writ of certiorari did Kramer invoke the arbitration clause in the agreement. The 2nd Circuit held that the extent to which Kramer engaged in litigation and the prejudicial effect this had on Hammond constituted a waiver of Kramer's right to arbitrate.
Prejudice to the non-moving party is an element to which the court looked in examining the issue of waiver. The court in Kramer identified two separate types of prejudice: (1) substantive prejudice, and (2) prejudice in terms of expense or delay. Citing two prior cases, Com-Tech and Rush,16 the court distinguished these two kinds of prejudice as follows:
Prejudice can be substantive, such as when a party loses a motion on the merits and then attempts, in effect, to relitigate the issue by invoking arbitration, or it can be found when a party too long postpones his invocation of his contractual right to arbitration, and thereby causes his adversary to incur unnecessary delay or expense.17
The 2nd Circuit continues its analysis of prejudice as an indispensable part of any finding of waiver by stating that:
[n]o bright line defines this second type of prejudice-neither a particular time frame nor dollar amount automatically results in such a finding-but it is instead determined contextually, by examining the extent of the delay, the degree of litigation that has preceded the invocation of arbitration, the resulting burdens and expenses, and the other surrounding circumstances.18
The approach outlined in Kramer encompasses the major elements used throughout this line of cases.
Also in 1991, the 2nd Circuit decided Com-Tech Assoc. v. Computer Assoc.19 In this case, the dispute arose out of two contracts requiring the firm Computer Associates to develop and market a software program created by Com-Tech. In 1979, Computer Associates urged Com-Tech to acquiesce in an extension of time within which Computer Associates was required to perform under its contract. Com-Tech agreed, but in 1987 filed this action claiming that Computer Associates intentionally misrepresented certain facts to induce Com-Tech's acquiescence. The 2nd Circuit upheld the district court's decision that Computer Associates had engaged in extensive litigation and waived their contractual right to arbitrate.
In arriving at this conclusion, the court reasoned that "[t]he protracted litigation which preceded the motion to arbitrate" affirmed the district court's holding that Computer Associates "waived their contractual right to compel arbitration."20 Reiterating how Computer Associates' own action constituted a finding of waiver and citing the underlying purpose of contractual arbitration, the court held that:
[t]o permit litigants to exercise their contractual rights to arbitrate at...a late date, after they have deliberately chosen to participate in costly and extended litigation would defeat the purpose of arbitration: that disputes be resolved with dispatch and with a minimum of expense.21
Leadertex v. Morganton Dyeing & Finishing Core is another significant 2nd Circuit case involving waiver of arbitration.22 Leadertex is a small family-owned New York corporation in the textile converting business. Leadertex's operation involves the purchase of raw, unprocessed fabrics from numerous sources. The company then contracts for the dyeing and finishing of these fabrics for subsequent sale. Morganton is a fabric dyer. The parties' standard-form agreements all contaro arbitration provisions.
A dispute arose when some of Leadertex's customers began returning substantial orders of fabric claiming that they were defective. For its part, Leadertex alleged that Morganton defectively dyed the fabric while Morganton argued that the product was damaged before it arrived from Leadertex.
On May 1, 1993, Leadertex started an action against Morganton in the New York Supreme Court. One month later, Morganton had the case removed to federal court where it then filed a counterclaim. In July 1993, Leadertex sought leave to file an amended complaint. A scheduling conference was conducted in Oct. 1993 and discovery was conducted and completed. In Dec. 1993, Leadertex moved for partial summary judgment and Morganton replied with a cross motion to compel arbitration. The district court held that Morganton had waived its right to arbitration and denied the motion.
In its review of the district court's holding concerning waiver, the 2nd Circuit analyzed the requirements for waiver employing a two-part test. The court reasoned that a finding of waiver must be supported by unnecessary expense, delay, and prejudice. The extent to which the parties engaged in pre-trial procedures, including discovery, was persuasive. However, the 2nd Circuit stated that "there can be no waiver unless that conduct has resulted in prejudice to the other party"23 and found that "pretrial expense and delay-unfortunately inherent in litigation--without more do not constitute prejudice sufficient to support a finding of waiver."24
Finally, the court considered whether Leadertex had suffered economic prejudice occasioned by Morganton's delay. The court found sufficient illustration "to demonstrate the prejudice necessary to support the district court's ruling that there was a waiver of arbitration."25
In 1998, the 2nd Circuit reviewed S & R Co. of Kingston v. Latona Trucking, Inc.26 In this matter, S & R, the construction owner, entered into a contract with Latona, a subcontractor, to perform site work. Hartford acted as S & R's surety and all parties were bound by an arbitration agreement requiring the use of the American Arbitration Association's (AAA) rules. A dispute arose between S & R and Latona who filed suit in district court. After extensive pretrial activity, S & R and Hartford filed a motion to compel arbitration. Holding that the petitioners had waived their right to arbitration, the court denied the motion and S&R and Hartford appealed.
S & R and Hartford first argued that the district court erred by not referring the issue of waiver to the arbitrator. Relying on Doctor's Assoc. v. Distajo27 and other cases, the court disagreed and held that, although ordinarily waiver is an issue properly submitted to the arbitrator, the district court could decide the issue when the party seeking arbitration had already engaged in litigation. Significantly, the 2nd Circuit noted that Doctor's Assoc. v. Distajo required that the party seeking arbitration engage in only "any prior litigation."28 This bright-line test means that courts following Doctor's Assoc. v. Distajo will not question the extent to which litigation has been conducted or whether such actions constitute "substantial litigation." Any prior litigation is enough to support a finding that the district court, and not the arbitrator, shall resolve such threshold, jurisdictional questions.
As to the standard of review used by the court to determine if a party had waived its right to arbitrate, the 2nd Circuit agreed with the district court's finding of waiver because S & R:
1. failed to plead the defense of arbitration and award;
2. actively participated in litigation for 15 months;
3. participated in two settlement conferences;
4. prejudiced Latona by engaging in discovery; and
5. imposed undue delay and expense.29
In addition, the court addressed S & R and Hartford's contention that the AAA's rules contain a so-called "no waiver" provision.30 Such provisions, the court recognized, are intended to provide merely interim and/or injunctive relief. They do not constitute a contractual agreement never to waive arbitration rights. Thus, based upon its finding that this section of the AAA's rules was designed only to provide for limited measures of protection, and not the adjudication of substantive contractual rights, the court determined that this language did not prevent a finding of waiver.31
Court of Appeals for the 5th Circuit
The 5th Circuit's most recent case involving a party's waiver of its arbitration rights is a consolidated action entitled Subway Equipment Leasing Corp. v. Forte.32 As this matter involves Subway Sandwich Shops, franchisees, a Subway development agent, realestate companies, and equipment leasing concerns, the parties to the action are numerous and the facts convoluted. In addition, the parties' procedural wrangling lasted approximately 10 years and involved several bankruptcy proceedings. In the interest of brevity and clarity, therefore, the following concentrates on the main issue in dispute-whether a party's conduct amounts to a waiver of arbitration.
The 5th Circuit's standard of review for such cases stems from an earlier 1986 case, Miller Brewing Co. v. Fort Worth Distributing Co.33 In that case, the court held that "[w]aiver will be found when the party seeking arbitration substantially invokes the judicial process to the detriment or prejudice of the other party."34 Thus, the 5th Circuit also includes "prejudice" as an essential element in any finding of waiver.
Primarily at issue in this case was the franchisee's argument that the actions of DAI-a Subway affiliate-constituted waiver. The 5th Circuit reversed the district court's finding that such waiver had occurred and held that DAI had not invoked the judicial process to such an extent that waiver was justified. The court reasoned that "in order to invoke the judicial process, a party must have litigated the claim that the party now proposes to arbitrate."35 Here, the court found DAI's prior conduct to involve merely "unrelated litigation" such that it did not "evince a desire to resolve the arbitrable dispute through litigation rather than arbitration."36
Court of Appeals for the 7th Circuit
The 7th Circuit's last case involving waiver of arbitration is entitled Iowa Grain Co. v. Brown.37 This case involves a number of individual customers who had been solicited by a registered commodity broker working on behalf of Iowa Grain. On June 27, 1997, these customers initiated a class action against Iowa Grain in a South Carolina Federal District Court. Some of the plaintiffs had signed arbitration agreements-Iowa Grain Customer Agreements while others had not. The customer agreements at issue contained a forum-selection clause mandating that any claim or dispute would be litigated in Cook County, Ill., if the dispute was not subject to a valid arbitration provision. Based upon this forum-selection language, the district court in South Carolina dismissed this case for lack of jurisdiction.
On Sept. 23, 1997, the customers that had entered into arbitration agreements with Iowa Grain, filed a demand for arbitration with the AAA in South Carolina, while Iowa Grain filed suit in Federal District Court for the Northern District of Illinois pursuant to the forum-selection provision in the customer agreements. Iowa Grain then argued that, by filing their class action in South Carolina, the customers had waived their contractual right to arbitrate.
Interpreting prior precedent, the court held that to invoke litigation creates a rebuttable presumption of waiver. However, this does not end the inquiry. The court found prior cases to stand for the following proposition:
First, an important part of the district court's waiver inquiry is to determine . . . whether the party filing the lawsuit intended to select the judicial forum rather than the arbitral tribunal. Second, uncertainty about the right to arbitrate is a factor that tends to undermine a finding of waiver from the mere filing of a court action. Third, even if a district court finds an initial waiver of the right to arbitrate, it is also entitled to permit that waiver be rescinded, depending on the course the litigation takes.38
In this case, therefore, the presumption was rebutted under a "totality of the circumstances" analysis. The 7th Circuit agreed with the lower court that the customers' intent in filing a class action was to pursue a remedy not readily available to them under the AAA's rules. Therefore, once the class action was dismissed and the customers filed for arbitration, only 11 calendar days thereafter, the court was not persuaded that such action constituted an intentional waiver.
Cabinetree of Wisconsin v. Kraftmaid Cabinetry, Inc.39 is another seminal case in the 7th Circuit's recent review of disputes involving waiver of contractual rights to arbitration. In 1989, Cabinetree entered into a contract with Kraftmaid in which Cabinetree became a franchised distributor of kitchen and bath cabinets made by Kraftmaid. The parties' agreement contained an arbitration clause calling for arbitration in Cleveland, Oh., under the AAA's rules. In 1993, Cabinetree filed suit in a Wisconsin state court alleging that Kraftmaid had terminated the franchise in violation of the Wisconsin Fair Dealership Law.
Kraftmaid removed the case to federal court. Discovery began, and a trial date was set for Dec. 1994. In July 1994, Kraftmaid moved the federal court to stay the proceedings pending arbitration. The district court denied Kraftmaid's motion and this appeal ensued.
The 7th Circuit began its analysis of this case by citing St. Mary's Medical Center of Evansville, Inc. v. Disco Aluminum Products Co.40 This case established four principles by which the 7th Circuit was guided. These included:
1. Review of a finding that a party has waived its contractual right to invoke arbitration is for clear error only; it is not plenary.
2. Such a waiver can be implied as well as expressed.
3. In determining whether a waiver has occurred, the court is not to place its thumb on the scales; the federal policy favoring arbitration is, at least so far as it concerns the interpretation of an arbitration clause, merely a policy of treating such clauses no less hospitably than other contractual provisions.
4. To establish a waiver of the contractual right to arbitrate, a party need not show that it would be prejudiced if the stay were granted and arbitration ensued.41
After citing these four guiding principles, the court "takes the next step in the evolution of doctrine."42 This next step constitutes the holding that:
... an election to proceed before a nonarbitral tribunal ... is a presumptive waiver of the right to arbitrate ... without insisting on evidence of prejudice beyond what is inherent in an effort to change forums in the middle (and it needn't be the exact middle) of a litigation.43
The 7th Circuit's focus on choice, election, and manifest intent not to arbitrate without requiring a contemporaneous finding of prejudice constitutes a significant departure from other circuits' precedent and is in vivid contrast to those analyses discussed above.
In conclusion, the 7th Circuit recognized that there are cases in which a forum choice does not constitute waiver automatically. However, the court's holding in this case that "invoking judicial process is presumptive waiver" remains an important and pervasive facet of the 7th Circuit's treatment of arbitration agreements.44
Court of Appeals for the 9th Circuit
Hoffman Construction v. Active Erectors45 is the 9th Circuit's most recent case addressing waiver of the right to arbitrate. In this case, Hoffman entered into a contract with a subcontractor, Active Erectors, as part of the construction of a high school in Homer, Ala. A dispute among the parties arose concerning cost overruns. In 1984, Active sued Hoffman in federal court asserting, among other things, a RICO46 claim. In 1985, the district court dismissed the federal suit, and Active sued in Alaska state court without asserting the RICO claim. The case was tried in 1987. In 1989, Active filed a new demand for arbitration including the RICO claim, and Hoffman brought this action in federal court seeking an injunction. At issue was whether Active waived its right to arbitrate the RICO claim.
The 9th Circuit, employing a three-prong test outlined in an earlier case, stated:
A party seeking to prove waiver of a right to arbitration must demonstrate: (a) knowledge of an existing right to compel arbitration; (b) acts inconsistent with that existing right; and (c) prejudice to the party opposing arbitration resulting from such inconsistent acts.47
Applying this three-prong test to the facts involved in this case, the court held that Active had waived its right to arbitrate.
Although the federal court cases outlined above may appear unrelated, the courts' opinions, taken together, do display a number of consistent, central themes. In terms of the tests, standards, and analyses used by the courts to determine if waiver has occurred, each case involves a review of the amount of delay involved, some speculation concerning the parties' intent to arbitrate, and, to varying degrees, whether the party opposing arbitration has suffered prejudice.
Each federal circuit has recognized the strong national policy favoring arbitration to the extent that a presumption against waiver of a party's right to arbitrate is now well-established throughout the country. As these cases have demonstrated, however, this presumption is not plenary or unqualified. Federal courts remain reluctant to allow litigants to invoke arbitration at a late date, after they have deliberately elected to participate in expensive and protracted litigation. To rule otherwise granting such permission would defeat the very purpose of alternative dispute resolution: "that disputes be resolved with dispatch and with a minimum of expense."48
' Kulukundis Shipping Co. v. Amtorg Trading Corp., 126 F.2d 978, 985 (2nd Cir. 1942).
' Bernhardt v. Polygraphic Co., 350 U.S. 198, 211 n. 5 (1956).
3 See Rodriguez de Quijas v. Shearson/American Express, Inc., 490 U.S. 477, 480-81 (1989).
Municipal Energy Agency of Mississippi v. Big Rivers Elec. Corp., 804 F.2d 338, 342 (5th Cir. 1986) (citing Southland Corp. v. Keating, 465 U.S. 1, 104 S. Ct. 852, 79 L. Ed. 2d 1 (1984)).
' Moses H. Cone Memorial Hospital v. Mercury Construction Corp., 460 U.S. 1, 22; 103 S. Ct. 927, 940; 74 L. Ed. 2d 765 (1983).
Id. at 24-25.
Walker v. J.C. Bradford ds' Co., 938 F.2d 575, 577 (5th Cir. 1991).
B Rush v. Oppenheimer &' Co., 779 F.2d 885, 887 (2nd Cir. 1987) (quoting Carcich v. Rederi AlB Nordie, 389 F.2d 692 (2d Cir. 1968)).
Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114, 121 (2nd Cir. 1991).
' Menorah Insurance Co. v. INX Reinsurance Corp., 72 F.3d 218 (1st. Cir. 1995).
" Id. at 221.
'Z Sevinor v. Merrill Lynch, Pierce, Fenner &' Smith, Inc., 807 F.2d 16, 18 (lst Cir. 1986).
" Supra, note 10, at 223.
" Kramer v. Hammond, 943 F.2d 176 (2nd Cir. 1991).
'S Id. at 178.
16 see Com-Tech v. Computer Assoc., 938 F.2d 1574, 1576 (2nd Cir. 1991); Rush v. Oppenheimer &' Co., 779 F.2d 885, 887 (2nd Cir. 1985).
" Supra, note 14, at 179. 18 Id.
' Cam-Tech Assoc. V. Computer Assoc., 938 F.2d 1574 (2nd Cir. 1991).
20 Id. at 1576. 21 Id. at 1578.
zz Leadertex v. Morganton Dyeing &' Finishing Corp., 67 F. 3d 20 (2nd Cir. 1995).
26 Id. at 26. 24 Id.
25 Id. at 27.
26 S &' R Co. of Kingston v. Latona Trucking, Inc., 159 F. 3d 80 (2nd Cir. 1998).
27 Doctor's Assoc. v. Distajo, 66 F. 3d 438 (2nd Cir. 1995).
26 Id. at 456.
26 Supra, note 26, at 83.
' Commercial Rules R-36, Construction Rules R-48., 159 F.3d 80, 83 (2nd Cir. 1998).
31 Supra, note 26, at 83.
32 Subway Equipment Leasing Corp. v. Forte, 169 F.3d 324 (5th Cir. 1999).
33 Miller Brewing Co. v. Fort Worth Distrib. Co., 781 F.2d 494 (5th Cir. 1986).
14 Id. at 497.
11 Supra, note 32, at 328-329. 36 Id. at 329.
17 Iowa Grain Co. v. Brown, 171 F.3d 504 (7th Cir. 1999).
66 Id. at 509.
66 Cabinetree of Wisconsin v. Kraftmaid Cabinetry, Inc., 50 F.3d 388 (7th Cir. 1995).
' St. Mary's Medical Center of Evansville, Inc. v. Disco Aluminum Products Co., 969 F.2d 585 (7th Cir. 1992).
' Supra, note 39, at 390. 42 Id.
43 Id. '' Id.
41 Hoffman Construction v. Active Erectors, 969 F.2d 796 (9th Cir. 1992).
^46 Racketeer Influenced and Corrupt Organizations laws, 18 U.S.C.A. 1961 et seq.
" Fisher v. A.G. Becker Paribas Inc., 791 F.2d 691, 694 (9th Cir. 1986).
'46 Supra, note 19, at 1578.
The author is an associate with Hall, Render, Killian, Heath & Lyman, specializing in construction and construction-- related claims. He is a member of the AAA's national panel of construction arbitrators and is a trained mediator.…