Supreme Court Addresses Volt's Choice-of-Law Trap: Is the End of the Problem in Sight?

Article excerpt

The Supreme Court's view of which law applies when parties select the law of a particular state in their arbitration agreement seems to be evolving. This article discusses the High Court's thinking in the Volt, Mastrobuono and Preston decisions and provides practical guidance for parties who wish to have the Federal Arbitration Act apply to the arbitration and state law apply to the merits of the dispute.

Many contracts with arbitration provisions contain choice-of-law clauses specifying which state's law governs the contract. Attorneys drafting these clauses typically consider the chosen state's substantive law, not its arbitration procedures-which often differ from those of the Federal Arbitration Act (FAA), a statute enacted in 1925 to enforce arbitration agreements and preempt state laws that are hostile to arbitration. For example, state laws that single out arbitration agreements for special treatment or make certain disputes inarbitrable would ordinarily be preempted by the FAA.

But during the last 20 years, some drafters of arbitration agreements have fallen into a trap for the unwary, as courts have interpreted choice-oflaw clauses to choose state arbitration procedures as well as substantive law. Recently, in a largely overlooked portion of the decision in Preston v. Ferrer,1 the U.S. Supreme Court took a welcome step toward eliminating this trap. This article describes the evolution of the trap and offers guidance to attorneys on how to avoid it.

The Choice-of-Law Trap

The choice-of-law trap emerged two decades ago out of a construction contract between Stanford University and Volt Information Sciences, an engineering firm. The parties had agreed to arbitrate disputes arising out of the contract, and to apply the law of the place where the project was located (California). Stanford later filed suit in California Superior Court against Volt and two non-parties to the agreement. Volt moved to compel arbitration under the FAA,2 and Stanford opposed the motion and requested a stay of arbitration. The trial court held that the choice-oflaw clause incorporated California arbitration procedures, and therefore granted Stanford's request for a stay.3 The California Court of Appeal affirmed, agreeing that the seemingly innocuous choice-of-law clause incorporated California arbitration rules in place of the FAA. The California Supreme Court denied Volt's petition for discretionary review.

The U.S. Supreme Court granted Volt's petition for review. It held that the FAA permitted state procedures to apply because the statute simply enforces arbitration agreements according to their terms. Although there was little evidence that the parties intended to abandon the FAA in favor of California arbitration law, the Court deferred to the state courts' interpretation of the choice-oflaw clause, reasoning that "the interpretation of private contracts," even when they involve federal rights, "is ordinarily a question of state law, which this Court does not sit to review."4

Most drafters of arbitration agreements intend the FAA to apply because the FAA applies to all contracts "involving" interstate commerce. This concept has been understood to reach to the fullest extent of Congress's interstate commerce power.5 Yet after the Supreme Court's decision in Volt Information Sciences Inc. v. Leland Stanford Jr. University, in one arbitration-related case after another, the courts have misread Volt to hold that choice-of-law clauses waive the application of the FAA unless the arbitration agreement explicitly invokes the federal statute. As a result, parties who have relied on the FAA's protections became subject to the vagaries of often-hostile state laws that hindered, if not prohibited, arbitration of the parties' disputes.6

The Court Begins to Limit Volt

In Mastrobuono v. Shearson Lehman Hutton, decided six years after Volt, the Supreme Court began to fix the trap it had created. …