Ability of Federal Courts to Compel Arbitration May Be Found in Underlying Claims

04/02/2009 / Carrie L. Zochert and Ashlee M. Bekish

On March 9, 2009, the United States Supreme Court issued its decision in Vaden v. Discover Bank, holding that a federal court can “look though” a petition to compel arbitration brought pursuant to section 4 of the Federal Arbitration Act (“FAA”) to determine whether the underlying controversy “arises under” federal law. If the underlying claims arise under federal laws, the court may issue an order compelling arbitration of the dispute.

In Vaden, Discover Bank (“Discover”) sued Betty Vaden, a Discover cardholder, in state court for failure to pay her credit card debt. Discover asserted only state law claims. Vaden filed counterclaims for breach of contract and violations of Maryland statutes regulating lending. Thereafter, Discover filed a petition in federal court to compel arbitration of Vaden’s counterclaims under section 4 of the FAA, which authorizes a federal district court to consider a petition to compel arbitration if the court would have jurisdiction of the dispute, except for the existence of the arbitration agreement. Discover argued that although the arbitration petition did not contain a federal question, the district court nonetheless had jurisdiction because Vaden’s underlying state-law counterclaims were completely preempted by federal banking law. The district court agreed and the Fourth Circuit Court of Appeals eventually affirmed, holding that the presence of a federal question (preemption) in Vaden’s counterclaim can provide jurisdiction.

The Supreme Court agreed that section 4 of the FAA requires a federal district court to “look through” an arbitration petition to the underlying controversy to determine whether it has jurisdiction to compel arbitration of the dispute. However, the Supreme Court also determined that federal question jurisdiction could not be predicated on the contents of Vaden’s counterclaim. Under well-established federal law, a counterclaim does not “provide a key capable of opening a federal court’s door” and cannot be considered for jurisdictional purposes.

The underlying controversy concerned Vaden’s alleged debt to Discover—a claim that does not “arise under” federal law. Accordingly, a majority of the Court concluded that the district court did not have jurisdiction to order arbitration. The majority, however, did note that Discover could file a motion to compel arbitration of the counterclaims in Maryland state court under section 2 of the FAA, which renders arbitration agreements enforceable in state courts as well.

What this Decision Means for Employers: Although the “look through” approach is more consistent with the liberal federal policy favoring arbitration, the conclusion that district courts cannot look to a counterclaim or defense for jurisdiction, could limit the ability of federal courts to enforce arbitration agreements in some cases. In that event, the state courts remain an option to enforce an arbitration agreement.

*Ms. Bekish is a law clerk at Larkin Hoffman law firm.