U.S. Supreme Court Resolves Split over “Wholly Groundless” Exception to Arbitration

Earlier this year, the U.S. Supreme Court in Henry Schein, Inc. v. Archer & White Sales, Inc., unanimously struck down the “wholly groundless” exception that had been invented by lower courts to defeat arbitration agreement clauses that delegate threshold questions of arbitrability to arbitrators. This is good news for franchisors who rely on arbitration as the franchise system’s chosen method of dispute resolution. The decision is the latest evidence of the law’s continued trend favoring the enforcement of arbitration agreements.

Those opposing the enforcement of arbitration agreements usually argue that courts should decide, in the first instance, whether the agreements are valid or cover the claims at issue, which is referred to as the “arbitrability” of the parties’ dispute. This is a popular argument among franchisees who contend that the arbitration agreement is unenforceable because the franchise agreement as a whole was the product of fraudulent inducement, adhesion, unconscionability, or some other inequity. Opponents of arbitration know that the longer they can keep the dispute out of arbitration, the better chance they have of avoiding it all together. This is why well-drafted arbitration agreements include clauses delegating threshold questions of arbitrability to the arbitrators themselves.

In response to such clauses, some federal courts had invented a “wholly groundless” exception, which they applied even “when an arbitration agreement clearly and unmistakably refers the issue of arbitrability to the arbitrator.”^[1] Under the “wholly groundless” exception, courts would refuse to enforce arbitration agreements when they deemed the claims at issue “so plainly outside the arbitration provision that a contrary argument is wholly groundless.”^[2] A split developed among federal circuits, with the Fifth, Sixth, and Federal circuits adopting the exception,[3] and the Tenth and Eleventh circuits rejecting it.[4]

The U.S. Supreme Court resolved the split earlier this year in Henry Schein, Inc. v. Archer & White Sales, Inc.:

In sum, we reject the “wholly groundless” exception. The exception is inconsistent with the statutory text and with our precedent. It confuses the question of who decides arbitrability with the separate question of who prevails on arbitrability. When the parties’ contract delegates the arbitrability question to an arbitrator, the courts must respect the parties’ decision as embodied in the contract. [5]

The decision reaffirms that “[t]his Court has consistently held that parties may delegate threshold arbitrability questions to the arbitrator, so long as the parties’ agreement does so by ‘clear and unmistakable’ evidence.”[6]

The decision also reaffirms our advice to clients that a well-draft arbitration agreement should always include a delegation clause that clearly and unmistakably provides the arbitrator with the authority to decide in the first instance whether the dispute is arbitrable. The delegation clause should define the arbitrator’s authority as broadly as possible to decide all issues relating to the enforceability, revocability, validity, conscionability, scope, reach, or existence of the arbitration agreement itself. One way to accomplish this is by expressly referring to and incorporating AAA Commercial Rule R-7, which provides an arbitrator with “the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope, or validity of the arbitration agreement or to the arbitrability of any claim or counterclaim,” as well as the “existence or validity of a contract of which an arbitration clause forms a part.”[7] To ensure that the delegation clause is unmistakable, it should be separated from the language providing generally for the parties’ agreement to arbitrate. Finally, the delegation clause should clearly state that the parties are waiving their right to have issues of arbitrability decided by a judge or jury.

The Court’s continued trend favoring the enforcement of arbitration agreements is good news for franchisors who rely on arbitration as the franchise system’s chosen method of dispute resolution. For resolving disputes in industry-specific areas like franchising, arbitration continues to provide many advantages over traditional litigation Since franchisors get to draft the arbitration agreement, they can craft custom dispute resolution procedures designed to control cost and exposure to the system, particularly for recurring and anticipated claims, as well as procedural protections such as limitations on claims, damages, class and collective actions, and forum-selection clauses.[8] Arbitration allows the parties to select a decision-maker with experience in franchising, making the process more efficient and reducing the likelihood of error that could be committed by a judge or jury lacking such experience.[9] Ultimately, despite anecdotes that the cost of arbitration can sometimes rival traditional litigation, studies continue to show that in the aggregate arbitration remains the more efficient method of dispute resolution, with abbreviated procedures for discovery, motion practice, and appeals providing the parties with greater finality than court, usually sooner, and at less cost.[10]