Circuit Courts Shift Arbitration Waiver Test to Legal Tactics

Federal appeals courts are developing a new standard for determining whether a company waives its right to arbitrate a dispute based on its litigation tactics, following the US Supreme Court’s rejection of a test requiring a showing of harm.

The justices’ 2022 Morgan v. Sundance decision reshaped circuit court precedent that required the party opposing private dispute resolution to demonstrate they’d been prejudiced by a delay to compel enforcement of an arbitration pact at the outset of litigation.

That prejudice requirement was based on the 100-year-old Federal Arbitration Act’s policy favoring arbitration over litigation. But the justices unanimously concluded that it lacked textual grounding in the FAA, and courts cannot “make up a new procedural rule based on” that policy.

Circuit courts have now shifted their focus to whether the party seeking to compel arbitration knowingly relinquished that right through inconsistent conduct during litigation, such as whether they engaged in the substance and merits of the underlying case before seeking to enforce a predispute arbitration clause.

The rulings serve as a warning to companies to invoke their right to arbitration early in litigation to prevent courts from viewing delays as a tactical maneuver inconsistent with the goal of private dispute resolution, which is to have a less costly and lengthy way to resolve issues, legal scholars said.

Some circuits differ on what precisely constitutes conduct that’s inconsistent with arbitration rights, teeing up an area for future high court review.

“In the wake of Morgan, there has been some tension or uncertainty in how the waiver standard is articulated,” said Imre Szalai, a professor at Elisabeth Haub School of Law at Pace University, who has written extensively about arbitration. “As a practical matter, waiver will likely exist if a party engages in motion practice about the substantive merits or engages in discovery.”

But courts still need to sort out how to articulate the waiver standard, Szalai said.

“Unfortunately, if parties quibble over the precise legal standard in judicial appeals, they will stall and undermine the potential effectiveness of the arbitration process,” he said.

‘Not a Fallback’

The US Court of Appeals for the Second Circuit was one of the latest to reconsider its longstanding arbitration waiver standard post-Morgan.

A three-judge panel ruled that the defendants in a case waived their right to arbitration because they sought to enforce an arbitration agreement only after a New York district court denied their motion to dismiss the case.

“By doing so, they intentionally availed themselves of the district court’s authority and sought affirmative, dispositive relief” in court, the judges said.

“This conduct is inconsistent with the right to arbitrate. Arbitration is not a fallback position. It is not a second bite at the apple,” they added.

The Fifth Circuit reached a similar view, ruling that a restaurant must face minimum wage violation claims in court because it engaged in discovery and court-ordered mediation, and waited five months before moving to compel arbitration.

These holdings align with those of the Eleventh, Ninth, and Eighth circuits: that engaging extensively in litigation and asking the court to address the merits without promptly invoking arbitration constitutes a waiver.

However, a delay in moving to compel arbitration hasn’t always resulted in that finding.

The Ninth Circuit held that limited engagement in discovery, when some claims aren’t subject to an arbitration agreement, may not close the door for private dispute resolution.

Actively litigating the merits of a case for a prolonged period of time could be grounds to deny a motion to compel, the Fourth Circuit also said. But in a case where the defendant waited nine months to file a motion, a Fourth Circuit panel didn’t find a waiver because an intent to arbitrate was “consistently” expressed.

High Waiver Bar

In its first post-Morgan decision on the waiver issue, the Sixth Circuit held that extensive litigation activities without reference to arbitration suggested an intent not to enforce an arbitration clause.

But in a recent ruling, the circuit court appeared to have set a higher bar for finding waiver, “focusing on whether there is knowledge of the right to arbitrate and by not allowing a court to raise the waiver issue” on its own, Szalai said.

This contrasts with the Second Circuit’s approach, which “focuses more on inconsistent conduct or actions as a stand-in or substitute for ‘knowing’ waiver,” he said.

“The Sixth Circuit is suggesting that the party opposing arbitration must raise the waiver argument,” Szalai said. “In effect, the party opposing arbitration can itself waive the waiver argument, according to the Sixth Circuit.”

Warning Shot

Despite the varying opinions, the courts are consistently rejecting the argument that a party can keep arbitration in reserve while attempting to win in court first, said Sarah Rudolph Cole, a law professor at Ohio State University and chair of the school’s alternative dispute resolution program.

“Judges are going to hold companies’ feet to the fire on the question of whether they knew they had an arbitration agreement,” she said.

Rafael Nendel-Flores, an attorney at management-side firm Clark Hill PLC, agreed that employers need to consistently invoke their arbitration right to avoid waiving it.

Discovery ‘Trap’

Defense counsel may occasionally delay their motion to compel, as it’s not always immediately clear whether the claims in question are arbitrable or if an enforceable arbitration agreement exists, attorneys said.

Another factor is that some jurisdictions, like Virginia, give employers “more leeway” regarding the types of claims they can exclude from an arbitration agreement, Nendel-Flores said.

An employer seeking discovery regarding claims they believe are non-arbitrable can still be tricky if there are overlapping allegations that are subject to arbitration, he said.

“Sometimes it’s hard to really segregate discovery that’s really only tailored to claims that are not subject to arbitration,” Nendel-Flores said. “That’s where it’s a little bit of a trap that you can get into.”