November 26, 2012

November 26, 2012:
Supreme Court holds than an arbitrator, not a court, should decide a challenge to the overall validity of a contract containing an arbitration clause when the arbitration clause, standing alone, is valid.  Nitro-Lift Techs., L.L.C. v. Howard, 568 U.S. 17 (2012).

Two employees of Nitro-Lift quit the company and went to work for a competitor.  The employees had noncompetition agreements with Nitro-Lift.  Those agreements contained an arbitration clause.  Nitro-Lift began an arbitration proceeding to enforce the noncompetition agreements.  The employees then sued in Oklahoma state court asking for a declaratory judgment that the noncompetition agreements were invalid in light of an Oklahoma statute.  The Oklahoma trial court dismissed the employees' complaint in light of the arbitration clause, holding than an arbitrator, not the court, should determine the validity of the noncompetition agreements.  The Oklahoma Supreme Court reversed.  Reasoning that the "'existence of an arbitration agreement in an employment contract does not prohibit judicial review of the underlying agreement,'" 568 U.S. at 19, the Oklahoma high court reached the validity issue and held the noncompetition agreements invalid in light of the state statute.  The United States Supreme Court vacated that ruling, concluding that it conflicted with federal law construing the FAA.

As a matter of federal law, an arbitrator, not a court, should in the first instance decide "attacks on the validity of [a] contract, as distinct from attacks on the validity of the arbitration clause itself."  Id. at 20.  "For these purposes, an 'arbitration provision is severable from the remainder of the contract,' . . . and its validity is subject to initial court determination; but the validity of the remainder of the contract (if the arbitration provision is valid) is for the arbitrator to decide."  Id. at 21.  The Oklahoma trial court found that the arbitration clause in the noncompetition agreement was valid, and the Oklahoma Supreme Court did not disturb that finding.  Accordingly, federal law required that an arbitrator, not a court, must first address the validity of the noncompetition agreements.

The lesson of Nitro-Lift is straightforward.  A court should decide a specific challenge to the validity of an arbitration clause.  On the other hand, if the challenge is to the overall validity of the contract containing the arbitration clause, and the arbitration clause standing alone is valid, an arbitrator must decide the validity issue.

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