The Tennessee Court of Appeals at Jackson recently enforced a NY choice-of-law provision against an arbitration challenge, holding that courts determine contract-formation issues, while arbitrators decide the scope and unconscionability of the arbitration agreement. The Court relied on the “intertwining doctrine” to send claims against a non-signatory employee to arbitration.

In Mid-South Maintenance, Inc. v. Paychex, Inc., No. W2014-02329-COA-R3-CV (TN App. – Jackson, August 14, 2015), the Court reversed the Chancery Court, holding it improperly relied on Tennessee law in refusing to compel arbitration.

Mid-South’s bookkeeper used the Paychex system to embezzle $1.8M. Mid-South sued Paychex and its customer representative in Chancery Court for breach of duty, negligence and failure to supervise in allegedly aiding-and-abetting the embezzlement. The parties’ agreements contained a narrow arbitration clause (disputes “arising out of” the Agreement), with a NY choice of law clause and reserving Paychex’s unilateral ability to file collections suits in court.

The Tennessee Court of Appeals held:

  1. The Federal Arbitration Act governs because the transactions were in interstate commerce. Tennessee law allows enforcement of the parties’ choice of NY law to govern their relationship.
  2. Arbitrability and related questions “are substantive in nature. Consequently, we will apply the FAA and New York state law to substantive matters, while Tennessee law will govern procedural issues.”
  3. Contract formation issues require judicial determination initially, but Mid-South waived the argument by not raising it expressly on appeal.
  4. Arbitrators decide scope and unconscionability issues. Although analyzing the claim that the clause was unconscionable for lack of mutuality, the Court did not even cite the Tennessee Supreme Court’s June 5 Berent decision on the issue (although this analysis was under NY law). We discussed that decision here.
  5. The “intertwining” doctrine allowed the non-signatory employee defendant to compel arbitration of Mid-South’s claim against him because the “all disputes under the agreement” clause was not limited to signatories and the claims were factually and legall intertwined with those against signatory Paychex.