In a decision that appears intentionally controversial, the Supreme Court of New Jersey yesterday refused to enforce the delegation clause in a for-profit college’s enrollment agreement in a 5-1 opinion. Morgan v. Sanford Brown Institute, 2016 WL 3248016 (N.J. June 14, 2016). Although the delegation clause had never been specifically challenged by the plaintiffs, as is required by SCOTUS’s Rent-A-Center in order to avoid delegating the issue of arbitrability to the arbitrator, the court found that was immaterial.

The plaintiffs alleged that Sanford Brown Institute had induced them to enroll via misrepresentations and deception. In response, the defendants moved to compel arbitration, based on an arbitration agreement in the plaintiffs’ enrollment agreement. The trial court denied the motion, but the intermediate appellate court reversed, concluding that an arbitrator should decide whether the arbitration agreement was enforceable, due to the presence of a delegation clause.

At the state’s highest court, the issue of whether the delegation clause was enforceable was the sole issue. The plaintiffs argued they were unaware the arbitration agreement “denied them their right of access to a judicial forum and to a jury trial,” making the arbitration agreement unenforceable under New Jersey’s Atalese decision. Plaintiffs — and the court– characterized their failure to understand that arbitration is a substitute for court, not an addition to court, as preventing a meeting of the minds, and therefore a challenge to the very existence of the entire agreement. In response, defendants pounded on Rent-A-Center, arguing that it is binding precedent and must be applied to conclude that since the plaintiff failed to challenge the validity of the delegation clause specifically, an arbitrator must address any challenges to arbitrability (including challenges under Atalese).

Although the NJ Supreme Court identified the key issue in this case as “who decides whether the parties agreed to arbitrate disputes arising from the enrollment agreement: a court or an arbitrator,” I would say the real issue in the case is “can New Jersey find a way around Rent-a-Center’s rule enforcing delegation clauses that does not entirely give the middle finger to SCOTUS and thereby invite reversal?”

The delegation clause that was enforced in Rent-A-Center, because plaintiff did not challenge its validity in particular, stated: “[t]he Arbitrator, and not any federal state, or local court or agency, shall have exclusive authority to resolve any dispute relating to the interpretation, applicability, enforceability or formation of this Agreement.” The delegation clause that New Jersey refused to enforce in Morgan stated: “Any disputes, claims, or controversies between the parties to this Enrollment Agreement arising out of or relating to…(v) any objection to arbitrability or the existence scope, validity, construction, or enforceability of this Arbitration Agreement shall be resolved pursuant to this paragraph (the “Arbitration Agreement”).” [Note that the NJ sample does not specifically say the issue will not be addressed by a court, but the words used to describe the types of disputes that will be arbitrated are very similar.]

After acknowledging that the plaintiffs did not specifically challenge the delegation clause in Morgan, the court went on to establish some logical building blocks for distinguishing Rent-A-Center. First, it noted that state law governs whether the parties “entered an agreement to delegate” arbitrability. Second, delegation clause must be clear and unmistakable under First Options. Third, no one challenged the “clarity” of the delegation clause in Rent-A-Center. (There is the wiggle room!) Therefore, because the NJ plaintiffs challenge whether the delegation clause was clear enough to allow a meeting of the minds, the New Jersey Supreme Court defines that as a challenge to the formation of the arbitration agreement containing the delegation clause, putting the issue of arbitrability squarely before the court. And, having concluded that the court, not an arbitrator could decide the validity of the arbitration clause, this Court went on to find it unenforceable. Critically:

The arbitration provision in the Sanford Brown enrollment agreement suffers from the same flaw found in the arbitration provision in Atalese — it does not explain in some broad or general way that arbitration is a substitute for the right to seek relief in our court system. That flaw– non-compliance with the dictates of Atalese–extends to the purported delegation clause…

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In conclusion, the arbitration provision and purported delegation clause do not meet the requirements of First Options and Atalese and do not satisfy the elements necessary for the formation of a contract, and therefore are unenforceable.

The lone dissenting justice stated “I cannot reconcile the majority’s reasoning with the United States Supreme Court’s decision in Rent-A-Center.”

Here is some context:

  • The Morgan majority repeatedly comments that the defendants did not raise the delegation clause issue at the trial court. So, why not just say the appeal issue was not properly preserved and reject delegation on those narrow procedural grounds? SCOTUS would never grant cert of that. Instead, however, NJ went out of its way to forge a path through Rent-A-Center.
  • Actually, not much forging happened here. NJ followed the trail blazed by Kentucky last year. Kentucky also refused to enforce the delegation clause in a for-profit college agreement, finding it was never formed (in that case, because the signatures were not at the end of the agreement). West Virginia did something similar, refusing to enforce a delegation clause because it was not “clear and unmistakable,” because “arbitrability” is an ambiguous word. (W. Va, Kentucky, and NJ are strange bedfellows, no?)
  • NJ may not have openly thumbed its nose at SCOTUS in this opinion, but a recent opinion from its intermediate appellate court did. It complained that SCOTUS’s “liberal federal policy favoring arbitration…in many cases has caused the forfeiture of important rights because consumers and employees lack the bargaining power to object to an arbitration clause’s inclusion; citation of the ‘liberal federal policy favoring arbitration’ merely evokes the old saying, ‘a good catchphrase can obscure fifty years of analysis’.” Kleine v. Emeritus at Emerson, Docket A-4452-14T3 (N.J. Ct. App. June 9, 2016).
  • The U.S. Department of Education has recently proposed a rule that would preclude postsecondary institutions from requiring that students arbitrate disputes. So, New Jersey has some political cover in deciding not to force these students into arbitration. (We just did it a year before the rule would have done it anyway!)
  • And – one state supreme court enforced a delegation clauses in recent weeks. Alabama enforced this delegation clause: “Any dispute regarding whether a particular controversy is subject to arbitration, including any …dispute over the enforceability, scope, reach or validity of this agreement…shall be decided by the arbitrator(s).” Regions Bank v. Rice, 2016 WL 3031357 (Ala. May 27, 2016).

All in all, I often feel that arbitration law is a big game of Whack-a-mole, where the U.S. Supreme Court is the kid holding the hammer, and the state courts keep randomly popping up with new and creative ways around arbitration precedent. But now, with only eight Justices, and no Scalia, will SCOTUS be willing to bring down the hammer on states for not following its controversial 5-4 decision in Rent-A-Center? I am guessing not. Send me your thoughts.