“We have an arbitration clause in our project contracts, but our project is in Ohio and every contractor working on the job is from Ohio. Why is the arbitration subject to federal law?” In order to answer that question, we need to review the history of arbitration and how federal law is applied.
There was a time when parties had to wait until a dispute arose before they could decide to use arbitration. Any agreement to arbitrate was not enforceable if it was made before the dispute actually arose between the opposing parties. In addition to hostility shown toward arbitration by the courts, some states had laws that prohibited pre-dispute arbitration agreements. This started to change in 1920 with the passage of the New York Arbitration Act.
After the United States Supreme Court upheld the validity of the New York law, Congress passed the Federal Arbitration Act. Very similar to the New York Act, the FAA provided that agreements to arbitrate contained in written contracts were valid and enforceable. As the Court said in Allied-Bruce Terminix Co. Inc. v. Dobson (1995), 513 U.S. 265, the intent of the FAA was to overcome the courts refusal to enforce arbitration agreements.
In the more than 80 years since the FAA was passed, it has more than fulfilled its original intent. Today, agreements to arbitrate disputes are routinely enforced by the courts. For a more detailed discussion on the enforcement of arbitration clauses, see the August 2007 ADR Corner of BrickerConstructionLaw.com.
The passage of the Act and the federal courts’ interpretation and enforcement of it explains why arbitration agreements are enforced when federal jurisdiction can be invoked. It does not, however, explain why federal law applies when federal jurisdiction could not be invoked. In other words, why does the FAA apply when the parties are from Ohio and the project is located in Ohio? To answer that question, we need to examine a concept known as preemption.
Our government is set in multiple layers from the federal government, to the state government, down to local government (counties, municipalities, villages, townships, etc.). At each level, there is generally some type of legislative law. As long as there is no conflict between the laws passed at each level, there is no question as to what law applies. When there is a conflict, however, that question must be answered. The answer to the question is addressed through the concept of preemption.
There are two types of preemption: total preemption and conflict preemption. When Congress passes a law, they may choose to make the law apply to all states regardless of what each individual state has decided for that particular subject. For example, individual states may not pass laws that in essence grant patents. Any attempt to either shorten or lengthen the period of protection for a patented item would be preempted by federal law. This is an example of total preemption. The federal government occupies the entire field.
Where Congress passes a law that does not occupy the entire field, individual states are free to regulate the areas of the field that Congress has not addressed. Where there is conflict between the federal and state laws, the federal law preempts the state law. This is known as conflict preemption.
When the FAA passed in 1925, a number of states had statutes that invalidated pre-dispute arbitration provisions. The FAA prohibits the enforcement of those statutes in state courts. Effectively, this means the determination of the validity and enforcement of arbitration provisions are governed by federal law. In the years since its passage, attempts by states to modify enforcement of arbitration provisions, such as making them invalid in consumer transactions or requiring special language and print for arbitration provisions, have been struck down by the federal courts.
However, that does not mean state law does not apply in arbitration. Today, nearly every state has enacted some type of arbitration law. These laws frequently parallel the FAA. The procedures adopted under some state laws vary from the procedures in the FAA. Applying the concept of preemption, it would seem logical that the procedures in the FAA would trump any conflicting state procedures, but this is not necessarily the case.
Not knowing which act, federal or state, applies in a particular situation can impact the outcome of an arbitration. A case from Pennsylvania illustrates this point well. In Trombetta v. Raymond James Financial Services (2006), 907 A.2d 550, two investors sued their stock broker after becoming dissatisfied with the broker’s performance. Since the brokerage agreement contained an arbitration provision, the suit was stayed pending resolution in arbitration.
On Nov. 2, 2004, the three-member arbitration panel returned a decision in favor of the broker. On Jan. 31, 2005, the investors filed a motion in court to set aside the decision. Pennsylvania’s arbitration law limited the time to file such a motion to 30 days while the FAA provides for a 90-day time frame to file such a motion.
The Pennsylvania court pointed to a U.S. Supreme Court decision, Moses H. Cone Memorial Hospital v. Mercury Construction Corp (1983), 460 U.S. 1, which held that “there is no federal policy favoring arbitration under a certain set of procedural rules; the federal policy is simply to ensure the enforceability, according to their terms, of private agreements to arbitrate.” Since the time limit on filing the motion to set aside an arbitration award did not undermine the goal of the FAA, the court determined that the 30-day time frame under Pennsylvania law, not the 90-day time frame under the FAA, applied. In other words, there was no conflict between the state and federal law and therefore no conflict preemption.
For the investors, this meant that the court would not consider any arguments on the merits of the motion since it was not filed within the time frame required by state law, thus the arbitration award was upheld. As the Pennsylvania court determined, the FAA preempts state law only where there is a conflict between the state and federal laws.
For the construction project in Ohio with all Ohio contractors, the arbitration will be governed by federal and state laws, and unless there is a conflict between the state and federal laws, the state law will apply. Knowing which law applies to a particular situation is the key to obtaining the most predictable outcome.