Broker-dealers seeking to enforce arbitration agreements in Maryland should consider utilizing stand-alone arbitration agreements — signed by both parties — that explicitly commit both the client and the broker-dealer to arbitrate disputes. Why?
Unlike New York law, under which mutuality of obligation is not required to enforce an arbitration agreement, under Maryland law, an arbitration agreement is enforceable only if it requires both parties to arbitrate. See Cheek v. United Healthcare of the Mid-Atlantic, 378 Md. 139, 141-43 (Md. 2003). The United States Supreme Court’s decision in AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (2011), raised questions about the ongoing viability of the Cheek decision. However, on February 26, 2013, the United States Court of Appeals for the Fourth Circuit rejected the argument that the Federal Arbitration Act (“FAA”) preempts the law set forth in Cheek. See Noohi v. Toll Bros., Inc., 708 F.3d 599 (4th Cir. 2013). Thus, broker-dealers seeking to enforce mandatory pre-dispute arbitration clauses in Maryland need to be aware of some nuances of Maryland law.
In Cheek, an employer required employees to arbitrate all employment related disputes pursuant to the employer’s policy. The employment handbook, however, provided that the employer reserved the right to alter, amend, modify or revoke the policy in its discretion at any time. Based on the unilateral right to revoke the arbitration at any stage, the Court of Appeals held that the employer’s agreement to arbitrate was illusory and, therefore, unenforceable.
In contrast, in Holloman v. Circuit City Stores, Inc., 391 Md. 580, 582 (Md. 2006), the Court of Appeals enforced a similar mandatory pre-dispute arbitration agreement that required the employer to provide thirty days’ notice before any amendments to its policy went into effect and bound the employer to the arbitration rules and procedures in effect at the time the employee requested arbitration. A similar provision was enforced in Harby v. Wachovia Bank, N.A., 172 Md. App. 415 (Md. Ct. Spec. App. 2007) (allowing the bank to alter the terms of its deposit agreement that contained an arbitration clause if depositors were notified thirty days in advance of any such changes adverse to the depositor).
In 2011, in Concepcion, the U.S. Supreme Court held that the FAA preempted California’s judicial rule regarding the unconscionability of class arbitration waivers in consumer contracts. Relying on that decision, the defendants in Noohi moved to compel arbitration in the Maryland federal court, even though the arbitration agreement provided that only the “Buyer” agreed to arbitrate all disputes. Finding that the arbitration agreement bound only the plaintiffs and, therefore, lacked the mutuality of obligation required by Cheek, the Fourth Circuit held that the Cheek rule remained binding. After careful consideration, the Fourth Circuit found that the Cheek rule did not single out an arbitration provision within a contract; rather, it treated the arbitration clause like a stand-alone contract, requiring separate consideration.
So, what does this all mean for broker-dealers? Often broker-dealers (1) include arbitration provisions as part of a larger client agreement that (2) the broker-dealer may amend and, (3) within the arbitration provision itself, only the client agrees to arbitrate disputes (and only the client signs the agreement). All three of these practices can potentially complicate enforcement of arbitration agreements in Maryland.
First, while some courts understand that broker-dealers, as members of the Financial Industry Regulatory Authority (“FINRA”), are bound to arbitrate client disputes, other courts sometimes will overlook those rules as outside the “four corners” of the arbitration agreement, which is all that courts can consider when evaluating the enforceability of an arbitration agreement. Thus, while it may be obvious to the broker-dealer — and to FINRA — that the broker-dealer cannot avoid arbitration initiated by a client (even if the broker-dealer may amend the other terms of the client agreement), clients and courts in Maryland might not recognize that fact.
Moreover, where an arbitration agreement is but a provision within a larger contract (particularly where the arbitration agreement is informed by FINRA rules and procedures), the courts might have a difficult time in determining precisely what “four corners” it should be evaluating. If a court looks solely to one paragraph of a client agreement, a changes clause in the overall agreement might not be incorporated into the arbitration agreement — but the FINRA rules might not be considered part of the arbitration agreement either.
Finally, as in Noohi, agreements signed only by the client and which include words to the effect of “I [or You or The Client] agree to arbitrate all disputes . . .” might not be interpreted as “the parties hereby agree to arbitrate all disputes.” Because broker-dealers must arbitrate such disputes, there is no downside for them to clarify that intent in their arbitration agreements.
Thus, because the rule in Cheek remains the law — i.e., arbitration agreements must bind both parties to some degree — broker-dealers seeking to enforce arbitration agreements in Maryland should consider utilizing stand-alone arbitration agreements (thereby defining the “four corners” for the court to consider), that are signed by both parties, and that explicitly commit both the client and the broker-dealer to arbitrate disputes (thereby clarifying that consideration exists for arbitration agreement itself). These simple steps, while not required, should increase the likelihood that a broker-dealer will be able to enforce an agreement to arbitrate in a Maryland court.