Client Bulletins
Supreme Court Backs Arbitration Again - In Non-Compete Case

Client Bulletin #484
December 6, 2012

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Once again, the U.S. Supreme Court has given expression to the strong federal policy favoring arbitration. The Court found last week that, because an arbitration clause in an employment agreement was valid, the Federal Arbitration Act compelled that it was the arbitrator's place -- rather than a court's -- to decide whether a non-compete provision in the agreement was valid under state law.

The Court's decision, in Nitro-Lift Technologies, LLC v. Howard, reversed a 2011 decision of the Oklahoma Supreme Court that had determined that (1) a court could review an "underlying contract's validity" despite the presence of an arbitration clause in the contract, and (2) the non-compete provision in the contract was not enforceable under state law. The U.S. Supreme Court held that the Oklahoma court should have applied the Federal Arbitration Act and that the enforceability of the non-compete provision was for the arbitrator to decide, not a court.

The Federal Arbitration Act

Section 2 of the FAA, enacted in 1925, provides that arbitration agreements are generally to be enforced:

A written provision in any maritime transaction or a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction, or the refusal to perform the whole or any part thereof, or an agreement in writing to submit to arbitration an existing controversy arising out of such a contract, transaction, or refusal, shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.

The Oklahoma Case

The dispute in Nitro-Lift began when two employees subject to individual employment agreements quit and began work for a competitor of their former employer. The employment agreements at issue contained a non-compete provision and an arbitration clause that provided, "Any dispute, difference, or unresolved question between [the employer and the employee] . . . shall be settled by arbitration by a single arbitrator . . . ." Seeking to enforce the non-compete provision in the employees' agreements, the employer sent each a demand for arbitration. The employees filed a declaratory judgment action in Oklahoma state court, seeking to have the non-compete provision ruled invalid and unenforceable. The former employer invoked the FAA, and a trial court dismissed the lawsuit, ruling that the arbitration clause was valid and that the case must go to arbitration. The employees appealed to the Oklahoma Supreme Court, which reversed. The court first rejected the employer's argument that the FAA controlled. It held "that the existence of an arbitration agreement … does not prohibit judicial review of the underlying agreement," apparently believing that a "specific" Oklahoma law on the subject of non-compete agreements controlled over the more "general" FAA. The court then ruled that the non-compete provision was unenforceable under Oklahoma law and would not be blue-penciled. Significantly, the Oklahoma court did not specifically find that the arbitration clause was invalid. The former employer sought review by the U.S. Supreme Court.

The Supreme Court Decision

The U.S. Supreme Court per curiam vacated the Oklahoma decision, noting that the trial court had found the arbitration clause valid and that the state supreme court had not held otherwise. The Court said, "[A]n 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." (Citations omitted.)

In other words, a state or federal court can decide whether the agreement contains a valid arbitration clause, and if the arbitration clause is invalid, the dispute is litigated in court. However, if the court determines that the arbitration clause is valid, then the arbitrator must be allowed to decide, in the first instance, all other issues, including issues of contract interpretation.

The Supreme Court, to some extent, chastised the Oklahoma court for assuming the role that should have belonged to the arbitrator -- deciding the validity of the non-compete provision. The Supreme Court said,

the Oklahoma Supreme Court must abide by the FAA, which is "the supreme Law of the Land," … and by the opinions of this Court interpreting that law. "It is this Court's responsibility to say what a statute means, and once the Court has spoken, it is the duty of other courts to respect that understanding of the governing rule of law." … Our cases hold that the FAA forecloses precisely this type of "judicial hostility towards arbitration."

(Citations omitted.) The Supreme Court decision is consistent with its past decisions broadly construing the applicability of the FAA.

The Impact

With Nitro-Lift, the Court continues to demonstrate that it reads the FAA as embodying a strong national policy favoring arbitration. Many employers may prefer arbitration over court resolution of disputes involving non-compete agreements, at least in states where non-compete agreements are extremely hard to enforce and where the law has many nuances that lead to the defeat of such agreements. A well-drafted arbitration clause may provide a route for avoiding the strict scrutiny that courts often use in striking down non-competes. If the arbitration clause is valid, the Nitro-Lift decision means that all other disputed issues should be decided by the arbitrator rather than the courts. It remains to be seen whether more state courts will begin creatively to find the arbitration clauses themselves to be invalid and unenforceable, as courts in some states already have been doing. Such an approach might invite further review and close scrutiny by the Supreme Court given the strong national policy favoring arbitration embodied in the FAA.

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