Tenth Circuit Rejects State Law Challenge to FAA Primacy

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In the aftermath of AT&T Mobility, LLC v. Concepcion and American Express Co. v. Italian Colors Restaurant, consumer lawyers have frequently argued that arbitration agreements should be invalidated if features other than the class action waiver are unconscionable under state contract law. In particular, they contend that arbitration agreements that are “one-sided” in favor of the company are void for lack of mutuality and should not be enforced. Although such arguments have gained some traction, the Tenth Circuit held earlier this week that they are “inconsistent with Supreme Court precedent” interpreting the Federal Arbitration Act (FAA) if they reflect “the notion that arbitration is inferior to litigation in court.”

The issue in THI of New Mexico at Hobbs Center, LLC v. Patton was whether the arbitration agreement in a nursing home contract was unconscionable under New Mexico state law because it unreasonably favored the nursing home. The district court declined to enforce the arbitration agreement because state court decisions held that the same agreement was unconscionable, and under the FAA, courts can apply general rules of unconscionability to set aside an arbitration agreement.

The Tenth Circuit reversed, holding that there are “limits imposed by the FAA on common-law defenses.” The nursing home agreement was allegedly unconscionable because it permitted the nursing home to litigate its most likely claims against the residents while requiring the residents to arbitrate their most likely claims against the nursing home. Nevertheless, the Tenth Circuit concluded, “the only way the arrangement can be deemed unfair or unconscionable is by assuming the inferiority of arbitration to litigation.” 

Under Concepcion and other U.S. Supreme Court decisions, the court explained, common law defenses to an arbitration agreement are preempted by the FAA if they “derive their meaning from the fact that an agreement to arbitrate is at issue.” Because “the heart of the asserted unfairness” of the nursing home contract was “the disparity in what claims must be arbitrated,” state unconscionability law was preempted by the FAA.

The Tenth Circuit’s ruling is likely to have a significant impact on the continuing debate over the interplay between state unconscionability laws and the FAA. Consumer lawyers have attempted to avoid Concepcion by asking courts to invalidate arbitration agreements under generally applicable state law. The Tenth Circuit has held, however, that a defense based upon generally applicable state law is still subject to preemption by the FAA when a closer examination reveals that the state law is “based on a policy hostile to arbitration.”