Arbitration Where You’re Not Expecting It

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American Bar Assocation - November 23, 2020

In the decade since the Supreme Court decided AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 339 (2011) and American Express Co. v. Italian Colors Restaurants, 570 U.S. 228, 233 (2013), arbitrability has become a threshold question for class action practitioners. On the plaintiffs’ side, a cautious practitioner might avoid bringing a claim that falls within an enforceable arbitration clause. And on the defendants’ side, the first move will be to invoke an arbitration clause with a class waiver whenever there is contractual privity between a plaintiff and a defendant. Arbitrability thus becomes a quasi-dispositive question, independent of a case’s merits.

The Supreme Court’s broad interpretation of the Federal Arbitration Act (FAA) is robust as ever. As a result, arbitrability questions have moved away from systemic policy questions about whether arbitration is permissible or unconscionable. The more recent arbitration cases—such as Lamps Plus, Inc. v. Varela, 139 S. Ct. 1407 (2019), and Henry Schein Inc. v. Archer & White Sales Inc., No. 19-963 (schedule for argument December 8, 2020)—instead often turn on interpreting arbitration clauses’ scope.

Remicade is a drug used to treat inflammatory conditions, including Crohn’s disease and rheumatoid arthritis. Rochester Drug Cooperative (RDC), a direct purchaser and wholesaler of Remicade, sued Johnson & Johnson (J&J), the drug’s manufacturer, claiming violations of the Sherman Act. In substance, RDC alleged that J&J established a monopoly through a series of exclusion and bundling agreements with insurers and healthcare providers that effectively removed many competitors from the market even after the FDA began approving Remicade “biosimilars” offered by RDC’s competitors.

RDC was not a competitor blocked from entering the market; it was a purchaser alleging it paid inflated prices because those competitors were unable to compete. Thus, RDC was not a party to the exclusion or bundling agreements on which it based its antitrust claims. But, it was party to a distribution agreement for Remicade that included a “Dispute Resolution” clause stating that “[a]ny controversy or claim arising out of or relating to this agreement” would be subject to arbitration.

J&J moved to compel arbitration, arguing that the antitrust claims “arose out of” or “related to” RDC’s distribution agreement. The district court denied that motion, and J&J appealed. (The FAA allows interlocutory appeals for orders denying motions to compel arbitration.)

RDC did not dispute the enforceability of the distribution agreement’s arbitration clause. The sole question on appeal was “whether the alleged antitrust violations fall within the scope of the Agreement’s arbitration clause . . . .” That, in turn, required first determining whether the court would interpret the contract under federal or state law. Writing for the court, Judge Krause, joined by Judges Shwartz and Fuentes, found that although state law generally applies, federal law provides an important backdrop for interpreting arbitration clauses. That is, under the FAA, courts construe ambiguities in a contract in favor of arbitration, and certain otherwise-applicable state law defenses might be preempted if they are not “generally applicable contract defenses, such as fraud, duress, or unconscionability.” Otherwise, courts interpret arbitration clauses under state contract law.

With these choice-of-law rules controlling, the court applied New Jersey law, which expansively interprets the terms “arising out of” or “relating to.” For arbitration clauses, New Jersey courts construe such terms “to require arbitration of any dispute between the contracting parties that is connected in any way with their contract.” Applying this case law, the Third Circuit concluded that J&J’s conduct, if true as alleged, would have artificially inflated the prices that RDC paid under its distribution agreement. The antitrust claims, thus, intertwined with the distribution agreement, and the arbitration clause applied to the complaint.

Importantly, the outcome might have been different if the distribution agreement had not been an agreement between two sophisticated parties. New Jersey contract law requires that when a party waives its rights, it must make that waiver knowingly and intentionally, and the waiver must be clear and unmistakable. See generally Skuse v. Pfizer, Inc., 236 A.3d 939 (N.J. 2020). As a result, New Jersey courts have held that an arbitration clause may not be enforceable when there is not a “plain language explanation[] of consequences,” since without such an explanation, “a person would not be presumed to understand what was being agreed to constituted waiver of a constitutional or statutory right,” especially in an agreement that “tuck[s] away” its “law-imbued terminology about procedures.” Kernahan v. Home Warranty Adm’r of Fla., Inc., 199 A.3d 766, 777 (N.J. 2019). RDC tried to invoke this principle to avoid arbitration, but the Third Circuit found that the heightened waiver standard in New Jersey only protects laypersons and other unsophisticated parties. The rule therefore had no applicability to commercial contracts between sophisticated parties, such as the distribution agreement between RDC and J&J.

The Third Circuit’s decision in Remicade is not an outlier, and it presents two important lessons for practitioners.

First, when agreeing to an arbitration clause, understand that if it is broadly phrased, courts may construe it to apply to claims that are external to the parties’ contractual obligations to one another. Instead, a broad arbitration clause could reach a claim under the Sherman Act or some other statute. Indeed, an arbitration clause’s full scope might not be foreseeable when the parties enter it. Before accepting an arbitration clause, a party should be imaginative when envisioning a dispute to which it might apply.

Second, be sensitive to state law because they are not uniform in their treatment of arbitration clauses. Even though RDC brought Remicade in the Eastern District of Pennsylvania, the Third Circuit applied New Jersey contract law under the distribution agreement’s choice-of-law provision. Although J&J successfully enforced the clause here, New Jersey courts are among the most hostile in the nation to arbitration, and the application of New Jersey law gave RDC several arguments against arbitrability it would not have had in most jurisdictions. Arbitration clauses’ proponents should consider the interplay between their arbitration clauses and the state law that will apply to interpret those clauses.

Third, consider the situation and the parties when drafting an arbitration clause. The same arbitration clause in Remicade might not have been enforceable if it had appeared in an adhesion contract with a consumer or employee rather than a distribution agreement between a manufacturer and a wholesaler. The parties’ identity and sophistication can affect enforceability in some states.

Reprinted with permission from the November 23, 2020, issue of the American Bar Association's Practice Points newsletter. © 2020 American Bar Association. All Rights Reserved.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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