A party claiming that its opponent waived their right to compel arbitration by participating in litigation cannot be required to show prejudice, the U.S. Supreme Court ruled on May 23, 2022 in a unanimous opinion written by Justice Elena Kagan. The decision is an important warning to employers to enforce their right to arbitration promptly when employees file suit in court or risk waiving this right.
Background
In Morgan v. Sundance, Inc., Case No. 21-328 (May 23, 2022), an hourly employee of a Taco Bell franchise, Morgan, signed an agreement at the beginning of his employment to arbitrate any and all future employment disputes. Despite that agreement, Morgan commenced a nationwide collective action against the franchise, Sundance, alleging unpaid overtime in violation of the Fair Labor Standards Act (FLSA). Under the FLSA, employers must pay an employee at a rate of not less than 1.5 times their regular rate of pay for all hours worked over 40 in a week. Morgan alleged that Sundance avoided paying employees this overtime premium by recording hours worked in one week as instead worked in another week, to prevent an employee’s hours in any given week from exceeding 40.
Sundance initially defended itself against Morgan’s suit as if no arbitration agreement existed. It unsuccessfully moved to dismiss the suit as duplicative of a collective action previously filed by other Taco Bell employees. Sundance then answered Morgan’s complaint and asserted 14 affirmative defenses, none of which mentioned the arbitration agreement. It then participated in a joint mediation with the named plaintiffs in both collective actions, where the previous suit settled but Morgan’s did not. Approximately eight months after Morgan’s complaint was filed, Sundance, pointing to Morgan’s arbitration agreement, moved to stay the litigation and compel arbitration under Sections 3 and 4 of the Federal Arbitration Act (FAA).
The lower courts applied 8th Circuit precedent in determining whether Sundance waived its right to arbitrate. Under that test, a party waives its contractual right to arbitration if it:
- Knew of the right to arbitrate
- “Acted inconsistently with that right”
- And “prejudiced the other party by its inconsistent actions.”
Such a test, both lower courts noted, was based on the strong federal policy favoring arbitration expressed in the FAA.
The district court found that Morgan satisfied the prejudice requirement and did not send the case to arbitration. The court of appeals disagreed, holding that Morgan was not prejudiced at that point in time because the parties had not begun formal discovery and had not contested any matters “going to the merits” of the claims. The court of appeals then ordered the parties to arbitrate Morgan’s claims.
The Supreme Court granted certiorari to decide whether the FAA, based on its “policy favoring arbitration,” authorizes federal courts to create arbitration-specific procedural rules such as the showing of prejudice.
The Supreme Court’s Holding
In reviewing the court of appeals’ decision, the Supreme Court limited its decision to one issue: whether a showing of waiver of the right to arbitrate requires a showing of prejudice.
The Supreme Court held that that the FAA’s “policy favoring arbitration” does not authorize federal courts to invent special, arbitration-preferring procedural rules. Instead, the FAA’s policy is to make “arbitration agreements as enforceable as other contracts, but not more so.” In other words, a court must treat an arbitration agreement like any other contract.
Thus, because a federal court assessing a waiver argument does not generally ask about prejudice outside of the arbitration context, the Supreme Court held that a required showing of prejudice is a “special, arbitration-preferring procedural rule” that is not supported by the FAA. As a result, prejudice cannot be considered when determining whether a party has waived its right to arbitrate. In the court’s words, “a court must not devise novel rules to favor arbitration over litigation.”
Since a party is not required to show prejudice to demonstrate waiver of the right to arbitrate, the Supreme Court remanded the case back to the 8th Circuit to determine whether Sundance knowingly relinquished its right to arbitrate by litigating Morgan’s claims.
Morgan’s Impact Going Forward
The decision in Morgan is narrow, but important: a party claiming an opponent waived its right to arbitration may not be required to show that it was prejudiced by the opponent’s participation in litigation and delay in seeking to enforce the arbitration agreement.
Other than determining that prejudice may not be required as part of the standard for showing waiver, the Supreme Court’s decision does not, for example, decide whether federal law of waiver or state law controls in setting the standard for waiver.
The decision is significant as a departure from recent decisions in which the U.S. Supreme Court relied on an expansive view of the FAA’s policy favoring arbitration to enforce arbitration agreements. In contrast to such decisions, here the Court sets that policy aside and views arbitration agreements simply as the law would view any other contract.
Morgan is a red flag for employers across the country with arbitration agreements: do not delay in asserting the right to arbitrate and avoid taking actions that may be inconsistent with that right, or you may risk waiving the right to arbitrate.
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