Ninth Circuit Holds That “Crux of Complaint” Rule Allows Courts to Decide Arbitrability Even Where Plaintiff Fails to Raise Challenge to Arbitrability as a Distinct Claim in Complaint

by charlesjung

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The Ninth Circuit Court of Appeals considered whether the “crux of the complaint” rule requires the question of arbitrability to be determined by the arbitrator when a plaintiff’s challenge to the arbitration clause does not appear in his complaint.  Bridge Fund Capital Corporation v. Fastbucks Franchise Corporation, No. 08-17071, 2010 WL 3584060 (9th Cir. Sept. 16, 2010).  The court held that “as long as the plaintiff’s challenge to the validity of an arbitration clause is a distinct question from the validity of the contract as a whole, the question of arbitrability is for the court to decide regardless of whether the specific challenge to the arbitration clause is raised as a distinct claim in the complaint.”  Id. *1.

Plaintiff-Appellees Bridge Fund Capital Corp. and Big Bad 1, LLC filed suit against Defendant-Appellant Fastbucks Franchise Corp. in California state court, alleging various claims sounding in contract.  Id. One of the claims alleged was the unconscionability of certain provisions of the franchise agreement, but through apparent clerical error, Plaintiffs failed to include in the complaint the list of the specific provisions of the franchise agreement they claimed were unconscionable.  Id. Fastbucks removed to federal court, and then moved to compel arbitration. Id. The district court declined the motion, and agreed with Plaintiffs, based on their motion papers, that the arbitration clause is unconscionable under California law.   The Ninth Circuit affirmed.

Plaintiff entered into franchise agreements with Fastbucks for the operation of “payday loan” franchises in California. Id. The franchise agreements included:

[A] Texas choice-of-law clause, as well as an arbitration provision directing that “any and all disputes between [the parties] and any claim by either party that cannot be amicably settled shall be determined solely and exclusively by arbitration under the rules of the American Arbitration Association,” In addition, the five-paragraph arbitration clause provides, in pertinent part, that (1) the arbitrator, a Texas bar member, shall hear the dispute in Dallas County, Texas; (2) the claims subject to arbitration shall not be arbitrated on a class-wide basis; (3) while the Franchisor may institute an action for temporary, preliminary, or permanent injunctive relief, the franchisee is not afforded the same remedy; (4) there is a one year statute of limitations for all claims; and (5) the parties are limited to recovery of actual damages, and waive any right to consequential, punitive or exemplary damages. In addition, the franchise agreement included an “Addendum” which mentioned that certain provisions of the franchise agreement may not be consistent with California law, and that”[i]f the Franchise Agreement contains provisions that are inconsistent with the law, the law will control.”

Id.

Abritrability and the Crux of the Complaint Rule

The Ninth Circuit cited to the U.S. Supreme Court opinion in Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, 444 (2006) to state the “crux of the complaint” rule: “While the validity of an arbitration clause can be a question for the arbitrator where the ‘crux of the complaint is that the contract as a whole (including its arbitration provision)’ is invalid, the court determines the validity of the clause where the challenge is ‘specifically [to] the validity of the agreement to arbitrate.’”  Id. *3.

In other words, when a plaintiff’s legal challenge is that a contract as a whole is unenforceable, the arbitrator decides the validity of the contract, including derivatively the validity of its constituent provisions (such as the arbitration clause). See Buckeye, 546 U.S. at 445-46 (explaining that “as a matter of substantive federal arbitration law, an arbitration provision is severable from the remainder of the contract. [U]nless the challenge is to the arbitration clause itself, the issue of the contract’s validity is considered by the arbitrator in the first instance.”). However, when a plaintiff argues that an arbitration clause, standing alone, is unenforceable–for reasons independent of any reasons the remainder of the contract might be invalid–that is a question to be decided by the court. See Cox v. Ocean View Hotel Corp., 533 F.3d 1114, 1120 (9th Cir.2008) (“[O]ur case law makes clear that courts properly exercise jurisdiction over claims raising (1) defenses existing at law or in equity for the revocation of (2) the arbitration clause itself.”).

The court found that this case presented a third scenario: “namely, a specific challenge to the arbitration clause that is not raised as a separate claim in the complaint.” Id. *4.  “What matters is the substantive basis of the challenge.”  The court held that “crux of the complaint” rule “did not create a pleading rule whereby the plaintiff must plead a separate and distinct challenge to the arbitration clause in order to have the court determine arbitrability.” Id. *4.  “The rule was instead designed to be an analytical tool for use by courts in determining the nature of the plaintiff’s challenge to the arbitration clause.” Id. “Indeed, in cases in which the arbitration clause’s invalidity is an entirely distinct issue from the contract claims in the case– the clearest cases in which arbitrability is to be decided by the court–we would not generally expect the plaintiff to raise claims against the validity of the arbitration clause in the complaint, because such claims generally would be unrelated to plaintiff’s principle prayer for relief.” Id.

The Ninth Circuit held that courts should “look not only to the complaint, but to Plaintiffs’ motion papers, to determine if Plaintiffs’ objections to the arbitration clause are severable from Plaintiffs’ challenge to the validity of the franchise agreement as a whole.” Id.

The court found that “Plaintiffs’ argument that the arbitration provision contained in the franchise agreement was both procedurally and substantively unconscionable, because the arbitration agreement (1) was not mutually entered into; (2) improperly limits Plaintiffs’ damages; (3) impermissibly shortens the statute of limitations; (4) contains invalid place and manner restrictions; (5) seeks to negate Plaintiffs’ unwaivable rights under the CFIL; and (6) wrongly bans class and consolidated actions, are clearly arguments marshaled against the validity of the arbitration clause alone, and separate from Plaintiffs’ fraudulent inducement claims.”  Id. *5 Thus, the question of arbitrability was properly decided by the district court.  Id.

Judges and Attorneys

Before Circuit Judges Myron H. Bright, Michael Daly Hawkins, Milan D. Smith, Jr.  Judge Smith wrote the opinion for the court.

Appeal from the United States District Court for the Eastern District of  California, Morrison C. England, District Judge, Presiding. D.C. No. 2:08-cv-00767-MCE-EFB.

Peter C. Lagarias, Lagarias & Boulter, LLP, San Rafael, CA, for the plaintiffs-appellees.

Margaret C. Toledo, Mennemeier, Glassman & Stroud LLP, Sacramento, CA;  Steven L. Solomon, Fastbucks Franchise Corp., Dallas, TX, for the defendants-appellants.

By CHARLES JUNG

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