9th Circuit botches another arbitration case

One has to wonder whether the 9th Circuit is paying attention to the principles embodied in the Federal Arbitration Act (FAA) as interpreted by the Supreme Court. Casa Del Caffe Vergnano v. ItalFlavors (9th Cir 03/15/2016) fails to even mention the Supreme Court decisions that are applicable. The case involves a situation in which two parties signed a franchise agreement (containing an arbitration clause) and then soon after signed another agreement saying that the franchise agreement "does not have any validity or effectiveness between the parties." Naturally, the parties had a falling out and one of them brought a lawsuit claiming violations of a state franchise statute, and the other one petitioned to compel arbitration. The district court issued an order compelling arbitration. The 9th Circuit reversed in a 2-1 decision.

The owners of ItalFlavors wanted to set up a coffee shop as a franchisee of Caffe Vergnano. During a three-hour meeting in Italy, everyone signed an 18-page franchise agreement. That agreement contained a clause agreeing to arbitrate "any dispute, controversy or claim arising out of or in connection with this Agreement, or the breach, termination or validity thereof." Later in the three-hour meeting the parties signed a second agreement specifying that the franchise agreement "does not have any validity." This second agreement recited that the franchise agreement was prepared solely for the purpose of helping one of the individuals to get a US work visa, and there was testimony that the Caffe Vergnano folks were worried that the agreement did not conform to franchise laws in the United States. The second agreement also recited that the parties would sign a future contract. (They never did.)

For the 9th Circuit the issue was simple. Just decide whether the parties intended to be bound by the franchise agreement. The majority went through these steps: (1) The two agreements were signed "contemporaneously." (2) The first agreement was "a sham." (3) "[T]he arbitration clause is no more enforceable than any other provision in [the first] document." (4) Therefore, the parties did not agree to arbitrate. The dissent simply agreed with the district court that the parties actually did intend the initial franchise agreement (which contained an arbitration clause) to be binding.

First, I was amazed that the 9th Circuit ran roughshod over the district court's finding that the parties initially agreed to be bound by the franchise agreement. The majority simply disagreed.

Second, I found it strange that the court did not mention the rule of severability laid out inPrima Paint Corp. v. Flood Conklin Mfg. Co., 388 U.S. 395 (1967) and Buckeye Check Cashing v Cardegna, 546 U.S. 440 (2006). In each of those cases the Supreme Court was considering whether it is for the court or for an arbitrator to decide whether a contract containing an arbitration clause was unenforceable (due to being either void or voidable). And in each case the Court said that the arbitration clause is severable from the remainder of the contract and has to be looked at separately.

In Prima Paint the issue was "whether a claim of fraud in the inducement of the entire contract is to be resolved by the federal court, or whether the matter is to be referred to the arbitrators." The Supreme Court held that "if the claim is fraud in the inducement of the arbitration clause itself — an issue which goes to the making of the agreement to arbitrate — the federal court may proceed to adjudicate it. But the statutory language does not permit the federal court to consider claims of fraud in the inducement of the contract generally."

In Buckeye the issue was whether a court or arbitrator is to decide whether a contract containing an arbitration provision is void for illegality. The Court laid out a pretty clear roadmap:

"First, as a matter of substantive federal arbitration law, an arbitration provision is severable from the remainder of the contract. Second, unless the challenge is to the arbitration clause itself, the issue of the contract's validity is considered by the arbitrator in the first instance. Third, this arbitration law applies in state as well as federal courts. *** Applying [these rules] to this case, we conclude that because respondents challenge the Agreement, but not specifically its arbitration provisions, those provisions are enforceable apart from the remainder of the contract. The challenge should therefore be considered by an arbitrator, not a court."

In Casa Del Caffe Vergnano v. ItalFlavors the issue really was the validity of the franchise agreement which contained an arbitration agreement. There was no attack against the arbitration provision itself. Therefore, one would have expected the 9th Circuit to at least consider – and not ignore – the Prima Paint and Buckeye cases. One might still reach the same conclusion, but I think it would be much harder to do so.

[Also see Ninth Circuit Refuses To Enforce Arbitration Clause In Sham Franchise Agreement atArbitration Nation.]