Stutler v. T.K. Constr Inc. ( 2006 )

RECOMMENDED FOR FULL-TEXT PUBLICATION
Pursuant to Sixth Circuit Rule 206
File Name: 06a0155p.06
UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT
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MICHAEL W. STUTLER; KATHY STUTLER; DAVID
Plaintiffs-Appellees, -
STUTLER,
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No. 04-6436
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v. >
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Defendant-Appellant. N
T.K. CONSTRUCTORS INC., an Indiana Corporation,
Appeal from the United States District Court
for the Eastern District of Kentucky at Covington.
No. 03-00130—William O. Bertelsman, District Judge.
Argued: January 26, 2006
Decided and Filed: May 9, 2006
Before: SILER, BATCHELDER, and MOORE, Circuit Judges.
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COUNSEL
ARGUED: C. Gregory Schmidt, SANTEN & HUGHES, Cincinnati, Ohio, for Appellant. Robert
N. Trainor, Covington, Kentucky, for Appellees. ON BRIEF: C. Gregory Schmidt, J. Robert
Linneman, SANTEN & HUGHES, Cincinnati, Ohio, for Appellant. Robert N. Trainor, Covington,
Kentucky, for Appellees.
BATCHELDER, J., delivered the opinion of the court, in which SILER, J., joined. MOORE,
J. (pp. 5-6), delivered a separate opinion concurring in the judgment.
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OPINION
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ALICE M. BATCHELDER, Circuit Judge. Appellant T. K. Constructors Inc. (“T. K.”),
moved in the district court for an order to stay these proceedings pending arbitration. The district
court denied the motion, relying on Morrison v. Circuit City Stores, Inc., 317 F.3d 646 (6th Cir.
2003) and Cooper v. MRM Investment Co., 367 F.3d 493 (6th Cir. 2004). Because we conclude that
the holdings in those cases do not extend to contracts requiring the mandatory arbitration of disputes
regarding state law claims only, we VACATE the district court’s order and REMAND the matter
for disposition consistent with this opinion.
This case originated in diversity of citizenship under 28 U.S.C. § 1331. The Stutlers are
residents of the Commonwealth of Kentucky, and T. K. is a resident of the State of Indiana.
1
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Appellee, Michael Stutler, hired T. K. to build a new house, which Kathy and David Stutler used
as a residence. T. K. completed the project, and the Stutlers provided T. K. with written acceptance
of the workmanship. Some time later, the Stutlers noticed defects and asked T. K. to perform repairs
covered by the home warranty. T. K. performed an initial inspection, but before it could begin any
repairs, the Stutlers retained an attorney and filed the instant complaint.
The complaint alleges state law claims for negligent misrepresentation, breach of contract,
breach of warranty, negligence, negligent hiring, negligent supervision, negligence per se and unjust
enrichment arising out of T. K.’s construction of the house, and demands damages in excess of
$100,000.
The contract entered into by T. K. and the Stutlers contains the following arbitration clause:
Any claims or disputes arising out of this contract or the breach thereof shall be
settled by arbitration in accordance with the Construction Industry Arbitration Rules
of [the] American Arbitration Association unless both parties mutually agree
otherwise.
The contract also provides that if a dispute over workmanship cannot be resolved:
Buyer and Builder agree to jointly engage the services of an independent third party
inspector to resolve said disputed item(s). The costs and expenses of the independent
third party inspector will be shared equally by the Buyer and the Builder and the
decision of the independent third party will be binding. Said inspector shall be
instructed to evaluate merits of [the] dispute solely in accordance with the terms and
conditions of the Agreement.
Relying on the contract, T. K. filed a motion to stay the proceedings in the district court.
Despite the contract’s unambiguous arbitration clause, the district court denied T. K.’s motion,
finding that the cost of arbitration would be prohibitive to the Stutlers. T. K. now appeals the district
court’s decision.
An order denying a motion to stay proceedings pending arbitration is immediately
appealable. 9 U.S.C. § 16(a)(1)(A). We review de novo the district court’s refusal to enforce an
arbitration clause, and we review its factual findings for clear error. Cooper, 367 F.3d at 497.
Our disposition of this appeal is governed by the Federal Arbitration Act, 9 U.S.C. § 1, et
seq. (the “FAA”). Congress enacted the FAA in 1925 pursuant to its power to regulate interstate
commerce “to ensure judicial enforcement of privately made agreements to arbitrate,” and “to
overrule the judiciary’s longstanding refusal to enforce agreements to arbitrate.” Dean Witter
Reynolds, Inc. v. Byrd, 470 U.S. 213, 219-20 (1985); see also Circuit City Stores, Inc. v. Adams, 532
U.S. 105, 111-12 (2001). The FAA preempts any contradictory provision of state law. See Circuit
City, 532 U.S. at 111-12; Conseco Financial Servicing Corp. v. Wilder, 47 S.W.3d 335, 341 (Ky.
Ct. App. 2001).
The FAA applies to “[a] written provision in any . . . contract evidencing a transaction
involving commerce to settle by arbitration a controversy thereafter arising out of such contract or
transaction . . . .” 9 U.S.C. § 2. It sets forth a fundamental rule regarding enforcement of an
arbitration clause: a written agreement to arbitrate shall be enforceable “save upon such grounds
as exist at law or in equity for the revocation of any contract.” Id. In other words, whether an
arbitration clause is enforceable is governed by state law. See Perry v. Thomas, 482 U.S. 483, 492
n. 9 (1987) (“An agreement to arbitrate is valid, irrevocable, and enforceable, as a matter of federal
law, ‘save upon such grounds as exist at law or in equity for the revocation of any contract.’ Thus
state law, whether of legislative or judicial origin, is applicable if that law arose to govern issues
No. 04-6436 Stutler, et al. v. T.K. Constructors Inc. Page 3
concerning the validity, revocability, and enforceability of contracts generally.”) See also Great
Earth Companies, Inc. v. Simons, 288 F.3d 878, 889 (6th Cir. 2002) (“state law governs ‘generally
applicable contract defenses [to an arbitration clause], such as fraud, duress, or unconscionability.’”)
(quoting Doctor's Assocs., Inc. v. Casarotto, 517 U.S. 681, 687 (1996)). If no such defenses apply,
an arbitration clause is generally enforceable under the FAA.
The district court erred by applying federal common law rather than considering state law
contract defenses. Specifically, the court relied on our holdings in Cooper v. MRM Investment Co.
and Morrison v. Circuit City Stores, Inc., supra.
We clearly limited our holdings in Morrison and Cooper to the validity of arbitration clauses
in employment agreements where an employee’s statutorily created federal civil rights are at issue.
Morrison, a Title VII employment discrimination case, held that an arbitration clause may be
unenforceable if the cost of arbitration would undermine “the purposes of federal anti-discrimination
legislation” by deterring potential claimants from pursuing their claims. 317 F.3d at 653. According
to Morrison, the resolution of an arbitral civil rights dispute must “reconcile the liberal federal
policy favoring arbitration agreements with the important rights created and protected by federal
civil rights legislation.” Id. at 652-53 (quotation omitted) (emphasis added). Toward that end,
Morrison provides that “potential litigants must be given an opportunity, prior to arbitration on the
merits, to demonstrate that the potential costs of arbitration are great enough to deter them and
similarly situated individuals from seeking to vindicate their federal statutory rights in the arbitral
forum.” Id. at 663 (emphasis added). Cooper, a second Title VII employment discrimination case,
also upheld a district court’s refusal to enforce an arbitration clause where the cost of arbitration was
prohibitive. 367 F.3d at 510-12. Cooper explicitly held that the objective of its cost deterrent
analysis was “to serve the underlying functions of the federal statute.” Id. at 511 (quoting Morrison,
317 F.3d at 663).
A third case is relevant. Green Tree Financial Corp. v. Randolph, 531 U.S. 79 (2000), a
predecessor to Morrison and Cooper, dealt exclusively with the arbitration of federal statutory
claims. In that case, the Supreme Court held that invalidation of an arbitration agreement on the
basis that arbitration was cost-prohibitive was in error where the agreement was silent as to how the
plaintiff and the defendant would share the costs. Id. at 91-92. The Court wrote that the plaintiff
in such a case bears the burden of establishing that Congress intended to preclude arbitration of the
statutory claims at issue and that the plaintiff is likely to suffer the costs of arbitration. Id. at 92.
Green Tree, Morrison and Cooper are limited by their plain language to the question of
whether an arbitration clause is enforceable where federal statutorily provided rights are affected.
In this case, no federally protected interest is at stake. The Stutlers, through diversity jurisdiction,
seek to enforce contractual rights provided by state law. As a result, Morrison and Cooper simply
do not apply. Under the FAA, the Stutlers must look to contract defenses available in Kentucky
rather than those found in federal common law.
Kentucky has a paramount interest in the enforcement of arbitration agreements. The
Constitution of Kentucky provides that “[i]t shall be the duty of the General Assembly to enact such
laws as shall be necessary and proper to decide differences by arbitrators, the arbitrators to be
appointed by the parties who may choose that summary mode of adjustment.” Ky. Const. § 250.
Toward that end, Kentucky has adopted the Uniform Arbitration Act, which mirrors the FAA in
several respects. See K.R.S. § 417.050. Furthermore, Kentucky courts take a broad view of the
enforceability of arbitration agreements. See Conseco, 47 S.W.3d at 344 (arbitration is presumed
to afford the parties “an adequate opportunity to vindicate their substantive claims” even if the
arbitration clause is one-sided and the contract is one of adhesion). Kentucky law is thus entirely
consistent with and complementary to the provisions of the FAA. To apply Morrison and Cooper
as the district court did is, in effect, to preempt these provisions of Kentucky law, despite the lack
No. 04-6436 Stutler, et al. v. T.K. Constructors Inc. Page 4
of any inconsistency that would permit their preemption by the FAA, and despite the explicit
provision of § 2 of the FAA itself, which reserves to state law the defenses against enforcement of
arbitration agreements.
Even if Morrison and Cooper were not explicitly limited to the arbitration of federal
statutory rights, Erie R. Co. v. Tompkins forbids their application to a question governed by state
law. 304 U.S. 64 (1938). Erie provides that “[e]xcept in matters governed by the Federal
Constitution or by acts of Congress, the law to be applied in any case is the law of the state.” Id. at
78. Although the FAA generally preempted states’ laws that are inconsistent with the FAA,
Congress explicitly preserved the applicability of state law defenses to arbitration agreements. 9
U.S.C. § 2; Perry, 482 U.S. at 492, n. 9. Accordingly, the Stutlers’ ability to avoid their agreement
with T. K. is governed by the generally applicable contract laws of the Commonwealth of Kentucky.
We cannot, under Erie, invalidate that agreement by reference to the federal common law
established by Green Tree, Morrison and Cooper.
Finally, if we were to flout Erie by extending Green Tree, Morrison and Cooper to disputes
over purely state law claims, we would, in effect, limit the enforcement of arbitration agreements
to situations in which all of the parties to the agreement are wealthy. This absurd result, we think,
is not what Congress intended when it enacted the FAA.
Accordingly, we VACATE the district court’s order and REMAND the matter for
disposition consistent with this opinion.
No. 04-6436 Stutler, et al. v. T.K. Constructors Inc. Page 5
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CONCURRENCE
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KAREN NELSON MOORE, Circuit Judge, concurring in the judgment. While I do not join
the majority opinion’s condemnation of the district court, I agree with the majority that it was
reversible error for the district court to apply the cost-deterrent defense to arbitration recognized by
this court in Morrison v. Circuit City Stores, Inc., 317 F.3d 646 (6th Cir. 2003) (en banc), and
Cooper v. MRM Investment Co., 367 F.3d 493 (6th Cir. 2004), to the state-law claims in this dispute
as a matter of federal common law. I write separately, however, to clarify that the majority
opinion’s fervid rejection of the extension of the cost-deterrent defense to state-law disputes as a
matter of federal law is immaterial to the issue of whether or not such a defense could be properly
recognized as a matter of state law. I believe the question of whether a state court or a federal court
sitting in diversity could properly recognize a cost-deterrent defense to arbitration as part of
generally applicable contract-defense doctrine is a complicated question deserving of some
comment.
The Federal Arbitration Act (”FAA”) states that arbitration agreements are “valid,
irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation
of any contract.” 9 U.S.C. § 2. Therefore parties may assert only general contract defenses that exist
in law or equity “for the revocation of any contract” in order to avoid enforcement of an arbitration
provision, but may not assert statutory defenses unique to arbitration clauses. See Southland Corp.
v. Keating, 465 U.S. 1, 16 n.11 (1984) (disallowing a state statutory defense to an arbitration clause
because to allow the defense “would permit states to override the declared policy requiring
enforcement of arbitration agreements.”). State common-law defenses unique to arbitration clauses
would appear to be similarly suspect, as they too would run afoul of the FAA’s goal “to place
arbitration agreements upon the same footing as other contracts.” Gilmer v. Interstate/Johnson Lane
Corp., 500 U.S. 20, 24 (1991). While state-law attempts specifically to undermine arbitration
agreements are improper, “generally applicable state-law contract defenses[,] like fraud, forgery,
duress, mistake, lack of consideration or mutual obligation, or unconscionability, may invalidate
arbitration agreements.” Cooper, 367 F.3d at 498 (citing, inter alia, Doctor’s Assocs. v. Casarotto,
517 U.S. 681, 687 (1996)). For instance, a state might determine that in addition to having an
interest in enforcing arbitration agreements, it also has an interest in ensuring that residents who can
demonstrate that high arbitration costs would deter them from vindicating their common-law rights
can avail themselves of generally applicable equitable contract defenses.
The Stutlers may therefore attempt to rely upon Kentucky contract defenses in support of
their claim that the up-front costs of arbitration are so prohibitive to vindicating their contractual
rights that they should be released from the obligation to arbitrate. For the following reasons,
however, I do not believe this is an appropriate case for us to find that a generally applicable
principle of state law applies to invalidate the arbitration clause. The Supreme Court of Kentucky
has never considered the question of arbitration costs as a defense to arbitration, or a closely
analogous question. The key question is, therefore, whether if faced with this issue, the Supreme
Court of Kentucky would be likely to recognize the “cost deterrent” defense under one of its
generally applicable doctrines of contract defense. See Managed Health Care Assocs., Inc. v.
Kethan, 209 F.3d 923, 927 (6th Cir. 2000) (“Our role in this diversity of citizenship case is to make
[the] best prediction, even in the absence of direct state court precedent, of what the Kentucky
Supreme Court would do if it were confronted with this question.”) (internal quotation marks
omitted). The most closely analogous case to this one, which comes from the Kentucky Court of
Appeals in Conseco Finance Serv. Corp. v. Wilder, 47 S.W.3d 335, 343-44 (Ky. Ct. App. 2001), is
ambiguous on this specific question. We must look to Conseco because state court of appeals
decisions constitute part of the “[r]elevant data” that a federal court must look to in predicting how
No. 04-6436 Stutler, et al. v. T.K. Constructors Inc. Page 6
a state supreme court would decide an issue, and decisions of courts of appeals “should not be
disregarded unless we are presented with persuasive data that the [Kentucky] Supreme Court would
decide otherwise.” Prestige Cas. Co. v. Mich. Mut. Ins. Co., 99 F.3d 1340, 1348 (6th Cir. 1996).
Contrary to T.K.’s claim, I do not read Conseco as “[r]ejecting a party’s argument of
excessive cost” under Green Tree Financial Corp.- Alabama v. Randolph, 531 U.S. 79 (2000).
Appellant Reply Br. at 13. Nor does Conseco explicitly approve of a Green Tree cost-related
defense, because the parties in Conseco did not make such a claim. Instead, in Conseco, which
involved the exact same arbitration clause at issue in Green Tree, the Kentucky Court of Appeals
explained the Supreme Court’s cost-related holding in Green Tree, and then relied upon Green
Tree’s reasoning to hold that the plaintiff’s analogous contention that the arbitration clause was
unconscionable must similarly be rejected on the plaintiff’s existing level of proof. The Conseco
court stated that, like the Green Tree plaintiff’s cost-related claim, the plaintiff’s argument that the
arbitration clause was “unfairly one-sided rests similarly on a presumption that arbitration will not
afford them an adequate opportunity to vindicate their substantive claims.” Conseco, S.W.3d at 344.
The court concluded, “Under both the FAA and Kentucky’s UAA, such a presumption is not a
proper basis for refusing enforcement of an arbitration clause.” Id. Like in Green Tree, the
Kentucky Court of Appeals required that the plaintiff meet some unspecified level of proof before
the plaintiff could be relieved of the duty to arbitrate. The Conseco court continued:
Should it transpire, however, that the unspecified details of Conseco’s arbitration
procedure prevent or unfairly hinder the [plaintiffs] from meaningfully presenting
their case, the arbitration clause consigning them to that procedure would appear in
a different light. In that event, our ruling today would not preclude the [plaintiffs]
from renewing their objection to the arbitration clause in circuit court on the ground
that the clause had proved unconscionable in practice. On the record before us,
however, there is no basis for such a conclusion.
Id. Thus at the same time that Conseco rejected the attempt to avoid an arbitration clause based on
a mere presumption of unconscionability, Conseco implied that Kentucky law might allow a plaintiff
who believes that the costs of arbitration “prevent or unfairly hinder” them from making a
meaningful presentation of their claims to attack the arbitration clause either pre- or post-arbitration
if that plaintiff can meet some level of proof about the hindrance caused by the costs of the
arbitration procedure. While I therefore believe that Conseco leaves the door open to the possibility
of recognizing a cost-related claim of unconscionability, the ambiguity of Kentucky law makes this
an inappropriate case in which to conclude that generally applicable state law invalidates the
arbitration clause because of the Stutlers’ cost-related concerns. I concur in the judgment.