Southland Corp. v. Keating , 104 S. Ct. 852 ( 1984 )

Chief Justice Burger

delivered the opinion of the Court.

This case presents the questions (a) whether the California Franchise Investment Law, which invalidates certain arbitration agreements covered by the Federal Arbitration Act, violates the Supremacy Clause and (b) whether arbitration under the federal Act is impaired when a class-action structure is imposed on the process by the state courts.

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Appellant Southland Corp. is the owner and franchisor of 7-Eleven convenience stores. Southland’s standard franchise agreement provides each franchisee with a license to use certain registered trademarks, a lease or sublease of a convenience store owned or leased by Southland, inventory financing, and assistance in advertising and merchandising. The franchisees operate the stores, supply bookkeeping data, and pay Southland a fixed percentage of gross profits. The franchise agreement also contains the following provision requiring arbitration:

“Any controversy or claim arising out of or relating to this Agreement or the breach hereof shall be settled by arbitration in accordance with the Rules of the American Arbitration Association . . . and judgment upon any award rendered by the arbitrator may be entered in any court having jurisdiction thereof.”

Appellees are 7-Eleven franchisees. Between September 1975 and January 1977, several appellees filed individual actions against Southland in California Superior Court alleging, among other things, fraud, oral misrepresentation, breach of contract, breach of fiduciary duty, and violation of the disclosure requirements of the California Franchise Investment Law, Cal. Corp. Code Ann. §31000 et seq. (West 1977). Southland’s answer, in all but one of the individual actions, included the affirmative defense of failure to arbitrate.

In May 1977, appellee Keating filed a class action against Southland on behalf of a class that assertedly includes approximately 800 California franchisees. Keating’s principal claims were substantially the same as those asserted by the other franchisees. After the various actions were consolidated, Southland petitioned to compel arbitration of the claims in all cases, and appellees moved for class certification.

The Superior Court granted Southland’s motion to compel arbitration of all claims except those claims based on the Franchise Investment Law. The court did not pass on ap-pellees’ request for class certification. Southland appealed from the order insofar as it excluded from arbitration the claims based on the California statute. Appellees filed a petition for a writ of mandamus or prohibition in the California Court of Appeal arguing that the arbitration should proceed as a class action.

The California Court of Appeal reversed the trial court’s refusal to compel arbitration of appellees’ claims under the Franchise Investment Law. Keating v. Superior Court, Alameda County, 167 Cal. Rptr. 481 (1980). That court interpreted the arbitration clause to require arbitration of all claims asserted under the Franchise Investment Law, and construed the Franchise Investment Law not to invalidate such agreements to arbitrate.¹ Alternatively, the court concluded that if the Franchise Investment Law rendered arbitration agreements involving commerce unenforceable, it would conflict with §2 of the Federal Arbitration Act, 9 U. S. C. §2, and therefore be invalid under the Supremacy Clause. 167 Cal. Rptr., at 493-494. The Court of Appeal also determined that there was no “insurmountable obstacle” to conducting an arbitration on a classwide basis, and issued a writ of mandate directing the trial court to conduct class-certification proceedings. Id., at 492.

The California Supreme Court, by a vote of 4-2, reversed the ruling that claims asserted under the Franchise Investment Law are arbitrable. Keating v. Superior Court of Alameda County, 31 Cal. 3d 584, 645 P. 2d 1192 (1982). The California Supreme Court interpreted the Franchise Investment Law to require judicial consideration of claims brought under that statute and concluded that the California statute did not contravene the federal Act. Id., at 604, 645 P. 2d, 1203-1204. The court also remanded the case to the trial court for consideration of appellees’ request for classwide arbitration.

We postponed consideration of the question of jurisdiction pending argument on the merits. 459 U. S. 1101 (1983). We reverse in part and dismiss in part.

II

A

Jurisdiction of this Court is asserted under 28 U. S. C. § 1257(2), which provides for an appeal from a final judgment of the highest court of a state when the validity of a challenged state statute is sustained as not in conflict with federal law. Here Southland challenged the California Franchise Investment Law as it was applied to invalidate a contract for arbitration made pursuant to the Federal Arbitration Act. Appellees argue that the action of the California Supreme Court with respect to this claim is not a “final judgment or decree” within the meaning of § 1257(2).

Under Cox Broadcasting Corp. v. Cohn, 420 U. S. 469, 482-483 (1975), judgments of state courts that finally decide a federal issue are immediately appealable when “the party seeking review here might prevail [in the state court] on the merits on nonfederal grounds, thus rendering unnecessary review of the federal issue by this Court, and where reversal of the state court on the federal issue would be preclusive of any further litigation on the relevant cause of action . . . .” In these circumstances, we have resolved the federal issue “if a refusal immediately to review the state-court decision might seriously erode federal policy.” Id., at 483.

The judgment of the California Supreme Court with respect to this claim is reviewable under Cox Broadcasting, supra. Without immediate review of the California holding by this Court there may be no opportunity to pass on the federal issue and as a result “there would remain in effect the unreviewed decision of the State Supreme Court” holding that the California statute does not conflict with the Federal Arbitration Act. Id., at 485. On the other hand, reversal of a state-court judgment in this setting will terminate litigation of the merits of this dispute.

Finally, the failure to accord immediate review of the decision of the California Supreme Court might “seriously erode federal policy.” Plainly the effect of the judgment of the California court is to nullify a valid contract made by private parties under which they agreed to submit all contract disputes to final, binding arbitration. The federal Act permits “parties to an arbitrable dispute [to move] out of court and into arbitration as quickly and easily as possible.” Moses H. Cone Memorial Hospital v. Mercury Construction Corp., 460 U. S. 1, 22 (1983).

Contracts to arbitrate are not to be avoided by allowing one party to ignore the contract and resort to the courts. Such a course could lead to prolonged litigation, one of the very risks the parties, by contracting for arbitration, sought to eliminate. In The Bremen v. Zapata Off-Shore Co., 407 U. S. 1, 12 (1972), we noted that the contract fixing a particular forum for resolution of all disputes

“was made in an arm’s-length negotiation by experienced and sophisticated businessmen, and absent some compelling and countervailing reason it should be honored by the parties and enforced by the courts.”

The Zapata Court also noted that

“the forum clause was a vital part of the agreement, and it would be unrealistic to think that the parties did not conduct their negotiations, including fixing the monetary terms, with the consequences of the forum clause figuring prominently in their calculations.” Id., at 14 (footnote omitted).

For us to delay review of a state judicial decision denying enforcement of the contract to arbitrate until the state-court litigation has run its course would defeat the core purpose of a contract to arbitrate. We hold that the Court has jurisdiction to decide whether the Federal Arbitration Act preempts §31512 of the California Franchise Investment Law.

B

That part of the appeal relating to the propriety of superimposing class-action procedures on a contract arbitration raises other questions. Southland did not contend in the California courts that, and the state courts did not decide whether, state law imposing class-action procedures was pre-empted by federal law. When the California Court of Appeal directed Southland to address the question whether state or federal law controlled the class-action issue, South-land responded that state law did not permit arbitrations to proceed as class actions, that the Federal Rules of Civil Procedure were inapplicable, and that requiring arbitrations to proceed as class actions “could well violate the [federal] constitutional guaranty of procedural due process.”² Southland did not claim in the Court of Appeal that if state law required class-action procedures, it would conflict with the federal Act and thus violate the Supremacy Clause.

In the California Supreme Court, Southland argued that California law applied but that neither the contract to arbitrate nor state law authorized class-action procedures to govern arbitrations. Southland also contended that the Federal Rules were inapplicable in state proceedings. Southland pointed out that although California law provided a basis for class-action procedures, the Judicial Council of California acknowledged “the incompatibility of class actions and arbitration. ” Petition for Hearing 23. It does not appear that Southland opposed class procedures on federal grounds in the California Supreme Court.³ Nor does the record show that the California Supreme Court passed upon the question whether superimposing class-action procedures on a contract arbitration was contrary to the federal Act.⁴

Since it does not affirmatively appear that the validity of the state statute was “drawn in question” on federal grounds by Southland, this Court is without jurisdiction to resolve this question as a matter of federal law under 28 U. S. C. §1257(2). See Bailey v. Anderson, 326 U. S. 203, 207 (1945).

HH í — I I — I

As previously noted, the California Franchise Investment Law provides:

“Any condition, stipulation or provision purporting to bind any person acquiring any franchise to waive compliance with any provision of this law or any rule or order hereunder is void.” Cal. Corp. Code Ann. §31512 (West 1977).

The California Supreme Court interpreted this statute to require judicial consideration of claims brought under the state statute and accordingly refused to enforce the parties’ contract to arbitrate such claims. So interpreted the California Franchise Investment Law directly conflicts with §2 of the Federal Arbitration Act and violates the Supremacy Clause.

In enacting §2 of the federal Act, Congress declared a national policy favoring arbitration and withdrew the power of the states to require a judicial forum for the resolution of claims which the contracting parties agreed to resolve by arbitration. The Federal Arbitration Act provides:

“A written provision in any maritime transaction or a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction, or the refusal to perform the whole or any part thereof, or an agreement in writing to submit to arbitration an existing controversy arising out of such a contract, transaction, or refusal, shall be 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.

Congress has thus mandated the enforcement of arbitration agreements.

We discern only two limitations on the enforceability of arbitration provisions governed by the Federal Arbitration Act: they must be part of a written maritime contract or a contract “evidencing a transaction involving commerce”⁵ and such clauses may be revoked upon “grounds as exist at law or in equity for the revocation of any contract.” We see nothing in the Act indicating that the broad principle of enforceability is subject to any additional limitations under state law.

The Federal Arbitration Act rests on the authority of Congress to enact substantive rules under the Commerce Clause. In Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U. S. 395 (1967), the Court examined the legislative history of the Act and concluded that the statute “is based upon . . . the incontestable federal foundations of ‘control over interstate commerce and over admiralty.’” Id., at 405 (quoting H. R. Rep. No. 96, 68th Cong., 1st Sess., 1 (1924)). The contract in Prima Paint, as here, contained an arbitration clause. One party in that case alleged that the other had committed fraud in the inducement of the contract, although not of the arbitration clause in particular, and sought to have the claim of fraud adjudicated in federal court. The Court held that, notwithstanding a contrary state rule, consideration of a claim of fraud in the inducement of a contract “is for the arbitrators and not for the courts,” 388 U. S., at 400. The Court relied for this holding on Congress’ broad power to fashion substantive rules under the Commerce Clause.⁶

At least since 1824 Congress’ authority under the Commerce Clause has been held plenary. Gibbons v. Ogden, 9 Wheat. 1, 196 (1824). In the words of Chief Justice Marshall, the authority of Congress is “the power to regulate; that is, to prescribe the rule by which commerce is to be governed.” Ibid. The statements of the Court in Prima Paint that the Arbitration Act was an exercise of the Commerce Clause power clearly implied that the substantive rules of the Act were to apply in state as well as federal courts. As Justice Black observed in his dissent, when Congress exercises its authority to enact substantive federal law under the Commerce Clause, it normally creates rules that are enforceable in state as well as federal courts. Prima Paint, supra, at 420.

In Moses H. Cone Memorial Hospital v. Mercury Construction Corp., 460 U. S., at 1, 25, and n. 32, we reaffirmed our view that the Arbitration Act “creates a body of federal substantive law” and expressly stated what was implicit in Prima Paint, i. e., the substantive law the Act created was applicable in state and federal courts. Moses H. Cone began with a petition for an order to compel arbitration. The District Court stayed the action pending resolution of a concurrent state-court suit. In holding that the District Court had abused its discretion, we found no showing of exceptional circumstances justifying the stay and recognized “the presence of federal-law issues” under the federal Act as “a major consideration weighing against surrender [of federal jurisdiction].” 460 U. S., at 26. We thus read the underlying issue of arbitrability to be a question of substantive federal law: “Federal law in the terms of the Arbitration Act governs that issue in either state or federal court.” Id., at 24.

Although the legislative history is not without ambiguities, there are strong indications that Congress had in mind something more than making arbitration agreements enforceable only in the federal courts. The House Report plainly suggests the more comprehensive objectives:

“The purpose of this bill is to make valid and enforcible [sic] agreements for arbitration contained in contracts involving interstate commerce or within the jurisdiction or [sic] admiralty, or which may be the subject of litigation in the Federal courts.” H. R. Rep. No. 96, 68th Cong., 1st Sess., 1 (1924) (emphasis added).

This broader purpose can also be inferred from the reality that Congress would be less likely to address a problem whose impact was confined to federal courts than a problem of large significance in the field of commerce. The Arbitration Act sought to “overcome the rule of equity, that equity will not specifically enforce an[y] arbitration agreement.” Hearing on S. 4213 and S. 4214 before a Subcommittee of the Senate Committee on the Judiciary, 67th Cong., 4th Sess., 6 (1923) (Senate Hearing) (remarks of Sen. Walsh). The House Report accompanying the bill stated:

“The need for the law arises from . . . the jealousy of the English courts for their own jurisdiction. . . . This jealousy survived for so lon[g] a period that the principle became firmly embedded in the English common law and was adopted with it by the American courts. The courts have felt that the precedent was too strongly fixed to be overturned without legislative enactment . . . .” H. R. Rep. No. 96, supra, at 1-2.

Surely this makes clear that the House Report contemplated a broad reach of the Act, unencumbered by state-law constraints. As was stated in Metro Industrial Painting Corp. v. Terminal Construction Co., 287 F. 2d 382, 387 (CA2 1961) (Lumbard, C. J., concurring), “the purpose of the act was to assure those who desired arbitration and whose contracts related to interstate commerce that their expectations would not be undermined by federal judges, or ... by state courts or legislatures.” Congress also showed its awareness of the widespread unwillingness of state courts to enforce arbitration agreements, e. g., Senate Hearing, at 8, and that such courts were bound by state laws inadequately providing for

“technical arbitration by which, if you agree to arbitrate under the method provided by the statute, you have an arbitration by statute[;] but [the statutes] ha[d] nothing to do with validating the contract to arbitrate.” Ibid.

The problems Congress faced were therefore twofold: the old common-law hostility toward arbitration, and the failure of state arbitration statutes to mandate enforcement of arbitration agreements. To confine the scope of the Act to arbitrations sought to be enforced in federal courts would frustrate what we believe Congress intended to be a broad enactment appropriate in scope to meet the large problems Congress was addressing.

Justice O’Connor argues that Congress viewed the Arbitration Act “as a procedural statute, applicable only in federal courts.” Post, at 25. If it is correct that Congress sought only to create a procedural remedy in the federal courts, there can be no explanation for the express limitation in the Arbitration Act to contracts “involving commerce.” 9 U. S. C. § 2. For example, when Congress has authorized this Court to prescribe the rules of procedure in the federal courts of appeals, district courts, and bankruptcy courts, it has not limited the power of the Court to prescribe rules applicable only to causes of action involving commerce. See, e. g., 28 U. S. C. §§2072, 2075, 2076 (1976 ed. and Supp. V). We would expect that if Congress, in enacting the Arbitration Act, was creating what it thought to be a procedural rule applicable only in federal courts, it would not so limit the Act to transactions involving commerce. On the other hand, Congress would need to call on the Commerce Clause if it intended the Act to apply in state courts. Yet at the same time, its reach would be limited to transactions involving interstate commerce. We therefore view the “involving commerce” requirement in §2, not as an inexplicable limitation on the power of the federal courts, but as a necessary qualification on a statute intended to apply in state and federal courts.

Under the interpretation of the Arbitration Act urged by Justice O’Connor, claims brought under the California Franchise Investment Law are not arbitrable when they are raised in state court. Yet it is clear beyond question that if this suit had been brought as a diversity action in a federal district court, the arbitration clause would have been enforceable.⁷ Prima Paint, supra. The interpretation given to the Arbitration Act by the California Supreme Court would therefore encourage and reward forum shopping. We are unwilling to attribute to Congress the intent, in drawing on the comprehensive powers of the Commerce Clause, to create a right to enforce an arbitration contract and yet make the right dependent for its enforcement on the particular forum in which it is asserted. And since the overwhelming proportion of all civil litigation in this country is in the state courts,⁸ we cannot believe Congress intended to limit the Arbitration Act to disputes subject only to federal-court jurisdiction.⁹ Such an interpretation would frustrate congressional intent to place “[a]n arbitration agreement . . . upon the same footing as other contracts, where it belongs.” H. R. Rep. No. 96, 68th Cong., 1st Sess., 1 (1924).

In creating a substantive rule applicable in state as well as federal courts,¹⁰ Congress intended to foreclose state legislative attempts to undercut the enforceability of arbitration agreements.¹¹ We hold that §31512 of the California Franchise Investment Law violates the Supremacy Clause.

IV

The judgment of the California Supreme Court denying enforcement of the arbitration agreement is reversed; as to the question whether the Federal Arbitration Act precludes a class-action arbitration and any other issues not raised in the California courts, no decision by this Court would be appropriate at this time. As to the latter issues, the case is remanded for further proceedings not inconsistent with this opinion.

It is so ordered.

1 California Corp. Code Ann. §31512 (West 1977) provides: “Any condition, stipulation or provision purporting to bind any person acquiring any franchise to waive compliance with any provision of this law or any rule or order hereunder is void.”

2 Supplemental Memorandum of Points and Authorities in Opposition to Petition for Writs of Mandate or Prohibition in Civ. No. 45162 (Ct. App. Cal., 1st App. Dist.), pp. 19-25.

3 The question Southland presented to the State Supreme Court was “[w]hether a court may enter an order compelling a private commercial arbitration governed by the Federal Arbitration Act... to proceed as a class action even though the terms of the parties’ arbitration agreement do not provide for such a procedure.” Petition for Hearing in Civ. No. 45162 (Cal. 1980). Southland argued that (1) the decision of the Court of Appeal “is in conflict with the decisions of other Courts of Appeal in this State,” id., at 3; (2) class actions would delay and complicate arbitration, increase its cost, and require judicial supervision, “considerations [which] strongly militate against the creation of class action arbitration procedures,” id., at 22; and (3) there was no basis in law for class actions. According to appellants, the Federal Kules of Civil Procedure did not apply in California courts. Id., at 23. Southland thus relied, not on federal law, but on California law in opposing class-action procedures.

4 The California Supreme Court cited “[a]nalogous authority” supporting consolidation of arbitration proceedings by federal courts. 31 Cal. 3d, at 611-612, 645 P. 2d, at 1208. E. g., Compania, Española de Petroleos, S. A. v. Nereus Shipping, S. A., 527 F. 2d 966, 975 (CA2 1975), cert. denied, 426 U. S. 936 (1976); In re Czarnikow-Rionda Co., 512 F. Supp. 1308, 1309 (SDNY 1981). This, along with support by other state courts and the California Legislature for consolidation of arbitration proceedings, permitted the court to conclude that class-action proceedings were authorized: “It is unlikely that the state Legislature in adopting the amendment to the Arbitration Act authorizing consolidation of arbitration proceedings, intended to preclude a court from ordering classwide arbitration in an appropriate case. We conclude that a court is not without authority to do so.” 31 Cal. 3d, at 613, 645 P. 2d, at 1209. The California Supreme Court thus ruled that imposing a class-action structure on the arbitration process was permissible as a matter of state law.

5 We note that in defining “commerce” Congress declared that “nothing herein contained shall apply to contracts of employment of seamen, railroad employees, or any other class of workers engaged in foreign or interstate commerce.” 9 U. S. C. § 1.

6 The procedures to be used in an arbitration are not prescribed by the federal Act. We note, however, that Prima Paint considered the question of what issues are for the courts and what issues are for the arbitrator.

7 Appellees contend that the arbitration clause, which provides for the arbitration of “any controversy or claim arising out of or relating to this Agreement or the breach hereof,” does not cover their claims under the California Franchise Investment Law. We find the language quoted above broad enough to cover such claims. Cf. Prima Paint, 388 U. S., at 403-404, 406 (finding nearly identical language to cover a claim that a contract was induced by fraud).

8 It is estimated that 2% of all civil litigation in this country is in the federal courts. Annual Report of the Director of the Administrative Office of the U. S. Courts 3 (1982) (206,000 filings in federal district courts in 12 months ending June 30, 1982, excluding bankruptcy filings); Flango & Eisner, Advance Report, The Latest State Court Caseload Data, 7 State Court J., 18 (Winter 1983) (approximately 13,600,000 civil filings during comparable period, excluding traffic filings).

9 While the Federal Arbitration Act creates federal substantive law requiring the parties to honor arbitration agreements, it does not create any independent federal-question jurisdiction under 28 U. S. C. § 1331 or otherwise. Moses H. Cone Memorial Hospital v. Mercury Construction Corp., 460 U. S. 1, 25, n. 32 (1983). This seems implicit in the provisions in § 3 for a stay by a “court in which such suit is pending” and in § 4 that enforcement may be ordered by “any United States district court which, save for such agreement, would have jurisdiction under title 28, in a civil action or in admiralty of the subject matter of a suit arising out of the controversy between the parties.” Ibid.; Prima Paint, supra, at 420, and n. 24 (Black, J., dissenting); Krauss Bros. Lumber Co. v. Louis Bossert & Sons, Inc., 62 F. 2d 1004, 1006 (CA2 1933) (L. Hand, J.).

10 The contention is made that the Court’s interpretation of § 2 of the Act renders §§ 3 and 4 “largely superfluous.” Post, at 31, n. 20. This misreads our holding and the Act. In holding that the Arbitration Act preempts a state law that withdraws the power to enforce arbitration agreements, we do not hold that §§3 and 4 of the Arbitration Act apply to proceedings in state courts. Section 4, for example, provides that the Federal Rules of Civil Procedure apply in proceedings to compel arbitration. The Federal Rules do not apply in such state-court proceedings.

11 The California Supreme Court justified its holding by reference to our conclusion in Wilko v. Swan, 346 U. S. 427 (1953), that arbitration agreements are nonbinding as to claims arising under the federal Securities Act of 1933. 31 Cal. 3d, at 602, 645 P. 2d, at 1202-1203. The analogy is unpersuasive. The question in Wilko was not whether a state legislature could create an exception to § 2 of the Arbitration Act, but rather whether Congress, in subsequently enacting the Securities Act, had in fact created such an exception.

Justice Stevens dissents in part on the ground that § 2 of the Arbitration Act permits a party to nullify an agreement to arbitrate on “such grounds as exist at law or in equity for the revocation of any contract.” Post, at 19. We agree, of course, that a party may assert general contract defenses such as fraud to avoid enforcement of an arbitration agreement. We conclude, however, that the defense to arbitration found in the California Franchise Investment Law is not a ground that exists at law or in equity “for the revocation of any contract” but merely a ground that exists for the revocation of arbitration provisions in contracts subject to the California Franchise Investment Law. Moreover, under this dissenting view, “a state policy of providing special protection for franchisees . . . can be recognized without impairing the basic purposes of the federal statute.” Post, at 21. If we accepted this analysis, states could wholly eviscerate congressional intent to place arbitration agreements “upon the same footing as other contracts,” H. R. Rep. No. 96, 68th Cong., 1st Sess., 1 (1924), simply by passing statutes such as the Franchise Investment Law. We have rejected this analysis because it is in conflict with the Arbitration Act and would permit states to override the declared policy requiring enforcement of arbitration agreements.