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From Antitrust Law Daily, October 29, 2018

U.S. Supreme Court hears arguments on arbitration issue in antitrust dental products distribution case

By Peter Reap, J.D., LL.M.

The U.S. Supreme Court heard oral arguments today over whether the Federal Arbitration Act permits a court to decline to enforce an agreement delegating questions of arbitrability to an arbitrator if the court concludes the claim of arbitrability is "wholly groundless." In the underlying dispute, Archer and White Sales, a distributor of low-cost dental equipment, alleged that Henry Schein, Inc., a leading distributor of dental equipment, along with dental equipment manufacturer Danaher Corporation and Danaher’s three subsidiaries, conspired with Danaher and another distributor to terminate or reduce Archer and White’s distribution territory in response to its low prices by engaging in an illegal boycott, in violation of Section 1 of the Sherman Act and the Texas Free Enterprise and Antitrust Act. Today’s arguments focused on the arbitrability issue (Henry Schein, Inc. v. Archer and White Sales, Inc.Dkt. 17-1272).

The decisions below. At issue is a decision of the U.S. Court of Appeals in New Orleans, which held that the complaining distributor’s claims were not subject to mandatory arbitration. In its complaint, Archer and White requested damages, estimated to be in the "tens of millions of dollars," and injunctive relief. Although, initially, a federal magistrate judge granted the defendant companies’ motion to compel arbitration, the federal district court in Marshall, Texas reversed the decision and vacated the magistrate’s order. The district court held that the court should decide the question of arbitrability and that the dispute was not arbitrable because the plain language of the arbitration clause expressly excluded lawsuits including requests for injunctive relief. The defendants then appealed that decision to the Fifth Circuit.

In addressing the arbitrability issue, the court conducted a two-step inquiry—the Douglas test—adopted in 2014 in Douglas v. Regions Bank 757 F.3d 460, 464 (5th Cir. 2014). The Douglas test inquires: (1) whether the agreement between the parties "clearly and unmistakably" delegates the issue of arbitrability; and (2) whether there is a plausible argument for the arbitrability of the dispute, or whether the argument for including the claim within the scope of arbitration is "wholly groundless." Undertaking the first step of the Douglas test and noting the parties’ competing arguments about the agreement’s relationship between the carve-out clause and the incorporation of American Arbitration Association Rules, the Fifth Circuit ultimately determined that the interaction between the two "is at best ambiguous." As a result, the court asserted, "[w]e need not decide which reading to adopt here because Douglas provides us with another avenue to resolve this issue: the ‘wholly groundless’ inquiry" under the second step.

According to the Fifth Circuit, the second step of the Douglas test provides a "narrow escape valve" because if an assertion of arbitrability is deemed to be "wholly groundless," a court "need not submit the issue of arbitrability to the arbitrator." Consequently, the court found that there was no plausible argument that the arbitration clause applied to Archer and White’s action because the lawsuit sought injunctive relief. Rejecting the defendant companies’ argument that the plaintiff was able to avoid arbitration by merely including a claim for injunctive relief in its complaint, the court stressed that, despite policy considerations favoring arbitration, the plain meaning of the arbitration clause was paramount, and the clause clearly excluded actions seeking injunctive relief.

Petitioner Henry Schein’s argument. Arguing on behalf of the petitioner, Kannon K. Shanmugam asserted that a court does not have the power to decide the issue of arbitrability for itself where the parties have agreed to delegate the authority to decide whether claims are subject to arbitration to the arbitrator. The "wholly groundless" exception that was relied on by the Fifth Circuit is unsupported by the text of the Federal Arbitration Act (FAA).

Shanmugam was initially sidetracked by questioning from the Justices about the nature of the arbitration agreement at issue and why the arbitration agreement was not between Archer and White and Henry Schein. Justice Ginsburg asserted that the district court’s first decision was that the contract at issue did not have a sufficiently clear delegation of arbitrability provision. Shanmugam agreed, but continued that the Fifth Circuit did not ultimately rest on that issue, and that the validity of the delegation provision was a discrete issue, separate from the question presented, and one for the Fifth Circuit in the first instance.

Justice Sotomayor brought up the Douglas case, the case relied upon by the Fifth Circuit for its "wholly groundless" exception. She asked what were the potential "outs" for a party who is stuck in an arbitration that legally is wholly groundless? Shanmugam answered that the remedies for such a situation are the same provided for review of arbitration decisions more generally. He discussed the defenses of manifest disregard of the law and an arbitrator exceeding his powers with Justice Sotomayor.

Justice Kagan brought up the First Options case, noting that the Supreme Court said in that ruling that it is not going to treat delegation clauses in exactly the same way as it treats other clauses. She said that in First Options "there was an idea that people don't really think about the question of who decides, and so we're going to hold parties to this higher standard, the clear and unmistakable intent standard. And wouldn't the same kind of argument be true here, that the parties never really considered who was going to decide these groundless claims of arbitrability, or maybe, if they did consider it, they would have thought that it was a pretty strange system to send it to an arbitrator just so that the arbitrator could send it back to the court?"

Shanmugam responded to Kagan’s line of reasoning by stating that "there is obviously an interpretive rule that requires clear and unmistakable evidence that the parties intended to delegate the issue. But I would respectfully submit that, once you have that evidence, that rule falls out of the equation." He stated that is what we have here, in this case.

Moving along to Step 2 of the Douglas test used by the Fifth Circuit, Justice Breyer began by restating Shanmugam’s position: "You say when you get to step 2, once we're there, now there is no wholly groundless exception, go send it to the arbitrator." He then inquired: "Now suppose it's really weird. I mean, you want to say no exception at all? He says my claim here is a Martian told me to do it.… Are you saying no matter what, even if he has to read the word yes in the contract to mean no, never, under no circumstances, is there no exception no matter what?" Shanmugam responded that yes, there are no exceptions no matter what, but there are remedies available for when a party makes a frivolous claim, such as sanctions by the arbitrator.

Justice Breyer brought the discussion back to Step 1 of the Douglas test. "Step 1 is we have to decide -- court, we're a court -- we have to decide whether there is a clear and unmistakable commitment to have this kind of matter decided in arbitration. … Now you would have thought if you really have a Martian case, the judge would have found some way not to send it. … There's no clear and unmistakable commitment to send that kind of matter [to an arbitrator]. Justice Breyer concluded his line of reasoning by querying: "In other words, if it is a totally ridiculous claim, shouldn't you have to find a clear and definite commitment to send a wholly ridiculous matter to the arbitrator?"

Justice Kavanaugh inquired of Shanmugam about the language of Section 4 of the FAA, specifically on the "failure to comply therewith" language. He asked Shanmugam what "work" that language does. Shanmugam replied that all that language requires is a court to determine that one of the parties desires arbitration and one of the parties does not. Kavanaugh responded that he expected such a response, and "that means, in essence, I think, that that language in the statute does no work."

Shanmugam concluded his portion of the argument by summing up his position: "The FAA does not permit this exception and, therefore, the judgment should be vacated." He also reserved the balance of his time for rebuttal.

Respondent Archer and White Sales’ argument. Daniel L. Geyser began his argument by stating that the petitioner’s position "is at odds with the FAA's plain language and the parties' obvious intent." He was quickly interrupted by Justice Sotomayor who pointed out that his position was contrary to the Supreme Court’s Rent-A-Center ruling. She stated "I don't see how determining whether something is wholly groundless is anything but a merits determination" and that Rent-A-Center said "don't look at the merits at all."

Geyser disagreed, contending that "I don't think Rent-A-Center, though, is saying that if there's only one possible outcome, then you should send it to the arbitrator anyway." He continued that, consistent with legal principles, with an absolutely futile claim with no possibility that the arbitrator will say belongs in arbitration, there is no bona fide dispute between the parties and there is no point in sending it on to arbitration. However, Justice Breyer interjected: "Once you look beyond the first question [of the Douglas test], did the parties agree to send this kind of dispute to arbitration, and then you start getting to the second question, did they mean this kind, that kind, you're really deciding arbitrability and courts will decide different things. Everybody will start making their arbitration argument."

Questioned by several justices about the nature of the exception he was advocating, Geyser said: "the wholly groundless doctrine is a very modest inquiry. All you need to do to satisfy it, in respect to my friend, it is not asking the court to decide the arbitrability determination. It's asking them to decide is there a dispute over arbitrability, a bona fide dispute?" Chief Justice Roberts, indicating concern over Geyser’s use of both "wholly groundless" and "bona fide dispute" asked exactly which of those two standards should be used to determine of the case should be sent to an arbitrator, Geyser replied: "I would say if there's not a bona fide dispute, then it goes to the arbitrator. I think that effectively, even though courts have used different articulations, that's where each standard points to."

Justice Gorsuch, in particular, was not satisfied with Geyser’s explanation. "[W]hy do we need to go down the baloney slicing road, to mix my metaphors?" To Geyser’s reply, indicating that he thought the Supreme Court would not take up this case because it was not a good vehicle for it because there is not a clear and unmistakable showing, Justice Gorsuch asked Geyser if he was saying that the High Court should not rule on the question presented and that he would just go back and as the court of appeals to rule on the first part of the Douglas test. Of course not, Geyser replied, to which Gorsuch added "I didn't think so."

Justice Kagan asked Geyser to comment on the textual language of Section 4 of the FAA, that had been earlier raised in the petitioner’s argument. She noted that "the failure to comply therewith" language could be interpreted one of two ways: (1) Shanmugam’s minimalist way, that the language does not mean very much at all; or (2) the maximalist way, which means that this language was meant to assign arbitrability issues to the courts. She contended that she could not understand how Geyser could read the language "to create this halfway house position."

Geyser replied to Kagan that he did thing that the most faithful interpretation of that statutory language was to assign to the courts the gateway issue of arbitrability, but he admitted "that ship has somewhat sailed." Geyser tried to explain by indicating that his position is that, in looking at the review called for of arbitration decisions under Section 10 of the FAA, it made sense for a similar type of review to occur under Section 4 when deciding to refer a matter to an arbitrator. "the ‘wholly groundless’ doctrine that it's -- it's tapping on an intuition that's already there. It's just giving this language some sort of reading that makes sense and that's consistent with the parties' intent."

Petitioner’s rebuttal argument. In his rebuttal, Shanmugam argued that "Respondent has no answer for Justice Sotomayor's question about this Court's decision in Rent-A-Center which provides that, where the parties have remitted the issue of arbitrability to the arbitrator, it should be treated just like any other issue. And what Respondent is asking this Court to do is to allow courts to make merits determinations on the issue of arbitrability even in the face of a delegation."

This case is No. 17-1272.

Attorneys: Kannon K. Shanmugam (Williams & Connolly LLP) for Henry Schein, Inc. Daniel L. Geyser (Geyser PC) for Archer and White Sales, Inc.

Companies: Henry Schein, Inc.; Archer and White Sales, Inc.

MainStory: TopStory Antitrust FranchisingDistribution

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