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U.S. SUPREME COURT LIMITS POWER OF FEDERAL COURTS TO COMPEL ARBITRATION

In a case that began as a credit card debt collection suit brought by the card-issuing federally insured bank, the United States Supreme court limited the power of federal courts to send a dispute to arbitration by holding that a federal court may not entertain a petition to compel arbitration where the “whole controversy” between the parties does not qualify for federal court adjudication. Vaden v. Discover Bank, 2009 WL 578636 (Mar. 9, 2009). The Supreme Court granted certiorari to resolve the conflict among lower federal courts on whether district courts, petitioned to order arbitration pursuant to Section 4 of the Federal Arbitration Act (“Section 4”) may “look through” the petition and examine the parties’ underlying dispute to determine whether federal-question jurisdiction exists over the Section 4 petition.

The dispute in this case arose when the bank’s servicing affiliate filed a complaint in Maryland state court to recover over $10,000 in past due charges from the cardholder, presenting claims solely under state law. The cardholder’s answer to the complaint included class action counterclaims alleging that the bank’s finance charges, interest and late fees violated Maryland law. The bank then filed a Section 4 petition to compel arbitration in the United States District Court for the District of Maryland. Section 4 authorizes a federal court to entertain a petition to compel arbitration if the court would have jurisdiction “save for [the arbitration] agreement” over a suit “arising out of the controversy between the parties.” The District court initially found that it had subject matter jurisdiction over the petition because the cardholder’s state law counterclaims fell under the governance of federal banking law. The United States Court of Appeals for the Fourth Circuit instructed the district court to “look through” the Section 4 petition to the substantive controversy between the parties to determine whether it had federal jurisdiction. On remand, the district court again found federal-question jurisdiction based on the cardholder’s concession that her counterclaims were preempted by federal law. The Fourth Circuit affirmed, concluding that although federal-question jurisdiction depends on the content of a well-pleaded complaint and may not be predicated on counterclaims, the complete preemption doctrine overrides the well-pleaded complaint rule.

The Supreme Court considered two questions concerning a federal district court’s subject matter jurisdiction over a Section 4 petition to compel arbitration: (i) whether a district court should “look through” the petition to determine if the court has federal-question jurisdiction over the underlying controversy, and (ii) if so, whether the court may exercise jurisdiction over the petition when the petitioner’s complaint rests on state law but an actual or potential counterclaim rests on federal law.

On the first question, the Supreme Court determined that a federal court may “look through” the petition to the underlying substantive controversy in determining federal-question jurisdiction. The phrase, “save for [the arbitration] agreement” in Section 4 was interpreted to mean that district courts should assume the absence of the arbitration agreement and determine whether it would have jurisdiction over the underlying controversy between the parties. The Supreme Court rejected the cardholder’s claim that the relevant controversy is limited to the parties’ dispute over the arbitrability of the claims, as the “save for” language invalidated this argument. The “look through” approach, according to the Supreme Court, permits a Section 4 petitioner to ask a federal court to compel arbitration without seeking federal adjudication of the questions it wants to arbitrate rather than litigate.

Having answered the first question in the affirmative, the Supreme Court then evaluated whether the controversy between the cardholder and the bank qualified for federal court adjudication. In light of the principle that Section 4 does not enlarge federal court jurisdiction, but instead confines federal courts to the jurisdiction they would have “save for [the arbitration] agreement,” the Supreme Court read Section 4 to permit a federal court to compel arbitration only where the entire, actual controversy between the parties, as they have framed it, could be litigated in federal court. The bank’s state court suit was not amenable to federal court jurisdiction. Furthermore, under the well-pleaded complaint rule, which provides that federal-question jurisdiction exists only when a federal question is presented on the face of the plaintiff’s properly pleaded complaint, the Supreme Court determined that the cardholder’s completely preempted counterclaim “does not provide a key capable of opening a federal court’s door.” Vaden, 2009 WL 578636 at *10.

Justices Roberts, Stevens, Breyer and Alito concurred in part and dissented in part. Although agreeing that a federal court that is asked to compel arbitration should “look through” the dispute over arbitrability to determine whether it has jurisdiction, the dissenters disagreed with the majority’s interpretation of whether the controversy in this case qualified for federal court adjudication. The dissent proposed that a court should look to the “controversy” that the Section 4 petitioner seeks to arbitrate, as set forth in the Section 4 petition (rather than the controversy that the parties framed in the suit), and assess whether a federal court would have subject matter over a suit arising out of that controversy.

Although the Supreme Court reversed the order to compel arbitration, it noted that the bank was not left without a remedy. Under the FAA, federal courts and state courts are obliged to honor and enforce agreements to arbitrate. The bank may petition a Maryland court to enforce the arbitration clause of its contracts with Maryland cardholders.

  • Judy Scheiderer