In Khan v. Dell Inc., 669 F.3d 350 (3d Cir. 2012), the Third Circuit Court of Appeals held that an unavailable arbitrator was not “integral” to a contract, that § 5 of the Federal Arbitration Act (FAA) required substituting an alternate arbitrator, and articulated an “integral” standard that future arbitration clause drafters should consider.
Introduction
In Khan v. Dell Inc.,[1] the Third Circuit addressed for the first time whether § 5 of the Federal Arbitration Act (FAA) requires a court to appoint an alternate arbitrator when the arbitrator named in the contract is unavailable.[2] Despite relatively clear language selecting an exclusive arbitrator, the court found that the arbitrator was not “integral” to the contract, and that the FAA required the court to name an alternate.[3]
The Khan court articulated an arguably higher standard than other circuits for when arbitrators are “integral” to arbitration clauses. Thankfully, Khan’s standard is also clearer than other jurisdictions. Parties drafting arbitration clauses with a potential to be litigated in the Third Circuit will want to take heed of the Khan standard to ensure their intentions are enforced. This commentary reviews Khan and suggests an alternate arbitration clause to survive Third Circuit scrutiny under Khan and § 5.
Behind the Case
Raheel Khan purchased a computer through Dell’s website.[4] The terms and conditions included an arbitration clause:
13. Binding Arbitration. ANY CLAIM, DISPUTE, OR CONTROVERSY . . . arising from or relating to this Agreement . . . SHALL BE RESOLVED EXCLUSIVELY AND FINALLY BY BINDING ARBITRATION ADMINISTERED BY THE NATIONAL ARBITRATION FORUM (NAF) under its Code of Procedure then in effect . . . . [T]his provision shall be governed by the Federal Arbitration Act 9 U.S.C. sec. 1-16 (FAA).[5]
When Khan had problems with his computer, Dell repaired it a few times but eventually claimed the warranty had expired.[6] Khan sued, arguing that the defects rendered the computer unusable as advertised.[7]
Prior to Khan’s lawsuit, a government investigation revealed that the National Arbitration Forum (NAF) engaged in deceptive practices disadvantageous to consumers.[8] A related consent judgment barred NAF from accepting any new consumer arbitrations.[9]
Khan argued that because NAF’s participation was integral to the arbitration provision, its absence rendered the arbitration agreement unenforceable, and, therefore, the parties were free to litigate.[10] The District Court of New Jersey agreed, holding that the clause indicated that the parties intended to arbitrate only before NAF.[11] NAF was “integral” to the agreement, and the arbitration clause was unenforceable in NAF’s absence.[12]
“Integral” under the FAA
The FAA embraces a “liberal federal policy favoring arbitration;”[13] however, it also acknowledges that arbitration is fundamentally contractual.[14] Parties must consent to arbitration, not be coerced.[15] When an arbitrator is unavailable, the FAA provides a mechanism for courts to appoint a substitute.[16] The unavailability of a selected arbitrator only invalidates an arbitration clause when the arbitrator’s selection is “integral” to the Agreement.[17]
Courts articulate various standards for whether a selection is “integral”: (1) more than an “ancillary logistical concern,”[18] (2) “so central to the arbitration agreement that the [arbitrator’s unavailability brings] the agreement to an end,”[19] or (3) a “clear” showing that the clause “is not an ancillary logistical concern but rather is as important a consideration as the agreement to arbitrate.”[20] Perhaps as a result, courts have split over when language specifying arbitrators or rules of arbitration is “integral” to arbitration clauses.[21]
Khan’s Ambiguity
Khan noted that § 5 of the FAA controls arbitrator substitution[22] and adopted the prevailing standard: whether the arbitrator designation was “integral to the arbitration provision or was merely an ancillary consideration.”[23] It also glossed the standard, declaring that the parties must “unambiguously express[] their intent not to arbitrate their disputes in the event that the designated arbitral forum is unavailable.”[24]
The court found the arbitration clause ambiguous in two ways. First, “EXCLUSIVELY” could modify “BINDING ARBITRATION,” “THE NATIONAL ARBITRATION FORUM,” or both.[25] Second, the requirement that arbitration be conducted under NAF’s rules was ambiguous when, in fact, NAF was unavailable.[26] NAF’s rules, however, provided that if they were unenforceable, the FAA governed.[27] The court concluded that the federal policy favoring arbitration required it to resolve the ambiguity towards arbitration.[28]
A Suggested Revision of Dell’s Arbitration Agreement
In Khan, the Third Circuit adopted a more stringent—but clearer—standard than other circuits.[29] Contracting parties must affirmatively express “their intent not to arbitrate their disputes in the event that the designated arbitral forum is unavailable.”[30] Given this heightened standard, parties wishing to avoid court scrutiny, and unintended application of § 5 of the FAA, must draft arbitration clauses clearly and carefully.
Borrowing language from Khan and § 5 of the FAA suggests a revision of Dell’s arbitration clause that better protects parties intending to name an exclusive arbitrator. (Bold language indicates revisions to Dell’s clause. Footnotes refer the reader to the source of the language.)
13. Binding Arbitration. ANY CLAIM, DISPUTE, OR CONTROVERSY . . . arising from or relating to this Agreement . . . SHALL BE RESOLVED EXCLUSIVELY AND FINALLY BY BINDING ARBITRATION, EXCLUSIVELY ADMINISTERED BY [insert arbitrator in caps] under its Code of Procedure then in effect . . . . This provision shall be the sole method for naming or appointing an arbitrator.[31] In the event that the designated arbitral forum is unavailable, the parties shall not arbitrate their dispute in an alternative forum.[32]
Alexander S. Radus
Temple University School of Law, J.D. Candidate 2013
[1] 669 F.3d 350 (3d Cir. 2012).
[2] Khan, 669 F.3d at 350–51.
[3] Id. at 351, 356–57 (citing Federal Arbitration Act, 9 U.S.C. § 5 (2006)).
[4] Id. at 351.
[5] Id.
[6] Id. at 352.
[7] Id.
[8] Id.
[9] Id.
[10] Id. at 353.
[11] Khan v. Dell, Inc., No. 09-3703 (JAP), 2010 WL 3283529, at *4 (D.N.J. August 18, 2010), vacated by 669 F.3d 350 (3d Cir. 2012).
[12] Id.
[13] Moses H. Cone Mem’l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24 (1983).
[14] Rent-A-Center, West, Inc. v. Jackson, 130 S.Ct. 2772, 2776 (2010).
[15] Stolt-Nielsen S.A. v. AnimalFeeds Int’l Corp., 130 S.Ct. 1758, 1773 (2010).
[16] Federal Arbitration Act, 9 U.S.C. § 5 (2006) (“[I]f for any . . . reason there shall be a lapse in the naming of an arbitrator . . . or in filling a vacancy, then upon the application of either party . . . the court shall designate and appoint an arbitrator . . . .”).
[17] E.g., Reddam v. KPMG LLP, 457 F.3d 1054, 1160 (9th Cir. 2006), abrogated on other grounds by Atlantic Nat. Trust, LLC v. Mt. Hawley Ins. Co., 621 F.3d 931 (9th Cir. 2010); Brown v. ITT Consumer Fin. Corp., 211 F.3d 1217, 1222 (11th Cir. 2000).
[18] E.g., Brown, 211 F.3d at 1222.
[19] Reddam, 457 F.3d at 1061.
[20] Adler v. Dell, No. 08-cv-13170, 2009 WL 4580739, at *2 (E.D. Mich. Dec. 3, 2009).
[21] Compare Brown, 211 F.3d at 1222 (arbitrator selection not integral); and Adler, 2009 WL 4580739, at *4 (same), with Carideo v. Dell, Inc., No. C06-1772JLR, 2009 WL 3485933, at *5 (W.D. Wash. Oct. 26, 2009) (arbitrator selection integral), and Carr v. Gateway, Inc., 918 N.E.2d 598, 603 (App. Ct. Ill. 2009) (same).
[22] Khan v. Dell Inc., 669 F.3d 350, 354 (citing Federal Arbitration Act, 9 U.S.C. § 5 (2006)).
[23] Id. (citations omitted); see also Reddam, 457 F.3d at 1161 (articulating the standard as “so central to the arbitration agreement that the unavailability of that arbitrator [brings] the agreement to an end”).
[24] Khan, 669 F.3d at 354.
[25] Id. at 355. Judge Sloviter’s dissent found the clause unambiguous, arguing that the phrase “EXCLUSIVELY AND FINALLY BY BINDING ARBITRATION ADMINISTRATED BY THE NATIONAL ARBITRATION FORUM” was set apart from the surrounding language because it was in capitals. Id. at 357–58 (Sloviter, J. dissenting). This “additional clue[]” demonstrated that the parties intended for the clause to be read together and to be essential to the agreement. Id. at 358.
[26] Id. at 355.
[27] Id.
[28] Id. at 356.
[29] See Brown, 211 F.3d at 1222 (“ancillary logistical concern”); Reddam, 457 F.3d at 1061 (“so central to the arbitration agreement that the [arbitrator’s unavailability brings] the agreement to an end”); Adler, 2009 WL 4580739, at *2 (“as important a consideration as the agreement to arbitrate”).
[30] Khan, 669 F.3d at 354 (emphasis added).
[31] See 9 U.S.C. § 5 (“If in the agreement provision be made for a method of naming or appointing an arbitrator or arbitrators or an umpire, such method shall be followed . . . .then upon the application of either party to the controversy the court shall designate and appoint an arbitrator or arbitrators or umpire . . . .”).
[32] See Khan, 669 F.3d at 354 (“[T]he parties must have unambiguously expressed their intent not to arbitrate their disputes in the event that the designated arbitral forum is unavailable.”).