Prima Paint Corporation v. Flood & Conklin Manufacturing Company/Dissent Black

Mr. Justice BLACK, with whom Mr. Justice DOUGLAS and Mr. Justice STEWART join, dissenting.

The Court here holds that the United States Arbitration Act, 9 U.S.C. §§ 1-14, as a matter of federal substantive law, compels a party to a contract containing a written arbitration provision to carry out his 'arbitration agreement' even though a court might, after a fair trial, hold the entire contract-including the arbitration agreement-void because of fraud in the inducement. The Court holds, what is to me fantastic, that the legal issue of a contract's voidness because of fraud is to be decided by persons designated to arbitrate factual controversies arising out of a valid contract between the parties. And the arbitrators who the Court holds are to adjudicate the legal validity of the contract need not even be lawyers, and in all probability will be nonlawyers, wholly unqualified to decide legal issues, and even if qualified to apply the law, not bound to do so. I am by no means sure that thus forcing a person to forgo his opportunity to try his legal issues in the courts where, unlike the situation in arbitration, he may have a jury trial and right to appeal, is not a denial of due process of law. I am satisfied, however, that Congress did not impose any such procedures in the Arbitration Act. And I am fully satisfied that a reasonable and fair reading of that Act's language and history shows that both Congress and the framers of the Act were at great pains to emphasize that nonlawyers designated to adjust and arbitrate factual controversies arising out of valid contracts would not trespass upon the courts' prerogative to decide the legal question of whether any legal contract exists upon which to base an arbitration.

The agreement involved here is a consulting agreement in which Flood & Conklin agreed to perform certain services for and not to compete with Prima Paint. The agreement contained an arbitration clause providing that '(a)ny controversy or claim arising out of or relating to this Agreement * *  * shall be settled by arbitration in the City of New York.' F & C, contending that Prima had failed to make a payment under the contract, sent Prima a 'Notice of Intention to Arbitrate' pursuant to the New York Arbitration Act. Invoking diversity jurisdiction, Prima brought this action in federal district court to rescind the entire consulting agreement on the ground of fraud. The fraud allegedly consisted of F & C's misrepresentation at the time the contract was made, that it was solvent and able to perform the agreement, while in fact it was completely insolvent. Prima alleged that it would not have made any contract at all with F & C but for this misrepresentation. Prima simply contended that there was never a meeting of minds between the parties. F & C moved to stay Prima's lawsuit for rescission pending arbitration of the fraud issue raised by Prima. The lower courts, relying on the Second Circuit's decision in Robert Lawrence Co. v. Devonshire Fabrics, Inc., 271 F.2d 402, cert. granted, 362 U.S. 909, 80 S.Ct. 682, 4 L.Ed.2d 618, dismissed, 364 U.S. 801, 81 S.Ct. 27, 5 L.Ed.2d 37, held that, as a matter of 'national substantive law,' the arbitration clause in the contract is 'separable' from the rest of the contract and that allegations that go to the validity of the contract in general, as opposed to the arbitration clause in particular, are to be decided by the arbitrator, not the court.

The Court today affirms this holding for three reasons, none of which is supported by the language or history of the Arbitration Act. First, the Court holds that because the consulting agreement was intended to supplement a separate contract for the interstate transfer of assets, it is itself a 'contract evidencing a transaction involving commerce,' the language used by Congress to describe contracts the Act was designed to cover. But in light of the legislative history which indicates that the Act was to have a limited application to contracts between merchants for the interstate shipment of goods, and in light of the express failure of Congress to use language making the Act applicable to all contracts which 'affect commerce,' the statutory language Congress normally uses when it wishes to exercise its full powers over commerce, I am not at all certain that the Act was intended to apply to this consulting agreement. Second, the Court holds that the language of § 4 of the Act provides an 'explicit answer' to the question of whether the arbitration clause is 'separable' from the rest of the contract in which it is contained. Section 4 merely provides that the court must order arbitration if it is 'satisfied that the making of the agreement for arbitration * *  * is not in issue.' That language, considered alone, far from providing an 'explicit answer,' merely poses the further question of what kind of allegations put the making of the arbitration agreement in issue. Since both the lower courts assumed that but for the federal Act, New York law might apply and that under New York law a general allegation of fraud in the inducement puts into issue the making of the agreement to arbitrate (considered inseparable under New York law from the rest of the contract), the Court necessarily holds that federal law determines whether certain allegations put the making of the arbitration agreement in issue. And the Court approves the Second Circuit's fashioning of a federal separability rule which overrides state law to the contrary. The Court thus holds that the Arbitration Act, designed to provide merely a procedural remedy which would not interfere with state substantive law, authorizes federal courts to fashion a federal rule to make arbitration clauses 'separable' and valid. And the Court approves a rule which is not only contrary to state law, but contrary to the intention of the parties and to accepted principles of contract law-a rule which indeed elevates arbitration provisions above all other contractual provisions. As the Court recognizes, that result was clearly not intended by Congress. Finally, the Court summarily disposes of the problem raised by Erie R. Co. v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188, recognized as a serious constitutional problem in Bernhardt v. Polygraphic Co., 350 U.S. 198, 76 S.Ct. 273, 100 L.Ed. 199, by insufficiently supported assertions that it is 'clear beyond dispute' that Congress based the Arbitration Act on its power to regulate commerce and that '(i)f Congress relied at all on' its power to create federal law for diversity cases, such reliance 'was only supplementary.'

Let us look briefly at the language of the Arbitration Act itself as Congress passed it. Section 2, the key provision of the Act, provides that '(a) written provision in * *  * a contract *  *  * involving commerce to settle by arbitration a controversy thereafter arising out of such contract *  *  * shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.' (Emphasis added.) Section 3 provides that '(i)f any suit *  *  * be brought *  *  * upon any issue referable to arbitration under an agreement in writing for such arbitration, the court *  *  * upon being satisfied that the issue involved in such suit *  *  * is referable to arbitration under such an agreement, shall *  *  * stay the trial of the action until such arbitration has been had *  *  * .' (Emphasis added.) The language of these sections could not, I think, raise doubts about their meaning except to someone anxious to find doubts. They simply mean this: an arbitration agreement is to be enforced by a federal court unless the court, not the arbitrator, finds grounds 'at law or in equity for the revocation of any contract.' Fraud, of course, is one of the most common grounds for revoking a contract. If the contract was procured by fraud, then, unless the defrauded party elects to affirm it, there is absolutely no contract, nothing to be arbitrated. Sections 2 and 3 of the Act assume the existence of a valid contract. They merely provide for enforcement where such a valid contract exists. These provisions were plainly designed to protect a person against whom arbitration is sought to be enforced from having to submit his legal issues as to validity of the contract to the arbitrator. The legislative history of the Act makes this clear. Senator Walsh of Montana, in hearings on the bill in 1923, observed, 'The court has got to hear and determine whether there is an agreement of arbitration, undoubtedly, and it is open to all defese s, equitable and legal, that would have existed at law * *  * .' Mr. Piatt, who represented the American Bar Association which drafted and supported the Act, was even more explicit: 'I think this will operate something like an injunction process, except where he would attack it on the ground of fraud.' And then Senator Walsh replied: 'If he should attack it on the ground of fraud, to rescind the whole thing. * *  * I presume that it merely (is) a question of whether he did make the arbitration agreement or not, *  *  * and then he would possibly set up that he was misled about the contract and entered into it by mistake *  *  * .' It is evident that Senator Walsh was referring to situations in which the validity of the entire contract is called into question. And Mr. Bernheimer, who represented one of the chambers of commerce in favor of the bill, assured the Senate subcommittee that '(t)he constitutional right to jury trial is adequately safeguarded' by the Act. Mr. Cohen, the American Bar Association's draftsman of the bill, assured the members of Congress that the Act would not impair the right to a jury trial, because it deprives a person of that right only when he has voluntarily and validly waived it by agreeing to submit certain disputes to arbitration. The court and a jury are to determine both the legal existence and scope of such an agreement. The members of Congress revealed an acute awareness of this problem. On several occasions they expressed opposition to a law which would enforce even a valid arbitration provision contained in a contract between parties of unequal bargaining power. Senator Walsh cited insurance, employment, construction, and shipping contracts as routinely containing arbitration clauses and being offered on a take-it-or-leave-it basis to captive customers or employees. He noted that such contracts 'are really not voluntarily (sic) things at all' because 'there is nothing for the man to do except to sign it; and then he surrenders his right to have his case tried by the court * *  * .' He was emphatically assured by the supporters of the bill that it was not their intention to cover such cases. The significant thing is that Senator Walsh was not thinking in terms of the arbitration provisions being 'separable' parts of such contracts, parts which should be enforced without regard to why the entire contracts in which they were contained were agreed to. The issue for him was not whether an arbitration provision in a contract was made, but why, in the context of the entire contract and the circumstances of the parties, the entire contract was made. That is precisely the issue that a general allegation of fraud in the inducement raises: Prima contended that it would not have executed any contract, including the arbitration clause, if it were not for the fraudulent representations of F & C. Prima's agreement to an arbitration clause in a contract obtained by fraud was no more 'voluntary' than an insured's or employee's agreement to an arbitration clause in a contract obtained by superior bargaining power.

Finally, it is clear to me from the bill's sponsors' understanding of the function of arbitration that they never intended that the issue of fraud in the inducement be resolved by arbitration. They recognized two special values of arbitration: (1) the expertise of an arbitrator to decide factual questions in regard to the day-to-day performance of contractual obligations, and (2) the speed with which arbitration, as contrasted to litigation, could resolve disputes over performance of contracts and thus mitigate the damages and allow the parties to continue performance under the contracts. Arbitration serves neither of these functions where a contract is sought to be rescinded on the ground of fraud. On the one hand, courts have far more expertise in resolving legal issues which go to the validity of a contract than do arbitrators. On the other hand, where a party seeks to rescind a contract and his allegation of fraud in the inducement is true, an arbitrator's speedy remedy of this wrong should never result in resumption of performance under the contract. And if the contract were not procured by fraud, the court, under the summary trial procedures provided by the Act, may determine with little delay that arbitration must proceed. The only advantage of submitting the issue of fraud to arbitration is for the arbitrators. Their compensation corresponds to the volume of arbitration they perform. If they determine that a contract is void because of fraud, there is nothing further for them to arbitrate. I think it raises serious questions of due process to submit to an arbitrator an issue which will determine his compensation. Tumey v. State of Ohio, 273 U.S. 510, 47 S.Ct. 437, 71 L.Ed. 749.

With such statutory language and legislative history, one can well wonder what is the basis for the Court's surprising departure from the Act's clear statement which expressly excepts from arbitration 'such grounds as exist at law or in equity for the revocation of any contract.' Credit for the creation of a rationalization to justify this statutory mutilation apparently must go to the Second Circuit' opinion in Robert Lawrence Co. v. Devonshire Fabrics, Inc., supra. In that decision Judge Medina undertook to resolve the serious constitutional problem which this Court had avoided in Bernhardt by holding the Act inapplicable to a diversity case involving an intrastate contract. That problem was whether the Arbitration Act, passed 13 years prior to Erie R. Co. v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188, could be constitutionally applied in adi versity case even though its application would require the federal court to enforce an agreement to arbitrate which the state court across the street would not enforce. Bernhardt's holding that arbitration is 'outcome determinative,' 350 U.S., at 203, 76 S.Ct., at 276, and its recognition that there would be unconstitutional discrimination if an arbitration agreement were enforceable in federal court but not in the state court, id., at 204, 76 S.Ct., at 276, posed a choice of two alternatives for Judge Medina. If he held that the Arbitration Act rested solely on Congress' power, widely recognized in 1925 but negated in Erie, to prescribe general federal law applicable in diversity cases, he would be compelled to hold the Act unconstitutional as applied to diversity cases under Erie and Bernhardt. If he held that the Act rested on Congress' power to enact substantive law governing interstate commerce, then the Erie-Bernhardt problem would be avoided and the application of the Act to diversity cases involving commerce could be saved.

The difficulty in choosing between these two alternatives was that neither, quite contrary to the Court's position, was 'clear beyond dispute' upon reference to the Act's legislative history. As to the first, it is clear that Congress intended the Act to be applicable in diversity cases involving interstate commerce and maritime contracts, and to hold the Act inapplicable in diversity cases would be severely to limit its impact. As to the second alternative, it is clear that Congress in passing the Act relied primarily on its power to create general federal rules to govern federal courts. Over and over again the drafters of the Act assured Congress: 'The statute establishes a procedure in the Federal courts * *  *. It rests upon the constitutional provision by which Congress is authorized to establish and control inferior Federal courts. So far as congressional acts relate to the procedure in the Federal courts, they are clearly within the congressional power.' And again: 'The primary purpose of the statute is to make enforcible in the Federal courts such agreements for arbitration, and for this purpose Congress rests solely upon its power to prescribe the jurisdiction and duties of the Federal courts.' One cannot read the legislative history without concluding that this power, and not Congress' power to legislate in the area of commerce, was the 'principal basis' of the Act. Also opposed to the view that Congress intended to create substantive law to govern commerce and maritime transactions are the frequent statements in the legislative history that the Act was not intended to be 'the source of * *  * substantive law.' As Congressman Graham explained the Act to the House:

'It does not involve any new principle of law except to     provide a simple method *  *  * in order to give enforcement *      *  *. It creates no new legislation, grants no new rights,     except a remedy to enforce an agreement in commercial      contracts and in admiralty contracts.' 65 Cong.Rec. 1931 (1924). (Emphasis     added.)

Finally, there are clear indications in the legislative history that the Act was not intended to make arbitration agreements enforceable in state courts or to provide an independent federal-question basis for jurisdiction in federal courts apart from diversity jurisdiction. The absence of both of these effects-which normally follow from legislation of federal substantive law-seems to militate against the view that Congress was creating a body of federal substantive law.

Suffice it to say that Judge Medina chose the alternative of construing the Act to create federal substantive law in order to avoid its emasculation under Erie and Bernhardt. But Judge Medina was not content to stop there with a holding that the Act makes arbitration agreements in a contract involving commerce enforceable in federal court even though the basis of jurisdiction is diversity and state law does not enforce such agreements. The problem in Robert Lawrence, as here, was not whether an arbitration agreement is enforceable, for the New York Arbitration Act, upon which the federal Act was based, enforces an arbitration clause in the same terms as the federal Act. The problem in Robert Lawrence, and here, was rather whether the arbitration clause in a contract induced by fraud is 'separable.' Under New York law, it was not: general allegations of fraud in the inducement would, as a matter of state law, put in issue the making of the arbitration clause. So to avoid this application of state law, Judge Medina went further than holding that the federal Act makes agreements to arbitrate enforceable: he held that the Act creates a 'body of law' that 'encompasses questions of interpretation and construction as well as questions of validity, revocability and enforceability of arbitration agreements affecting interstate commerce or maritime affairs.' 271 F.2d at 409.

Thus, 35 years after the passage of the Arbitration Act, the Second Circuit completely rewrote it. Under its new formulation, § 2 now makes arbitration agreements enforceable 'save upon such grounds as exist at federal law for the revocation of any contract.' And under § 4, before enforcing an arbitration agreement, the district court must be satisfied that 'the making of the agreement for arbitration, as a matter of federal law, is not in issue.' And then when Judge Medina turned to the task of 'the formulation of the principles of federal substantive law necessary for this purpose,' 271 F.2d, at 409, he formulated the separability rule which the Court today adopts-not because § 4 provided this rule as an 'explicit answer,' not because he looked to the intention of the parties, but because of his notion that the separability rule would further a 'liberal policy of promoting arbitration.' 271 F.2d, at 410.

Today, without expressly saying so, the Court does precisely what Judge Medina did in Robert Lawrence. It is not content to hold that the Act does all it was intended to do: make arbitration agreements enforceable in federal courts if they are valid and legally existent under state law. The Court holds that the Act gives federal courts the right to fashion federal law, inconsistent with state law, to determine whether an arbitration agreement was made and what it means. Even if Congress intended to create substantive rights by passage of the Act, I am wholly convinced that it did not intend to create such a sweeping body of federal substantive law completely to take away from the States their power to interpret contracts made by their own citizens in their own territory.

First. The legislative history is clear that Congress intended no such thing. Congress assumed that arbitration agreements were recognized as valid by state and federal law. Courts would give damages for their breach, ut would simply refuse to specifically enforce them. Congress thus had one limited purpose in mind: to provide a party to such an agreement 'a remedy formerly denied him.' 'Arbitration under the Federal * *  * (statute) is simply a new procedural remedy.' The Act 'creates no new legislation, grants no new rights, except a remedy to enforce *  *  * .' The drafters of the Act were very explicit:

'A Federal statute providing for the enforcement of     arbitration agreements does relate solely to procedure of the Federal courts. It is no infringement upon the     right of each State to decide for itself what contracts shall      or shall not exist under its laws. To be sure whether or not     a contract exists is a question of the substantive law of the      jurisdiction wherein the contract was made.' Committee on      Commerce, Trade & Commercial Law, The United States      Arbitration Law and Its Application, 11 A.B.A.J. 153, 154. (Emphasis added.)

'Neither is it true that such a statute, declaring     arbitration agreements to be valid, is the source of their      existence as a matter of substantive law. * *  *

'So far as the present law declares simply the policy of     recognizing and enforcing arbitration agreements in the      Federal courts it does not encroach upon the province of the      individual States.' Cohen & Dayton, The New Federal      Arbitration Law, 12 Va.L.Rev. 265, 276-277.

All this indicates that the § 4 inquiry of whether the making of the arbitration agreement is in issue is to be determined by reference to state law, not federal law formulated by judges for the purpose of promoting arbitration.

Second. The avowed purpose of the Act was to place arbitration agreements 'upon the same footing as other contracts.' The separability rule which the Court applies to an arbitration clause does not result in equality between it and other clauses in the contract. I had always thought that a person who attacks a contract on the ground of fraud and seeks to rescind it has to seek rescission of the whole, not tidbits, and is not given the option of denying the existence of some clauses and affirming the existence of others. Here F & C agreed both to perform consulting services for Prima and not to compete with Prima. Would any court hold that those two agreements were separable, even though Prima in agreeing to pay F & C not to compete did not directly rely on F & C's representations of being solvent? The simple fact is that Prima would not have agreed to the covenant not to compete or to the arbitration clause but for F & C's fraudulent promise that it would be financially able to perform consulting services. As this Court held in United States v. Bethlehem Steel Corp., 315 U.S. 289, 298, 62 S.Ct. 581, 587, 86 L.Ed. 855:

'Whether a number of promises constitute one contract (and     are non-separable) or more than one is to be determined by      inquiring 'whether the parties assented to all the promises      as a single whole, so that there would have been no bargain      whatever, if any promise or set of promises were struck out."

Under this test, all of Prima's promises were part of one, inseparable contract.

Third. It is clear that had this identical contract dispute been litigated in New York courts under its arbitration act, Prima would not be required to present its claims of fraud to the arbitrator if the state rule of nonseparability applies. The Court here does not hold today, as did Judge Medina, that the body of federal substantive law created by federal judges under the Arbitration Act is required to be applied by state courts. A holding to that effect-which the Court seems to leave up in the air-would flout the intention of the framers of the Act. Yet under this Court's opinion today-that the Act supplies not only the remey of enforcement but a body of federal doctrines to determine the validity of an arbitration agreement-failure to make the Act applicable in state courts would give rise to 'forum shopping' and an unconstitutional discrimination that both Erie and Bernhardt were designed to eliminate. These problems are greatly reduced if the Act is limited, as it should be, to its proper scope: the mere enforcement in federal courts of valid arbitration agreements.

The Court's summary treatment of these issues has made it necessary for me to express my views at length. The plain purpose of the Act as written by Congress was this and no more: Congress wanted federal courts to enforce contracts to arbitrate and plainly said so in the Act. But Congress also plainly said that whether a contract containing an arbitration clause can be rescinded on the ground of fraud is to be decided by the courts and not by the arbitrators. Prima here challenged in the courts the validity of its alleged contract with F & C as a whole, not in fragments. If there has never been any valid contract, then there is not now and never has been anything to arbitrate. If Prima's allegations are true, the sum total of what the Court does here is to force Prima to arbitrate a contract which is void and unenforceable before arbitrators who are given the power to make final legal determinations of their own jurisdiction, not even subject to effective review by the highest court in the land. That is not what Congress said Prima must do. It seems to be what the Court thinks would promote the policy of arbitration. I am completely unable to agree to this new version of the Arbitration Act, a version which its own creator in Robert Lawrence practically admitted was judicial legislation. Congress might possibly have enacted such a version into law had it been able to foresee subsequent legal events, but I do not think this Court should do so.

I would reverse this case.