Commercial Litigation and Arbitration

Arbitration: § 5 of FAA Authorizes Court to Name Substitute Arbitrator when Contractually-Designated One Is Unavailable and Not “Integral” — Circuit Split on Interpretation of § 5

Khan v. Dell, Inc., 2012 U.S. App. LEXIS 1167 (3d Cir. Jan. 20, 2012):

This appeal involves a matter of first impression for this Circuit — whether Section 5 of the Federal Arbitration Act (FAA) requires the appointment of a substitute arbitrator when the arbitrator designated by the parties is unavailable.***

I. Factual Background

***Khan purchased a Dell 600m computer in September 2004 for approximately $1,200. Khan purchased the computer online through Dell's website, To complete the purchase, Khan was required to click a box stating "I AGREE to Dell's Terms and Conditions of Sale." Just beneath the box was a notice stating:

The Terms and Conditions of Sale contain very important information about your rights and obligations as well as limitations and exclusions that apply to you. They contain limitations of liability and warranty information. They also contain an agreement to resolve disputes through arbitration, rather than through litigation. Please read them carefully.

As Dell's notice indicated, its Terms and Conditions of Sale contained an arbitration provision that reads as follows:

13. Binding Arbitration. ANY CLAIM, DISPUTE, OR CONTROVERSY (WHETHER IN CONTRACT, TORT, OR OTHERWISE, WHETHER PREEXISTING, PRESENT OR FUTURE, AND INCLUDING STATUTORY, COMMON LAW, INTENTIONAL TORT AND EQUITABLE CLAIMS) BETWEEN CUSTOMER AND DELL, its agents, employees, principals, successors, assigns, affiliates (collectively for purposes of this paragraph, "Dell") arising from or relating to this Agreement, its interpretation, or the breach, termination or validity thereof, the relationships which result from this Agreement (including, to the full extent permitted by applicable law, relationships with third parties who are not signatories to this Agreement), Dell's advertising, or any related purchase SHALL BE RESOLVED EXCLUSIVELY AND FINALLY BY BINDING ARBITRATION ADMINISTERED BY THE NATIONAL ARBITRATION FORUM (NAF) under its Code of Procedure then in effect (available via the Internet at, or via telephone at 1-800-474-2371). The arbitration will be limited solely to the dispute or controversy between customer and Dell. NEITHER CUSTOMER NOR DELL SHALL BE ENTITLED TO JOIN OR CONSOLIDATE CLAIMS BY OR AGAINST OTHER CUSTOMERS, OR ARBITRATE ANY CLAIM AS A REPRESENTATIVE OR CLASS ACTION OR IN A PRIVATE ATTORNEY GENERAL CAPACITY. This transaction involves interstate commerce, and this provision shall be governed by the Federal Arbitration Act 9 U.S.C. sec. 1-16 (FAA). Any award of the arbitrators shall be final and binding on each of the parties . . . . Information may be obtained and claims may be filed with the NAF at P.O. Box 50191, Minneapolis, MN 55405.

Rule 1 of the NAF's "Code and Procedure," referred to in paragraph 13 above, provided that "[t]his Code shall be administered only by the National Arbitration Forum or by any entity or individual providing administrative services by agreement with the National Arbitration Forum." Also, as we can see in paragraph 13, the arbitration provision did not designate a replacement forum in the event that NAF was unavailable for any reason. But, as we see, the Terms and Conditions did incorporate the Federal Arbitration Act.

***The Terms and Conditions did not contain a severance provision and any alterations to the Terms and Conditions required the signature of both parties.

Khan alleged that his 600m suffered from design defects, causing his computer to overheat and thereby destroy the computer's motherboard. ***

On July 24, 2009, Khan filed a putative consumer class action on behalf of himself and other similarly situated purchasers and lessees of defectively designed 600m computers sold from approximately 2003 through 2006. *** At the time the lawsuit was filed, the NAF had been barred from conducting consumer arbitrations by Consent Judgment, which resolved litigation brought by the Attorney General of Minnesota. The Consent Judgment "barred [the NAF] from the business of arbitrating credit card and other consumer disputes and [ordered the NAF to] stop accepting any new consumer arbitrations or in any manner participate in the processing or administering of new consumer arbitrations." This was the result of government investigations revealing that the NAF engaged in various deceptive practices that disadvantaged consumers. ***

On October 2, 2009, Dell moved to compel arbitration, arguing that the arbitration provision was binding and covered all of Khan's claims. Khan did not dispute that the Terms and Conditions governed the contract. Khan did, however, assert that the arbitration provision was unenforceable because the NAF, which the arbitration provision designated as the arbitral forum, was no longer permitted to conduct consumer arbitrations. Khan further contended that the NAF's designation was integral to the arbitration provision. He argued, for that reason, that, because the NAF could not perform its function, the arbitration provision in the Terms and Conditions should not be enforced and the parties should proceed to litigation.

On August 18, 2010, the District Court denied Dell's motion to compel arbitration and stay claims. ***

III. Analysis In this appeal, we must determine whether the provision in the Terms and Conditions that the NAF be the arbitrator is exclusive to the NAF and is an integral part of the agreement between Dell and Khan, thus preventing the appointment of a substitute arbitrator. Because this is a question of arbitrability, it is governed by the FAA. Puleo v. Chase Bank USA, N.A., 605 F.3d 172, 180 (3d Cir. 2010). Congress passed the FAA "in response to widespread judicial hostility to arbitration agreements." AT&T Mobility LLC v. Concepcion, U.S. , , 131 S. Ct. 1740, 1745 (2011). The FAA reflects a "liberal federal policy favoring arbitration." Moses H. Cone Mem'l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24 (1983). The Supreme Court has unequivocally stated "that questions of arbitrability must be addressed with a healthy regard for the federal policy favoring arbitration." Id. However, the FAA respects the "fundamental principle that arbitration is a matter of contract," Rent-A-Center, West, Inc. v. Jackson, U.S. , , 130 S. Ct. 2772, 2776 (2010), and that "arbitration 'is a matter of consent, not coercion,'" Stolt-Nielsen S.A. v. AnimalFeeds Int'l Corp., U.S. , , 130 S. Ct. 1758, 1773 (2010) (quoting Volt Info. Sci., Inc. v. Bd. of Trs. of Leland Stanford Junior Univ., 489 U.S. 468, 479 (1989)).

The particular problem presented in this case -- the unavailability of the NAF -- is addressed in section 5 of the FAA, which provides a mechanism for substituting an arbitrator when the designated arbitrator is unavailable. 2 See Brown v. ITT Consumer Fin. Corp., 211 F.3d 1217, 1222 (11th Cir. 2000) ("Where the chosen forum is unavailable . . . or has failed for some reason, § 5 applies and a substitute arbitrator may be named."). In determining the applicability of Section 5 of the FAA when an arbitrator is unavailable, courts have focused on whether the designation of the arbitrator was "integral" to the arbitration provision or was merely an ancillary consideration. See, e.g., Reddam v. KPMG LLP, 457 F.3d 1054, 1061 (9th Cir. 2006), abrogated on other grounds by Atlantic Nat'l Trust LLC v. Mt. Hawley Ins. Co., 621 F.3d 931 (9th Cir. 2010); Brown, 211 F.3d at 1222. As the Eleventh Circuit has articulated the standard: "[o]nly if the choice of forum is an integral part of the agreement to arbitrate, rather than an 'ancillary logistical concern,' will the failure of the chosen forum preclude arbitration." Id. In other words, a court will decline to appoint a substitute arbitrator, as provided in the FAA, only if the parties' choice of forum is "so central to the arbitration agreement that the unavailability of that arbitrator [brings] the agreement to an end." Reddam, 457 F.3d at 1061. In this light, the parties must have unambiguously expressed their intent not to arbitrate their disputes in the event that the designated arbitral forum is unavailable.

Footnote 2. Section 5[of the FAA] provides:

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; but if no method be provided therein, or if a method be provided and any party thereto shall fail to avail himself of such method, or if for any other reason there shall be a lapse in the naming of an arbitrator, or arbitrators or umpire, or in filling a vacancy, then upon the application of either party to the controversy the court shall designate and appoint an arbitrator or arbitrators or umpire, as the case may require, who shall act under the said agreement with the same force and effect as if he or they had been specifically named therein; and unless otherwise provided in the agreement the arbitration shall be by a single arbitrator.

According to Khan, this standard has been met because the Terms and Conditions designate the NAF as the exclusive arbitral forum, implying that disputes should not be arbitrated if the NAF is unavailable. Khan relies on the contract language that states that all disputes "SHALL BE RESOLVED EXCLUSIVELY AND FINALLY BY BINDING ARBITRATION ADMINISTERED BY THE NATIONAL ARBITRATION FORUM."

In our view, this language is ambiguous: "EXCLUSIVELY" could be read to modify "BINDING ARBITRATION," "THE NATIONAL ARBITRATION FORUM," or both.

Khan, however, points out that the NAF's rules are incorporated into the contract, and that these rules provide that all arbitrations must be conducted by the NAF or an entity having an agreement with it. We conclude, however, that this requirement is also ambiguous as to what should happen in the event that the NAF is unavailable. The NAF's rules provide that they shall be interpreted in a manner consistent with the FAA and that, if any portion of the NAF rules are found to be unenforceable, that portion shall be severed and the remainder of the rules shall continue to apply.

Our finding of ambiguity is confirmed by the conflicting interpretations of this language adopted by the courts that have considered it.

The court in Brown supports Dell's position that "exclusively" modifies "binding arbitration." The arbitration agreement in Brown was interpreted as demonstrating an intent to arbitrate that trumped the designation of a particular arbitrator who was no longer available. ***

Adler v. Dell, Inc., 2009 WL 4580739 (E.D. Mich. Dec. 3, 2009), also supports Dell's position. The facts and arguments proffered in Adler are identical to those before us. After noting the "integral" exception, the Adler court articulated the presumption in favor of enforceability of Section 5 of the FAA***.

On the other hand, in Carideo v. Dell, Inc., No. C06-1772JLR, 2009 WL 3485933 (W.D. Wash. Oct. 26, 2009), a case factually similar to this one, the plaintiff who had bought an allegedly defective Dell computer, brought suit against Dell. Dell moved to compel arbitration, pursuant to the arbitration provision that designated the NAF as the arbitral forum. Applying the Ninth Circuit's decision in Reddam, the court in Carideo held that the parties' selection of the NAF was integral to the arbitration agreement. Carideo, 2009 WL 3485933 at *4. Because the court found that the selection of the NAF and of its rules was integral to the arbitration provision, it concluded that appointing a substitute arbitrator would be a wholesale revision of the arbitration agreement. Id. at *6. In coming to its conclusion, however, the court stated that "[i]n general, the FAA provides that where the chosen arbitrator is unavailable, the court may appoint a substitute arbitrator." Id. at *3 (emphasis added). We do not agree with the language used by the Carideo court. We note that Section 5 provides that in the case of an unavailable arbitrator, "upon the application of either party to the controversy the court shall designate and appoint an arbitrator." 9 U.S.C. § 5 (emphasis added). The difference between may and shall significant. We do not find Carideo persuasive. Although courts are divided on the issue, we conclude that the "liberal federal policy in favor of arbitration" counsels us to favor the Brown line of cases. The language relied on by Khan is at best ambiguous as to whether the parties intended to have their disputes arbitrated in the event that NAF was unavailable for any reason. Because of the ambiguity, it is not clear whether the designation of NAF is ancillary or is as important a consideration as the agreement to arbitrate itself. See Brown, 211 F.3d at 1222. Therefore, we must resolve this ambiguity in favor of arbitration. See Seus v. John Nuveen & Co., Inc., 146 F.3d 175, 186 (3d Cir. 1998), overruled on other grounds by Green Tree Fin. Corp. Al. v. Randolph, 531 U.S. 79 (2000).

We note moreover that the arbitration provision in the Terms and Conditions specifically incorporated the FAA, 9 U.S.C. §§ 1-16, suggesting that, in the event of the NAF's unavailability, the FAA's procedures for addressing such a problem should apply. Finally, we note the notice, provided to Khan when he accepted the Terms and Conditions, which stated that they "contain an agreement to resolve disputes through arbitration, rather than through litigation."

Khan, however, argues that, even if the NAF's designation as the arbitral forum was not integral to the Terms and Conditions, Section 5 of the FAA nevertheless did not apply here because NAF's unavailability was not a "lapse" within the meaning of statute. In support of this argument, Kahn cites In re Salomon Inc. S'holders' Derivative Litig., 68 F.3d 554, 560 (2d Cir. 1995), a case in which the arbitral forum, the NYSE, had refused to arbitrate. Khan argues that the word "lapse" in Section 5 of the FAA means "a lapse in the naming of the arbitrator or in the filling of a vacancy on a panel of arbitrators or some other mechanical breakdown in the arbitrator selection process," not the NYSE's refusal to arbitrate the dispute — or the NAF's unavailability to do so.

We find In re Salomon unpersuasive. First, we do not see why the NAF's unavailability is not a "mechanical breakdown in the arbitrator selection process." Apparently, the NAF's Consent Judgment with the State of Minnesota prevents it from acting as an arbitrator. This unavailability appears to us to be a breakdown in the mechanics of the appointment process. To take a narrower construction of Section 5 would be inconsistent with the "liberal federal policy in favor of arbitration" articulated in the FAA.

We conclude therefore that the unavailability of NAF to hear the disputes between Khan and Dell constitutes a "lapse" within the meaning of Section 5.

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