Alternative Dispute Resolution»

Federal Question Jurisdiction Raised Only in Counterclaims

With its decision in Vaden v. Discover Bank [PDF] this March, the U.S. Supreme Court has settled a long-standing controversy on federal court compulsion of arbitration. In Vaden, the Court clarified the standards by which the federal courts can “look through” a Section 4 petition to compel arbitration under the Federal Arbitration Act (FAA). The “well pleaded complaint” rule articulated in Holmes Group, Inc. v. Vornado Air Circulation Systems, Inc., was reaffirmed and clarified.

Background
In 2003, Discover Bank filed an action in the Maryland state court against cardholder Betty Vaden predicated entirely upon state law grounds and seeking to recover past-due charges on Vaden’s account of approximately $10,000. Vaden answered and counterclaimed alleging violations of Maryland law by Discover Bank for its interest rates, late fees, and finance charges, and brought a class action claim on behalf of Maryland cardholders. The counterclaim presented purely state law issues that were preempted by federal banking law.[1] Discover Bank responded by filing an FAA Section 4 petition in the U.S. District Court for the District of Maryland, seeking to compel arbitration of the counterclaims.

Discover Bank reasoned, and both the district court and Fourth Circuit Court of Appeals eventually agreed, that the federal courts could “look through” a §4 petition and order arbitration if, save for the arbitration agreement, the court would have jurisdiction over the substantive controversy between the parties, and that the preemption doctrine was paramount over the well pleaded complaint rule articulated in Holmes Group. The U.S. Supreme Court agreed unanimously with the first point but not with the second point, based upon what constituted the substantive controversy between the parties.

Decision
Writing for the majority, Justice Ginsburg held that a federal court may “look through” a FAA Section 4 petition to determine whether it is predicated on a controversy that “arises under” federal law. However, the FAA requires an independent jurisdictional basis over the parties’ dispute to access a federal forum. In keeping with the well-pleaded complaint rule set forth in Holmes Group, a federal court may not entertain a Section 4 petition based on the contents of a counterclaim when the entire controversy between the parties does not qualify for federal court adjudication. Concurring in part and dissenting in part, Chief Justice Roberts, along with Justices Stevens, Breyer, and Alito, agreed that the court could “look through” the Section 4 petition, but not that the complaint controlled the counterclaims, instead viewing the controversy as that set forth in the Section 4 petition.

Consequences
Many states view filing an action as a waiver of the right to arbitrate. If the action lacks a controversy arising under federal law, arbitration may not be available under the FAA. Without a federal law controversy in the underlying complaint, the federal courts lack jurisdiction to compel arbitration; if the state does not provide such a mechanism, arbitration is deemed waived. Conversely, as articulated by Chief Justice Roberts in the dissent, the potential exists that a purely state-law-based claim can be submitted for arbitration through the FAA if the underlying complaint would be subject to federal jurisdiction.

Conclusion
The U.S. Supreme Court has cleared a long-standing controversy over federal court compulsion of arbitration. It is now established clearly that federal courts can look through an FAA Section 4 petition to compel arbitration when the underlying complaint, aside from the arbitration agreement, would convey federal jurisdiction.

David B. Collier is an attorney practicing in New London, Connecticut.

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