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Supreme Court Limits Federal Jurisdiction to Compel Arbitration

By Henry R. Chalmers, Litigation News Associate Editor – May 11, 2009

Federal court jurisdiction to enforce arbitration agreements is not as broad as one may have thought, according to a recent U.S. Supreme Court decision. Vaden v. Discover Bank.

In Vaden, the Supreme Court has held that a federal district court may exercise jurisdiction over a petition to compel arbitration of litigation pending in state court only where the complaint, and not the counterclaim, in the state action establishes a basis for federal jurisdiction. Where a complaint rests on state law only, a federal law counterclaim is not sufficient to vest jurisdiction in the district court.

Background of Vaden
Discover Bank asserted state law claims against Betty Vaden in state court, seeking to recover past due charges on her credit card. Vaden counterclaimed, alleging that Discover Bank’s finance charges, interest, and late fees violated state law, and sought class certification. Discover Bank then petitioned the federal district court to compel arbitration of the counterclaims pursuant to an arbitration clause in its cardholder agreement with Vaden.

Discover Bank filed its petition pursuant to Section 4 of the Federal Arbitration Act, 9 U.S.C. § 4, which provides that a party may request an order compelling arbitration from any district court that would have jurisdiction “in a civil action or in admiralty of the subject matter of a suit arising out of the controversy between the parties.” Section 4 does not itself confer federal jurisdiction.

Discover Bank agued that the district court would have had jurisdiction over the subject matter of a lawsuit arising out of the parties’ controversy because Vaden’s counterclaims were preempted by federal banking law. The district court agreed, and the Fourth Circuit Court of Appeals affirmed.

Supreme Court Review
The Supreme Court granted certiorari to answer two questions: First, must the federal question be evident on the face of the Section 4 petition itself, or may a district court “look through” the petition and examine the underlying dispute between the parties to determine if federal question jurisdiction exists? The Court’s unanimous answer was “yes,” a court may “look through” a Section 4 petition to find a federal question.

Second, may a district court exercise jurisdiction over a Section 4 petition when the petitioner’s complaint rests on state law, but an actual or potential counterclaim rests on federal law? In other words, may Discover Bank invoke Section 4, not on the basis of its own complaint, which had no federal law element, but on the basis of the counterclaims asserted by Vaden?

On this second question, the Court split 5-4, with the majority finding that a federal court may not entertain a Section 4 petition based solely on counterclaims. Only the plaintiff’s claims in the state court action may be considered.

The majority found its holding compelled by the “well-pleaded complaint rule,” that federal-question jurisdiction depends on the contents of a well-pleaded complaint, and may not be predicated on counterclaims. Holmes Group, Inc. v. Vornado Air Circulation Systems, Inc.

Is Vaden Anti-Arbitration?
Neal Eiseman, New York, cochair of the Arbitration Subcommittee of the Section of Litigation’s Alternative Dispute Resolution Committee, does not see this as an anti-arbitration decision. Eiseman views Vaden instead “as a decision on jurisdiction rather than one limiting federal review of arbitrability disputes.”

Edward M. Mullins, Miami, cochair of the Section’s Alternative Dispute Resolution Committee, agrees. He notes that, in drafting Chapter Two of the Federal Arbitration Act, dealing with international arbitration, Congress explicitly created federal jurisdiction over international arbitration agreements. “If Congress wanted to do that in the domestic context, it easily could have. That it chose not to lends support to the majority’s holding in Vaden,” says Mullins.

Both Eiseman and Mullins note that the Arbitration Fairness Act pending in Congress could undo some aspects of the Vaden decision. “Provisions in the act could be interpreted to create federal court jurisdiction where the Vaden Court just found none to exist,” says Mullins.

Meanwhile, Eiseman points out that, as currently drafted, the act might render arbitration provisions in cardholder agreements like that between Vaden and Discover Bank unenforceable.

Keywords: Vaden v. Discover Bank, Supreme Court, arbitration, jurisdiction, Federal Arbitration Act, Section 4, Arbitration Fairness Act


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