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Robert Lawrence Co. v. Devonshire Fabrics Inc.

October 28, 1959


Author: Medina

Before MEDINA, LUMBARD and BURGER, Circuit Judges.

MEDINA, C. J.: Devonshire Fabrics, Inc. (Devonshire) appeals from an order denying its motion for a stay of proceedings pending arbitration pursuant to the United States Arbitration Act, 9 U.S.C. Section 3.

Plaintiff in this action, Robert Lawrence Company, Inc. (Lawrence) is seeking damages for allegedly fraudulent misrepresentations made by Devonshire inducing it to purchase and pay for a quantity of woolen fabric. The transaction out of which this case arose was initiated on August 4, 1955 when Lawrence, a Massachusetts corporation, ordered through its New York City office 36 pieces of a certain style of wool. Devonshire, a New York corporation, upon receipt of the order issued a confirmation which differed in several respects from the terms of the order. While the parties disagree as to which document embodies the final contract, each of the two documents contains the following provision for arbitration:

"Any complaint, controversy, or question which may arise with respect to this contract that cannot be settled by the parties thereto, shall be referred to arbitration. If the controversy concerns the condition or quality of merchandise it shall be referred to the Mutual Adjustment Bureau of the cloth and garment trades pursuant to the rules and regulations thereof.All other controversies shall be submitted to the American Arbitration Association."

Delivery of the goods, originally scheduled for October 1, 1955 was postponed at Lawrence's request until June 1956 when shipment to Boston was made. Lawrence paid the purchase price of $9,062.43 in July 1956. According to Lawrence, whose version of the fraud we must accept in the present posture of the case, certain latent defects were subsequently discovered and the merchandise proved not to be "first quality" as called for by the agreement. It is disputed whether Lawrence "rescinded" the contract or whether it waived its right to do so by later inconsistent acts.

The court below denied the stay of proceedings pending arbitration and held: "The question whether or not there is a valid agreement to arbitrate must be decided by the court prior to the issuance of a stay and cannot be submitted to arbitration 'as a controversy thereafter arising out of such contract' within section 2. * * * If the contract was fraudulent in its inception and therefore voidable at the option of the plaintiff and plaintiff has disaffirmed such contract, then there is no valid agreement to arbitrate which would justify a stay."

I. Questions of the Validity and Interpretation of an Arbitration Agreement "In Any Maritime Transaction or a Contract * * * Involving Commerce" Are Governed by Federal Not by Local Law

The case involves questions left open by the Supreme Court in Bernhardt v. Polygraphic Co. of America, Inc ., 1956, 350 U.S. 198, and these questions are interesting and important. The basic inquiry must be whether the validity and interpretation of the arbitration clause of the contract in this case is governed by Federal law, i.e. the federal Arbitration Act, or by local law. But this critical issue is imbedded in a proliferation of collateral questions, and all must be considered against the background of the concurring opinion of Mr. Justice Frankfurter in Bernhardt to the effect that, in order to avoid vexing constitutional questions under Erie R.R. v. Tompkins, 1938, 304 U.S. 64, the Arbitration Act must be held wholly inapplicable in a diversity case. We are reluctant to disagree with so eminent a jurist whose views are so widely respected but feel compelled to reach a different conclusion, not only because the exclusion of diversity cases would emasculate the federal Arbitration Act, but because we find a reasonably clear legislative intent to create a new body of substantive law relative to arbitration agreements affecting commerce or maritime transactions. Thus we think we are here dealing not with state-created rights but with rights arising out of the exercise by the Congress of its constitutional power to regulate commerce and hence there is involved no difficult question of constitutional law under Erie .

The arbitration agreement before the Court in Bernhardt did not involve commerce nor did it affect a maritime transaction. But the defendant in that case moved for a stay pending arbitration on the theory that the federal Arbitration Act was applicable because the limitations of Section 2 were said not to affect Section 3 and, even if the Act was not applicable, that arbitration was a mere mode of procedure and a federal court should follow its own practice rather than that of Vermont because in matters of procedure the law of the forum controls. This reasoning would have by-passed certain old Vermont cases holding arbitration agreements to be revocable prior to the making of an award and unenforceable. But such a result ran into Erie v. Tompkins head-on for the obvious reason that, had the case not been removed from the Vermont state court by reason of the diversity of citizenship of the parties, the determination of the merits of the controversy between the parties in the federal court might well have been just the opposite to the one that would have been reached had the case been permitted to remain in the state court. So the Court decided the case by holding: (1) that the federal Arbitration Act was inapplicable because the limitation to commerce and maritime matters in Section 2*fn1 applied as well to Section 3*fn2 and the rest of the Act; and, (2) that the enforceability of an arbitration agreement, apart from the Arbitration Act, "substantially affects the cause of action created by the State" and, because the dispute between the litigants was sufficiently substantive to bring into operation the Erie doctrine, the Court refused to apply the rule that the law of the forum governs matters of procedure. The Court flatly disagreed with the statement that arbitration "is merely a form of trial." Instead, the Court held that it was dealing with "a right to recover that owes its existence to one of the States, not to the United States"; and the view of the federal District Judge in Vermont as to the Vermont law relative to the enforceability of arbitration agreements was adopted. This conclusion was reached notwithstanding the fact that in several other contexts the enforceability of an arbitration agreement had generally been considered to be procedural only.*fn3 But the constitutional difficulties Justice Frankfurter feared only become operative if the Arbitration Act is regarded as exclusively procedural in character and scope. And, if the Congress had relied solely on its power to regulate procedure in the federal courts to make arbitration agreements valid and enforceable, it might well be doubted whether the constitutional base provided adequate support for the legislative structure. But see Sturges and Murphy, Some Confusing Matters Relating to Arbitration Under the United States Arbitration Act, 17 Law & Contemp. Probs. 580, 587 (1952).

We think it is reasonably clear that the Congress intended by the Arbitration Act to create a new body of federal substantive law affecting the validity and interpretation of arbitration agreements. In the first place Section 2 of the Arbitration Act specifically limits its applicability to "any maritime transaction or a contract evidencing a transaction involving commerce." This indicates a congressional intention to rely on the admiralty power implied from Article III, Second 2, Clause 2 and the commerce power, Article I, Section 8, Clause 3. Such intention is confirmed by the legislative history. See H.R. Rep. 96, 68th Cong., 1st Sess., p. 1 (1924). Moreover, the Bernhardt ruling is specifically to the effect that the maritime or commerce requirements had to be met before any other section of the Act could be applied. It is true that an additional reason for construing the Act "narrowly" was that such a construction avoided a constitutional difficulty arising out of the Erie doctrine; but we think this does not lessen the force of the principal basis for the ruling which is that the Congress intended the maritime or commerce requirements to permeate the Act in its entirety.

It is also clear that the Congress intended to exercise as much of its constitutional power as it could in order to make the new Arbitration Act as widely effective as possible. One of the dark chapters in legal history concerns the validity, interpretation and enforceability of arbitration agreements. From the standpoint of business men generally and of those immediately affected by such agreements they were beneficial and salutary in every way. But to the courts and to the judges they were anathema. In England and in America the courts resorted to a great variety of devices and formulas to destroy this encroachment on their monopoly of the administration of justice, protecting what they called their "jurisdiction." An attempt to enumerate the ways in which arbitration agreements were declared to be against public policy and void, or revocable or unenforceable would now serve no useful purpose. See Kulukundis Shipping Co., S/A v. Amtorg Trading Corp ., 2 Cir., 1942, 126 F.2d 978, 982. Suffice it to say for a considerable time prior to the passage of the Arbitration Act in 1925*fn4 the Congress had come to the conclusion that an effort should be made to legislate on the subject of arbitration in such fashion as to remove the hostility of the judiciary and make the benefits of arbitration generally available to the business world. See Sen. Rep. 536 supra .At that time and even today, in various states judge-made law still stands as an obstacle to the enforceability of arbitration agreements, as was illustrated in Bernhardt . It was not assumed that this hostility could be easily overcome, despite certain encouragement in the ranks of those in opposition. See Red Cross Line v. Atlantic Fruit Co ., 1924, 264 U.S. 109; Atlantic Fruit Co. v. Red Cross Line, S.D.N.Y., 1921, 276 Fed. 319, affirmed, 2 Cir., 1924, 5 F.2d 218; United States Asphalt Refining Co. v. Trinidad Lake Petroleum Co ., S.D.N.Y., 1915, 222 Fed. 1006. Hence the Congress took pains to utilize as much of its power as it could and by doing so it sought to reduce to a minimum the danger of judicial rejection on constitutional grounds.

Thus we think the text of the Act and the legislative history demonstrate that the Congress based the Arbitration Act in part on its undisputed substantive powers over commerce and maritime matters. To be sure much of the Act is purely procedural in character and is intended to be applicable only in the federal courts. But Section 2 declaring that arbitration agreements affecting commerce or maritime affairs are "valid, irrevocable, and enforceable" goes beyond this point and must mean that arbitration agreements of this character, previously held by state law to be invalid, revocable or unenforceable are now made "valid, irrevocable, and enforceable." This is a declaration of national law equally applicable in state or federal courts. See Kochery, The Enforcement of Arbitration Agreements in the Federal Courts: Erie v. Tompkins, 39 Corn. L.Q. 74, 78 (1953). This conclusion flows directly from the realization by the Congress that nothing of significance would have been accomplished without tapping these substantive sources of power. It is these that put teeth into the statute and make it accomplish the salutary and beneficial ends the Congress had in mind. It matters not that in the interval of years since the passage of the Act this point has only rarely been noticed. See Standard Magnesium Corp. v. Fuchs, 10 Cir., 1957, 251 F.2d 455; Kentucky River Mills v. Jackson, 6 Cir., 1953, 206 F.2d 111, 117-18, cert. denied, 346 U.S. 887. What does matter is whether or not this reasoning is sound. And we believe it to be sound if the Congress intended to use to the fullest possible extent its powers to regulate commerce as it was affected by arbitration agreements and to do the same thing in the field of maritime law.

Nor do we think there is any tenable distinction between the holding in Bernhardt that the enforceability of an arbitration agreement is sufficiently substantive to call into play the Erie doctrine and our holding in this case that the questions of the validity and interpretation of the arbitration agreement before us are substantive questions. In any event, it seems safe to say that those who drafted the Arbitration Act and supervised its progress through the House and Senate Committees had not the least suspicion that there might at some future day be raised the constitutional question referred to in Mr. Justice Frankfurter's concurring opinion in Bernhardt, the avoidance of which led him to the view that the Arbitration Act was wholly inapplicable to cases where the jurisdiction of the federal court was based on diversity of citizenship. Erie still was hidden in the mist of the future.

Mere catchwords, labels and cliches no longer smooth the path of justice as they so often did in the past. As noted above, arbitration has often been described as pertaining to the law of remedies, but this tendency is losing much of its fascination in these modern times. See Rossv. Twentieth Century-Fox Film Corp ., 9 Cir., 1956, 236 F.2d 632; Jackson v. Atlantic City Electric Co ., D.N.J., 1956, 144 F. Supp. 551; Miller v. American Insurance Co ., W.D. Ark., 1954, 124 F. Supp. 160; Kochery, The Enforcement of Arbitration Agreements in the Federal Courts. Erie v. Tompkins, supra ; Note, 56 Colum. L. Rev. 902 (1956); 41 Va. L. Rev. 379 (1955); Comment 27 Tex. L. Rev. 218 (1948). The opinion of Mr. Justice Douglas in Bernhardt summarizes nicely the manifold effects of such agreement.*fn5 We need not belabor them here. The crucial point is that the "nature of the tribunal where suits are tried is an important part of the parcel of rights behind a cause of action." See 350 U.S. at 203. Whether the bargain evidenced by the contract or agreement is or is not valid cannot differ ...

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