Recently, a divided panel of the U.S. Court of Appeals for the Third Circuit held in Zirpoli v. Midland Funding, LLC that an arbitrator, not the district court, must decide whether class action claims brought against Midland Funding LLC are subject to arbitration. The question in Zirpoli was whether a challenge to the legality of an assignment of a loan that is subject to an arbitration agreement challenges the formation of the arbitration agreement itself. The Third Circuit answered that question in the negative and ordered the district court to grant Midland Funding’s motion to compel arbitration.
Midland Funding, the assignee of a loan agreement between Zirpoli and the original lender, moved to compel arbitration after Zirpoli brought a class action against it alleging violations of the Pennsylvania Consumer Discount Company Act (CDCA). Zirpoli opposed the motion on the ground that the assignment of the loan was illegal and void under state law because Midland Funding did not have a CDCA license or approval from the Pennsylvania Secretary of Banking to purchase the loan. Therefore, Zirpoli argued, only the original lender, not its assignee Midland Funding, could enforce the arbitration clause in his loan agreement. The district court concluded that it was authorized to decide this question of arbitrability, and it denied arbitration on the ground that the assignment of the loan contract to Midland Funding was invalid.
On appeal, the Third Circuit acknowledged that arbitrability issues can be “mind-bending.” By way of background, nearly 30 years ago, the U.S. Supreme Court in First Options of Chicago, Inc. v. Kaplan distinguished between the merits of a claim (is the defendant liable to the plaintiff) and the arbitrability of that claim (did the parties agree to arbitrate it). It recognized that there is also a “who” question (should a court or an arbitrator decide arbitrability). Under First Options, an arbitrator decides arbitrability only if the arbitration agreement “clearly and unmistakably” shows that the parties intended to delegate arbitrability to the arbitrator. Otherwise, the court must decide arbitrability.
Later decisions added more complexity. As the Zirpoli court summarized: “[W]hen an arbitration agreement contains a delegation clause, a challenge to arbitrability must be ‘directed at the delegation [clause] specifically to invoke a court’s power to intervene.’ However, that is not true if a party challenges the very formation of the arbitration agreement. Courts have the authority to adjudicate formation challenges—even if there is a delegation clause—unless the parties have clearly and unmistakably referred formation issues to arbitration in a written contract whose formation is not in issue.”
Against that background, the Third Circuit proceeded to “figure out whether the parties should arbitrate the question of whether the parties agreed to arbitrate the dispute.” It first determined that Zirpoli had entered into a valid agreement to arbitrate claims he might have against the original lender and its future assignees (such as Midland Credit). The court emphasized that while Zirpoli had raised a question as to the validity of the assignment, there was no question as to the validity of the agreement itself. The court next found that there was clear and unmistakable evidence that the parties intended to delegate arbitrability issues to the arbitrator, since the arbitration agreement covered “the arbitrability of a Claim” relating to the loan agreement and “any defenses to the enforceability” of the agreement.
Zirpoli argued that his objection to the assignment of the loan agreement constituted a challenge to the arbitration agreement’s formation because no contract between Zirpoli and Midland Funding was ever made. The Third Circuit rejected that argument, explaining that: “[D]etermining whether Midland is a valid assignee goes directly to whether it can enforce arbitration as the agreement provides, not whether the agreement exists; it clearly does exist and Zirpoli does not argue to the contrary.” Moreover, citing the U.S. Supreme Court’s decisions in Buckeye Check Cashing, Inc. v. Cardegna (2006) and Rent-A-Center, West, Inc. v. Jackson (2010), the Third Circuit reasoned that an otherwise valid delegation clause is enforceable even if the arbitration agreement in which it is contained is alleged to be invalid and unenforceable. In Zirpoli, “[a] plain reading of the text of the arbitration agreement” showed that the parties “clearly and unmistakably expressed an agreement to arbitrate the issue of arbitrability.”
Zirpoli thus underscores that arbitration agreements must be drafted carefully and precisely in order to reflect the intent of the contracting parties on issues of arbitrability.