Waiving Arbitration Goodbye

By J. Malcolm DeVoy

Despite strong policies favoring arbitration, companies seeking it may be forced into court

Likely everyone who reads this magazine has signed a contract requiring arbitration of disputes. Arbitration occurs in a closed forum with limited opportunity for judicial review and no jury present—a right guaranteed by the United States Constitution’s Seventh Amendment—and has long been a source of controversy. Normally, the costs of arbitration must be split evenly between the parties, while the costs for a plaintiff to get into the courtroom are much smaller. In a David-versus-Goliath scenario, going to court is less of a burden for an individual seeking redress from a large company. Simultaneously, arbitration offers advantages to parties who seek a private, speedy resolution of their dispute, such as companies fighting over trade secrets. Against this backdrop, arbitration clauses have become increasingly common in a wide variety of agreements…as well as the source of heated litigation before the nation’s highest courts.

For individuals and the attorneys who represent them, arbitration clauses have been targeted for attack for many years—and sometimes with success. While federal law such as the Federal Arbitration Act (and the case law surrounding it) generally favors arbitration, it is not a guarantee that a contract’s arbitration clause will be enforceable. Even in the face of a broad policy favoring arbitration, exceptions still exist.

The Nevada Supreme Court recently took up this issue in Principal Investments, Incorporated, doing business as Rapid Cash, versus Cassandra Harrison et al. 132 Nev. Adv. Op. 2 (2016). The Court’s decision was a weighty one, issued by the Court en banc, meaning all of the justices participated, rather than a normal three-justice panel; together with Justice Saitta’s concurrence, the Court’s full treatment of the case was a meaty 23 pages long.

Prelude: Phantom Service of Process, Forgery, and the “Sewer.”

The Principal Investments case begins with a process server claiming to have served numerous defendants with complaints and summonses, but having never done so. Principal Investments exclusively used the company On-Scene Mediations as its process server in Southern Nevada, relying on On-Scene Mediations to serve lawsuits against borrowers who defaulted on the short-term, high-interest loans that Principal Investments offered. Service of process—the actual, physical delivery of a complaint, stating the basis of a lawsuit, and a summons that contains instructions about how to respond to the lawsuit—is a fundamental threshold for beginning a lawsuit and requiring the defendant to participate.

The amounts Principal Investments sued to recover were below the $10,000 threshold for District Court. As a result, thousands of its cases were filed in the Justice Court for Las Vegas Township, which has jurisdiction over disputes involving less than $10,000. Many of Principal Investments’ cases against individual borrowers ended in default, where the defendant fails to appear or defend the lawsuit after receiving service of process, yielding a judgment for the amount due to Principal Investments under its original loan.

Eventually, one of the Justice Court’s judges questioned how quickly On-Scene Mediations was accomplishing so many serves for Principal Investments, as the lending company had filed more than 16,000 cases in Las Vegas Township’s Justice Court in 7 years. The ensuing investigation discovered that On-Scene Mediations was not serving Principal Investments’ lawsuits at all. Instead, it filed false affidavits of service claiming that it served the defendants, but never actually did so.

Describing this practice as “sewer service,” the Nevada Supreme Court implied that the documents that were supposed to be served were disposed of instead. On-Scene Mediation’s principal was charged with and convicted of 17 counts of forgery and offering false instruments. While this stemmed the tide of affidavits based on process service that never occurred, the question of Principal Investments’ many default judgments obtained against borrowers who never received notice of an action against them remained unanswered.

Court for Me, But Not for Thee.

Following the revelations of On-Scene Mediation’s actions, a number of individuals brought suit in District Court, alleging that Principal Investments improperly obtained its default judgments against them based on On-Scene Mediations’ “sewer service.” The individuals (first individually, and then later as an asserted class action) brought numerous claims, including fraud, upon the court abuse of process, civil conspiracy, negligence, and violation of Nevada’s fair debt collection laws. Among the relief they sought was the court’s declaration that the judgments entered against them by the Justice Court were void and uncollectable.

Principal Investments moved to compel arbitration under the agreements it entered with the individual plaintiffs. Among the three plaintiffs, there were two agreements that governed Principal Investments’ ability to seek arbitration. The first version of the agreement broadly defined what constituted a “claim,” and contained language seeking to allow either party to elect arbitration for certain claims, even while others remained active in court. The second version of the agreement required either party to submit a claim to mediation before arbitration, but also contained a carve-out that sought to exempt actions filed in Justice Court from the mediation and arbitration requirements:

[either party may] bring a Claim in a small claims or the proper Las Vegas Justice Court, as long as the Claim is within the jurisdictional limits of that court […] All Claims that cannot be brought in small claims court or Las Vegas Justice Court . . . must be resolved consistent with . . . the Arbitration Agreement”

In addition to these provisions intended to allow Principal Investments to move forward with its collections, the agreements contained more language favoring arbitration. Both agreements stated that they were made “pursuant to a transaction involving interstate commerce,” as a way to invoke the use of federal law such as the Federal Arbitration Act. The agreements went on to state they were governed by the Federal Arbitration Act, and require borrowers to waive class action and class arbitration participation.

The District Court rejected Principal Investments’ attempts to compel arbitration of the pending action. Specifically, the court held that Principal Investments’ initiation of the Justice Court actions waived its right to insist on arbitration. Both Nevada and federal law allowed the Nevada Supreme Court to hear an interlocutory appeal on the District Court’s denial of Principal Investments’ requests to compel arbitration, which the Supreme Court invoked in rendering its decision.

Going to Court May Not Waive Arbitration…But Obtaining a Judgment Does.

On appeal, Principal Investments acknowledged it waived its right to arbitrate the collections claims it filed in Justice Court, but that did not prevent arbitration of the new claims asserted against it, which arose from the On-Scene Mediations revelations. Courts disfavor finding waivers, and do not likely reach that conclusion. Even where there is prior litigation despite an agreement to arbitrate, that waiver normally extends only to the same legal and factual issues that have been litigated—meaning that the party seeking arbitration does not get to arbitrate the issues it has already litigated in court.

The Nevada Supreme Court found that the District Court claims against Principal Investments were “integrally related to” its Justice Court claims. But for the default judgments Principal Investments obtained against the plaintiffs through the use of On-Scene Mediations, the later lawsuit—and its appeal—never would have existed. Because these new claims directly arose from Principal Investments’ litigation and default judgments in Justice Court, the Supreme Court concluded that they threaded the needle for being based on the same factual or legal issues.

Rather than standing for a broad rollback of arbitration clauses, the Nevada Supreme Court’s ruling leaves room for unrelated claims to be forced into arbitration even where there is underlying litigation. The Supreme Court recognized one case in particular, from Wisconsin, where a payday lender’s filing suit in small claims court did not waive its right to demand arbitration of a claim against it under the Wisconsin Consumer Act. The crucial distinction was that the small claims action did not waive the borrower’s claims against the lender in the Wisconsin case. The issue before the Nevada Supreme Court was that the claims against Principal Investments arose from the judgments it obtained by bringing legal proceedings in the Justice Court, when the lender had already chosen not to arbitrate.

Principal Investments’ other defenses were unavailing and quickly dispatched by the Supreme Court. The lender asserted its “no-waiver” clause in its agreements, which provided that bringing one claim in court does not waive the right to arbitrate other claims. The Supreme Court held, however, that those clauses could be waived, and further rendered ineffective where they interfered with a judge’s ability to control litigation, or were used “to sanctify a fraud upon the court allegedly committed by the party who itself elected a litigation forum for its claim.” It is unlikely the Nevada Supreme Court’s use of such forceful language was accidental.

Consequences for Litigants.

The simplest way to avoid a dispute becoming as involved as the Principal Investments case is to draft clean arbitration agreements, and then follow them. The question of waiver would not have arisen if the plaintiff had not gone to court in the first place, even though the contract theoretically allowed it…all but inviting a waiver question as an obstacle to arbitration. Then, the parties to those contracts needed to enact them as drafted to avoid questions of waiver—or worse, fraud on the court—arising from conduct inconsistent with the agreement.

For individuals, this will have little if any impact, as binding arbitration has long been the bane of plaintiffs. For them, this decision has a silver lining: Rather than having to share the costs of arbitration, an individual can stay in court despite an arbitration clause as long as the other side began the judicial proceeding. The facts of this case are unique, though, and the case’s effects may be narrow in scope.

The facts underlying the decision, particularly arising from On-Scene Mediation’s service, bore on its result and hopefully will not be present in future cases. Simply going to court despite an arbitration clause may not completely remove all claims from arbitration, depending on how the clause is written. Where causes of action arise from a judgment obtained from a waiver of arbitration, though, Nevada law likely will exempt those new claims from arbitration.

For companies that must regularly sue over unpaid contracts (or for any other reason), compliance-testing one’s process servers is recommended. Another alternative is spreading out the work among a small number of approved vendors in order to examine their performance for any irregularities. As the Supreme Court noted, On-Scene Mediations provided services for companies other than Principal Investments, and their judgments as well were at risk of invalidation—to say nothing of the other claims against the company.

In all, the Principal Investments decision is shocking, and provides occasion for companies and individuals entering arbitration agreements to re-examine their policies and practices. For every company regularly involved in litigation, this case underscores the importance of ensuring due process safeguards for defendants are satisfied, including steps as fundamental as proper service of process. While the effect of the Supreme Court’s ruling may turn out to be limited, its language and consequences should also promulgate thoughtful action from both sides in arbitration clause disputes.

Malcolm (“Jay”) DeVoy is the owner of DeVoy Law P.C. and serves as of counsel to The Firm P.C. DeVoy focuses on providing representation in commercial disputes, serious personal matters, and advising medical professionals and practices about issues including HIPAA, the Stark Law, and the Anti-Kickback Statute.