The Arbitrability Dicta in First Options


A. Introduction

In May of 1995 the U.S. Supreme Court handed down a significant decision about the allocation of functions between judges and arbitrators. First Options of Chicago v. Kaplan1 arose from an arbitral award rendered against both an investment company and its owners with respect to debts owed to a securities clearing house. The owners argued that they had never signed the arbitration agreement from which the arbitral tribunal drew its power, and consequently were not bound by its award. The Supreme Court held that the scope of the arbitration agreement was a matter for courts to decide independently (i.e. without deference to the arbitral finding on the matter), and affirmed the Court of Appeals’ decision that the owners had not agreed to arbitrate.2 So far so good.

The problematic part of the Supreme Court’s opinion lies in dicta suggesting that in some situations (although not under the facts of Kaplan) what the Court called “the arbitrability question itself” may be submitted to arbitration,3 in which case the courts must defer (“give considerable leeway”4) to arbitrators’ decisions on the limits of their own jurisdiction.

What exactly these dicta might mean is unclear. Human nature being what it is, however, the securities industry and other groups relying on arbitration clauses in standard form contracts can be expected to give the dicta an expansive interpretation, tending to further a degree of arbitral autonomy that may be at odds with sound arbitration policy.

B. When and Why Arbitral Jurisdiction Matters

The public side of private adjudication

As the volume5 and scope6 of non-judicial dispute resolution increases, so does the need for scholars to address how courts should deal with jurisdictional challenges in private adjudication. Truly private forms of dispute resolution, such as conciliation and mediation, depend for their effectiveness on the moral force of the adjudicator and the socio-economic pressures brought to bear within trade associations and relatively homogeneous communities that sponsor the adjudicatory process. Victims of procedural irregularity in such non-binding adjudication reserve the right to walk away from their execution, turning the process into little more than expensive foreplay to litigation.7

Arbitration, however, exists in the shadow of public coercion. When one party to an arbitration agreement regrets the decision to renounce recourse to courts, the state lends its power to enforce the agreement to arbitrate. Court proceedings are stayed; arbitral awards are given res judicata effect; and the loser’s assets may be seized. Therefore the contours of an arbitrator’s power must concern judges as well as business managers, if for no other reason than to maintain confidence in the integrity of the judicial system on whose power the arbitral process relies.

Commercial actors will care about the jurisdictional legitimacy of private dispute resolution for reasons different than those of judges. The business manager’s need for some reasonable measure of certainty in contract enforcement requires that arbitrators do more than roll dice or flip coins. Fidelity to the parties’ shared ex ante expectations in dispute resolution constitutes as basic an element of voluntary and optimally efficient conflict settlement as do speed and economy. Rational business actors will not long tolerate a private adjudicatory scheme that decides cases quickly and cheaply at the expense of respect for the arbitrators’ contractually defined mission.

The arbitrator: neither judge, vigilante nor officious intermeddler

Unlike judges who receive decision-making authority from the state, or vigilantes and officious intermeddlers, whose role in furthering justice is self-generated, arbitrator’s power derives from the consent of the individuals or entities involved in a particular dispute.8 Absent this consent, commercial arbitrators will normally have no connection to the controverted issue even sufficient to justify deference to their authority, either by the parties to the dispute or by courts called upon to recognize and to enforce the arbitral process.

The consent on which private dispute resolution rests is qualitatively different from the implied submission to government courts that arguably results from living in society. Arbitration agreements empower a particular adjudicator to decide specific questions with respect to identified individuals or entities, constrained by the bounds of contractually conferred authority and the fundamental public interests of jurisdictions that directly or indirectly lend support to the arbitral process.

An efficient and fair arbitration system will implicate several principles that may sometimes be in tension one with another. First, the arbitrator’s decision on the merits of the dispute must be final. Second, an arbitral award must be rendered within the scope of the arbitrators’ jurisdiction with respect to the persons alleged to be bound and the adjudicated questions. Finally, the arbitral award must not violate basic notions of public policy of the place of the award or its enforcement.

Renunciation of the right to seek justice through government courts means that an arbitrator has the right to get it wrong, in the sense of evaluating a controverted event differently than would the otherwise competent judge.9 Assuming the risk of a bad award on the merits of the dispute does not, however, mean giving arbitrators power to decide matters never submitted to them. Therefore the relevant political communities that enforce the arbitral process arguably have a duty to monitor the existence and extent of an alleged waiver of judicial jurisdiction through arbitration.

C. An Overview of First Options v. Kaplan

The U.S. Supreme Court decision in First Options of Chicago v. Kaplan serves as a springboard for discussion of the allocation of power between judge and arbitrator.10 An investment company’s losses during the October 1987 stock market crash led to an arbitration award in favor of a securities clearinghouse (First Options) against the company (MK Investments) and its owners (Carol and Manuel Kaplan) to cover unpaid debts owed by the company to the clearinghouse. The “workout agreement” that submitted to arbitration any disputes arising from the rescheduling of the investment company’s debts was signed by the corporation but not its shareholders. Nevertheless, the arbitral tribunal hearing the claim pierced the corporate veil to render an award against the owners as well as their company. This award was confirmed by the federal district court.

The Court of Appeals disagreed with the arbitral tribunal on the matter of its jurisdiction, and determined that the Kaplans were not bound to arbitrate, thus reversing the lower court confirmation of the award. A unanimous Supreme Court affirmed the Court of Appeals, stating that in the case at bar the arbitrability of the owners’ debt was a question for the courts.

The Supreme Court distinguished three elements in the interaction of judge and arbitrators: the merits of the dispute (whether the Kaplans were personally liable for the investment company’s debt); the arbitrability of the dispute (whether the Kaplans agreed to arbitrate the matter of their liability); and the allocation of functions between courts and arbitrators with respect to determinations of arbitrability (whether courts show deference to arbitrators’ ruling on jurisdiction). In dealing with the last of these issues (the respective roles of judges and arbitrators) the Court held that the question of jurisdiction was for courts rather than arbitrators under the facts in First Options, which is to say, when jurisdictional issues had not been clearly submitted to the arbitrators.11

In the context of the United States’ federal system, the First Options

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