A Closer Look At High Court Schein Carveout Case Arguments

Authored by Partner Michele M. Vercoski; Published in Law360

On Dec. 8, the U.S. Supreme Court heard argument for the second time in the familiar case of Henry Schein Inc. v. Archer and White Sales Inc.[1] The court perhaps made the case’s second visit inevitable by issuing a narrow decision in Schein I.

The issues in both Schein I and Schein II no doubt caught the eagle eyes of the Supreme Court not because they are as rare as unicorns, but because a decision on these issues will change the way we practice law.

Indeed, at large is the question important to almost all real-world, run-of-the-mill arbitration agreements across industries: Where there is a disagreement as to whether a particular dispute is subject to arbitration, who decides whether that dispute is arbitrable, the arbitrator or the court?

The answer to this question will hopefully be put to rest once and for all by the justices, and regardless of the answer, it will no doubt shape how transactional and litigation attorneys alike, on both sides of the aisle, navigate the so-called gateway issues going forward.

The dispute here first arose in Schein I under a contract between two dental equipment companies, Henry Schein Inc. and Archer and White Sales Inc., in which Archer and White sued Henry Schein, seeking monetary damages and injunctive relief.

The arbitration clause provided, inter alia, that “[a]ny dispute arising under or related to this Agreement (except for actions seeking injunctive relief …) shall be resolved by binding arbitration in accordance with the arbitration rules of the [AAA].”

Henry Schein moved for arbitration in response to Archer and White’s lawsuit, but Archer and White opposed the application on the grounds that the dispute is not subject to arbitration per the language of the arbitration clause because the action seeks injunctive relief.

In denying Henry Schein’s motion to compel arbitration, the U.S. District Court for the Eastern District of Texas, in accord with precedent from the U.S. Court of Appeals for the Fifth Circuit, held that Schein’s arguments for arbitration were “wholly groundless.” The district court relied on the provision’s carveout of claims seeking injunctive relief, despite the delegation clause. On appeal, the Fifth Circuit affirmed.

Upon hearing this case the first time around, the Supreme Court summarily rejected the wholly groundless exception as inconsistent with the Federal Arbitration Act and prior court precedent and remanded the case to the Fifth Circuit to make the determination as to whether the contract at issue delegated the gateway question of arbitrability to an arbitrator.

On remand to the Fifth Circuit, the court of appeals recognized that the arbitration clause, by incorporation of the American Arbitration Association‘s rules, contained a valid delegation to the arbitrator, but held that because the agreement also contained a carveout provision for injunctive relief, it is the court that decides whether a particular dispute is an action seeking injunctive relief, and not the arbitrator. 

In a déjà vu round of argument before the justices, with the elimination of the wholly groundless exception in this second round, the most notable questions and commentary focused on the narrowness of the question presented.

Schein II comes to the Supreme Court with a finding that the arbitration agreement contained a valid delegation clause, delegating gateway issues to the arbitrator, arguably resolving the “who decides” question. It thus follows that the only question left to consider the second time is whether, despite the delegation provision, the carveout for injunctive relief also carves out the issue of who decides thus taking the gateway issue from the arbitrator and giving it to the court to decide.

If this question is perplexing because it seems to have already been answered, then the commentary of Justice Samuel Alito during the oral argument is well taken:

This case comes to us in a rather artificial posture, so we’re required to assume that the contract … provides for the arbitration of [the] “who decides” question. … And, of course, if that’s true, then the answer to the question that we’re supposed to decide is foreordained.

Justice Samuel Alito

This sentiment is echoed by the probing comment Justice Clarence Thomas made to Kannon Shanmugam, counsel for Henry Schein: “[I]t sounds as though you think this is — that the delegation of arbitrability is — is all or nothing,” which would mean that delegation of arbitrability cannot be divided up between a court and arbitrator. The argument that ensued seemed to involve not disputes on statutory language, case law or even the contract language itself, but instead a battle of common sense.

Interestingly, Chief Justice John Roberts’ opening line of inquiry signaled that perhaps the better reasoning is to allow some issues to be decided by the courts, while some are decided by the arbitrator:

Now, if … it was important enough for … them to spell it out right at the outset, wouldn’t the last thing they would want is for an arbitrator to decide which disputes qualify? I mean, that would seem to follow a fortiori. They don’t want arbitrators deciding this. Why would they want arbitrators to decide who gets to decide?

Chief Justice John Roberts

Justice Elena Kagan likewise suggested that she too sees a certain logic to bifurcating the arbitrability decision:

[O]nce you decide that certain questions should be in the court … here suits seeking injunctive relief, you’re not going to want to go to the arbitrator to decide whether suits plausibly seeking injunctive relief are, in fact, that. You would just want to keep this in the courts generally.

Justice Elena Kagan

This commentary offered by Chief Justice Roberts and Justice Kagan seems to suggest that bifurcation of arbitrability would be logical, because if the universe of actions can be divided up between court and arbitration, a presumption against doing the same with arbitrability seems to defy common sense and eviscerates the parties’ express intentions.

Even though Justice Thomas led with the recognition of an all-or-nothing delegation proposition, he followed up with asking: “How would [Schein] draft this provision so that it can divide … the authority to arbitrate?”

In response to Justice Thomas’ inquiry, Shanmugam provided an example of language where the carveout would clearly and unambiguously operate on the question of arbitrability: “[E]xcept for an action seeking injunctive relief, the arbitrator shall decide whether the parties’ dispute is subject to arbitration.”

But Shanmugan quickly pivoted, arguing that such language is still problematic because “someone would still have to decide whether the action is, in fact, an action seeking injunctive relief.” This reasoning is circular at first blush and seems to suggest, despite statements to the contrary, that Henry Schein is effectively advocating for an all-or-nothing delegation, even if there is an express carveout on the issue of arbitrability.

Much later in the argument, Justice Kagan commented that she understands Shanmugan finds it problematic to give the question of arbitrability to the court because “you force the court to decide what is arbitrable before the court decides who gets to decide that issue.”

The articulation of these finer distinctions seems to indicate that when there is a clear and unmistakable delegation of arbitrability, it is likely that the court will find that a carveout of actions does not take the gateway issue of who decides away from the arbitrator.

For drafters of arbitration agreements, it is important to know whether or not parties are permitted to divide up gateway issues between the court and the arbitrator, or whether a clear delegation clause negates such language.

As the argument continued, it was clear that several of the justices had either abandoned or outright rejected the possibility of bifurcation.

Justice Brett Kavanaugh, who authored the opinion in Schein I, emphasized his “understanding … that the question of who decides arbitrability … is almost never decided between a court and an arbitrator because that would be almost nonsensical … you need one person to decide, and it’s either going to be the court or the arbitrator, not both the court and the arbitrator.”

This aligns with the reasoning and argument presented by counsel for Henry Schein. For Kavanaugh, that point seemed to settle the disputed issue:

Virtually every arbitration contract … specifies either limits or has carveouts. And so, if that alone means the court decides what is arbitrable, then the court will always decide arbitrability and really eradicate the idea that arbitrators can ever decide arbitrability.

Justice Brett Kavanaugh

The sentiment of bifurcating arbitrability between the court and arbitrator expressed in the first half of the argument was indeed short lived, leaving Justice Kavanaugh’s viewpoint dictating the second half of the argument.

For instance, when Chief Justice Roberts initiated questioning of Daniel Geyser, counsel for respondent Archer and White, he expressed that Justice Kavanaugh’s commentary was “the most important challenge for you. How do you distinguish a situation we call the run-of-the-mill situation where there is no express carveout?”

Chief Justice Roberts illustrated the challenge by offering a hypothetical agreement applying to all labor disputes “within the factory,” suggesting that Geyser’s reading would call for judicial determination of whether a dispute about use of an adjacent storage building that keeps supplies used in the factory qualifies as a dispute “within the factory,” thereby gutting the parties’ agreement to delegate gateway questions to the arbitrator.

Justice Sonia Sotomayor expressed confusion and doubt that Geyser’s argument “gets you where you want to be for all the reasons that my colleagues have said” and continued with the same concerns Justice Roberts expressed to Geyser:

I don’t see any way to avoid that your position basically says … that every arbitrability issue has to be decided by the court, because every arbitration agreement has limitation. Almost all agreements say any disputes “related to” this contract are subject to arbitration. And almost inevitably a party will come in and say this dispute is not related to a contract. And what would you have a court do? Decide that issue and then send it to arbitration — even when the contract says all disputes involving arbitrability go to the arbitrator?

Justice Sonia Sotomayor

That brings us back to the heavy hitter, Justice Kavanaugh, at bat again near the end of the argument, driving home the same point:

[T]hat’s just not how it works in the real world, nor could it realistically work that way in the real world. I don’t think any arbitration contract says arbitrability of certain subjects shall be decided by the arbitrator and [arbitrability] of other subjects [shall be decided] by the court.

Justice Kavanaugh

This expression of concern of real-world implications on ordinary agreements indicates that while we await final decision, attorneys should be cautious in drafting delegation clauses and carveouts alike.

While we are uncertain if delegation of arbitrability to the arbitrator can carve out certain gateway issues to the courts, if the parties wish to do so, the intent must be clear and unambiguous. This suggests that any intent to divide up gateway issues between the court and arbitrator must be clearly and carefully drafted, leaving no room for doubt.

If the justices are inclined to find a presumption of complete delegation of arbitrability to the arbitrator any time there is any delegation of arbitrability, regardless of any clear carveouts to the contrary, then it may be wise to expressly exclude the delegation clause and give all gateway issues to the court to decide.

The intent of the parties and the weight of the importance of having the court rather than the arbitrator decide gateway issues will provide the best guidance on how one drafts client arbitration agreements. Boilerplate templates should be revisited and clarified pending final decision, regardless of the outcome.

Although the argument seems to suggest a presumption of delegation is forthcoming, doubt is literally the only certain outcome in the aftermath of such vigorous argument on a perplexing issue. The roving nature of the arguments involved, coupled with the questions about exactly which issues are properly before the justices for decision, it is premature to predict an outcome with certainty.

What is clear, though, is that (1) the outcome is certain to change the way the legal profession approaches gateway arbitrability issues, and (2) the argument shows that several justices who were present for Schein I may have a bad case of reflux brought on by the Fifth Circuit’s recurrent denial to enforce the arbitration agreement before them.