U.S. Supreme Court Holds That the Federal Arbitration Act Supersedes State Laws Lodging Primary Jurisdiction in Another Forum

February 27, 2008

On February 20, the Supreme Court of the United States issued an 8-1 decision in Preston v. Ferrer, which held that when parties agree to arbitrate all questions arising under a contract, the Federal Arbitration Act (FAA) supersedes state laws lodging primary jurisdiction in another forum, whether judicial or administrative.

Arnold Preston, a California attorney, brought a demand for arbitration for non-payment of fees allegedly due under a “personal manager” agreement against Alex Ferrer, a former judge who appears as “Judge Alex” on a Fox television program. The contract incorporated the AAA Commercial Arbitration Rules and the parties agreed to arbitrate “any dispute . . . relating to the terms of [the contract] or the breach, validity or legality thereof.” In response to Preston’s arbitration demand, Ferrer filed a petition with the California Labor Commissioner and subsequently sought declaratory and injunctive relief in California state court, contending that the agreement was void under the Talent Agencies Act (TAA) because Preston was not a licensed talent agent as required by the statute. The TAA grants exclusive jurisdiction over such disputes to the California Labor Commissioner. The California courts enjoined Preston, pursuant to the TAA, from proceeding before the arbitrator unless and until the Labor Commissioner determined that she was without jurisdiction over the dispute.

The question before the U.S. Supreme Court was whether the Labor Commissioner, pursuant to the grant of exclusive jurisdiction under the TAA, or the arbitral tribunal, under the FAA, was the proper forum to determine the validity of the agreement. 

The Supreme Court held that the validity issue was for the arbitral tribunal to decide. In so holding, the Court rejected the conclusion of the California appeals court that the recent Supreme Court case of Buckeye Check Cashing, Inc. v. Cardegna–under which a challenge to the validity of a contract providing for arbitration is generally decided by an arbitrator rather than a court–does not apply to a conflict between the FAA and a statute granting initial exclusive jurisdiction to a state administrative agency. No requirement of exhaustion of administrative remedies could be read into the arbitration clause. Nor does the agency’s interest in being informed of potentially illegal activity limit the obligation of private parties to comply with their arbitration agreements. 

The Court also rejected Preston’s argument that the choice of law provision in the agreement selecting California law mandated the application of California procedural law to the parties’ dispute. This general incorporation of California law was trumped by the parties’ express incorporation in the agreement of the AAA Commercial Arbitration rules, which provide for the arbitrator to determine the validity of the contract. Consistent with existing Supreme Court precedent, the Court reasoned that “the best way to harmonize the parties’ adoption of the AAA rules and their selection of California law is to read the latter to encompass prescriptions governing the substantive rights and obligations of the parties, but not the State’s special rules limiting the authority of arbitrators.” Thus, the procedural law of the jurisdiction selected in a choice-of-law provision will not displace the procedural rules incorporated in an arbitration clause.

Preston reaffirms that "[t]he FAA’s displacement of conflicting state law is ‘now well-established.’" Among other things, Preston should put parties on notice, to the extent they were not before, that "attacks on the validity of an entire contract, as distinct from attacks aimed at the arbitration clause, are within the arbitrator’s ken." This is a welcome result, in line with prior Court decisions and contributing further to the predictability of federal arbitration law and the strong national policy in favor of arbitration.