A substitute arbitrator must be appointed, a federal appeals panel has ruled, in cases where a consumer contract is governed by the Federal Arbitration Act (FAA) and designates a particular arbitrator who was unavailable when a dispute arose.

In Khan v. Dell Inc., the U.S. Court of Appeals for the Third Circuit, by a 2-1 vote, specifically rejected a consumer’s claim that the arbitration clause was rendered unenforceable due to the unavailability of the designated arbitrator. Instead, the majority found that such a situation triggers the substitution process outlined in Section 5 of the FAA.

The plaintiff claimed he experienced problems with his Dell computer and filed a proposed class action lawsuit. His purchase was governed by Terms and Conditions of Sale that included an arbitration clause designating the National Arbitration Forum (NAF) as the arbitrator for any disputes. Prior to the plaintiff’s lawsuit, NAF had agreed to a Consent Judgment with the Minnesota Attorney General barring it from conducting any further consumer arbitrations.

Dell moved to compel arbitration of the lawsuit, but the District Court denied the motion, finding that the arbitration clause was rendered unenforceable by the unavailability of NAF. It relied on the language of the contract stating that disputes "shall be resolved exclusively and finally by binding arbitration administered by the National Arbitration Forum (NAF) under its Code of Procedure." The District Court agreed with plaintiff that this language demonstrated "the parties’ intent to arbitrate exclusively before a particular arbitrator, not simply an intent to arbitrate generally." It found that that the designation of NAF as the arbitrator was "integral" to the arbitration clause, and appointing a substitute arbitrator would force the parties to "submit to an arbitration proceeding to which they have not agreed."

The Third Circuit reversed the lower court’s ruling and declared that the unavailability of NAF does not preclude enforcement of the arbitration clause. The majority found the language of the arbitration clause relied on by the plaintiff and the lower court "is at best ambiguous as to whether the parties intended to have their disputes arbitrated in the event that NAF was unavailable for any reason." As a result, the majority said, "it is not clear whether the designation of NAF is ancillary or is as important a consideration as the agreement to arbitrate itself… Therefore, we must resolve this ambiguity in favor of arbitration."

The court emphasized that the arbitration clause specifically incorporated the FAA, and that Section 5 of the FAA prescribes a procedure for the appointment of a substitute arbitrator when the arbitrator designated in the parties’ contract is unavailable.

Although it acknowledged that courts "are divided on the issue," the majority concluded that "the fundamental presumption in favor of arbitration" militated in favor of requiring the parties to proceed with arbitration before a substitute arbitrator.

Ballard Spahr’s Consumer Financial Services Group has done pioneering work in the use of pre-dispute arbitration in consumer financial services contracts; we have designed, implemented, and enforced arbitration programs for many of the largest financial institutions in the world. The Group also produces the CFPB Monitor, a blog that focuses exclusively on important Consumer Financial Protection Bureau developments. To subscribe, use the link provided to the right.

For more information, please contact Practice Leader Alan S. Kaplinsky, 215.864.8544 or kaplinsky@ballardspahr.com, or Burt M. Rublin, 215.864.8116 or rublin@ballardspahr.com.

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