Jurisdictional Statement — Southland Corp. v. Keating

[ Office - Supreme Court, U.S.

82-500 [mE D

Iwo. B62Z-_

ALEXANDER L. STEVAS,

OCTOBER TERM, 1982

THE SOUTHLAND CORPORATION, ef al.,

Appellants,

-_Vi—

RICHARD D. KEATING, ef al.,

Appellees.

ON APPEAL FROM THE SUPREME COURT OF CALIFORNIA

JURISDICTIONAL STATEMENT

Of Counsel: PETER K. BLEAKLEY*

MARK J. SPOONER

MARC D. GUREN

1200 New Hampshire Ave., N.W.

Washington, D.C. 20036

(202) 872-6700

MCKENNA, CONNER & CUNEO AARON M. PECK

San Francisco, California CHARLES G. MILLER

MARTIN H. KRESSE

1920 Mills Tower

220 Bush Street

San Francisco, California 94104

(415) 433-0640

Attorneys for Appellants,

The Southland Corporation,

et al.

September 1982 *Counsel of Record

ARNOLD & PORTER

Washington, D.C.

QUESTIONS PRESENTED

1. Whether the federally protected right of arbitration under

the Federal Arbitration Act is unlawfully impaired when a

state court superimposes judicial class action procedures (in-

cluding court-supervised discovery, briefing, certification,

notice and opt-out procedures, mandatory preparation of tran-

scripts, and ongoing judicial control) on a private arbitration

of a commercial dispute involving interstate commerce.

2. Whether a state statute violates the Supremacy Clause of

the United States Constitution when it invalidates arbitration

agreements involving interstate commerce that are “valid,

irrevocable, and enforceable” under the terms of the Federal

Arbitration Act.

PARTIES BELOW

This appeal involves eight cases that were consolidated in the

court below.* Plaintiffs, who are former franchised operators

of 7-Eleven® convenience stores in the State of California, are

Richard and Darla Keating, Edward and Betty Gouveia, Harry

Battersby, Patrick and Cathy Cheng, Michael and Gloria Coy,

Phillip and Joan Newell, Thomas and Wanda Sampson, and

Arthur and Jenny Scovis. Some of the plaintiffs purport to

represent a class consisting of all current and former 7-Eleven

franchisees in California.

Defendants are The Southland Corporation, which owns the

7-Eleven® service mark, and several of its current and former

officers, directors and employees: John P. Thompson, Jere W.

Thompson, Walton Grayson, III, Joseph S. Hardin, R.G.

e One additional case, Garza v. Southland, was originally consoli-

dated with the others but has since been settled.

Smith, Eugene Pender, S.R. Dole, Terry De Bard, Gene Jans-

sen, Curtis Pare, Ray Berry, Paul Stevenson, Michael Wild-

man, Robert Johnson, Ernest Arzabal, Michael Drury, Keith

Jenkins, Robert Duncan, Fred Elwood, Joseph Galea, Dave

Pava, Tal Colson and Douglas Porter.

Defendant The Southland Corporation has no parent corpo-

ration, subsidiaries (except wholly owned subsidiaries), or

affiliates.

TABLE OF CONTENTS

QUESTIONS PRESENTED.......ccccccccccccccees

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TABLE OF AUTHORITIES..............-2eeeeeee

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FES e oc ccevescscncegisascveccusccocees

CONSTITUTIONAL PROVISIONS AND STATUTES

EE wv cecccccccccescsscocesescoescescces

STATEMENT OF THE CASE .............-0000ees

THE QUESTIONS ARE SUBSTANTIAL ............

A. The Viability of Arbitration Under the Federal

Arbitration Act Depends on Its Freedom from the

Strict Judicial Controls and Procedures Required

by the Decision Below. ............ccscceeeees

1. Arbitration Is a Highly Favored Alternative to

Litigation in the Courts ..............0005:

2. The Essence of Arbitration Is Its Avoidance of

Judicial Procedures; Class Actions Require

Active Judicial Involvement................

3. A Class Action Arbitration Would Destroy the

Parties’ Agreement To Arbitrate............

B. The Federal Arbitration Act Supersedes the Anti-

Arbitration Policy of the California Franchise

ED GD occ kvcnveucnensusésescecesess

COs cc ccccccccneccccccccccccesccencess

PAGE

11

15

TABLE OF AUTHORITIES

Cases PAGE

Alabama v. Blue Bird Body Co., 573 F.2d 309 (Sth Cir.

Di nbGedenskhevdobndukceunuecassedeseesédec 13

Allison v. Medicab International, Inc., 92 Wash. 2d 199,

es io ec cd dekdousnatensess 23

American Almond Products Co. v. Consolidated Pecan

Sales Co., 144 F.2d 448 (2d Cir. 1944).............. 12

Bache Halsey Stuart Shields, Inc. v. Moebius, 531 F.

CE, Ss SEED ee cacclcdcecececccssees 24

Barron v. Tastee Freez International, Inc., 482 F. Supp.

re i Os eee edteenees 24

Belcher v. Bassett Furniture Industries, Inc., 588 F.2d

i, Cec nh cre idduddeulenguncens$eees 13

Bernhardt v. Polygraphic Co. of America, 350 U.S. 198

Di skceeuussncnstadechsudeunn<tekeesnnesads 9

Cavanaugh v. McDonnell & Co., 357 Mass. 452, 258

i 6/keudndsoneséceebeunetukenss 11

Chicago & N.W. Transp. Co. v. Kalo Brick & Tile Co.,

SE on ce ceael a Caddcecucsaussiednes 10, 25

Collins Radio Co. v. Ex-Cell-O Corp., 467 F.2d 995 (8th

i oneiwelieedhageaseeeedned tees aeesese 21

Colorado Anti-Discrimination Comm’n v. Continental

Air Lines, Inc., 372 U.S. 714 (1963) ............... 25, 26

Commonwealth Edison Co. v. Gulf Oil Corp., 541 F.2d

a 21

Coopers & Lybrand v. Livesay, 437 U.S. 463 (1978). ... 13

De Sapio v. Kohimeyer, 35 N.Y.2d 402, 362 N.Y.S.2d

we Tee 12, 19

PAGE

Dickinson v. Heinold Securities, Inc., 661 F.2d 638 (7th

GR Sec ccususecsséousouiavsteceseueweuuauees 18

EEOC v. Korn Industries, Inc., 662 F.2d 256 (4th Cir.

Py 6b ceccovescsudeesccceacenscubebeeeenenues 14

Eisen v. Carlisle & Jacquelin, 417 U.S. 156 (1974)..... 13

Galt v. Libbey-Owens-Ford Glass Co., 376 F.2d 711 (7th

Ge Ge o wie ccccceucesnicugeecceusescaseunenenn 10

General Telephone Co. v. Falcon, 102 S. Ct. 2364

GENE 6 6600000evkeessevesenedseenecsecaseeeuel 13, 14

Gonzales v. Cassidy, 474 F.2d 67 (Sth Cir. 1973)....... 12, 14

Green v. Wolf Corp., 406 F.2d 291 (2d Cir. 1968), cert.

denied, 395 U.S. 977 (1969) .......... cece cece eee 14

Greenfield v. Villager Industries, Inc., 483 F.2d 824 (3d

GR CUE wc cvcceceeuscnnvccccséecestcunseneeseaes 15

Grunin v. International House of Pancakes, 513 F.2d

114 (8th Cir.), cert. denied, 423 U.S. 864 (1975)..... 14

Guerine v. J & W Investment, Inc., 544 F.2d 863 (Sth

- EB . PPT eee eee 13

Gulf Oil Co. v. Bernard, 452 U.S. 89 (1981).......... 14, 18

Hansberry v. Lee, 311 U.S. 32 (1940)............64.. 12

Harris v. Shearson Hayden Stone, Inc., 82 A.D.2d 87,

441 N.Y.S.2d 70 (1981), aff’d mem., 56 N.Y.2d 627,

450 N.Y.S.2d 482, 435 N.E.2d 1097 (1982).......... 16, 17

Hines v. Davidowitz, 312 U.S. 52 (1941) ............. 25

H.L. v. Matheson, 450 U.S. 398 (1981) .............. 12, 13

In re Fine Paper Antitrust Litigation, 617 F.2d 22 (3d

Geb. FE v ccvcccccsusescosonéceseauvescesesennen 13

In re General Motors Corp. Engine Interchange Litiga-

tion, 594 F.2d 1106 (7th Cir.), cert. denied, 444 U.S.

SPP POEEL co ccdncvcesvissioccccdscecadecenenene 14

_

vi

PAGE

In re Transit Co. Tire Antitrust Litigation, 67 F.R.D. 59

ia odd ceennas suasetétesesdeees 13

Ingbar v. Drexel Burnham Lambert, Inc., No. 82-1279,

slip op. (Ist Cir. July 28, 1982).............200000- 23

International Brotherhood of Teamsters v. United

i ih PCE cceccecoeeeeseeeeecees 14

Jones v. Rath Packing Co., 430 U.S. 519 (1977)....... 25

J.S. & H. Construction Co. v. Richmond County Hosp’

tal Authority, 473 F.2d 212 (Sth Cir. 1973).......... 10

Mandujano v. Basic Vegetable Products, Inc., 541 F.2d

i Ti ide eeepc cegeeeesdsetaeese 14

Merrill Lynch Pierce Fenner & Smith Inc. v. Melamed,

405 So. 2d 790 (Fla. Dist. Ct. App. 1981) .......... 24, 27

Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Ware,

i nS ce cceueepeenesesoreses$t 24-25

Middle East Transcontinental, Inc. vy. Onion Crock,

Inc., 144 Mich. App. 57 (1982) .............000058- 23

National Ass’n of Regional Medical Programs, Inc. v.

Mathews, 551 F.2d 340 (D.C. Cir. 1976), cert. denied,

EL 13

Oppenheimer Fund, Inc. v. Sanders, 437 U.S. 340 (1978) =—:113

Perez v. Campbell, 402 U.S. 637 (1971) ..........55.. 25, 26

Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388

dh pcicacegegneeasesdeueeooeeeee 8, 11

R.J. Palmer Construction Co. v. Wichita Band Instru-

ment Co., 7 Kan. App. 2d 363, 642 P-2d 127 (1982).. 24

Robert Lawrence Co. v. Devonshire Fabrics, Inc., 271

F.2d 402 (2d Cir. 1959), cert. dismissed, 364 U.S. 801

EEE AE a 10

Robertson v. National Basketball Ass’n, 556 F.2d 682

CC a a 12

Vii

PAGE

Romnes v. Bache & Co., 439 F. Supp. 833 (W.D. Wis.

isneéhsnessaedbecdasevennecedcouseséecceens 23

Sam Fox Publishing Co. v. United States, 366 U.S. 683

Dt tn6veneedidnennéabedeesésédcbenaseadodoens 12

Scherk v. Alberto-Culver Co., 417 U.S. 506 (1974) .... 8, 18,

23, 26, 27

Social Services Union, Local 535 v. County of Santa

Clara, 609 F.2d 944 (9th Cir. 1979) ..........00045. 13

Sommers v. Abraham Lincoln Federal Savings & Loan

Ass'n, 66 F.R.D. 581 (E.D. Pa. 1975).............. 13

Supak & Sons Mfg. Co. v. Pervel Industries, Inc., 593

is Mi. os ccscenseiwecesadssunbe 21

Susman v. Lincoln American Corp., 561 F.2d 86 (7th

it Phe dnnegededsawssadedeownnacestbaccees 13

United Steelworkers v. Enterprise Wheel & Car Corp.,

i a6 ode bi eves deaneeren 9

Wilko v. Swan, 346 U.S. 427 (1953)... 2.2... eens 22-23

Constitutional Provisions

Due Process Clause of the Fourteenth Amendment to

the Constitution (amend. XIV, § 1)................ 3

Supremacy Clause of the United States Constitution

tt i Mi cceepbadeceesebeds toadseenkeaoend passim

Statutes

California Franchise Investment Law, CAL. CORP. CODE

§§ 31000-31516 (West 1977)... 22... cece cee eee ee passim

California Franchise Relations Act, CAL. BUS. & PROF.

CODE § 20040 (West 1982 Supp.).................. 21

Federal Arbitration Act, title 9, U.S.C. (1976)........ passim

BP DK. | CEPA c cc cccccvcvcccccsccccccees 2

vill

A TEE eS Ee Fr

Is a ala

8 eS rrr mr ream

Rules

FU Ths GOS FE ROD cc ccncccccccccccccnscocesesece

es Gh, GS FE Be ccccccccccccceccscosceceses

PE Gis GS BE BD ccccccscccccccescesecesenscece

Legislative Materials

Arbitration of Interstate Commercial Disputes: Joint

Hearings on S. 1005 and H.R. 646 Before the Sub-

comms. of the Comms. on the Judiciary, 68th Cong.,

SD EE, Ge ov one eccseecccescdnsesesvoucceses

H.R. REP. No. 96, 68th Cong., Ist Sess. (1924) .......

S. REP. No. 536, 68th Cong., Ist Sess. (1924).........

H.R. REP. No. 542, 97th Cong., 2d Sess. (1982).......

Miscellaneous

ADMINISTRATIVE OFFICE OF THE UNITED STATES

CourTS, 1980 ANNUAL REPORT OF THE DIRECTOR

GREED cccccccccccccosccceseccceceseosecousoecee

ADMINISTRATIVE OFFICE OF THE UNITED STATES

COURTS, 1981 ANNUAL REPORT OF THE DIRECTOR

GUE. GB. FETED ccc ccccccccccccccccccccccscoss

Brown, Some Practical Thoughts on Arbitration, 6 LITI-

I Is ono ncn cnenseecuounsened

Burger, /sn’t There a Better Way, 68 A.B.A.J. 274 (1982)

Burger, Judicial Conference for the District of Columbia

SE, GP ee CP ED wccccccecsccccoccoses

10

ix

PAGE

DOMKE ON COMMERCIAL ARBITRATION (1968) ....... 10, 11

G. GOLDBERG, A LAWYER’S GUIDE TO COMMERCIAL

ARBITRATION (ALI-ABA 1977) ...............556. 15

Kirkham, Problems of Complex Civil Litigation, 83

da ieee eameeuenaieudedeee a

Rehnquist, A Jurist’s View of Arbitration, 32 ARB. J. 1

i ‘act Miia cate teedd needs gheen es 10

Report of the Pound Conference Follow-Up Task Force,

PE, SEE cancccdkdddeunadnseisccoonce 11

A. WIDISS, ARBITRATION: COMMERCIAL DISPUTES, IN-

SURANCE, AND TORT CLAIMS (PLI 1979) .......... 10

7A C. WRIGHT & A. MILLER, FEDERAL PRACTICE AND

PROCEDURE §§ 1791, 1793 (1972) ................. 14

IN THE

Supreme Court of the United States

OCTOBER TERM, 1982

No. 82-__

THE SOUTHLAND CORPORATION, ef ai.,

Appellants,

SS

RICHARD D. KEATING, ef ai.,

Appellees.

ON APPEAL FROM THE SUPREME COURT OF CALIFORNIA

JURISDICTIONAL STATEMENT

Appellants, The Southland Corporation and several of its

current and former officers, directors and employees (herein-

after collectively referred to as “Southland”), appeal from a

final judgment of the Supreme Court of California.

OPINIONS BELOW

The majority and dissenting opinions of the California

Supreme Court are reported at 31 Cal. 3d 584, 183 Cal. Rptr.

360, 645 P.2d 1192 (1982), and are reprinted in the separate

Appendix to this Jurisdictional Statement at la-4Sa (herein-

after “App.”). The opinion of the California Court of Appeal,

First Appellate District, is reported at 109 Cal. App. 3d 784,

167 Cal. Rptr. 481 (1980), and is reprinted at App. 47a-70a.

The orders of the Superior Court of Alameda County (App.

71a-80a) are unreported.

JURISDICTION

The judgment of the Supreme Court of California was

entered on June 10, 1982. Southland filed a timely notice of

appeal in that court on August 24, 1982. (App. 83a-84a.) Upon

timely application, Justice Rehnquist granted Southland an

extension of time until September 22, 1982 to docket an appeal

or, in the alternative, to file a petition for a writ of certiorari.

(App. 85a.) The jurisdiction of this Court is conferred by 28

U.S.C. § 1257(2) (1976), because the California Supreme

Court has sustained the validity of the California Franchise

Investment Law and California class action rules notwithstand-

ing Southland’s contention that such statute and rules, as

construed, violate the Constitution and laws of the United

States.

CONSTITUTIONAL PROVISIONS AND

STATUTES INVOLVED

The following constitutional provisions and statutes are

involved in this appeal and are set forth in the separate

Appendix to this Jurisdictional Statement (App. 87a-88a): the

Supremacy Clause of the United States Constitution (art. VI,

cl. 2); the Due Process Clause of the Fourteenth Amendment

to the Constitution; Sections 1-3 of the Federal Arbitration

Act, 9 U.S.C. §§ 1-3 (1976); and Section 31512 of the Califor-

nia Franchise Investment Law, CAL. CORP CODE § 31512

(West 1977).

STATEMENT OF THE CASE

This appeal involves an unprecedented decision of the Cali-

fornia Supreme Court, holding that individual franchisees,

who agreed to arbitrate any disputes arising under their inter-

state franchise agreement, could file a judicial action, asking

the court to direct their arbitration claim to proceed on a “class

action” basis. The court rejected Southland’s argument that

3

this state-imposed, judicial procedure would violate the Su-

premacy Clause of the United States Constitution by impairing

the exercise of substantive rights protected by the Federal

Arbitration Act, title 9, U.S.C. (1976), and would violate the

Due Process Clause of the Fourteenth Amendment unless the

court exercised strict control over the arbitration.

This appeal also concerns the California Supreme Court's

holding that the California Franchise Investment Law, CAL.

CorP. CODE §§ 31000-31516 (West 1977), preempts the Federal

Arbitration Act and renders arbitration agreements unenforce-

able with respect to claims brought by franchisees against

franchisors under that statute. The court rejected Southland’s

argument that the Federal Arbitration Act preempts anti-arbi-

tration statutes such as the California franchising statute. The

decision of the California Supreme Court on both the class

action issue and the preemption issue is in conflict with

decisions of other state and federal courts and has widespread

implications affecting the viability of arbitration throughout

the country.

This litigation began in May 1977 with the filing of an action

by Richard and Darla Keating in the Superior Court for Santa

Clara County, California. Plaintiffs were franchised operators

of a 7-Eleven convenience store. They alleged that their fran-

chisor, Southland, had utilized an accounting system in pre-

paring financial statements for their store that was unfair and

inaccurate and that representatives of Southland had made

certain fraudulent representations concerning the accounting

system. Southland’s conduct was alleged to give rise to several

related causes of action, including common law fraud, breach

of contract, breach of fiduciary duty and a violation of the

California Franchise Investment Law.' Plaintiffs purported to

l The California Franchise Investment Law requires franchisors to

mak: certain disclosures to prospective franchisees, and prohibits

franchisors from making fraudulent or misleading statements to those

prospective franchisees. In essence, it establishes a specific statutory

cause of action for certain fraudulent conduct. Plaintiffs’ claim under

this statute is based on the same facts as, and is largely duplicative of,

plaintiffs’ various common law causes of action.

4

represent a class of all current and former 7-Eleven franchisees

in California.’ Thereafter, similar complaints were filed by the

other appellees herein, and the actions were consolidated for

pretrial proceedings in the Superior Court for Alameda

County.’

Pursuant to an arbitration clause in plaintiffs’ franchise

agreements, which provided that the parties would arbitrate

“any controversy or claim arising out of or relating to this

Agreement or the breach hereof . . . in accordance with the

Rules of the American Arbitration Association. . . ,”

Southland moved to compel arbitration in each of the cases.

Plaintiffs argued, among other things, that their claims based

on the California Franchise Investment Law were nonarbitra-

ble.‘ Southland responded that if the state statute were inter-

preted as plaintiffs urged to contain an anti-arbitration policy,

then it would be contrary to the Federal Arbitration Act and

invalid under the Supremacy Clause of the United States

Constitution.

As a fallback position, plaintiffs suggested that if their

claims were arbitrable, the court should create a procedure

whereby the arbitration would be conducted as a class action.

Plaintiffs did not seriously pursue this issue in the Superior

Court.

2 Plaintiffs’ original complaint alleged a class consisting of all current

and former 7-Eleven franchisees in the United States, but the scope of

the purported class was narrowed to California franchisees in an

amended complaint filed in December 1977. Plaintiffs alleged that

there were about 800 persons in this narrowed class.

3 Some of the consolidated cases were commenced prior to the

Keating case. However, after Keating had been filed, amended com-

piaints were filed in these cases to conform their allegations to those of

the newly-filed complaint in Keating. These amended pleadings sub-

stantially changed the focus of those earlier cases. See App. 21a-22a.

4 Plaintiffs also contended that Southland had waived its right to

arbitrate and that the agreements were unenforceable adhesion con-

tracts. However, the California Supreme Court rejected these argu-

ments on the basis of the law and the facts. (App. Sa-8a, 19a-23a.) The

“waiver” and “adhesion contract” issues are not involved in this

appeal.

5

The Superior Court held that plaintiffs were required to

arbitrate their claims of common law fraud, breach of contract

and breach of fiduciary duty, but not their claims under the

Franchise Investment Law. (See App. 72a, 74a, 79a.)' The

court did not reach the issue whether the arbitration should

proceed as a class action.

The California Court of Appeal rejected plaintiffs’ argu-

ment that the Franchise Investment Law contains an anti-arbi-

tration policy. (App. 66a-68a.) It further concluded that if the

Statute were so interpreted, it would be invalid with respect to

contracts involving interstate commerce, because the Federal

Arbitration Act provides that such arbitration agreements are

“valid, irrevocable, and enforceable.” (App. 68a-70a.) The

court therefore held that the Franchise Investment Law claims

were arbitrable along with the remainder of plaintiffs’ causes

of action. (App. 70a.) The Court of Appeal also ruled, how-

ever, that there is no “insurmountable obstacle” to conducting

an arbitration on a class-wide basis (App. 63a), and it re-

manded the cases to the trial court for class certification

proceedings, since such proceedings could not constitutionally

be conducted by an arbitral tribunal. (App. 64a.)

The California Supreme Court, by a divided vote of 4-2,

ruled on both of these issues. First, it reversed the Court of

Appeal’s ruling that claims asserted under the California Fran-

chise Investment Law are arbitrable. The court concluded that

the California legislature intended to render arbitration agree-

ments unenforceable with respect to claims based on that

5 The Superior Court's orders did not explain the reasons for denying

arbitration of the Franchise Investment Law claims. However, the trial

judge later explained on the record (i) that in his view the arbitration

clause in the 7-Eleven franchise agreement was not broad enough to

include these claims, and (ii) that he therefore had not reached

plaintiffs’ argument that Franchise Investment Law claims were nonar-

bitrable. Transcript of Hearing of July 19, 1978, at 20-24, Market

Franchise Cases, Cal. Jud. Council Coord. No. 387 (Cal. Super. Ct.,

Alameda Co.). The Superior Court’s narrow construction of the

contract was reversed by the California Court of Appeal (App.

6Sa-66a), and that ruling was not disturbed by the California Supreme

Court.

6

statute. It held further that anti-arbitration statutes of this

kind do not contravene the federal substantive law embodied

in the Federal Arbitration Act. (App. 8a-18a.)

Second, the California Supreme Court affirmed the Court of

Appeal’s ruling on the availability of a class action arbitration

procedure. (App. 23a-30a.) It stated that California public

policy favors class actions and that, in some cases, this proce-

dure might be fairer than an individual arbitration. It therefore

held that a class action arbitration could be imposed on the

parties without their mutual consent. The majority did not

directly address Southland’s argument that this pro-class ac-

tion policy is overridden, at least with respect to interstate

contracts such as those at issue here, by the federal statutory

policy favoring simple, quick, inexpensive and nonjudicial

arbitrations. The court acknowledged, however, that a judi-

cially ordered classwide arbitration “would entail a greater

degree of judicial involvement than is normally associated with

arbitration,” including “a measure” of ongoing judicial super-

vision “in order to safeguard the rights of absent class mem-

bers to adequate representation and in the event of dismissal or

settlement.” (App. 28a-29a.) The court contemplated that the

trial court would authorize discovery and briefing on the class

action issue; determine whether a class action was appropriate;

supervise any notice and opt-out procedures; oversee the arbi-

tration proceedings themselves to ensure that the interests of

the class were being adequately represented by the named

claimants and adequately protected by the arbitrators; and

review any decision to dismiss or settle the dispute. (See App.

29a.) The majority recognized that the trial court would

necessarily walk a thin and sensitive line between adequate

supervision and inappropriate intrusion: It observed that the

trial court would need to use “a good deal of care, and

ingenuity” in order to supervise the arbitration proceedings in

these ways while “avoid{ing] judicial intrusion upon the

merits” and “minimiz[ing) complexity, costs, or delay.” (App.

29a.)

The dissenting justices in the California Supreme Court

(Richardson and Mosk, JJ.) disagreed with both rulings. First,

-

with respect to the California Franchise Investment Law issue,

they referred to the long line of authority establishing that the

Federal Arbitration Act creates a body of federal substantive

law that supersedes any anti-arbitration policies at the state

level with respect to interstate arbitration agreements. (App.

32a-34a.) They disagreed with the majority’s view that the

states are free to carve out exceptions to the coverage of the

federa! statute, and concluded that the majority opinion’s

“chances of surviving federal review are very dubious.” (App.

37a.)

Second, the dissenting justices found that class action arbi-

trations would be “fundamentally contrary to the purpose of

arbitration and to the public policy encouraging arbitration.”

(App. 44a.) The dissenters noted the absence of statutory or

precedential authority for the procedure; catalogued ways in

which courts inevitably would supervise and review arbitrators’

actions; and then concluded that the majority’s newly-fash-

ioned procedure “would tend to make arbitration inefficient

instead of efficient, lengthy instead of expeditious, and proce-

dural instead of informal.” (App. 41a.)

THE QUESTIONS ARE SUBSTANTIAL

The decision of the California Supreme Court constitutes a

substantial threat to the efficacy and viability of private arbi-

tration as an alternative to judicial proceedings. The decision

seeks to establish the right of state legislatures to enact statutes

restricting the coverage of the Federal Arbitration Act, and,

with respect to other, arbitrable claims, it encumbers and

eviscerates arbitration by imposing precisely the kinds of judi-

cial procedures that arbitration was designed to avoid.

The California court's decision on the class action issue is

unprecedented. No state or federal court has ever previously

suggested that it would be proper to engraft class action

procedures—and the close judicial supervision that necessarily

comes with those procedures—onto private arbitration pro-

ceedings.

8

The California court’s decision on the Franchise Investment

Law issue improperly attempts to preempt federal substantive

law relating to interstate commerce and is in conflict with

numerous rulings by other federal and state courts. These

courts have held that interstate arbitration contracts are gov-

erned by the Federal Arbitration Act, which provides that

arbitration agreements shall be “valid, irrevocable, and en-

forceable. . . .”

Unless it is overturned by this Court, the California Supreme

Court’s decision will promote forum shopping and will restrict

the arbitrability of claims both within and outside of Califor-

nia. Moreover, the outcome of this case will determine whether

state legislatures and courts are free to adopt statutes and

policies overriding the Federal Arbitration Act.

The Federal Arbitration Act was enacted in 1925 for the

specific purposes of (i) providing an alternative to lengthy,

expensive, formalized court actions and (ii) overruling state

anti-arbitration policies where interstate commerce is in-

volved.* These policies are even more important today than

they were then. The judicial system has become burdened with

an increasingly heavy workload, and lawsuits have become

more costly, protracted and complex than they were in 1925.’ It

6 H.R. Ree No. 96, 68th Cong., Ist Sess. 1-2 (1924); Scherk v.

Alberto-Culver Co., 417 U.S. 506, 510-11 (1974); Prima Paint Corp. v.

Flood & Conklin Mfg. Co., 388 U.S. 395, 404 (1967). See S. Rer No.

536, 68th Cong., Ist Sess. 2-3 (1924); Arbitration of Interstate Com-

mercial Disputes: Joint Hearings on S. 1005 and H.R. 646 Before the

Subcomms. of the Comms. on the Judiciary, 68th Cong., Ist Sess.

34-35 (1924) (brief submitted by American Bar Association).

7 From 1940 to 1981, annual federal district court civil case filings

increased from approximately 35,000 to 180,000. Federal civil cases

increased almost six times as fast as population, and despite a signifi-

cant increase in the number of federal district court judges, the yearly

civil filings per judgeship almost doubled between 1940 and 1981, from

approximately 180 to 350 cases. Class action cases are responsible for a

significant degree of the burdens imposed upon judges. See Apminis.

trative Orrice of THe Unitep States Courts, 1981 Annuat Report oF THE

Director 3-4, 56-59, 82-83 (Prelim. ed. 1981); Aosunistrative Orrice oF

THe Unirep States Courts, 1980 Annuat Report of tHe Director 2-4,

9

is therefore of the utmost importance for this Court to prevent

the erosion of arbitration as a meaningful alternative to the

judicial method of dispute resolution.

A. The Viability of Arbitration Under the Federal Arbitration

Act Depends on Its Freedom from the Strict Judicial

Controls and Procedures Required by the Decision Below.

1. Arbitration Is a Highly Favored Alternative to Litiga-

tion in the Courts.

Arbitration is a contractual meihod of dispute resolution

that is intended to take place outside the judicial system,

without interference by the courts and without adherence to

conventional judicial procedures. By choosing arbitration, par-

ties elect to have one or more nonjudicial umpires of their

choosing, often experts in the subject matter of the dispute,

hold an informal, prompt hearing and reach a fair decision.

The arbitrators need not be lawyers, for the process they

administer is not legalistic. They enjoy wide latitude in con-

ducting the proceedings. Judicial procedures—such as pretrial

discovery, the rules of evidence, the right to appeal, a written

transcript, and the necessity of rendering carefully articulated

written decisions—are not applicable. Parties frequently con-

clude that lawyers are unnecessary in this informal setting.

Moreover, arbitrators, unlike courts, need not consider the

impact of their decisions as precedent that may be applicable to

nonparties to the controversy. Arbitration thereby facilitates

prompt decisions and discourages parties from overlitigating a

dispute because of concerns that an adverse decision may

extend beyond the particular facts at issue."

$4-58 (1980); Burger, /sn't There a Better Way, 68 A.B.A.J. 274, 275

(1982) (address to ABA). See also Kirkham, Problems of Complex

Civil Litigation, 83 F.R.D. 497, 499-501 (1979) (congestion in courts).

The congestion is not confined to the federal courts. See, e.g., Judicial

Conference for the District of Columbia Circuit, 89 F.R.D. 169, 175

(1980) (remarks of Burger, C.J.).

8 See, ¢.g., Bernhardt v. Polygraphic Co. of America, 350 U.S. 198,

203 & n.4 (1956); United Steelworkers v. Enterprise Wheel & Car

10

When Congress enacted the Federal Arbitration Act, it

sought to protect the right of parties to interstate contracts to

elect arbitration as an alternative to judicial litigation. Prior to

the Act, courts in a number of states had held arbitration to be

contrary to public policy, so Congress expressly provided, in

Section 2 of the statute, that interstate arbitration agreements

are “valid, irrevocable, and enforceable, save upon such

grounds as exist at law or in equity for the revocation of any

contract.” 9 U.S.C. § 2. The courts have uniformly held that

the Act establishes a strong federal policy favoring arbitration

and that this procedure should be protected from any efforts to

dilute its effectiveness.’ Thus, under the Supremacy Clause of

the Constitution (art. VI, cl. 2), the states cannot apply their

own Statutes and rules to interstate arbitration agreements if

those policies would constitute “an obstacle to the accomplish-

ment and execution of the full purposes and objectives of

Congress.” E.g., Chicago & N.W. Transp. Co. v. Kalo Brick &

Tile Co., 450 U.S. 311, 317 (1981). See also cases cited infra at

25-26.

The strong federal policy favoring arbitration was recently

reiterated by Congress in enacting the patent and trademark

appropriations bill for 1983-85. Pub. L. No. 97-247 (1982).

Congress included a provision in that statute which overrules

judicial decisions holding that disputes concerning patent va-

lidity or infringement are nonarbitrable. /d. § 17(b). In ex-

plaining the purpose of this provision, the House Report

Corp., 363 U.S. 593, 598 (1960). For a discu > = of the informality of

arbitration and its differences from judicial litigation, see generally A.

Wipiss, ArsitrRaTion: Commerciat Disputes, INSURANCE, and Tort CLAIMS

6-7, 339 (PLI 1979); Domxe on Commerciat Arpitration § 24.02 at

235-39, § 24.07 at 252, § 25.01 at 255-56, § 26.01 at 265-66, § 27.01 at

271-72, § 29.06 at 286-89, and pp. 312-13 (1968); Rehnquist, A Jurist’s

View of Arbitration, 32 Ars. J. 1, 5-7 (1977); Brown, Some Practical

Thoughts on Arbitration, 6 Litication 8, 8-10 (Winter 1980).

9 See, e.g., Robert Lawrence Co. v. Devonshire Fabrics, Inc., 271

F.2d 402, 406-07, 410 (2d Cir. 1959), cert. dismissed, 364 U.S. 801

(1960); Galt v. Libbey-Owens-Ford Glass Co., 376 F.2d 711, 714 (7th

Cir. 1967); J.S. & H. Construction Co. v. Richmond County Hospital

Authority, 473 F.2d 212, 214-15 (Sth Cir. 1973).

emphasized that arbitration benefits not only the parties to a

particular dispute but also the public at large by reducing the

burdens on the courts:

The advantages of arbitration are many: it is usually

cheaper and faster than litigation; it can have simpler

procedural and evidentiary rules; it normally minimizes

hostility and is less disruptive of ongoing and future

business dealings among the parties; it is often more

flexible in regard to scheduling of times and places of

hearings and discovery devices; and, arbitrators are fre-

quently better versed than judges and juries in the area of

trade customs and the technologies involved in these

disputes.

The enforcement of voluntary arbitration would serve

the public in two ways. First, . . . [it] will enhance the

patent system .. . . Secondly, arbitration could relieve

some of the burdens on the overworked Federal courts.

Chief Justice Burger in his speech to the American Bar

Association on January 24, 1982, generally endorsed the

use of arbitration to reduce the judicial backlog."

. The Essence of Arbitration Is Its Avoidance of Judicial

Procedures; Class Actions Require Active Judicial In-

volvement.

Waiver of judicial procedures goes to the heart of arbitra-

tion. Arbitration “isn’t ‘just like the courts.’ In fact, its

strongest points lie in those areas where it most widely differs

from the courts.” DOMKE ON COMMERCIAL ARBITRATION

§ 1.01, at 2. Thus, it has repeatedly been held that arbitration

should not be encumtered with procedures that might delay or

complicate the proceedings, or require judicial intervention

when the arbitration is in progress.’ As Judge Learned Hand

10

H.R. Rep. No. $42, 97th Cong., 2d Sess. 13 (1982). See also Report

of the Pound Conference Follow-Up Task Force, 74 F.R.D. 159, 166,

169, 179-81 (1976) (discussing the advantages of arbitration and

recommending its increased use).

See, ¢.g., Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S.

at 404; Cavanaugh v. McDonnell & Co., 387 Mass. 452, 457, 258

12

stated in American Almond Products Co. v. Consolidated

Pecan Sales Co., 144 F.2d 448, 451 (2d Cir. 1944):

Arbitration may or may not be a desirable substitute for

trials in courts; as to that the parties must decide in each

instance. But when they have adopted it, they must be

content with its informalities; they may not hedge it about

with those procedural limitations which it is precisely its

purpose to avoid.

The court below has done precisely that. It has imposed a

judicial mechanism which is radically different than the infor-

mal procedure agreed to by the parties, and which has a

profound impact on the scope, costs, risks and procedures of

the litigation. Indeed, class actions are the paradigm example

of large, time-consuming, rigorously-regulated, difficult-to-

manage judicial procedures.

Class actions require a much greater degree of judicial

supervision, and more rigid adherence to formalities, than

other court proceedings. Because they bind the rights of

persons who have not sued and who do not control the lawsuit,

class actions pose delicate constitutional issues. They satisfy

due process standards only if and to the extent that the named

plaintiff's claim is typical of those of other class members, the

best practicable notice is given to the class, and the named

plaintiff and his counsel fully and adequately protect the

interests of the class."

In a class action, absent class members cannot constitu-

tionally be bound by the result of the proceeding unless there

has been careful and active judicial participation in virtually all

aspects of the litigation. For example, discovery, briefing and a

N.E.2d 561, 564 (1970); De Sapio v. Kohimeyer, 35 N.Y.2d 402, 406,

362 N.Y.S.2d 843, 847, 321 N.E.2d 770, 773 (1974).

12 See Hansberry v. Lee, 311 U.S. 32, 42-43, 45 (1940); Sam Fox

Publishing Co. v. United States, 366 U.S. 683, 691 (1961); HL. v.

Matheson, 480 U.S. 398, 432 n.9 (1981) (Marshall, J., dissenting);

Robertson v. National Basketball Ass'n, $56 F.2d 682, 685-86 (2d Cir.

1977); Gonzales v. Cassidy, 474 F.2d 67, 74 (Sth Cir. 1973).

13

hearing are usually required before the court decides whether

to certify a class."’ The court must carefully define the class,

determine the best practicable form of notice to the class, and

approve the conient of the notice;'* and class members must be

allowed to opt out of the litigation." After completion of these

preliminary proceedings, which normally consume many

months," t « _9urt must continue to supervise all phases of the

litigation to eusure that plaintiff's case is based on evidence

common to the class, that plaintiff's interests are compatible

with those of the class, and that plaintiff is a vigorous,

effective and adequate class representative." If, at any time,

the initial class certification appears to have been erroneous,

the class must be realigned or decertified." If plaintiff's claims

13 See General Telephone Co. v. Falcon, 102 S. Ct. 2364, 2372 (1982)

(often necessary to “probe behind the pleadings” to decide class

issues); Coopers & Lybrand v. Livesay, 437 U.S. 463, 469 & n.12

(1978) (class issues usually “ ‘enmeshed in the factual and legal issues

comprising the plaintiff's cause of action’); Alabama v. Blue Bird

Body Co., $73 F.2d 309, 312, 322-24 (Sth Cir. 1978); Belcher v. Bassett

Furniture Industries, Inc., 588 F.2d 904, 906 (4th Cir. 1978).

14 Oppenheimer Fund, Inc. v. Sanders, 437 U.S. 340, 357 n.24 (1978);

Eisen v. Carlisle & Jacquelin, 417 U.S. 156, 173-74 (1974).

1S Feo R. Cw P 2Xc). See also the decision of the California Supreme

Court at App. 28a.

16 Frequently, a year or more will be consumed in class action discov-

ery, briefing and hearings alone. See, e.g., In re Transit Co. Tire

Antitrust Litigation, 67 F.R.D. 59, 63, 72 (W.D. Mo. 1975); Sommers

v. Abraham Lincoln Federal Savings & Loan Ass'n, 66 F.R.D. 581,

$85 (E.D. Pa. 1975).

17 E.g., In re Fine Paper Antitrust Litigation, 617 F.2d 22, 27 (3d Cir.

1980); Susman v. Lincoln American Corp. , 561 F.2d 86, 89-90 (7th Cir.

1977); National Ass'n of Regional Medical Programs, Inc. v.

Mathews, 551 F.2d 340, 344-46 (D.C. Cir. 1976), cert. denied, 431 U.S.

954 (1977).

18 General Telephone Co. v. Falcon, 102 S. Ct. at 2372; Coopers &

Lybrand v. Livesay, 437 U.S. at 469 & n.11; H.L. v. Matheson, 450

U.S. at 432 n.11 (Marshall, J., dissenting); Social Services Union,

Local 535 v. County of Santa Clara, 609 F.2d 944, 948-49 (9th Cir.

1979); Guerine v. J & W Investment, Inc., 544 F.2d 863, 864 (Sth Cir.

1977).

14

are amended, or if other significant events occur, the court may

require or authorize supplemental notices to the class.” If

either the plaintiff or the defendant wishes to communicate

with class mernbers, the court may act to prevent misrepresen-

tations or other abuses.” At trial, the court must ensure that

plaintiff's evidence is “common,” class-wide evidence.”' After

trial of the “common” issues, there may be hundreds of

additional hearings on “individual” issues, such as damages.”

Transcripts of the proceedings must be prepared, and the court

must render written decisions, so that other courts can ascer-

tain the scope of the class, the judgment, etc. After all issues of

liability and damages have been resolved, a class member

might seek to appeal from, or to avoid the res judicata effects

of, the verdict by contending that the evidence was not “com-

mon” and/or that he was not adequately represented; if he was

not, then the verdict cannot be binding on him.” In a class

action, the parties cannot even settle their dispute without

judicial review and approval: Due process requires that class

members be given notice of the settlement, and if a class

member objects, he must receive an opportunity for a hearing;

the court must then determine whether the terms of the

compromise are fair in view of the strengths and weaknesses of

plaintiff's case, and other factors.” In short, class actions

require intimate, ongoing judicial management at every stage.

19 See, e.g., Feo R. Cw P 23d,(2); 7A C. Wricnt & A. Murer,

Feperat Practice & Proceoure § 1791 at 193-94, § 1793 at 201, 207-11

(1972).

20 Gulf Oil Co. v. Bernard, 452 U.S. 89, 100 (1981).

21 = See General Telephone Co. v. Falcon, 102 S. Ct. at 2372.

22s E.g., International Brotherhood of Teamsters v. United States, 431

U.S. 324, 361 (1977); EEOC v. Korn Industries, Inc., 662 F.2d 256,

260-61 (4th Cir. 1981); Green v. Wolf Corp. , 406 F.2d 291, 301 (2d Cir.

1968), cert. denied, 395 U.S. 977 (1969).

23s E.g., Gonzales v. Cassidy, 474 F.2d 67 (Sth Cir. 1973).

24 Im re General Motors Corp. Engine Interchange Litigation, $94 F.2d

1106, 1124 & n.21 (7th Cir), cert. denied, 444 U.S. 870 (1979);

Mandujano v. Basic Vegetable Products, Inc., $41 F.2d 832, 835-36

(9h Cir. 1976); Grunin v. International House of Pancakes, $13 F.2d

15

The California Supreme Court recognized that these essen-

tial procedures, which arise from due process considerations,

cannot properly be performed by arbitrators—who often are

not even lawyers, much less judges. The California Supreme

Court therefore acknowledged that in a purported class action

arbitration the court, and not the arbitrators, would conduct

the certification proceedings, monitor the adequacy of repre-

sentation, review any proposed settlements, and so forth.

(App. 28a-29a. See also the decision of the Court of Appeal at

App. 64a.) The court below attempted to downplay the extent

to which a judge would be involved but expressly conceded

that the judiciary would be required to participate actively in

several aspects of the litigation.”

3. A Class Action Arbitration Would Destroy the Parties’

Agreement To Arbitrate.

It is difficult to imagine a procedure more alien to the spirit

of arbitration. The procedure contemplated by the court below

would seriously affect the viability of the rights guaranteed by

the Federal Arbitration Act in many ways. For example:

— a procedure designed to operate outside the judicial

system would require careful and continuous judicial

Participation;

— a mechanism intended to operate informally would be

transformed into one involving detailed, legalistic pro-

cedures;

— a procedure designed to simplify the litigation would

become more complex than if the litigation had re-

114, 120-24 (8th Cir.), cert. denied, 423 U.S. 864 (1975); Greenfield v.

Villager Industries, Inc., 483 F.2d 824, 831-34 (3d Cir. 1973). See also

Feo R. Cw P 23e).

25 Even where the complications of a class action are not present, it is

difficult for a court to play only a limited role in an arbitration. As one

commentator has noted: “[Ojnce a court gets into an arbitration

proceeding, it has almost no way to get out of it. Pretrial discovery

procedures require continual supervision.” G. Gotoserc, A Lawyer’S

Guiwe to Cowmerciat Arartration 41 (ALI-ABA 1977).

16

mained in court in the first place; the parties would

litigate their dispute in two forums rather than one,

and there would be substantial overlaps between the

roles of the judge and arbitrator;

— a mechanism intended to be quick and inexpensive

would become protracted and expensive;

— a procedure designed to permit parties to resolve a

dispute privately, and without disrupting ongoing con-

tractual relationships, would become a highly publi-

cized, high-stakes lawsuit;

— a procedure designed to facilitate compromise would

inhibit settlements by burdening them with costly and

time-consun:ing procedural hurdles;

— parties would be less willing to enter into arbitration

agreements since the risks associated with arbitration

would be significantly increased while its efficiency

and privacy would be diminished; and

— individual lawyers, accountants, architects, etc.,

would be less willing to volunteer their services as

arbitrators, because few of them will have the time,

patience or ability to participate in a massive proceed-

ing of the kind contemplated by the California Su-

preme Court.

Class actions and. arbitrations are each a useful procedural

tool for resolving disputes. This Court need not decide that one

is good, and the other bad. But the two are like oil and water

and cannot be mixed, for the use of both at the same time

would not be true to the objectives or procedures of either. One

emphasizes speed, simplicity, informality and privacy, while the

other requires caution, complexity, strict adherence to es-

tablished procedures, and publicity.

This fundamental inconsistency between the two types of

proceedings was recognized in the only other reported decision

to consider the propriety of class action arbitration. In Harris

v. Shearson Hayden Stone, Inc., 82 A.D.2d 87, 441 N.Y.S.2d

70, 75-76 (1981), aff'd mem., 56 N.Y.2d 627, 450 N.Y.S.2d

17

482, 435 N.E.2d 1097 (1982), the court held that a party should

not be permitted to avoid arbitration of his individual claim by

filing a class action in court. A dissenting justice felt that the

policy favoring class actions should prevail over the policy

favoring arbitration, but even he recognized that a class action

necessarily is a judicial procedure, unsuited to the arbitration

setting. 441 N.Y.S.2d at 79.

The California Supreme Court ignored this obvious incom-

patibility and justified its decision by erroneously assuming

that individual, small claims might be “effectively fore-

clos{ed]” unless claimants are able to aggregate their resources

by bringing class actions. (App. 25a.) The court overlooked the

fact that the objectives of class actions (relieving burdens on

the courts, reducing the cost of prosecuting individual claims)

are served by arbitration in another way. Arbitration assists the

administration of justice by consensually removing cases from

the often tortuous route of the judicial system and by provid-

ing a quick, informal, inexpensive remedy to facilitate the

prosecution of claims—particularly small claims. In other

words, arbitration satisfies the principal goals that led to the

creation of class actions without the delay, burden and expense

which accompanies that procedure. Cf. Harris v. Shearson

Hayden Stone, Inc., 441 N.Y.S.2d at 76. The California Su-

preme Court’s contrary assertion is unsupportable and should

be rejected.”

The California Supreme Court was unrealistic when it sug-

gested that hundreds or thousands of individual, duplicative

arbitrations would occur unless it created an unprecedented

class action procedure. (See App. 25a-29a.) The court cited no

evidence to support the hypothesis that this sort of wasteful

practice has occurred—either in the 7-Eleven convenience store

26 Our research has not revealed any studies that support the proposi-

tion that individual arbitration has tended to thwart the prosecution of

individual claims. Nor is there any support for that proposition in case

law or commentary prior to this litigation. Moreover, the plaintiff-

franchisees in the court below did not allege that it would be impossi-

ble or impractical to prosecute individual claims. Indeed, all of the

plaintiffs are represented by the same attorneys and yet they filed some

of the cases individually and some as purported class actions.

18

system or elsewhere—and we believe such evidence does not

exist for several reasons. First, the typical case involves only

one or a few claims, not hundreds or thousands. Class actions

stir up litigation to some extent by creating claimants who have

not previously felt aggrieved and who are not affirmatively

interested in filing suit.” Thus, the true alternative to a class

action in the instant litigation, and most others, is arbitration

with a few claimants, not hundreds. Second, even if hundreds

of claims were asserted, it is wrong to assume that it would be

necessary to duplicate the expense of arbitrating each one

individually. To the extent that the individual claims involved

similar issues, the claimants could achieve substantial econo-

mies by retaining the same attorneys (as plaintiffs have done

here), hiring the same expert witnesses, and so forth. Third,

hundreds of repetitive proceedings would not benefit either

side. In the real world, parties to contracts would probably

agree to consolidate similar claims, or, if a number of arbitra-

tions were decided in favor of one side or the other, they would

likely conform their conduct to the results of those arbitra

tions. Fourth, if a party did attempt to engage in wasteful

relitigation of hundreds of identical claims, arbitrators would

at some point give precedential weight to the outcome of prior

cases. Fifth, in positing that the “alternatives” were a single

class action or hundreds of individual hearings, the court

below overlooked the fact that a class action arbitration would

not eliminate the need for hundreds of individual trials on

“non-common” issues such as individualized damages, affirm-

ative defenses and counterclaims.

In any event, the Federal Arbitration Act does not permit a

court to upset the agreement of the parties on the ground that

some other procedure would be more “efficient” in the partic-

ailar case.™ As the court stated in Dickinson v. Heinold Securi-

ties, Inc., 661 F.2d 638, 646 (7th Cir. 1981):

27 Cf. Gulf Oil Co. v. Bernard, 452 U.S. at 100 nn.11, 12 (potential of

class action for “stirring up” litigation).

28 = See Scherk v. Alberto-Culver Co., 417 U.S. at $19 (“An agreement

to arbitrate before a specified tribunal is, in effect, a specialized kind

of forum-selection clause that posits not only the situs of the suit but

19

[T]he Arbitration Act requires that we enforce the bargain

of the parties as to dispute resolution and not substitute

our own views of economy and efficiency. There is no

room in the language of the Act, the decisions of the

Supreme Court or the decisions of this court for an ad

hoc approach, based on speculative considerations of

efficiency toward enforcement of arbitration agreements.

Or, as the New York Court of Appeals has stated:

The courtroom may not be used as a convenient vestibule

to the arbitration hall so as to allow a party to create his

own unique structure combining litigation and arbitra-

tion.

De Sapio v. Kohimeyer, 35 N.Y.2d at 406, 362 N.Y.S.2d at 847,

321 N.E.2d at 773.

The California Supreme Court missed the mark when it

attempted to analogize class action arbitrations to situations in

which some lower courts have consolidated two separate arbi-

trations involving a common set of facts and three parties

(e.g., X initiates an arbitration with Y and Y files an arbitra-

tion demand against Z in a single dispute relating to a con-

struction contract). (See App. 26a-28a.) As the dissenters

recognized, the two situations are quite different. (App. 4la-

42a.) Consolidation of two arbitrations merely brings all three

parties into one proceeding so that their mutually interdepen-

dent rights and liabilities can be adjudicated at one time.

Significantly, it did not appear in any of the decided cases that

consolidation would increase the duration or costs of the

proceeding or the amount in controversy, that consolidation

would pose manageability problems such as those presented by

class actions, or that consolidation would interfere with the

also the procedure to be used in resolving the dispute.”) (emphasis

supplied).

29 = The dissenting justices also correctly noted that the authority of

courts to compel parties to consolidate separate arbitrations is unset-

tled. (App. 42a.)

20

ability of the arbitrators to conduct the proceedings as they

saw fit.” The courts in those cases were able to make a

clear-cut, one-time decision whether the arbitrations should go

forth separately or together, and could thereafter divorce

themselves from the conduct of the proceedings. Moreover, in

the consolidation setting each party can be personally repre-

sented rather than being forced to rely on the hope that

someone else will adequately protect his interests. Thus, those

cases did not involve any of the due process and impairment-

of-arbitration issues presented here.

The California Supreme Court recognized that its class

action procedure would be radically different than a normal

arbitration and accordingly held that a party “should be given

the option of remaining in court rather than submitting to

classwide arbitration.” (App. 30a.) A person presented with

this Hobson’s choice would almost surely elect the judicial

forum. A class action arbitration would involve overlapping

responsibility between two tribunals and would be even more

complex, protracted and uncertain than a judicial class action.

Moreover, while parties to contracts are often willing to forego

their rights of appeal, discovery and adherence to rules of

evidence in the context of an informal arbitration, waiver of

these protections would involve decidedly different considera-

tions in the context of a massive class action involving hun-

dreds of litigants. Thus, the net result of a class action

arbitration would be to take the controversy out of arbitration

and back into court, effectively terminating the agreement to

arbitrate.

As noted, the objective of the Federal Arbitration Act is to

validate arbitration agreements in interstate commerce and to

protect them from efforts by individual states to require the

use of dispute-resolution procedures other than those chosen

by the parties. The California Supreme Court’s radical depar-

ture from established arbitration procedures thus presents

substantial issues affecting the administration of justice and of

federally protected rights, warranting close scrutiny by this

Court.

30 — See the cases cited by the court below at App. 26a-27a.

21

B. The Federal Arbitration Act Supersedes the Anti-Arbi-

tration Policy of the California Franchise Investment

Law.

Under Section 2 of the Federal Arbitration Act, interstate

arbitration agreements are “valid, irrevocable, and enforce-

able,” and can be avoided only on the basis of legal or

equitable principles that permit the revocation “of any con-

tract.” 9 U.S.C. § 2. This means that an agreement can be

invalidated on the basis of general principles that are applica-

ble to any contract (e.g., fraud, duress, lack of legal capacity,

waiver), but not on the basis of restrictive principles that are

aimed at arbitration agreements in particular.”

The California Franchise Investment Law requires franchi-

sors to make certain disclosures to prospective franchisees and

renders unlawful the making of materially false or misleading

statemerts. Aggrieved franchisees are given a cause of action,

and Section 31512 of the statute renders unenforceable any

agreement by a franchisee to waive rights given to him by the

Franchise Investment Law. As interpreted by the court below,”

any arbitration agreement constitutes a waiver of rights and

accordingly is void under the state statute. This is true regard-

less of whether an agreement is entered into voluntarily by

31 E.g., Collins Radio Co. v. Ex-Cell-O Corp., 467 F.2d 995, 997-98

(8th Cir. 1972); Commonwealth Edison Co. v. Gulf Oil Corp., 541

F.2d 1263, 1268-70 (7th Cir. 1976); Supak & Sons Mfg. Co. v. Pervel

Industries, Inc., $93 F.2d 135, 137 (4th Cir. 1979).

32.‘ The California Supreme Court was quite willing to discern an

anti-arbitration policy in the California Franchise Investment Law,

even though the state legislature had not addressed the subject in the

statute. The California Franchise Investment Law contains no express

provision prohibiting arbitration or even mentioning the subject of

arbitration. Nor does the legislative history of the statute refer to

arbitration. In contrast, another California statute, the California

Franchise Relations Act, Car Bus. & Pror Cope § 20040 (West 1982

Supp.), expressly declares that franchise disputes arising under that

Statute are arbitrable, and the California Supreme Court below was

hard-pressed to explain why it would be appropriate to arbitrate

controversies under one franchising statute but not the other. (See

App. 12a-13a.)

22

persons with legal capacity, regardless of whether it satisfies all

other requisites for the making of a valid contract, and

regardless of whether it provides for an impartial decision

under rules such as those of the American Arbitration Associa-

tion.”

The premise of the California Franchise Investment Law, as

construed by the state supreme court, is that arbitration of

certain franchise disputes is inherently unfair or inappropriate

(for reasons that the court below was at a loss to explain).

Accordingly, the statute invalidates arbitration agreements be-

tween franchisors and franchisees, although such a legal im-

pediment is not even-handedly applicable to all contracts. This

policy might be valid as to strictly intrastate agreements, but it

directly contravenes Section 2 of the Federal Arbitration Act

and is therefore invalid with respect to interstate contracts.

The California Supreme Court based its contrary decision on

a purported analogy between the state Franchise Investment

Law and federal Securities Act of 1933, both of which require

disclosures to prospective investors. It reasoned that since this

Court had declared in Wilko v. Swan, 346 U.S. 427 (1953),

that preexisting arbitration agreements are nonbinding as to

claims arising under the federal statute, the same result should

pertain to claims arising under the analogous California stat-

ute.

The analogy to Wilko is invalid on several grounds.“ The

most important is that Wi/ko did not involve a conflict be-

33, The California Supreme Court did not base its decision on any

finding that the 7-Eleven arbitration agreement is one-sided or that it

would give any unfair advantage to the franchisor. The arbitration

clause in the 7-Eleven franchise agreement stipulates that the rules of

the American Arbitration Association shall be applied. These es-

tablished rules, which have been incorporated into tens of thousands

of commercial agreements across the country, provide, inter alia, for

the selection of neutral arbitrators.

34s As the unanimous Court of Appeal and the dissenting justices in the

California Supreme Court recognized, the 1953 decision in Wilko was

based on the Court’s conclusion that arbitration of a securities claim

might cause a claimant to waive the benefit of the unusually liberal

venue provision in the Securities Act of 1933. (See App. 67a-68a,

23

tween a federal statute regulating contracts in interstate com-

merce and a state /jaw purporting to limit the federal statute.

Rather, Wilko involved two federal laws, and the Court in that

case was simply called upon to determine whether a particular

provision in the subsequently enacted federal Securities Act of

1933 superseded the parties’ agreement to arbitrate. Thus,

Wilko has no bearing on the Supremacy Clause issue presented

herein.

The decision of the California Supreme Court is in conflict

with the decisions of several other state and federal courts

which have rejected the Wi/ko “analogy” in the context of

conflicts between the Federal Arbitration Act and state anti-ar-

bitration statutes. They have held that the states are not free to

enact anti-arbitration statutes applicable to contracts involving

interstate commerce, because the federal statute overrides the

state law by virtue of the Supremacy Clause.

For example, in Allison v. Medicab International, Inc., 92

Wash. 2d 199, 597 P.2d 380, 382-83 (1979), which involved a

state franchise disclosure statute similar to California’s, the

Washington Supreme Court rejected plaintiffs’ argument that

the state statute rendered arbitration agreements unenforce-

able, succinctly noting:

Plaintiff cites Wilko v. Swan, . . . where the Supreme

Court refused to enforce an arbitration clause when the

dispute arose under the federal securities act. However,

31a-32a.) This Court has suggested that Wi/ko may have been based on

that narrow ground. Scherk v. Alberto-Culver Co., 417 U.S. at 513-14.

The California Franchise Investment Law does not contain a broad

venue provision similar to the one in the federal Securities Act.

Other courts have held that in view of the strong policy favoring

arbitration, the Wilko “analogy” should not be extended to other

situations. See Ingbar v. Drexel Burnham Lambert Inc., No. 82-1279,

slip. op. (Ist Cir. July 28, 1982) (rationale of Wilko does not extend to

claims under Commodities Exchange Act); Romnes v. Bache & Co.,

439 F. Supp. 833, 838 (W.D. Wis. 1977) (same); Middle East Transcon-

tinental, Inc. v. Onion Crock, Inc., 144 Mich. App. 57 (1982) (Wilko

rationale inapplicable to claims under Michigan Franchise Investment

Law).

24

this case involved two federal acts and not as here the

federal arbitration act and a state franchising act.

We hold that the supremacy clause of the federal

constitution must prevail and thus the federal arbitration

act requires enforcement of the arbitration clause in the

franchise agreement despite the judicial remedies afforded

by the [state] Franchise Investment Protection Act.

The same reasoning was applied by a federal court in Barron v.

Tastee Freez International, Inc., 482 F. Supp. 1213, 1216-17

(E.D. Wis. 1980), in holding that the Federal Arbitration Act

prevails over any anti-arbitration policy of the Wisconsin

Franchise Investment Act.

In the instant case, the three-judge panel of the California

Court of Appeal, as well as the two dissenting justices in the

state Supreme Court, agreed that the federal policy favoring

arbitration supersedes any effort by California to prohibit

arbitration of disputes to which the Federal Arbitration Act

applies. (App. 31a-37a; 66a-70a.) See also, e.g., Bache Halsey

Stuart Shields, Inc. v. Moebius, 531 F. Supp. 75 (E.D. Wis.

1982); R.J. Palmer Construction Co. v. Wichita Band Instru-

ment Co., 7 Kan. App. 2d 363, 642 P.2d 127 (1982); Merrill

Lynch Pierce Fenner & Smith Inc. v. Melamed, 405 So. 2d 790

(Fla. Dist. Ct. App. 1981). In these and many other cases (a

few of which are cited at App. 32a-37a), the courts have almost

uniformly held that the Federal Arbitration Act establishes

national substantive law that prevails over any contrary state

policies.

In support of its conclusion that the California statute is not

preempted by federal law, the California Supreme Court mis-

takenly relied on this Court’s decision in Merrill Lynch, Pierce,

Fenner & Smith, Inc. v. Ware, 414 U.S. 117 (1973). (App.

17a-18a.) Ware simply held that the particular state statute at

issue in that case was not preempted by a particular federal

statute because there was no conflict between them. Ware is

25

plainly distinguishable from the case at bar, which involves a

direct federal-state conflict, and indeed, the preemption princi-

ples summarized in that case dictate the opposite conclusion

here.”

As the Court noted in Ware, preemption depends on whether

the state statute “frustrates any part of the purpose of the

federal legislation.” 414 U.S. at 139. The Court has similarly

articulated the standard in other cases. For instance, in Perez

v. Campbell, 402 U.S. 637 (1971), it was stated that a state

statute is void under the Supremacy Clause if it “ ‘stands as an

obstacle to the accomplishment and execution of the full

purposes and objectives of Congress.’” 402 U.S. at 649,

quoting Hines v. Davidowitz, 312 U.S. 52, 67 (1941). The

Court reiterated this test in its recent decisions in Chicago &

N.W. Transp. Co. v. Kalo Brick & Tile Co., 450 U.S. at

317-18, and Jones v. Rath Packing Co., 430 U.S. 519, 525-26

(1977). And in Colorado Anti-Discrimination Comm'n vy. Con-

tinental Air Lines, Inc., 372 U.S. 714, 722 (1963), the Court

framed the issue in terms of whether the state enactment “is in

direct conflict with federal law, . . . denies rights granted by

Congress, or. . . stands as an obstacle to the full effectiveness

of a federal statute.”

35. Ware involved an alleged conflict between a state Labor Code

provision exempting wage disputes from arbitration and a New York

Stock Exchange rule providing for compulsory arbitration of wage

disputes between members of the exchange and their employees. This

Court found that there was no conflict between the policies underlying

the state statute and the policies underlying the federal securities laws

(pursuant to which the stock exchange had promulgated its compulsory

arbitration rule), and accordingly held that the state legislation was not

preempted by the stock exchange rule.

Ware did not involve an alleged conflict between a state law and the

Federal Arbitration Act. Therefore, as the California Supreme Court

me eS “the holding in the case is consequently not controlling

" (App. 18a.) (A likely reason why no issue under the Federal

pond ghapmpcbony h Ware is the proviso in § | of the Act,

which exempts from the coverage of the Act contracts of employment

of workers engaged in interstate commerce.)

26

Under these principles, the California Franchise Investment

Law must give way to the strong federal policy favoring

arbitration. There is here a direct conflict between the state and

federal statutes: One renders arbitration clauses in interstate

franchise agreements unenforceable; the other provides that

such agreements shall be “valid, irrevocable, and enforceable.”

Instead of supplementing federal remedies, the California

franchising statute “denies rights granted by Congress.” Col-

orado Anti-Discrimination Comm’n, 372 U.S. at 722. Finally,

in view of the fact that Congress’ objective in enacting the

Federal Arbitration Act was to expand the availability of

arbitration, it is plain that the California statute’s constriction

of that remedy, “ ‘stands as an obstacle to the accomplishment

and execution of the full purposes and objectives of Con-

gress.” Perez v. Campbell, 402 U.S. at 649.

The California Supreme Court held that although the Fed-

eral Arbitration Act overrides any state policy that might be

hostile “to arbitration generally,” the Act allows the states to

adopt “exceptions” to the general principle of arbitrability.

(App. 1Sa-16a.) The court made no effort to define the subject

areas or scope of the permissible exceptions, and there is in

fact no sound basis for allowing a state to chip away at the

federal arbitration remedy piece by piece. Under the reasoning

of the California court, a state might be prohibited from

eliminating the right to arbitration in one fell swoop, but it

would be allowed to do so by means of a series of “excep-

tions.” This year’s exception could be for franchisor-franchisee

disputes, next year’s could be for disputes between lenders and

borrowers, and the following year the state might ban the

arbitration of tort claims. In each instance, the state could

easily identify a “public policy” favoring judicial resolution of

the category of disputes.

The California court’s decision would also impair arbitra-

tion by inviting “unseemly and mutually destructive jockeying

by the parties to secure tactical litigation advantages.” Scherk

v. Alberto-Culver Co., 417 U.S. at 517. A party desiring to

27

avoid arbitration could, through artful pleading, structure his

claims so as to fit within one of the state-created “exceptions”

to arbitration.” It would also encourage forum shopping since

the enforceability of an arbitration agreement would often

depend on whether the claim were brought in state or federal

court. (See App. 35a.) See also Merrill Lynch Pierce Fenner &

Smith Inc. v. Melamed, 405 So. 2d at 792-93. This Court

should not countenance such results. Just as the stability of

international business transactions would be undercut if one

country were to refuse to enforce international arbitration

agreements based on parochial concerns, Scherk v. Alberto-

Culver Co., 417 U.S. at 516-517, orderliness and predictability

in interstate commerce would be impaired if individual states

36 =‘ This case offers a good example of the possibilities for such

maneuvering. The claim in this litigation is that Southland misled the

plaintiffs by misstating and failing to disclose material facts at the time

they franchised their 7-Eleven stores. Accordingly, the primary allega-

tion in plaintiffs’ original pleadings was that Southland had engaged in

intentional and nezligent fraud in violation of common law. However,

after the trial court had ruled that claims based on the California

Franchise Investment Law are nonarbitrable, new complaints were

filed in two of the consolidated cases (Coy and Scovis); these pleadings

contained a single count, based on the Franchise Investment Law.

Plaintiffs’ counsel candidly conceded to the trial court that they had

phrased their claims as statutory violations, and not as common law

causes of action, for the express purpose of avoiding their contractual

commitment to arbitrate their disputes. See plaintiffs’ “Memorandum

of Points and Authorities in Opposition to Petition to Compel Arbitra-

tion,” at 3-4 (filed July 17, 1978), where plaintiffs’ attorneys stated:

(Mjay these plaintiffs . . . avoid arbitration by limiting their

complaints to causes of action under the Franchise Investment

Law? The answer to this question is clearly: yes, of course they

can. Having had the benefit of guidelines provided by the

Court, plaintiffs’ counsel have filed pleadings best calculated to

both present the essential claims of the particular plaintiffs in-

volved, and to plead an effective class action. . . .

were free to create “exceptions” to the arbitrability of disputes

involving interstate contracts.”

State-created “exceptions” would fly in the face of the

express language of Section 2 of the Federal Arbitration Act,

and would also violate the intent of Congress, which was to

provide for the uniform treatment of interstate arbitration

agreements among the states. If this policy is deemed to be

unduly broad, California’s remedy is not to enact its own

contradictory legislation, but to petition Congress to modify

the law to permit the states to restrict the permissible subjects

of arbitration.

CONCLUSION

The decision of the California Supreme Court opens the

door to widespread efforts by state legislatures and courts to

declare various areas of interstate commerce to be “off limits”

for arbitration under the Federal Arbitration Act. In addition,

the California court’s ruling would saddle the remaining,

arbitrable disputes with burdensome, self-defeating, judicial

class action procedures. The court’s ruling on both issues is in

conflict with decisions of numerous other courts, which have

given full effect to the strong policy favoring arbitration

embodied in the federal statute.

37 In the instant case, the court below suggested that plaintiffs might be

able to avoid their duty to arbitrate altogether—both with respect to

their statutory claims and their common law claims—by asserting a

claim under the Franchise Investment Law. (App. 18a n.15.)

29

For these reasons, we respectfully submit that this appeal

presents substantial legal issues requiring full consideration by

this Court.”

Respectfully submitted,

Of Counsel:

ARNOLD & PORTER

Washington, D.C.

MCKENNA, CONNER & CUNEO

San Francisco, California

September 1982

PETER K. BLEAKLEY*

MARK J. SPOONER

MARC D. GUREN

1200 New Hampshire Ave., N.W.

Washington, D.C. 20036

(202) 872-6700

AARON M. PECK

CHARLES G. MILLER

MARTIN H. KRESSE

1920 Mills Tower

220 Bush Street

San Francisco, California 94104

(415) 433-0640

Attorneys for Appellants,

The Southland Corporation,

et al.

*Counsel of Record

38 If this Court should conclude that this case does not fall within its

appellate jurisdiction, Southland requests that this jurisdictional state-

ment be treated as a petition for a writ of certiorari, in which case

jurisdiction is invoked pursuant to 28 U.S.C. § 1257(3) (1976). See 28

U.S.C. § 2103 (1976).