Painewebber Incorporated v. Mohamad S. Elahi, Kokab Moarefi Elahi and Maryam Elahi
Docket: 95-2188
Court: Court of Appeals for the First Circuit; July 3, 1996; Federal Appellate Court
Mohamad S. Elahi, Kokab Moarefi Elahi, and Maryam Elahi, former clients of PaineWebber Incorporated, sought arbitration for claims related to unsuitable investments made in 1986. PaineWebber filed a federal complaint to stay arbitration, arguing the claims were time-barred under the arbitration agreement's terms. The district court dismissed PaineWebber's complaint and compelled arbitration, a decision that PaineWebber appealed.
The Elahis had signed a 'Client's Agreement' with PaineWebber, which mandated arbitration for disputes and was governed by New York law. In 1994, they claimed that PaineWebber's broker sold them inappropriate investments and misled them about their security. A tolling agreement executed on August 3, 1994, intended to pause the statute of limitations from June 28, 1994. However, this agreement came over seven years after the last investment purchase.
On December 29, 1994, the Elahis filed for arbitration with the NASD, citing various legal violations. PaineWebber argued that the NASD arbitration rules barred claims filed more than six years after the relevant investment transactions, citing Section 15 of the NASD Code of Arbitration Procedure. This section states that claims are not eligible for arbitration if over six years have passed from the triggering event. The Elahis contested this by filing motions to dismiss PaineWebber's complaint and to compel arbitration under the Federal Arbitration Act.
The district court ruled in favor of the Elahis, confirming the existence of a valid arbitration agreement related to investment transactions and determining that the time-bar provision of section 15 should be addressed by an arbitrator rather than the court. PaineWebber appealed, arguing that the section 15 time bar renders the Elahis' claims ineligible for arbitration and that the court should decide the timeliness issue. The appeal presents a legal question regarding whether the court or the arbitrator should interpret the time-bar provision, with a split among circuit courts on this issue.
PaineWebber's arguments include: (1) the choice of New York law in the arbitration agreement implies that the court must apply the section 15 time bar, as established by New York case law; and (2) under federal law, the time bar is a matter of arbitrability to be resolved by the court unless there is clear evidence of intent to submit such determinations to arbitration. The choice-of-law provision is analyzed under federal arbitration law, which promotes arbitration agreements despite conflicting state laws. The Federal Arbitration Act (FAA) indicates a federal policy favoring arbitration, suggesting that it creates a federal standard for arbitrability applicable to all agreements within the Act’s scope.
The agreement between the parties falls under the Federal Arbitration Act (FAA) as it is deemed to involve commerce. The determination of whether the section 15 time bar is applied by a court or an arbitrator pertains to 'arbitrability,' necessitating adherence to federal common law established under the FAA. The FAA's primary goal is to enforce private arbitration agreements according to their terms, emphasizing that arbitration is based on consent. The Supreme Court has clarified that state powers are limited in requiring judicial resolution for claims agreed to be arbitrated.
State laws generally applicable to contracts may apply to arbitration agreements, but specific state laws targeting arbitration are overridden by the FAA. Consequently, New York law cannot compel the parties to submit the section 15 time bar question to a court; the focus is on whether the parties intended to adopt state caselaw that mandates court resolution. The Supreme Court's ruling in Mastrobuono highlighted that a choice-of-law provision does not imply an intention to exclude punitive damages unless clearly stated.
Applying Mastrobuono's principles, the current case's choice-of-law clause does not signify an intention to adopt New York law requiring courts to handle section 15. The broad arbitration clause, encompassing all disputes related to the agreement, suggests that the choice-of-law clause does not limit arbitrator authority. Furthermore, stipulations for arbitration to follow NASD rules weaken the argument for adopting New York arbitration rules. Therefore, the choice-of-law provision pertains to substantive rights and obligations, while the arbitration clause governs the arbitration process, without imposing limitations on arbitrators.
A contractual choice of New York law does not necessitate a judicial ruling on the NASD Code section 15 time bar. Instead, the focus shifts to the arbitration clause and the NASD Code of Arbitration Procedure, examining whether the arbitrator or the court should apply the time bar based on federal arbitration law principles. Federal arbitration law asserts that arbitration is fundamentally contractual; parties cannot be compelled to arbitrate disputes that they have not explicitly agreed to submit. Where an agreement's scope is ambiguous, default rules and presumption principles apply.
The Supreme Court has stated that the determination of arbitrability—the obligation to arbitrate a specific grievance—must generally be made by the court unless there is clear evidence that the parties designated the arbitrator to make this determination. Therefore, if the section 15 time bar is relevant to the arbitrability of the claims, the district court must interpret and apply it unless there is explicit agreement for the arbitrator to decide.
The established presumption favors arbitration, meaning any uncertainties regarding the scope of arbitrable issues should be resolved in favor of arbitration. If the time bar does not affect arbitrability, then the arbitrator would address its applicability under the broad arbitration clause, unless the parties' agreement indicates otherwise. The case's outcome depends on whether the time bar is considered an arbitrability issue or a separate matter, guiding which presumption—court or arbitrator—applies in this context.
The NASD time bar's classification as an issue of 'arbitrability' is examined through relevant Supreme Court precedents, particularly First Options and AT&T. In First Options, the Court determined that whether a party is bound by an arbitration agreement—specifically, if individuals are liable for corporate debts without having signed the agreement—is an 'arbitrability' issue for courts to decide. AT&T further clarified that if an arbitration agreement explicitly excludes certain subjects, such as management decisions including layoffs, the courts must decide whether those subjects are arbitrable.
In the current case involving PaineWebber and the Elahis, both parties are bound by a broadly scoped arbitration agreement regarding unsuitable investments. However, PaineWebber argues that the NASD section 15 time bar, which it views as a substantive eligibility requirement, prevents arbitration of this dispute. The critical question is whether the time bar affects the 'arbitrability' of the dispute's merits. The Supreme Court has defined 'arbitrability' as whether an agreement creates a duty to arbitrate specific grievances. Thus, the analysis hinges on whether the parties intended to arbitrate only disputes less than six years old, which would categorize the time bar as an 'arbitrability' issue. The complexity arises in considering whether procedural rules, such as payment of arbitrator fees, could similarly be deemed 'arbitrability' issues if they prevent the arbitration of merits.
Determining who decides the applicability of the section 15 time bar in arbitration is complex. Five circuits (Third, Sixth, Seventh, Tenth, and Eleventh) have concluded that courts must decide this issue, interpreting the time bar as a substantive eligibility requirement that serves as a jurisdictional prerequisite to arbitration. They argue that since section 15 indicates that claims over six years old are not "eligible for submission," this limits the arbitrator's jurisdiction, thus necessitating court involvement. These circuits find no clear intent in arbitration agreements to delegate this time-bar issue to arbitrators.
Contrarily, the text asserts that the language of section 15 is not unambiguous regarding who decides its applicability. It does not clearly categorize the time bar as an "arbitrability" issue nor address the scope of the arbitration clause. It can be seen more like a statute of limitations, where timeliness issues typically fall to arbitrators. The Seventh Circuit's reliance on a 1988 NASD staff attorney's letter to support the view that section 15 is a court-determined eligibility requirement is criticized, as the letter's relevance and authority are questionable. The NASD has since clarified its position, stating that section 15 does not specify whether courts or arbitrators should adjudicate time-bar issues and has proposed an amendment to assign this decision to the NASD Director of Arbitration.
Four circuits—the Second, Fifth, Eighth, and Ninth—hold that the arbitrator should determine the applicability of the section 15 time bar. While agreeing with their conclusions, the analysis provided by these circuits raises unresolved questions. The Fifth Circuit, in *Smith Barney Shearson, Inc. v. Boone*, distinguished between 'substantive' and 'procedural arbitrability,' concluding that issues of timeliness related to section 15 are procedural and must be decided by the arbitrator. The Eighth Circuit also assigned the application of section 15 to the arbitrator but did not classify the time bar as procedural or substantive, instead relying on section 35 of the NASD Code, which empowers arbitrators to interpret all provisions. The Second Circuit, in *PaineWebber, Inc. v. Bybyk*, similarly determined that the arbitrator has the authority to decide the time bar issue, interpreting the parties' broad arbitration agreement as a clear indication of their intent to delegate this decision to the arbitrator. The Ninth Circuit, in *O'Neel v. National Ass'n of Secs. Dealers, Inc.*, asserted that the validity of time-barred defenses should generally be addressed by the arbitrator, although this ruling predates the current section 15 and lacks extensive analysis. The overarching consideration is whether the parties intended for the time bar to qualify as an 'arbitrability' issue, which must be resolved by a court prior to arbitration, as the parties' intent governs arbitration matters.
A valid and extensive arbitration clause exists, covering all disputes related to investment transactions and agreements. The question arises whether the parties intended for the statute of limitations in section 15 to determine 'arbitrability' as defined in AT&T and First Options. If the parties intended for a specific issue to be resolved by the courts prior to arbitration, the courts must honor that intent. However, if the intent is unclear, a presumption about their intent is applied.
If the parties have a valid arbitration agreement and it encompasses the subject matter of the dispute, it is presumed they intended for an arbitrator to resolve all remaining issues related to the dispute. Signing a valid arbitration agreement suggests a commitment to arbitration, making it likely that any procedural or substantive issues are for the arbitrator to decide.
Conversely, if the parties explicitly state that a matter pertains to 'arbitrability,' the court must resolve that issue before any arbitration can occur. This presumption aligns with federal arbitration policy and reflects the assumption that parties expect arbitrators to handle all related issues unless they clearly indicate otherwise.
The presumption adopted here distinguishes between whether an issue is categorized as 'arbitrability' and who decides those issues. The AT&T and First Options cases establish that courts typically decide arbitrability questions, particularly in situations where the existence of an arbitration agreement is in dispute or where the subject matter falls outside the arbitration's scope. This presumption acknowledges that parties likely did not consider who should resolve arbitrability when forming their agreement.
Where parties have clearly agreed to arbitrate their dispute, it is unlikely they intended ancillary issues, such as the timeliness of a claim, to affect the arbitrability of the dispute, especially with a broad arbitration clause. The presumption is that the time bar under section 15 is not an arbitrability question for the courts. The agreement between PaineWebber and the Elahis does not contain a clear intent to classify the NASD time bar as an arbitrability issue. Under New York contract law, the intent should be derived from the agreement's plain language, which here simply states that arbitration will follow NASD rules. PaineWebber's argument that the time bar is an arbitrability issue hinges on the 'eligible for submission' language in section 15, suggesting that only the courts can determine eligibility. However, this interpretation is not the only plausible one, as 'submission to arbitration' could refer to full adjudication rather than preliminary determinations. The NASD has indicated that section 15 does not clarify who determines eligibility, supporting the conclusion that the time bar is not intended as an arbitrability issue. Additionally, NASD Code section 35, which empowers arbitrators to interpret all provisions, further negates the notion that the time bar should be exclusively determined by courts.
The section 15 time bar is part of the NASD Code of Arbitration Procedure, indicating it is intended for application by the NASD to regulate its own procedures. The NASD rules apply only once the NASD is selected as the arbitral forum, and while other forums may have similar six-year time bars, they could potentially feature different rules or phrasing. If the parties aimed for the time bar to be a judicial issue rather than an arbitrable one, they would likely have specified this more clearly. The parties' agreement to arbitrate "all controversies" related to investment transactions suggests they intended for any issues regarding the timeliness of disputes to be resolved by an arbitrator. The district court's decision to refer the time bar issues to arbitration is affirmed, with costs awarded to the appellees. The court noted that determining the triggering "occurrence or event" for the time bar and whether it is subject to equitable tolling are issues for future resolution, but the immediate question was whether the district court correctly deferred to the arbitrator on these matters. This approach aligns with prior cases and the Federal Arbitration Act, which supports arbitration agreements unless there are grounds to revoke them.
The Supreme Court's decision in First Options of Chicago, Inc. v. Kaplan significantly referenced labor arbitration cases to establish whether courts or arbitrators determine arbitrability in commercial arbitration agreements, particularly drawing from AT&T precedents. It is deemed appropriate to apply these labor arbitration principles to the current commercial arbitration context. Notably, McCarthy v. Azure and Finegold v. Alexander Associates illustrate the integration of labor arbitration precedents in commercial contexts, albeit with caution against conflating the two. Raytheon Co. v. Automated Business Systems highlights the inapplicability of labor arbitration standards when assessing arbitrators' authority to award punitive damages, due to the differing nature of labor-management and commercial relationships.
The parties involved acknowledge that the NASD Code of Arbitration Procedure was included by reference in their agreement, despite the NASD not being determined as the arbitral forum at the time of the agreement's execution. Additionally, related cases demonstrate a consistent application of similar time-bar rules without significant variances in arbitration clause language. The NASD's withdrawal of a proposed amendment in October 1994, while not negating its earlier statements, underscores ongoing efforts to achieve a consensus on procedural matters.
The Fourth Circuit's stance, which has yet to address this specific issue, aligns with the Fifth Circuit's "substance vs. procedure" approach, as seen in Miller v. Prudential Bache Securities Inc., where arbitration clauses governed procedural aspects, but did not prevent NASD arbitrators from applying anti-fraud provisions from other exchanges.
The court determined that the NASD arbitration rules pertain solely to arbitration procedures rather than the substantive aspects of disputes. The Fourth Circuit's interpretation aligns with this view, suggesting that the NASD Code of Arbitration Procedure, including section 15, is meant for the arbitrator's interpretation. Although the small investors likely lacked awareness of the NASD arbitration rules, the parties recognized that these rules were incorporated into their agreement, binding them to section 15 regardless of their understanding. The court referenced the precedent from Level Export Corp. v. Wolz, Aiken. Co., asserting that accepting a contract implies knowledge of its contents.
The discussion further referenced the Supreme Court's decision in John Wiley & Sons, Inc. v. Livingston, which asserted that time limits for grievance submissions should be resolved by the arbitrator, not the court. This was echoed in Local 285, Serv. Employees Int'l Union v. Nonotuck Resource Assocs. Inc., where the court maintained that procedural questions, even if framed as conditions precedent to arbitration, are for the arbitrator to decide. Despite acknowledging this precedent, the court emphasized the necessity of respecting the parties' contractual intent regarding timeliness issues, suggesting that if parties explicitly designate a procedural issue as one that the arbitrator cannot resolve, that intent must be honored.
