Failure to Pay Arbitration Fees Breaches Agreement That Requires Arbitration

Roach v. BM Motoring, LLC, 228 N.J. 163 (2017).  Plaintiffs bought used cars from defendants.  In connection with those purchases, plaintiffs signed Dispute Resolution Agreements (“DRA’s”) that required any disputes to be arbitrated “in accordance with the rules” of the American Arbitration Association (“AAA”).  Several months later, plaintiffs filed for arbitration with the AAA, asserting claims under consumer protection statutes.  The DRA’s required defendants to pay filing fees for the arbitration, but defendants neither paid the fees nor otherwise responded.  No arbitration proceeded.

Plaintiffs then filed suit in the Law Division.  Defendants moved to dismiss in favor of arbitration, which the Law Division granted.  Plaintiffs again demanded arbitration through the AAA, but the AAA dismissed the arbitration demand because defendants had previously failed to comply with the AAA’s procedures.  Plaintiffs sued anew in the Law Division, and defendants again moved to compel arbitration.  Defendants claimed that they had not contemplated arbitrating through the AAA, due to its allegedly excessive fees.  Plaintiffs argued that defendants had breached the DRA’s when they failed to pay the fees, or that defendants had waived the right to arbitration.

The Law Division again dismissed the case in favor of arbitration, and the Appellate Division affirmed.  Today, the Supreme Court reversed that ruling.  Justice Solomon wrote the opinion for a unanimous Court.  He applied the de novo standard of review, while being “mindful of the strong preference to enforce arbitration agreements.”

Justice Solomon noted that both federal and New Jersey statutes endorse arbitration.  But arbitration agreements are contracts like any other, and are to be interpreted in accordance with general principles applicable to contracts.  A material breach of an arbitration contract would excuse performance by the non-breaching party.  Justice Solomon invoked the “flexible criteria” contained in Restatement (Second) of Contracts §241 to determine whether there was a material breach here.  This was the first time that the Court had adopted that section of the Restatement (though, as stated in a footnote, this was not the first time that the Court had relied on the Restatement (Second) of Contracts), just as the Court recently endorsed for the first time a provision of the Restatement (Second) of Conflict of Laws that determines the applicable state statute of limitations in tort cases.  McCarrell v. Hoffman-LaRoche, Inc., ___ N.J. ___ (2017), discussed here.

Justice Solomon quickly rejected defendants’ argument that plaintiffs did not act in accordance with the DRA’s when they demanded AAA arbitration.  Applying the “plain and ordinary meaning” of the DRA’s, and construing any ambiguities in the DRA’s against defendants, the drafters, the Court concluded that the requirement of arbitration “in accordance with the rules” of the AAA permitted parties to go to the AAA as plaintiffs did, and that defendants should have expected to be before the AAA.

Turning to the Restatement §241 criteria, Justice Solomon did not need to go beyond two of those criteria to find defendants in material breach.  The first crtierion– “the extent to which the injured party will be deprived of the benefit which he reasonably expected”– favored plaintiffs.  “The benefit expected under an arbitration agreement is the ability to arbitrate claims.”  Plaintiffs tried to invoke that benefit but were rebuffed because defendants did not pay the required fees.  That failure by defendants went “to the essence” of the DRA’s and therefore constituted a material breach.

The other criterion that Justice Solomon cited was “the extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing.”  Defendants’ refusal to pay the AAA fees breached their duty of good faith and fair dealing in that defendants thereby “destroy[ed] or injur[ed] the right of [plaintiffs] to receive the fruits of the [DRA].”

To buttress his opinion, Justice Solomon cited cases from federal courts that had reached this same result.  He approved of the reasoning of one of those decisions in particular, which cautioned that a contrary result would create a “perverse incentive scheme,” under which “a company could ignore an arbitration demand and, if the claimant did not abandon the claim, later compel arbitration.”

Justice Solomon cautioned that this opinion did not establish a bright-line rule that any refusal or failure to respond to an arbitration demand constitutes a material breach of an arbitration agreement that excuses the need to go to arbitration and instead allows a lawsuit in court.  The Restatement criteria are designed to be applied “on a case-by-case basis after considering the agreement’s terms and the conduct of the parties.”

The lower courts here were presumably influenced by the strong policy in favor of arbitration that prior cases have articulated.  The Supreme Court, however, had the ability to recognize that, on these facts, any such policy was overridden by defendants’ patent breach of their own contracts.

One other aspect worthy of comment appeared in a footnote.  Justice Solomon observed that the arbitration clause might have been unenforceable because it appeared in a very small font size.  The parties had not raised that issue, so the Court did not decide it.  But the footnote opens up a tantalizing possibility for plaintiffs to void arbitration clauses based on their formatting.