Third Circuit Concludes Arbitration Agreement Is Unenforceable Under the Prospective Waiver Doctrine

The Third Circuit Court of Appeals has refused to enforce an arbitration agreement because it impermissibly limited claims to those available under tribal law at the expense of federal statutory claims. The court also concluded that the relevant clause could not be severed from the agreement.

Christina Williams and Michael Stermel entered into payday loan agreements that provided that they were subject to and governed by tribal law. The agreements also "limit[ed] disputes to tribal laws and to tribal courts." The agreements also contained arbitration agreements.

Williams and Stermel sued in federal court on behalf of a putative class for violations of federal and Pennsylvania law, claiming that the agreements charged unlawfully high interest rates. The defendants moved to compel arbitration. The district court denied the defendants' motion.

The Third Circuit affirmed. It explained "that arbitration is only appropriate so long as the prospective litigant effectively may vindicate his or her statutory cause of action in the arbitral forum" and that "arbitration agreements that limit a party's substantive claims to those under tribal law, and hence forbid federal claims from being brought, are unenforceable."

Applying those principles to Williams' and Stermel's claims, the court evaluated the loan agreements and concluded that they impermissibly limited claims to tribal law claims. The court rejected the defendants' argument that the agreements were proper because they allowed borrowers to make claims under "such federal law as is applicable under the Indian Commerce Clause." The court read the contract differently, as only allowing claims under tribal law, and also concluded that the restriction to the Indian Commerce Clause was improper because it precluded claims under other federal provisions, including a RICO claim asserted by the plaintiffs.

The Third Circuit also concluded that a severability clause did not save the balance of the arbitration agreement "because the prohibited waiver here [was] not severable." The court concluded that clauses limiting claims to those available under tribal law was an essential term of the contract and that "the arbitration agreement's clear reference to the exclusive application of tribal law is intertwined with the arbitration process and is central to it." The court could not enforce arbitration without impermissibly rewriting the contract.

Williams v. Medley Opportunity Fund II, LP, No. 19-2058 (3d Cir. July 14, 2020).