When a party is sued and has a right to move to compel arbitration, but delays and engages in the litigation process instead, there arises the question of whether, or at what point, the defending party has waived its right to arbitration. In May 2022, the Supreme Court issued its opinion in Morgan v. Sundance, Inc., where it held that under the Federal Arbitration Act (“FAA”), courts may not “condition a waiver of the right to arbitration on a showing of prejudice.” Prior to Morgan, a majority of federal courts of appeal had required a showing of prejudice before finding arbitration waiver. According to the Supreme Court that was erroneous because the federal policy “favoring arbitration” does not permit courts to “invent special, arbitration preferring procedural rules.” Rather, it simply requires courts to place arbitration agreements “on the same footing as other contracts.” Since “a federal court assessing waiver does not generally ask about prejudice,” the Court held it could not do so in the context of arbitration waiver either.

As noted in Part III of Alto Litigation’s blog series on Morgan v. Sundance, courts have identified ambiguity in Morgan’s primary holding. Specifically, it is not clear whether courts should continue to apply their unique arbitration waiver tests (shorn of any prejudice requirement) or simply apply their general test for waivers of all contractual rights. While there often will not be “much daylight between those two tests,” the Southern District for New York concluded that in the Second Circuit at least, the two tests could lead to different results. That conclusion led the court to perform two waiver analyses before rendering its ruling.

But what should state courts do? After all, Morgan was a federal holding regarding federal procedural rules. However, because the FAA applies to lawsuits that involve interstate commerce, it preempts state laws that fail to place arbitration agreements on equal footing with other contracts. Therefore, if state court litigation involves interstate commerce within the meaning of the FAA, then the court will have to apply Morgan. If the litigation involves wholly intrastate issues, then Morgan will not be binding. Thus, the first step for a state court is to evaluate whether the dispute is inter- or intra-state.

If the dispute is truly interstate, then the state court must grapple with the impact of Morgan. The biggest problem arises in states where prejudice is an integral component of the implied waiver analysis that applies to all contracts. While Morgan was based on the premise that “a federal court assessing waiver does not generally ask about prejudice,” that is not true in all fifty states. Thus, the second step, is to ascertain the jurisdiction’s test for arbitration waiver and compare it to the general test for waiver to see if there is meaningful daylight between them.

For example, in Nevada, the test for implied waiver requires a showing of prejudice: “In order to establish a waiver, the intention to waive must clearly appear, and the party relying upon the waiver must have been misled to his prejudice.” If a Nevada court were to try to apply Morgan, it is faces something of a catch-22:

If the court follows Morgan’s command to strip prejudice from the test, then the court would violate Morgan’s command to avoid bespoke procedural rules that treat arbitration agreements different from other agreements;

If the court applies its general implied waiver rule, it would violate Morgan’s express holding that prejudice should not be part of the arbitration waiver analysis.

While it is unclear how the ambiguity in Morgan should be resolved, it may not have much bearing on case outcomes, as explained in Part V of this blog series.

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Please contact Alto Litigation partners Bahram Seyedin-Noor (bahram@altolit.com) or Bryan Ketroser (bryan@altolit.com) if you require counseling on a securities litigation matter.

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¹ Morgan v. Sundance, Inc., 142 S.Ct. 1708, 1713 (2022)

² Id.

³ Id.

⁴ Id.

⁵ Herrera v. Manna 2nd Avenue LLC, 1:20-cv-11026-GHW, 2022 WL 2819072, at *7 (July 18, 2022) (internal citations omitted).

⁶ Id.

⁷ 9 U.S.C. § 1.

⁸ Southland Corp. v. Keating, 465 U.S. 1 (1984).