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October Term, 2009

April 27, 2010

Today the Supreme Court issued two decisions, described below, of interest to the business community.

Federal Arbitration Act—Class Arbitration

Stolt-Nielsen S.A. v. Animalfeeds International Corp., No. 08-1198 (Apr. 27, 2010) (previously discussed in the June 15, 2009 docket report)

Until a 2003 Supreme Court decision highlighted the possibility, few arbitration agreements expressly addressed whether the arbitrator may adjudicate claims on a class-wide basis. Instead, most parties to arbitration agreements assumed that arbitration would take place on a bilateral basis. In Green Tree Financial Corp. v. Bazzle, 539 U.S. 444 (2003), a plurality of the Court concluded that, in the first instance, the arbitrator should resolve whether such a “silent” agreement permits class arbitration. Today, in Stolt-Nielsen S.A. v. Animalfeeds International Corp., No. 08-1198, a majority of the Court squarely held that imposing class arbitration on parties who have not agreed to authorize class arbitration is inconsistent with the Federal Arbitration Act, 9 U.S.C. §§ 1–16.

In the underlying action, Animalfeeds had brought a class action alleging price fixing against major shipping companies. After the court compelled arbitration of the dispute pursuant to an arbitration clause that was silent on the issue of class arbitration, the arbitrators determined that the clause allowed for class arbitration. The district court vacated the award, holding that the arbitrators’ decision was made in “manifest disregard” of federal maritime law. The Second Circuit reversed, concluding that the Supreme Court’s decision in Bazzle permits arbitrators to determine whether a “silent” clause permits class arbitration.

In an opinion authored by Justice Alito and joined by the Chief Justice and Justices Scalia, Kennedy, and Thomas, the Supreme Court reversed the Second Circuit. The Court held that the arbitrators had exceeded their powers by imposing their own policy choice favoring class arbitration instead of identifying and applying a rule of decision for construing “silent” arbitration clauses that is derived from the Federal Arbitration Act or from maritime or New York law. The Court explained that Bazzle had left open the question of what standard governs the determination of whether class arbitration is permitted.

Answering that open question, the Court held that the Federal Arbitration Act prohibits imposing class arbitration on a party unless there is a “contractual basis for concluding that the party agreed to do so.” Slip op. 20. The Court acknowledged that parties to an arbitration agreement often implicitly authorize the arbitrator to adopt procedures necessary to give effect to the parties’ agreement to arbitrate. But an implicit agreement to allow class arbitration, the Court explained, could not be inferred in this manner. To do so, the Court explained, would run counter to the long-standing principle that parties may structure their arbitration agreements—including the procedures under which arbitration takes place—as they see fit. Superimposing class procedures on an individual arbitration would be so fundamental a change in the scope, burdens, and stakes of an arbitral proceeding that it would frustrate the parties’ assumptions in agreeing to arbitrate in the first place. As the Court explained, “class-action arbitration changes the nature of arbitration to such a degree that it cannot be presumed the parties consented to it by simply agreeing to submit their disputes to an arbitrator.” Id. at 21.

Justice Ginsburg wrote a dissenting opinion, joined by Justices Stevens and Breyer. (Justice Sotomayor did not participate in the case.) The dissenters contended that the issue was not ripe for Supreme Court review because the arbitrators had determined only that the parties’ arbitration agreement permits class arbitration, not whether the dispute actually was suitable for class-wide adjudication. The dissenters also challenged the majority’s decision on the merits, arguing that the arbitrators’ award should have been upheld under the applicable narrow standard of review, and that the majority erred in concluding that class arbitration is impermissible under the Federal Arbitration Act in the absence of “contractual language one can read as affirmatively authorizing class arbitration.” Id. at 11. 

Finally, the dissenters pointed out what they characterized as two “stopping points” in the majority’s decision. Slip op. 12 (Ginsburg, J., dissenting). First, Justice Ginsburg wrote, the Court did not decide what “contractual basis” is necessary to support the conclusion that the parties agreed to class arbitration. Id. at 12–13. Second, the dissenters argued that by referring to the sophistication of the parties in this case, the majority left open the issue of whether its holding applies more broadly to standardized contracts used in consumer and employment settings. Id. at 13.

The practical impact of the Court’s decision in Stolt-Nielsen is significant. Millions of arbitration agreements do not expressly address class arbitration, and hundreds of millions more expressly prohibit class arbitration. The Court’s decision will provide substantial support to businesses that seek to avoid the imposition of class arbitration procedures or to defeat arguments by plaintiffs that clauses requiring arbitration to take place on an individual basis are unconscionable or violate public policy. The decision also gives businesses that have been forced into class arbitration a powerful argument that any class-wide award would be in excess of the arbitrators’ powers.

Mayer Brown filed an amicus brief in support of the Stolt-Nielsen petitioners on behalf of CTIA—The Wireless Association.

Securities Exchange Act—Statute of Limitations

Merck & Co. v. Reynolds, No. 08-905 (previously discussed in the May 26, 2009 Docket Report).

The Securities Exchange Act of 1934 provides that private actions alleging securities fraud are timely if they are filed within “2 years after the discovery of the facts constituting the violation” and within “5 years after such violation.” 28 U.S.C. § 1658(b). Today, in a decision likely to have significant ramifications, the Supreme Court addressed the first of these limitations, holding in Merck & Co. v. Reynolds, No. 08-905, that the two-year limitation period does not begin to run until a reasonably diligent plaintiff would have uncovered evidence of scienter—that is, evidence that the defendant not only made a false or misleading statement, but did so knowingly or deliberately.

In an opinion by Justice Breyer, the Court held that § 1658(b)(1), which imposes the two-year limitation, instructs courts to apply the so-called “discovery rule,” according to which a claim accrues when the plaintiff knows, or with the exercise of reasonable diligence should have known, the facts that give rise to the cause of action. The Court also held that one of the facts necessary to trigger the two-year limitations period for securities fraud claims is evidence of scienter, since the heightened pleading requirements in fraud cases require the plaintiff to set forth facts suggesting scienter in the complaint. Further, the Court explained that for the plaintiff to have notice of scienter, there must be evidence not just that the defendant made a false or misleading statement, but that the defendant was aware that the statement was false and deliberately lied. Finally, the Court clarified that it is not sufficient for the plaintiff to have mere “inquiry notice” that would lead a reasonably diligent plaintiff to begin investigating; rather, the two-year statute of limitations does not begin to run until the time that a reasonably diligent investigation would have actually uncovered the evidence of scienter.

Justice Scalia wrote a brief concurrence, joined by Justice Thomas, explaining that as he reads the statute, the two-year limitations period should begin to run only once the plaintiff has actual knowledge of scienter, rather than mere constructive knowledge based on what a reasonably diligent plaintiff should have discovered. Justice Stevens also authored a short concurrence stating that he would reserve decision on whether the statute requires actual or constructive knowledge because the answer to that question would not affect the outcome in this case.
The Court’s decision will be of great significance to any business facing potential securities fraud claims, since today’s decision makes it substantially more difficult for defendants accused of fraud to prevail on a statute of limitations defense. The Court acknowledged concerns that its decision “will give life to stale claims or subject defendants to liability for acts taken long ago” (slip op. 14), but stated that these concerns are adequately addressed by the statutory bar on any private securities action brought more than five years after the alleged violation. There is also a significant likelihood that the decision will be applied to a variety of fraud claims arising outside of the securities context, which would potentially allow plaintiffs to bring claims based on long-ago conduct where businesses do not have the benefit of the securities statute’s five-year repose period.

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