Third Circuit Holds That Challenges to the Validity of a Contract Containing an Arbitration Provision Can Only Be Adjudicated by the Arbitrator

In a recent precedential decision, South Jersey Sanitation Co., Inc. v. Applied Underwriters Captive Risk Assurance Co., Inc., the Third Circuit held that although arbitration agreements may be invalidated by generally applicable contract defenses, like fraud, in order for the court to decide the issue, the challenge “must focus exclusively on the arbitration provision, rather than on the contract as a whole.” “If the challenge encompasses the contract as a whole, the validity of that contract, like all other disputes arising under the contract, is a matter for the arbitrator to decide.”

In South Jersey Sanitation, the dispute arose after South Jersey refused to pay premiums allegedly owed pursuant to a Reinsurance Placement Agreement (“RPA”), which contained an arbitration provision stating that any disputes arising under the contract will be arbitrated. South Jersey initially filed a complaint in the New Jersey Superior Court, seeking declaratory relief and rescission of the RPA on several grounds, including fraud, intentional misrepresentation, and illegality. In response, Applied Underwriters filed a motion to compel arbitration in accordance with the Federal Arbitration Act (“FAA”). The District Court denied Applied Underwriters’ motion to compel arbitration, on the ground that Nebraska law – the choice of law stipulated in the RPA – rendered unenforceable all arbitration provisions concerning or relating to an insurance policy.

The Third Circuit reversed. First, the Court held that it was plain from a review of the complaint that “South Jersey alleges no arbitration provision-specific fraud, but rather challenges the arbitration provision only as part of its general challenge of the contract. Indeed, South Jersey states in its brief that ‘[f]raud is a defense that is generally applicable to all contracts and can invalidate a whole contract or certain portions thereof, including arbitrations [sic] agreements.’” The panel found that the plaintiff’s “wholesale fraud defense could not defeat a clear arbitration provision.”

Second, the court held that South Jersey did not carry its burden of showing that the RPA was an agreement concerning an insurance policy which would have implicated the Nebraska statute, and therefore, the question of whether the RPA’s arbitration provision is enforceable under Nebraska law was for the arbitrator to decide. As the court explained, “by the clear and comprehensive arbitration provision in the RPA, it is for the arbitrator to determine what the precise nature of the RPA is and whether the RPA falls within” the Nebraska statute, and whether this determination, “like the fraud challenge, implicates the RPA as a whole.”

The Third Circuit’s decision is significant because it reinforces the U.S. Supreme Court’s decisions in Rent-A-Ctr., W., Inc. v. Jackson, 561 U.S. 63 (2010), and Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395 (1967), which held that, when a contract contains an arbitration provision, the court can only adjudicate claims for fraud in the inducement of the arbitration clause itself, and cannot consider claims for fraud in the inducement of the contract generally. Thus, it is clear to parties doing business within the Third Circuit that, if a contract contains an arbitration provision, the court can only consider challenges to the legal validity of the arbitration provision. As such, any challenges to the legal validity of the contract as a whole can only be adjudicated by the arbitrator.