Involving Commerce: How Far Does the Federal Arbitration Act Reach?

Because of the risk of what some might perceive as extortion via class action lawsuits, arbitration agreements have be come a critical line of defense. But what if you are sued by residents of your own state and the claim is made that the suit isn’t one “involving commerce”?

Preemption and the “Involving Commerce” Standard

One of the benefits of the Federal Arbitration Act (FAA) is that it generally preempts state and local laws which make entering into and enforcing an arbitration clause more difficult. For example, some state laws require arbitration agreements to be “signed” by both parties, which can be difficult (if not impossible) to achieve in an online setting. Others prohibit arbitration of constitutional or civil rights issues. Some bar arbitration clauses in some or all consumer contracts.

But, preemption has its limits. One such limit is that it only applies to transactions “involving commerce,” and, by commerce, it means “interstate commerce.” But what, in fact, does it mean for a transaction to involve interstate commerce? Does it apply, for example, to a contract where both parties reside in the same state?

“Involving commerce” is as broad as it gets

Fortunately, case law establishes that “involving commerce” basically means as far as the federal government’s power extends under the Commerce Clause. What that means, in short, is that even the most tenuous connection to interstate activity may suffice. Of course, that doesn’t mean that broad reach won’t be tested by class action lawyers.

In 1995, the U.S. Supreme Court looked at the FAA’s “involving commerce” language in the case of Allied-Bruce Terminix Companies, Inc. v. Dobson, and concluded that it is broader than “in commerce,” and covers more than “only persons or activities within the flow of interstate commerce.” Indeed, it concluded that the phrase “involving commerce” is broad enough to reflect Congress’ intent to exercise to the fullest its Commerce Clause powers.

Whether a contract “involves commerce” extends to actual connections to interstate commerce (direct or indirect), not just what the parties understood or intended when they entered into their agreement. This opens up the chance to demonstrate a connection to interstate commerce even in contracts that appear to be purely intrastate in nature.

Analyzing Allied-Bruce Terminix, Inc. v. Dobson

So far, so good. But, in the Dobson case, the parties did not contest that their transaction, “in fact, involved interstate commerce.” Eight years after Dobson, the Supreme Court looked at this question in Citizens Bank v. Alafabco, Inc.

In Alafabco, the Court found that the a debt-restructuring agreement “involved commerce,” even though it was signed in Alabama by Alabama residents. It relied on three factors. First, Alafabco, the borrower, used the proceeds of the loan it obtained throughout the southeastern United States. Second, the borrower secured its loan with inventory that had, in the past, moved in interstate commerce. Finally, the Court found that all commercial lending has important interstate attributes.

Thus, Alafabco teaches that we should look at connections to interstate commerce that lie beyond the the purchase and sale agreement. For example, was the product sold by a retailer originally acquired via interstate commerce? Does its website business involve interstate communications? Was the product delivered from an out-of-state location via drop shipping? Because the test is whether interstate commerce is involved “in fact” — that is, even if the parties are unaware of it — these kinds of connections can make a world of difference.

The possibility of an absolute rule

It should be noted there is language in more recent U.S. Supreme Court cases that suggests a per se invalidation of state law limits on arbitration — in essence deeming any transaction to, effectively, “involve commerce” under the FAA. These cases include AT&T Mobility LLC v. Concepcion (2013) (“When state law prohibits outright the arbitration of a particular type of claim, the analysis is straightforward: The conflicting rule is displaced by the FAA.”), Marmet Health Care Center, Inc. v. Brown (2012) (involving a claim of negligence by West Virginia residents against a West Virginia nursing home), and Nitro-Lift Technologies, L.L.C. v. Howard (2012). The Supreme Court’s decision in Kindred Nursing Centers Ltd. Partnership v. Clark (2017) has similarly expansive language.

Some lower state courts have pushed back, rejecting this broad interpretation. Best to be prepared for a fight.