Third Circuit Holds Agreement to Arbitrate in Illusory Forum Is Unenforceable

The Third Circuit Court of Appeals recently held, in a precedential decision, that when parties enter an agreement directing them to arbitrate in an illusory forum, the forum selection clause is not severable and the entire agreement to arbitrate is unenforceable.

In MacDonald v. CashCall, Inc. et al., a plaintiff brought suit on behalf of himself and a putative class, alleging a loan agreement between the parties was unconscionable and usurious. The agreement at issue included “(1) a provision requiring that all disputes be resolved through arbitration conducted by a representative of the Cheyenne River Sioux Tribe (‘CRST’) and (2) a clause that delegates questions about the arbitration provision’s enforceability to the arbitrator.” The defendants moved to compel arbitration. The district court declined to compel arbitration because the agreement at issue expressly disavowed federal and state law, thus rendering the arbitration provisions invalid as an impermissible prospective waiver of federal and state statutory rights. The district court further held that the arbitration agreement was unenforceable because the forum was illusory, as the selected forum did not conduct arbitrations or have rules for conducting arbitrations.

The Third Circuit affirmed the district court’s conclusion that the loan agreement’s arbitration provision cannot direct arbitration to an illusory forum—here, the CRST. Similar to its sister circuits, the Third Circuit found that in the loan agreement at issue, “there is no arbitration forum in which an arbitrator could evaluate whether the arbitration provision is enforceable.” In Inetianbor v. CashCall, Inc., the Eleventh Circuit addressed a similar issue arbitration clause, holding that such a tribal arbitral forum does not exist. Shortly thereafter, in Jackson v. PayDay Fin., LLC, the Seventh Circuit, reviewed a loan agreement with a similar arbitration provision and concluded that “[t]he [CRST] ‘did not authorize Arbitration,’ it did not involve itself in the hiring of arbitrators, and it did not have consumer dispute rules,” and that the loan agreement included an illusory and unreasonable forum. Accordingly, similar to the Seventh and Eleventh Circuits, the Third Circuit concluded that the CRST arbitral forum found in the loan agreement was nonexistent, and that the arbitration provision was unenforceable because the forum is illusory.

The Third Circuit also rejected the defendants’ argument that the arbitration agreement was still valid and enforceable because the illusory forum provision could be severed. The Panel, applying New Jersey law, found that the tribal “arbitration provision was an integral, not ancillary, part of the parties’ agreement, despite inclusion of a severability clause in the contract.” The forum selection clause and references to the CRST and its rules “reflect[ed] that the primary purpose of the Loan Agreement was to arbitrate disputes subject to CRST oversight and its laws.” Applying New Jersey law in construing the choice of arbitrator provision in the loan agreement, the Third Circuit found the defendants’ arguments meritless with respect to the availability of an alternative arbitral forum because of the inclusion of the choice of arbitration provision.

Since the MacDonald decision, a district court in the Ninth Circuit, in Rideout v. CashCall, Inc., has addressed a similarly worded arbitration provision. Although the Rideout court invalidated the arbitration clause on other grounds, the court found the Third Circuit’s decision in MacDonald to be a separate basis to invalidate the arbitration clause. To that end, Inetianbor, Jackson, MacDonald, and Rideout all demonstrate that courts are inclined to deny a motion to compel arbitration and find an arbitration provision unenforceable when it provides for an arbitral forum that is illusory and unreasonable.