Third Circuit Enforces Arbitration Provision in Consumer Contract Where Designated Arbitral Forum is Unavailable

In a matter of first impression, the Third Circuit in Khan v. Dell Inc. held that the Federal Arbitration Act requires the appointment of a substitute arbitral forum where the forum designated by the parties is unavailable and the designation of that particular (unavailable) forum was not integral to the arbitration provision.

The case stemmed from alleged design defects in a Dell computer purchased by plaintiff Khan. Dell’s Terms and Conditions of Sale included an arbitration provision which provided that any dispute between Khan and Dell “SHALL BE RESOLVED EXCLUSIVELY AND FINALLY BY BINDING ARBITRATION ADMINISTERED BY THE NATIONAL ARBITRATION FORUM (NAF)” and that “this provision shall be governed by the Federal Arbitration Act 9 U.S.C. sec. 1-16 (FAA).” The arbitration provision did not designate a replacement arbitrator in the event that NAF was unavailable.

Khan filed a putative class action in the District of New Jersey alleging several claims, including consumer fraud and breach of warranties. At the time Khan filed suit, a consent judgment resolving unrelated litigation barred the NAF from conducting consumer arbitrations as a result of having engaged in deceptive practices that disadvantaged consumers. There was no evidence that Dell knew of such practices when it selected the NAF as the arbitral forum.

The district court denied Dell’s motion to compel arbitration, but a divided Third Circuit panel vacated that decision and remanded for further proceedings. The Third Circuit majority noted that the Terms and Conditions specifically incorporated the FAA and that section 5 of the FAA, which states that “if for any other reason there shall be a lapse in the naming of an arbitrator . . . or in filling a vacancy, then upon the application of either party . . . the court shall designate and appoint an arbitrator,” provided a mechanism for substituting an unavailable arbitrator. The majority further explained that the applicability of section 5 depends upon “whether the designation of the arbitrator was ‘integral’ to the arbitration provision or was merely an ancillary consideration.” Thus, to avoid application of section 5 — and therefore arbitration — “the parties must have unambiguously expressed their intent not to arbitrate their disputes in the event that the designated arbitral forum is unavailable.”

Applying that standard, the majority found the Terms and Conditions to be ambiguous, reasoning that “EXCLUSIVELY” could modify “BINDING ARBITRATION,” “THE NATIONAL ARBITRATION FORUM,” or both and that other courts have reached conflicting interpretations of such language. Citing federal policy favoring arbitration, the majority resolved that ambiguity in favor of arbitration, concluding that the FAA requires appointment of a substitute arbitrator.

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