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«No. W2002-01275-SC-R11-CV - Filed August 31, 2004 We granted permission to appeal in this case to determine whether a claim for fraudulent inducement ...»

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April 7, 2004 Session


Appeal by permission from the Court of Appeals, Western Section

Chancery Court for Shelby County

No. CH-02-0287-3 Hon. D. J. Alissandratos, Judge

No. W2002-01275-SC-R11-CV - Filed August 31, 2004

We granted permission to appeal in this case to determine whether a claim for fraudulent inducement to a contract must be submitted to arbitration when the contract’s arbitration clause covers “all claims, demands, disputes or controversies” and states that it is governed by the Federal Arbitration Act (“FAA”). We hold that parties may agree to arbitrate claims of fraudulent inducement despite prohibition of arbitration of such claims under Tennessee law, and because the parties in this case specifically agreed that the FAA governs the arbitration clause, they agreed to arbitrate the claim for fraudulent inducement of the contract. However, we also find that the arbitration clause in this case is unconscionable and therefore void because it reserves the right to a judicial forum for the defendants while requiring the plaintiff to submit all claims to arbitration.

For these reasons, the trial court’s dismissal of the complaint is overruled, and the decision of the Court of Appeals is affirmed.

Tenn. R. App. P. 11 Appeal by Permission; Judgment of the Court of Appeals is Affirmed.

WILLIAM M. BARKER, J., delivered the opinion of the court, in which FRANK F. DROWOTA, III, C.J., and E. RILEY ANDERSON and ADOLPHO A. BIRCH, Jr., JJ. joined. JANICE M. HOLDER, J., filed a concurring and dissenting opinion.

Joseph D. Barton, Millington, Tennessee, for the appellant, City Auto Sales.

Sam F. Cole, Jr., Memphis, Tennessee, for the appellee, Sharon Taylor.



On June 4, 1998, Sharon Taylor (“Taylor”) purchased a car from City Auto Sales (“City Auto”).1 The parties signed a contract entitled “As Is Used Vehicle Retail Buyers Order” (“Buyers Order”). The Buyers Order provided that the total cost of the vehicle was $10,058.00. Taylor was to make a cash down payment to City Auto in the amount of $1,310.00 and finance the remainder.

The Buyers Order contained an arbitration provision which stated that “all claims, demands, disputes or controversies of every kind or nature between [the parties] arising from the [sale of the vehicle] shall be settled by binding arbitration conducted pursuant to the provisions of the Federal Arbitration Act, 9 U.S.C. Section 12 et seq.” Taylor sold her carfor $1,000.00 and used the proceeds therefrom as part of her down payment; she then signed a short-term promissory note agreeing to pay the remainder of the down payment over the following three months. City Auto delivered the vehicle to Taylor on the day the Buyers Order was signed. Taylor claims that City Auto told her at the time of delivery that her longterm financing had been approved. It is undisputed, however, that at the time of delivery, Taylor signed a separate “Spot Delivery Agreement.” This agreement stated that City Auto was giving Taylor immediate possession of the car “pending the purchase of the installment sale agreement by a financing institution.” The agreement also provided that, if proper financing could not be obtained within three days, City Auto would have the option to “immediately rescind the sale.” Additionally, in the event that Taylor did not immediately return the vehicle, City Auto would “have the right to take immediate possession of the vehicle.” Approximately one week after the sale, City Auto notified Taylor that her application for financing had not been approved. When Taylor did not return the vehicle, City Auto repossessed the car along with personal items belonging to Taylor that were inside the vehicle at that time. City Auto retained possession of Taylor’s personal belongings along with the $1,000.00 down payment.

Taylor filed suit against City Auto alleging a violation of the Tennessee Consumer Protection Act (“TCPA”), arguing that City Auto improperly obtained her $1,000.00 down payment and her personal property that was in the car by using deceptive tactics in violation of the TCPA. Taylor also alleged that she was told that the Spot Delivery Agreement was “simply a formality and did not change the fact that she had already been approved for financing” on the sale of the car. City Auto responded by filing a motion to dismiss.

Taylor also names Douglas Butler as a defendant in her complaint as a representative of City Auto. No separate allegations were made against Butler; he and City Auto were referred to collectively as “defendants.” The Court of Appeals treated the defendants collectively. On appeal to this Court, only City Auto filed an application for permission to appeal.

-2The trial court granted City Auto’s motion to dismiss the complaint, holding that Taylor was bound by the arbitration provision in the Buyers Order. The Court of Appeals reversed the trial court, holding that a plaintiff cannot be compelled to arbitrate a claim pursuant to an arbitration provision that was fraudulently induced.

We granted City Auto’s application to appeal to determine whether parties can be bound to arbitrate a claim for fraudulent inducement when the arbitration clause specifically states that it is governed by the FAA. On appeal, Taylor also raises the issue of whether the arbitration agreement is unconscionable because it reserves for City Auto the right to pursue judicial remedies while limiting Taylor to arbitration.

–  –  –

I. Arbitration of Claim for Fraudulent Inducement The FAA applies to “a written provision in any maritime transaction or a contract evidencing a transaction involving interstate commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction.” 9 U.S.C. § 2 (1994). The purpose of the FAA is “to ensure the enforceability, according to their terms, of private agreements to arbitrate.” Mastrobuono v.

Shearson Lehman Hutton, Inc., 514 U.S. 52, 57 (1995) (quoting Volt Info. Sci., Inc. v. Bd. of Tr. of Leland Stanford Junior Univ., 489 U.S. 468, 476 (1989)). Generally, arbitration “should not be denied unless it may be said with positive assurance that the arbitration clause is not susceptible of an interpretation that covers the asserted dispute. Doubts should be resolved in favor of coverage.” United Steelworkers of Am. v. Warrior & Gulf Navigation Co., 363 U.S. 574, 582-83 (1960).

As the United States Supreme Court has stated,

Arbitration under the [FAA] is a matter of consent, not coercion, and parties are generally free to structure their arbitration agreements as they see fit. Just as they may limit by contract the issues which they will arbitrate, so too may they specify by contract the rules under which that arbitration will be conducted.

Volt Info. Sci., Inc., 489 U.S. at 479 (citations omitted). Therefore, the question becomes “what the contract has to say about the arbitrability of petitioner’s claim.” Mastrobuono, 514 U.S. at 58; see also Frizzell Const. Co. v. Gatlinburg, L.L.C., 9 S.W.3d 79, 84 (Tenn. 1999).

In this case, the arbitration clause governs “all claims, demands, disputes or controversies of every kind or nature between [the parties] arising from the [sale of the vehicle].” The arbitration clause also states that arbitration shall be “conducted pursuant to the provisions of the Federal Arbitration Act, 9 U.S.C. Section 12 et seq.” Furthermore, it contains the provision that the parties “agree that any question regarding whether a particular controversy is subject to arbitration shall be decided by the arbitrator.”

-3When a contract is controlled by the FAA and contains a broad arbitration clause, claims of fraudulent inducement are subject to arbitration. Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 403-04 (1967). Specifically, the United States Supreme Court held that the language of the FAA “does not permit the federal court to consider claims of fraud in the inducement generally.” Id. at 404. Instead, the court may address allegations of fraud only if they are directed to the arbitration clause itself. Id. at 403-04.

In the case under submission, the Court of Appeals found that the claim of fraud in the inducement was not subject to arbitration despite the holding in Prima Paint. The Court of Appeals relied upon City of Blaine v. John Coleman Hayes & Assoc., Inc., 818 S.W.2d 33 (Tenn. Ct. App.

1991) and Frizzell, 9 S.W.3d at 85, as well as two unreported cases.

In City of Blaine, the Court of Appeals rejected the majority opinion in Prima Paint and held that the issue of fraudulent inducement could not be submitted to arbitration under the Tennessee Uniform Arbitration Act. 818 S.W.2d 33, 37-38 (Tenn. Ct. App. 1991). While recognizing that the FAA provides for arbitration of claims of fraud, the Court of Appeals interpreted the Tennessee arbitration statute as requiring judicial determination on the issues of rescission of the contract including fraud in the inducement. Id. Specifically, the Court found that there was no contract to arbitrate if the contract were procured by fraud. Id. at 37.

This Court has also held that claims of fraud in the inducement are to be resolved by the courts and not by an arbitrator when the contract is governed by Tennessee law. Frizzell Constr. Co., 9 S.W.3d at 84. In Frizzell, the arbitration clause purported to govern “[a]ll claims, disputes and or other matters in questions arising out of, or relating to, this Agreement.” Id. at 81. In addition to this arbitration clause, the contract contained a clause stating that Tennessee law would form the basis

for deciding questions concerning the contract’s scope and interpretations. We held that:

By stating that the contract is to be governed by Tennessee law, the parties have indicated their intention to arbitrate all disputes “arising out of, or relating to” their agreement – but only to the extent allowed by Tennessee law.... Therefore, because Tennessee law contemplates judicial resolution of contract formation issues, we conclude that the parties have indicated their intention not to submit such issues to arbitration.

Id. at 85.

The case under submission differs from City of Blaine and Frizzell in that both City of Blaine and Frizzell specifically provided that the laws of Tennessee would govern the arbitration of the contract. In contrast, the arbitration agreement in this case clearly states that it is to be governed by the FAA and not the Tennessee Uniform Arbitration Act. This distinction is important considering the long history in the federal courts of allowing arbitration of fraudulent inducement claims under the FAA, see Prima Paint, 388 U.S. at 402-05, even though Tennessee law prohibits the arbitration of such claims, see Frizzell, 9 S.W.3d at 84.

-4In Frizzell, we stressed that, in deciding whether a claim of fraudulent inducement is subject to arbitration, courts must focus upon the specific terms of the contract at issue. 9 S.W.3d at 84. We held that if the parties agreed to arbitrate the claim of fraudulent inducement, then despite such a prohibition under Tennessee law, the claim must be submitted to arbitration. Id. The converse is equally true – if the parties did not agree to arbitrate the claim of fraudulent inducement, then they could not be compelled to arbitrate the claim despite the fact that the claim could be arbitrated under the FAA. Id.

It is undisputed that Taylor signed a contract that specifically stated that “all claims, demands, disputes or controversies of every kind or nature between [the parties] arising from the [sale of the vehicle] shall be settled by binding arbitration pursuant to the provisions of the Federal Arbitration Act.” (Emphasis added). Therefore, because Taylor knowingly signed the contract, she agreed to arbitrate a claim of fraudulent inducement.

II. Was the Arbitration Provision Unconscionable?2

Taylor also argues that the arbitration agreement is void because it is unconscionable. She maintains that even if the contract was not induced by fraud, the terms of the arbitration provision are unconscionable because the contract reserves for City Auto the right to litigate claims it may have against Taylor while requiring Taylor to submit any of her claims to arbitration.

A. Who Determines Whether the Arbitration Clause Is Unconscionable?

In Prima Paint, the United States Supreme Court held that while claims of fraud are to be submitted to an arbitrator, claims that specifically attack the formation of the arbitration provision of a contract are to be judicially determined.

Under [section] 4 [of the FAA], with respect to a matter within the jurisdiction of the federal courts save for the existence of an arbitration clause, the federal court is instructed to order arbitration to proceed once it is satisfied that ‘the making of the agreement for arbitration or the failure to comply (with the arbitration agreement) is not in issue.’ Accordingly, if the claim is fraud in the inducement of the arbitration clause itself – an issue which goes to the ‘making’ of the agreement to arbitration – the federal court may proceed to adjudicate it.

Prima Paint, 388 U.S. at 403-04 (internal footnote omitted).

The dissent contends that the issue of unconscionability was waived because it was not raised until the case was before this Court, and therefore should not be considered. The majority agrees with the dissent to the extent that the pleadings are vague and unclear as to the issues raised by the pleadings. However, this appeal requires us to interpret the provisions of the contract, and the majority is of the opinion that we would not be doing justice in this case were we to consider only the duties and obligations of Ms. Taylor under the contract and not look to the rights and remedies available to the defendant.

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