Bernhardt v. Polygraphic Co. of America, Inc.
1956 U.S. LEXIS 1487, 76 S. Ct. 273, 350 U.S. 198 (1956)
Rule of Law:
In a diversity case, federal courts must apply state law regarding the enforceability of arbitration agreements if the state law substantially affects the outcome of the litigation, and the Federal Arbitration Act only applies to maritime transactions or contracts involving interstate commerce.
Facts:
- Bernhardt, a resident of New York at the time, entered into an employment contract with Polygraphic Co. of America, a New York corporation.
- The contract was made in New York and stipulated that any disputes would be submitted to arbitration under New York law by the American Arbitration Association, with the determination being "final and absolute."
- Bernhardt later moved to Vermont, where he was to perform his duties under the employment contract.
- Bernhardt was subsequently discharged from his employment.
Procedural Posture:
- Bernhardt sued Polygraphic Co. of America in a Vermont state court for damages for discharge under an employment contract.
- Polygraphic Co. of America removed the case from the Vermont state court to the United States District Court for the District of Vermont on grounds of diversity of citizenship.
- In the District Court, Polygraphic Co. of America moved for a stay of proceedings so the controversy could go to arbitration in New York, arguing New York law should govern the arbitration provision.
- The District Court denied the stay, ruling that under Erie R. Co. v. Tompkins, Vermont law governed the arbitration provision and Vermont law makes such agreements revocable before an award is made.
- Polygraphic Co. of America (appellant) appealed the District Court's denial of the stay to the United States Court of Appeals for the Second Circuit.
- The Court of Appeals reversed the District Court's decision, holding that the arbitration provision was a matter of procedure, not substance, and that Section 3 of the Federal Arbitration Act applied to all arbitration agreements, thus requiring a stay.
- Bernhardt (petitioner) filed a petition for certiorari with the Supreme Court of the United States, which was granted due to the Court of Appeals' doubtful application of Erie R. Co. v. Tompkins.
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Issue:
Does the Federal Arbitration Act apply to an employment contract that does not involve maritime transactions or interstate commerce, and if not, must a federal court in a diversity case apply state law regarding the enforceability of an arbitration agreement if that state law considers such agreements revocable?
Opinions:
Majority - William O. Douglas
No, the Federal Arbitration Act does not apply to an employment contract that does not involve maritime transactions or interstate commerce, and a federal court in a diversity case must apply state law regarding the enforceability of an arbitration agreement if that state law considers such agreements revocable and its application would substantially affect the outcome of the litigation. The Court first addressed the applicability of the Federal Arbitration Act (FAA), finding that the contract in question did not involve a "maritime transaction" or a "transaction involving commerce" as defined in Section 2 of the Act. The Court rejected the Court of Appeals' interpretation that Section 3 of the FAA, which provides for stays of actions pending arbitration, could apply independently of Section 2's limitations. The Court reasoned that Sections 1, 2, and 3 are integral parts of a whole, and Section 3's reference to "an agreement in writing for such arbitration" refers only to the types of contracts regulated by Sections 1 and 2. Interpreting Section 3 more broadly would raise a serious constitutional question under Erie R. Co. v. Tompkins, as it would involve Congress dictating substantive law in diversity cases, which Erie prohibits. To avoid this constitutional issue, the Court adopted a narrow reading of Section 3. Second, the Court considered whether, absent the FAA, state law should govern the enforceability of the arbitration agreement under Erie R. Co. v. Tompkins. Citing Guaranty Trust Co. v. York, the Court held that the enforceability of an arbitration agreement is a matter of substantive law, not mere procedure, because it "substantially affects the enforcement of the right as given by the State." Arbitration, the Court explained, changes the nature of the tribunal and important rights such as the right to a jury trial, judicial instruction, and the scope of judicial review. Therefore, allowing arbitration in federal court when a state court would not would lead to a "substantially different result" and an "unseemly forum-shopping" as forbidden by Erie. Since Vermont law, as interpreted by the District Court judge, held that agreements to arbitrate are revocable before an award is made, the federal court, sitting in diversity, was bound to apply that Vermont law. The Court gave special weight to the District Court judge's interpretation of Vermont law due to his local expertise.
Concurring - Felix Frankfurter
Yes, I agree that the Federal Arbitration Act does not apply to this diversity case and that the enforceability of an arbitration agreement is a substantive matter governed by state law under Erie R. Co. v. Tompkins. I concur with the majority's conclusion that the distinction between "substance" and "procedure" for Erie purposes is not always clear, but that the differences between arbitration and judicial determination sufficiently impact the outcome to be considered substantive. I also agree that applying the FAA to diversity cases would raise serious constitutional questions under Erie, and thus the Act should be construed as not applicable to such cases. However, I disagree with the majority's decision to affirm the District Court's interpretation of Vermont law directly. While the District Court judge's understanding of Vermont law is valuable, the Court of Appeals, whose judgment was reversed, did not have the opportunity to make its own assessment of contemporary Vermont law on this issue, especially considering the contract explicitly provided for New York law to govern and the general judicial trend towards favoring arbitration. The defendant is entitled to the Court of Appeals' view on Vermont law, and it is not for the Supreme Court to bypass that intermediate appellate review on an issue of state law that may have evolved since the last Vermont Supreme Court decision in 1910. I would remand the case to the Court of Appeals to determine what Vermont law is today.
Concurring - John M. Harlan II
Yes, I agree with the Court's opinion and its reasoning, with one exception. I agree with Justice Frankfurter that reviewing and affirming the District Court’s interpretation of Vermont law is inappropriate for this Court. Such questions of state law should ordinarily be decided by the Courts of Appeals, and therefore, I would remand the case to the Court of Appeals for that specific purpose.
Dissenting - Harold H. Burton
No, I dissent because the judgment of the Court of Appeals, which directed a stay of proceedings for arbitration, should be affirmed. I believe that the procedure for arbitration outlined in the contract is a permissible "form of trial." Under this view, the United States District Court for the District of Vermont should be able to stay its own proceedings to allow arbitration, even if a Vermont state court would not. I do not interpret Erie R. Co. v. Tompkins or Guaranty Trust Co. v. York as requiring federal courts in diversity cases to follow state law on arbitration if federal law views it as a procedural matter.
Analysis:
This case significantly clarified the scope of the Federal Arbitration Act (FAA), holding that it applies only to contracts involving maritime transactions or interstate commerce, thereby limiting its reach in federal diversity cases. More importantly, it reaffirmed and applied the Erie doctrine, particularly the 'outcome determinative' test from Guaranty Trust Co. v. York, to arbitration agreements. By classifying the enforceability of an arbitration clause as substantive law, the decision ensured that litigants in federal diversity courts would receive the same basic rights and remedies as those in state courts, preventing forum shopping and upholding the principle that federal courts are 'only another court of the State' for state-created rights. The case's nuance also highlights the complexities federal courts face in ascertaining state law, especially when state precedents are old or potentially outdated.
