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Business Law Newsletter

Scope of the Commerce Power and the Federal Arbitration Act

First enacted in 1925, the Federal Arbitration Act (FAA) was created as an alternative to the high costs and delays of litigation. Up until that time, states were permitted to require disputants to litigate despite the existence of a signed agreement to arbitrate. The introduction of the FAA, however, preempted such laws and implemented a policy that encouraged arbitration.

Scope of Application in Agreements “Involving Commerce”

The FAA is comprised of three chapters. Chapter 1 addresses the enforceability of agreements and jurisdictional matters while Chapters 2 and 3, both enacted years after chapter one, contain provisions addressing international arbitration. Chapter 1 indicates that its text specifically applies to “written [provisions] in any maritime transaction or a contract evidencing a transaction involving commerce…” However, the interpretation and application of “involving commerce” within the FAA’s context has been litigated repeatedly.

During the 90’s, the Supreme Court handed down numerous opinions addressing this issue. One of the common threads of many of these decisions was the premise that Congress intended “involving commerce” “to signal the broadest permissible exercise of Congress’ Commerce Clause power.” More recently, in Citizens Bank v. Alafabco (2003), the Court provided guidance regarding the application of “involving commerce” to commercial loan transactions.

Application of “Involving Commerce” to Commercial Loans

Citizens Bank involved a strained relationship between an Alabama construction company, Alafabco and a lender, Citizens Bank. Beginning in 1986, Citizens Bank periodically supplied Alafabco the necessary capital to fund construction projects. However, in 1998, the relationship suffered when Citizens Bank allegedly encouraged Alafabco to bid on a large construction project but then refused to provide the necessary capital in support of the bid. Consequently, Alafabco suffered significant financial difficulties and entered into two debt restructuring agreements with Citizens Bank. Both agreements included a provision requiring the parties to submit disputes to arbitration.

Several months following the signing of the debt restructuring agreements, Alafabco filed suit alleging, among numerous causes of action, that Citizens Bank had negligently caused Alafabco to incur “massive debt.” In response to Alafabco’s lawsuit, Citizens Bank successfully moved to compel arbitration. However, on appeal to the Alabama Supreme Court, the court reversed and found that there “was an insufficient nexus with interstate commerce to establish FAA coverage of the parties’ dispute.” In arriving at its conclusion, the Court noted there was no showing that “any portion of the restructured debt was actually attributable to interstate transactions.” Further, there was no showing that the “funds comprising that debt originated out-of-state” or that “the restructured debt was inseparable from any out-of-state projects.”

U.S.Supreme Court Decision

On appeal, the U.S. Supreme Court reversed and held that the commercial loan transactions at issue involve commerce since the transactions were related to numerous inter-state commerce actions. Facts considered by the Court included the following:

  1. The loans that were renegotiated were for Alafabco’s continued business throughout the southeastern United States. The loans given to Alafabco “had been used in part to finance large construction projects in North Carolina, Tennessee, and Alabama.”
  2. Alafabco secured its restructured debt with all of its business assets. This included goods which were comprised of “out-of-state parts and raw materials.” The Court reasoned that if “the Commerce Clause gives Congress the power to regulate local business establishments purchasing substantial quantities of goods that have moved in interstate commerce…it necessarily reaches substantial commercial loan transactions secured by such goods.”
  3. Commercial lending has a broad and significant impact on the national economy and is subject to the regulation of the Commerce Clause.

Thus, according to the Court, such transactions were sufficiently related to interstate commerce to come within the purview of the Constitution’s commerce clause.

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