ARBITRATION: Separation doctrine on fraud and enforceability of mandatory arbitration clause in contract not unconstitution and not violative of jural rights (which does not apply): DUTSCHKE V. JIM RUSSELL REALTORS, INC. (COA 8/1/2008)

ARBITRATION:  Separation doctrine on fraud and enforceability of mandatory
arbitration clause in contract; arbitration clause does not violate jural rights
doctrine which does not apply to arbitration clauses; and clause does not
violate right to jury trial

The Dutschke’s appeal from the dismissal of their claims against the
realtor in a dispute concerning the Dutschkes’ purchase of a residence from Fred Faust, deceased.

The real estate purchase contract contained an arbitration clause, which the circuit court determined was enforceable.
The Dutschkes allege that the underlying contract was a product of fraud, and that to the extent that the Kentucky Uniform Arbitration Act contained in KRS Chapter 417 (KUAA) compels arbitration under such circumstances, the Act is unconstitutional under the jural rights doctrine, the right to a jury trial contained in Section 7 of the Kentucky Constitution, the separation of powers doctrine, and the prohibition against arbitrary power contained in Section 2 of the Kentucky Constitution, Louisville Peterbilt, Inc. v. Cox, 132 S.W.3d 850 (Ky. 2004), notwithstanding.

The COA disagreed and affirmed.

The Dutschkes’ purchase of the property was consummated through the use of a standardized sales and purchase contract
which contained a binding arbitration clause). 
The complaint did not, however, allege that the Dutschkes were fraudulently induced to enter into the arbitration agreement.  At this time Marks v. Bean, 57 S.W.3d 303 (Ky.App. 2001), was the controlling case in situations involving fraud and the enforceability of an arbitration clause. It held that an allegation of fraud in the inducement relating to the underlying contract alone was sufficient to avoid the enforcement of an arbitration clause.

In the meantime, the Supreme Court issued its decision in Louisville Peterbilt, Inc. v. Cox, 132 S.W.3d 850 (Ky.
2004) which overruled Marks v. Bean and held that a party to a contract containing an arbitration clause could not avoid arbitration where the alleged fraud was limited to fraudulent acts inducing the party to enter into the underlying contract alone; rather, avoidance could only be had when the allegations of fraud went to the making of the arbitration clause itself.

The Arbitrator substantially agreed with the Dutschkes upon their claims relating to undisclosed defects, but awarded them only $12,691.00 out of the total of
$41,600.00 they sought.  The trial court subsequently entered an order denying the Dutschkes’ motion to vacate the arbitration award and, instead, confirming the award.

Louisville Peterbilt established the “separability doctrine,” which requires courts to separate an otherwise valid arbitration clause from the contract within which it is contained to allow arbitration of all claims not going to the validity of the arbitration clause itself.

In other words, under the holding in Louisville Peterbilt, fraudulent acts inducing someone to enter into the underlying contract is not a basis for avoiding the arbitration clause; rather, to avoid the clause upon the basis of fraud, the fraudulent inducement must relate specifically to the arbitration clause. The underlying notion is that the Arbitrator himself is capable of evaluating and issuing a ruling upon allegations relating to fraud in the inducement vis-à-vis the underlying contract.

In their brief the Dutschkes purport to challenge the constitutionality of Chapter 417 under the jural rights doctrine. We believe the Dutschkes’ use of the term “jural rights” in their arguments to be a misnomer. Section 7 is not an aspect of the jural rights doctrine in Kentucky as used in its normal sense.

The jural rights doctrine is not expressly set out in the Kentucky Constitution. Rather, the doctrine is derived from a reading of Sections 14, 54, and 241 of the Kentucky Constitution. In essence, the doctrine states that the General Assembly has no authority to abolish or restrict a common law right of recovery for personal injury or wrongful death.Bishop v. Manpower, Inc. of Cent. Kentucky, 211 S.W.3d 71 (Ky.App. 2006); Williams v. Wilson, 972 S.W.2d 260, 265 (Ky. 1998);

In summary, the jural rights doctrine is limited to application in the areas of negligence, personal injury, or wrongful death. As fraud in the inducement does not fall within any of those categories, we believe the jural rights doctrine to have no application to the issues under consideration.

Section 7 of the Kentucky Constitution provides, “The ancient mode of trial by jury shall be held sacred, and the right thereof remain inviolate, subject to such modifications as may be authorized by this Constitution.” (Emphasis added). Thus, the Section contemplates that there may be other provisions in the Constitution which may make exceptions to the general rule that a citizen is entitled to a trial by jury.

One of these exceptions is contained in Section 250 of the Constitution, which provides that “[i]t shall be the duty of the General Assembly to enact such laws as shall be necessary and proper to decide differences by arbitrators, the arbitrators to be appointed by the parties who may choose that summary mode of adjustment.”

The COA believed Section 250 to be dispositive of the issue. The Section specifically provides for a system of arbitration to be enacted by the legislature and, by definition, arbitration does not include a trial by jury.

Section 250 of the Kentucky Constitution specifically vests the legislature with the power to enact necessary and proper laws to establish an arbitration system in Kentucky. It follows that it was not a violation of the separation of powers doctrine for the legislature to enact the

Finally, the COA disagreed with the appellants that the KUAA does not provide for judicial review.
The level of judicial review provided is consistent with the underlying purposes of arbitration generally, one of which is to avoid the time and expense involved with courtroom litigation; is authorized by Section 250 of the Constitution; and, moreover, is sufficient to comply with the requirements of Section 2 of the Constitution.

Digested by Michael Stevens

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