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In a case arising from alleged defects in residential construction, the California Court of Appeal held that the builder's use of out-of-state materials brought the transaction within the reach of the Federal Arbitration Act (FAA). Accordingly, the FAA preempted application of a California law that would have deprived the parties of the benefits of arbitration.
In Shepard v. Edward Mackay Enterprises, Inc., No. C052564, 2007 WL 853456 (Cal. Ct. App. Mar. 22, 2007), Shepard bought a house from Edward Mackay Enterprises (Mackay). When the interior of the house suffered water damage, Shepard sued Mackay for alleged defects in the plumbing system. Mackay filed a motion to compel arbitration pursuant to an arbitration clause in the purchase agreement.
In opposing the motion, Shepard cited section 1298.7 of the California Code of Civil Procedure, which requires a judicial forum for construction defect cases even if the parties have agreed to arbitrate. In response, Mackay argued that the FAA preempted application of California law that would deprive a party of its right to demand arbitration.
Based on section 1298.7, the trial court denied the motion to compel arbitration. Regarding the FAA, the trial court found that the Mackay failed to demonstrate that the transaction involved interstate commerce.
The issue on appeal was whether Mackay carried his burden of proving that the transaction involved interstate commerce, thus triggering FAA preemption. Before analyzing this issue, the Court explained that the phrase "involving commerce" has been equated with the phrase "affecting commerce," meaning the FAA should be construed as the broadest permissible exercise of Congress' commerce clause power.
In examining whether the transaction involved interstate commerce, the Court applied the standard enunciated by the Supreme Court in Citizens Bank v. Alafabco, Inc., 539 U.S. 52 (2003). Under Alafabco, the FAA is applicable "'without showing any specific effect upon interstate commerce' if in the aggregate the economic activity in question would represent 'a general practice . . . subject to federal control.'"
Applying that standard, the Court found that Mackay carried its burden of proving that the transaction involved interstate commerce because Mackay submitted evidence proving that several materials used in constructing the house, including flooring, doors, windows, and appliances, were manufactured out of state. Accordingly, the FAA was applicable and thus preempted the application of section 1298.7, thereby preserving Mackay's right to demand arbitration.
In general, as this case demonstrates, the party claiming FAA preemption must prove that the transaction involves interstate commerce. Though the required showing is minimal, parties can eliminate the need to demonstrate an aggregate impact on interstate commerce by stipulating that the transaction involves interstate commerce, see Pest Management, Inc. v. Langer, 96 Ark. App. 220 (Ark. Ct. App. 2006), aff'd, 2007 WL 538178 (Ark. Feb. 22, 2007), or by specifically invoking the FAA in the arbitration agreement. Under Rule 48B of the National Arbitration Forum Code of Procedure, the FAA applies to all arbitration agreements unless the parties agree otherwise.
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