Who Decides Illegality?

August 2005
Dispute Resolution Journal;Aug-Oct2005, Vol. 60 Issue 3, p91
Academic Journal
The article reports that the Federal Arbitration Act in the U.S. does not prevent arbitrators from deciding that a court should determine whether a contract containing an arbitration clause is illegal in cases where the parties' agreement states that the arbitrator should apply California law, the California Court of Appeal, Second Department, has ruled. In this case, the defendant demanded arbitration, claiming that the plaintiff breached the loan agreement. The plaintiff, who claimed the loan agreement was illegal because the defendant was not licensed in California, moved to stay the arbitration so that a court could decide the illegality issue. The arbitrator granted the stay, concluding that although he could decide the illegality issue, it would be more economical and expeditious to allow a court to do so. The plaintiff then commenced an action seeking a declaration by the court that the loan agreement between the parties was illegal and void. The court of appeal affirmed the denial of the motion to compel arbitration. California law obligates the trial court to decide whether an entire contract or transaction is illegal.


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