Court Opinion

ID: 2982000
Source: CourtListenerOpinion
Date Created: 2015-09-22 19:59:32.514449+00
Date Added: 2024-06-11T11:44:27.008276
License: Public Domain

NOT RECOMMENDED FOR FULL-TEXT PUBLICATION
                           File Name: 13a0827n.06

                                       No. 12-6304; 12-6305                                FILED
                                                                                     Sep 12, 2013
                                                                                 DEBORAH S. HUNT, Clerk
                           UNITED STATES COURT OF APPEALS
                                FOR THE SIXTH CIRCUIT

YVONNE DAY, LEONARD HASLAG,
JAMES McCORMICK, and JOHN TURNER,

       Plaintiffs-Appellees, (12-6304)

               and                                     ON APPEAL FROM THE UNITED
                                                       STATES DISTRICT COURT FOR THE
REBECCA WALLACE, BARBARA WRIGHT,                       EASTERN DISTRICT OF KENTUCKY
and MADALYN SUOZZO,

       Plaintiffs-Appellees, (12-6305)

v.

FORTUNE HI-TECH MARKETING, INC.,
et al.,

       Defendants-Appellants.

                                                /

BEFORE:        CLAY, SUTTON, and GRIFFIN, Circuit Judges.

       CLAY, Circuit Judge. These two closely related cases involve Defendant Fortune Hi-Tech

Marketing, Inc. (“Fortune Hi-Tech” or “FHTM”). Defendant hired Plaintiffs as independent

representatives and Plaintiffs sued, alleging that FHTM was in fact running an illegal pyramid

scheme. Defendant moved the district court to compel Plaintiffs to proceed to arbitration pursuant

to the terms of the contract they had signed with Defendant. While the district court initially granted

that motion, upon reconsideration the court reversed itself and vacated its earlier decision and
                                           No. 12-6304

ordered the cases to proceed to trial. Defendant now appeals the two orders denying its motion to

compel arbitration. We AFFIRM the judgment of the district court.

                                      BACKGROUND

        A.      Factual Background1

        Defendant Fortune Hi-Tech Marketing, Inc. is a “multi-level marketing company that

independently markets the services of various organizations.”2 In essence, Fortune Hi-Tech acted

as a third-party marketing firm that sold services from companies to consumers. Fortune Hi-Tech

hired each of the Plaintiffs as an Independent Representative (“IR”). An IR would pay an enrollment

fee to Fortune Hi-Tech, and would sell the services of different companies on behalf of Fortune Hi-

Tech and receive commissions for each sale he or she made. IRs also received bonuses if they

recruited others to become IRs. If an IR signed up someone else who paid the enrollment fee, then

the IR could get a bonus of $100. Plaintiffs allege that it was far more lucrative to recruit new IRs

than to sell services.

        When an IR joined Fortune Hi-Tech, they filled in an application and agreement which

included a clause which stated that the IR had read the “FHTM Polices and Procedures” and that the

terms of those polices were incorporated into the agreement between the company and the IR. (R.

11, Motion to Compel, Attachment 3, Application and Agreement, Nov. 8, 2010, at ¶ 4.) Section

        1
         There are two cases before this Court, Day v. Fortune Hi-Tech, No. 12-6304, (“Day”) and
Wallace v. Fortune Hi-Tech, No. 12-6305, (“Wallace”), and while they have some minor differences
in facts and procedural history, the substantive issue in each case is identical.
        2
         Plaintiffs also sued several individual Defendants, but those claims are not relevant to the
instant appeal.

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                                            No. 12-6304

8.4 of the policies and procedures stated that any claim brought under the agreement would be

brought in arbitration handled by the American Arbitration Agreement, and included language that

stated that the agreement to arbitrate would survive any termination of the agreement. Another

clause in the same document stated that Fortune Hi-Tech could modify the agreement at any time.

That clause made change effective upon notice, and defined notice as occurring when it was issued.

Finally, section 12 of the FHTM Polices and Procedures stated that the agreement consisted of all

of the documents, which FHTM retained the ability to modify at any time.

        Plaintiffs allege that FHTM is a pyramid scheme and that they were each duped into joining

the company on the promise that they could supplement their income or otherwise make a great deal

of money, but that the promises were false and that the only way to make money on their initial

outlay of $299 was to recruit more members. The merits of these claims has not yet been examined;

the only issue before this Court is whether the contracts require the parties to submit their dispute

to arbitration rather than to the courts for resolution. Plaintiffs all terminated their agreements with

FHTM prior to the start of this litigation. During the time period in which Plaintiffs allege harm,

there were no modifications to the contract.

        B.      Procedural History

        Plaintiffs in the Day case, No. 12-6304, filed their complaint on September 2, 2010, in the

United States District Court for the Eastern District of Kentucky. They alleged violations of the

Racketeer Influenced and Corrupt Organizations Act (“RICO”), 18 U.S.C. §§ 1961 68, the Kentucky

Consumer Protection Act, and Kentucky common law. Defendants filed a motion to compel

arbitration on November 8, 2010. On December 22, 2010, Plaintiffs in the Wallace case, No. 12-

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                                             No. 12-6304

6305, filed a complaint in the United States District Court for the Southern District of California.

Plaintiffs alleged violations under RICO, and California’s Business and Professions Code, § 17500,

et seq. Plaintiffs also sought class certification.

        In January of 2011, Defendant filed a motion with respect to the Wallace Plaintiffs, asking

the court to dismiss for improper venue pursuant to Federal Rule of Civil Procedure 12(b)(3), or to

transfer the action pursuant to 28 U.S.C. § 1404(a). In April 2011, the case was transferred to the

Eastern District of Kentucky. In November 2011, Defendant filed a motion to compel arbitration,

or to stay the case pending the resolution of the Day case. Also in November 2011, Defendant filed

a motion in the Day case itself, asking the court to compel arbitration.

        The motion to compel arbitration in the Day case was granted in February 2012. The district

court found that Plaintiffs had agreed to arbitrate their claims, and therefore it lacked jurisdiction to

hear Plaintiffs’ challenge to the validity of the arbitration clause. Plaintiffs moved the court to

reconsider its decision. Upon reconsideration, the district court rescinded its order and opinion, and

issued a new one on September 13, 2012, which denied Defendant’s motion and ordered the case

to proceed. The district court’s reconsidered opinion was based on the Supreme Court’s decision

in Granite Rock Co. v. Int’l Broth. of Teamsters, 130 S. Ct. 2847 (2010), which clarified the nature

of a court’s jurisdiction in addressing agreements to arbitrate. On September 24, 2012, the district

court issued an order in the Wallace case, which denied Defendant’s motion on the same grounds

and ordered the case to proceed to trial. These two appeals followed the denials of the motions to

compel arbitration.

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                                            No. 12-6304

       This Court has jurisdiction to review a district court’s denial of a motion to compel

arbitration as an interlocutory appeal under 9 U.S.C. § 16(a)(1). Albert M. Higley Company v. N/S

Corp., 445 F.3d 861, 863 (6th Cir. 2006). Because federal jurisdiction is based on diversity of

citizenship, 28 U.S.C. § 1332, the applicable substantive law is the state law of Kentucky.3 See Erie

R.R. Co. v. Tompkins, 304 U.S. 64, 79 (1938).

                                           DISCUSSION
       A.      Standard of Review

       A district court decision over either the existence or validity of an arbitration clause or its

application to a particular dispute is reviewed de novo. Floss v. Ryan’s Family Steak Houses, Inc.,

211 F.3d 306, 311 (6th Cir. 2000). “We review the enforceability of an arbitration agreement

according to the applicable state law of contract formation.” Morrison v. Circuit City Stores, Inc.,

317 F.3d 646, 666 (6th Cir. 2003) (en banc) (citing First Options of Chicago, Inc. v. Kaplan, 514
U.S. 938, 943 44 (1995)).

       B.      Analysis

       Under the Federal Arbitration Act, 9 U.S.C. § 1 et seq., arbitration agreements are “valid,

irrevocable, and enforceable, save upon grounds that exist at law or in equity for the revocation of

any contract.” Id. § 2; accord Floss, 211 F.3d at 314. Plaintiffs claim that the arbitration clause of

their contract with Defendant is void for lack of consideration. Because the clause could be modified

at any time, within the sole discretion of Defendant, Plaintiffs claim that the provision lacked

       3
         Plaintiffs have alleged violations of RICO, which would provide an alternative basis for
federal jurisdiction. Regardless, because the question before the Court concerns contractual validity,
which is a question of state law, the applicable law is that of Kentucky.

                                                  5
                                            No. 12-6304

consideration and is therefore void. The district court agreed with Plaintiffs, and declined to compel

arbitration. This appeal followed, and we now affirm the district court’s decision.

       There is a general presumption in favor of arbitration. See, e.g., Gateway Coal Co. v. United

Mine Workers of Am., 414 U.S. 368, 377 (1974). Where parties have agreed to arbitrate some

disputes, courts should generally construe their agreement to arbitrate broadly, and should generally

resolve disputes over the scope of the arbitration clause in favor of arbitration. Granite Rock Co.

v. Int’l Broth. of Teamsters, 130 S. Ct. 2847, 2857 (2010). However, if the dispute is itself over the

validity of the arbitration clause, then it is a matter of ordinary judicial resolution, and no such

presumption applies. Id. at 2857 58 (2010). Even if courts are meant to favor a finding that parties

have agreed to submit their claims to arbitration, parties must still have a valid and enforceable

agreement to resolve their claims in arbitration. Id. at 2856. Although it is a basic principle of

contract law that every contract requires mutuality and consideration, Cuppy v. Gen. Accidental Fire

& Life Assurance Corp., 378 S.W.2d 629, 632 (Ky. 1964), an arbitration clause does not require

independent consideration; so long as the contract as a whole is adequately supported by

consideration, each clause is valid unless there is some other deficiency in the contract’s validity.

Glazer v. Lehman Brothers, Inc., 394 F.3d 444, 452 54 (6th Cir. 2005); accord Ozormoor v. T-

Mobile USA, Inc., 354 F. App’x 972, 975 (6th Cir. 2009).

       The district court found that the arbitration clause was unenforceable because the contract

between Plaintiffs and Defendantwas not supported by adequate consideration, and we agree.

Because Defendant retained the ability to modify any term of the contract, at any time, its promises

were illusory. See Fowler’s Bootery v. Shelby Boot Co., 117 S.W.2d 931, 932 33 (Ky. 1938).

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                                             No. 12-6304

Defendant was not bound by any particular provision of the contract because at any point, including

immediately after acceptance, Defendant could have changed any clause without any recourse

sounding in contract law available to Plaintiffs. The only notice provision made changes effective

upon their issuance, rather than after a fixed period of time. Had the contract permitted unilateral

alteration upon thirty days’ notice, for example, there might have been consideration, because the

altering party would still have been bound to the original terms for the thirty day period. See

Restatement (Second) of Contracts § 77 cmt. b, illus. 5 (1981). But in this case, in effect, Defendant

promised to do certain things unless it decided not to, and that is by definition illusory. Id. § 2

cmt. e; see also id. § 77. While some states may permit enforcement of a contract that requires only

notice, rather than advance notice, for alteration of its terms, Kentucky is not one of those states.

See Fowler’s Bootery, 117 S.W.2d at 932 33; Killebrew v. Murray, 151 S.W. 662, 664 65 (Ky.

1912) (overruled on other grounds as recognized by Johns Hopkins Hosp. v. Peabody Coal Co., 920
F. Supp. 738, 749 50 (W.D. Ky. 1996)). Accordingly, because the contract lacked consideration,

the entire contract, including the arbitration clause, is void and unenforceable.

        This Court’s decision in Floss v. Ryan’s Family Steak Houses, Inc., 211 F.3d 306 (6th Cir.

2000) is also instructive. In that case, this Court found that an arbitration clause was invalid because

the promise to provide an arbitral forum, without any further detail, was “fatally indefinite.” While

the clause in the agreement provided details such as which arbitration organization would conduct

the arbitration, and where the arbitration would take place, the fact that those could be unilaterally

modified at any time rendered such promises illusory. The contract in the instant case is more

detailed, but just as illusory as the one at issue in Floss, because as with the contract in Floss, it did

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                                            No. 12-6304

not ultimately require Defendant to submit to any particular forum or set of rules for arbitration

inasmuch as Defendant could modify the arbitration clause to suit its purposes at any time.

       Defendant raises three arguments as to why the agreement was supported by consideration,

or why, even if there was no consideration, the contract is still enforceable. First, there was no

modification of the arbitration clause at any point during the relevant time period here. Second, there

was mutual performance under the existing terms of the contract, which means that for the period

in which this performance took place, there was mutuality of obligation. Third, because the

arbitration clause had a survival language clause, it was in fact bound to the clause once Plaintiffs

terminated their contract. Each of these arguments fails.

       As to Defendant’s argument that the fact that it did not modify the contract indicates that

there was mutuality of obligation during the relevant time period, that argument confuses

performance of the terms with an obligation to perform under the contract. The fact that Defendant

voluntarily continued to maintain the terms of their promise is irrelevant; the question is whether it

had a legally binding obligation to continue to do so. Nothing bound Defendant to continue its

agreement, or even to maintain the same terms. As the district court pointed out, Defendant could

have, through any one of the various notice devices it included, changed the contract immediately

upon receipt of a signed copy from any one of the Plaintiffs. Without a binding obligation, a promise

is illusory, and therefore not enforceable as a contract. Morgan v. Morgan, 309 Ky. 581, 218 S.W.2d
410, 412 (1949) (a contract “must be binding on both or else it is binding on neither”); Rehm-Zeiher

v. F.G. Walker Co., 160 S.W. 777 (Ky. 1913). In the cases cited by Defendant modification only took

effect at some point after notice was given. No such limit existed in this case; the changes would

                                                  8
                                            No. 12-6304

be in place effective at the whim of Defendant, with no chance for Plaintiffs to leave the arrangement

or seek better terms in exchange for the modification. See, e.g., Morrison v. Circuit City Stores, Inc.,

317 F.3d 646, 667 68 (6th Cir. 2013) (relying on the fact that there was a time-lag between notice

and the effect of the change to uphold an agreement).4

        Next, Defendant argues that because the parties performed, mutuality of obligation existed

under Kentucky law, and therefore a court can find a contract during that time period. But this

argument fails for the same reason that Defendant’s contention regarding modification fails. Nothing

bound Defendant to perform. The fact that it continued to do so may be indicative of goodwill, or

of its belief that it had an obligation, but the terms of the agreement itself were subject to

modification at any point, and subsequent performance cannot excuse a want of consideration. See

Rehm-Zeiher Co., 160 S.W. at 780.

        While Defendant cites cases that state if there is consideration, mutuality of obligation is not

required, when the offered consideration was itself an agreement to be bound, then that argument

becomes circular. It may be conceivable that there are residual claims arising under the contract that

can be resolved by the terms of the contract, or that part of the contract was effectively ratified by

the parties’ performance, and thus should be enforced to that extent. But that question is not

properly before the Court at this time. For now, the question is whether the claims should proceed

to arbitration, and so to the extent that there was no binding contract including an arbitration clause,

the question cannot be addressed by this Court. In other words, while there may be an equitable

       4
        While that case was decided under Ohio law, it was based on the Restatement (Second) of
Contracts, which is generally applicable in Kentucky. See, e.g., Sawyer v. Mills, 295 S.W.3d 79, 89
(Ky. 2009).

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                                            No. 12-6304

reason why the district court could enforce discrete provisions of the contract based on the parties’

course of conduct, that is not the same as finding that there was a contract in place during the

relevant time period. Cf. Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, 448 49 (2006)

(holding that nothing necessarily prevents a court from finding an arbitration clause unenforceable

in a contract that it later finds is enforceable). The survival language is similarly illusory. As the

district court found, that provision itself could have been altered or removed at any time. If the

clause itself is unenforceable, then a sub-clause must also be unenforceable; a subclause that was

never valid and binding cannot survive the termination of the agreement, because it was never

binding in the first place.

        Finally, Defendant asks the court to sever the amendment provision, and enforce the

remainder of the contract as written. We cannot find any authority (and Defendant has cited none)

that would permit us to revise the contract to cure this deficiency. Furthermore, there is no evidence,

anywhere in the agreement, that permits a court to infer that the parties intended this language to be

severable, or regarding which terms should be severable..

                                          CONCLUSION

        For the foregoing reasons, the judgment of the district court is AFFIRMED.

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