Contractual Forum-Selection Clauses are Enforceable in Iowa Unless Induced by Fraud

Feb 19, 2020

On January 10, 2020, the Iowa supreme court held that, pursuant to a contractual forum-selection clause, a claim of fraud in the inducement must be decided in the selected forum unless the alleged fraud induced the plaintiff’s agreement to the forum-selection clause itself. Roy Karon, et al. v. Elliott Aviation, et al., No. 18-1199. Several points about this decision are worth noting.

First, and most significantly, under Iowa law, fraud in the inducement is a tort. The Iowa Arbitration Act (unlike the Federal Arbitration Act) excludes “claim[s] sounding in tort whether or not involving a breach of contract[]” unless all parties to the contract have executed a “separate writing” agreeing to submit such claims to arbitration. Iowa Code § 679A.1(2)(c) (cited by Appel, J., dissenting). Although no such writing was executed by the parties in Karon, the majority did not discuss this issue at all.

Second, under Iowa law, forum-selection clauses are generally not enforceable—or, at least, are disfavored. See Davenport Mach. & Foundry Co. v. Adolph Coors Co., 314 N.W.2d 432, 435 (Iowa 1982) (“Traditionally, Iowa courts have held [forum-selection] clauses to be unenforceable.”); but see Liberty Bank, F.S.B. v. Best Litho, Inc., 737 N.W.2d 312, 315 (Iowa Ct. App. 2007) (“A forum selection clause ‘should control absent a strong showing that it should be set aside.’”) (quoting M/S. Bremen v. Zapata Off-Shore Co., 407 U.S. 1, 15 (1972)). Nonetheless, adopting the holding in Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395 (1967), the supreme court in Karon determined that, where a contract includes a forum-selection clause, the question whether the contract was procured by fraud must be litigated in the forum chosen in the contract. It is not clear that Prima Paint necessarily dictates this result.

Prima Paint did not concern a forum-selection clause but a contractual provision to arbitrate. Prima Paint Company filed suit in court, seeking rescission of the contract on the ground that it was fraudulently induced to enter the agreement. The U.S. Supreme Court held that the contractual provision to arbitrate was valid and would be enforced unless the allegation of fraud in the inducement was directed at the arbitration provision itself. Id. at 406-07. The fraud claim—like any other claim arising from the subject matter of the contract—must be submitted to arbitration rather than the court. Id. The Supreme Court relied on language in the Federal Arbitration Act (“FAA”) to reach this conclusion. Prima Paint, 388 U.S. at 399 (internal citation marks and alterations original) (citing 9 U.S.C. § 2 (“a written provision for arbitration ‘in any maritime transaction or a contract evidencing a transaction involving commerce … shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.’”)). Because the Prima Paint Company did not allege fraud in the inducement as to the arbitration provision, the provision was binding and all claims had to be arbitrated. Id. at 406-07. (Justice Black wrote a lengthy dissent, which was joined by Justice Douglas and Justice Harlan. A discussion of the dissent is beyond the scope of this post, but it is worth reading.)

Although Prima Paint did not concern a forum-selection clause, the Iowa supreme court determined that Prima Paint should apply in Karon because: 1) it had followed the Prima Paint rule in Dacres v. John Deere Ins. Co., 548 N.W.2d 576 (Iowa 1996); 2) the parties to the contract were sophisticated and represented by counsel; and 3) “[i]f a forum-selection clause could be challenged simply based on fraud in an overall transaction, then the advantages of predictability and efficiency would be lost.” No. 18-1199 at 9, 21. The court also noted that the majority of other states to consider the issue have adopted the Prima Paint approach with regard to the enforceability of forum-selection clauses. Id. at 12-16.

Finally, in my view, Karon is a less-than-ideal case on which to base such an important holding. In Karon, Roy Karon and his company, Peddler, Inc., entered into an oral agreement with the defendants pursuant to which defendants would locate a Citation X airplane that Karon could purchase and then broker the purchase. Only after defendants located the Citation X and Karon agreed to a price was a written agreement (the purchase agreement for the plane) executed. Karon subsequently learned that defendants had lied to him about the price, causing him to pay $400,000 than the actual purchase price. Accordingly, Karon alleged that he and Peddler were fraudulently induced to enter into the purchase agreement.

However, the agreement that gave rise to the fraud was the initial oral agreement. There was no allegation that Karon and Peddler were fraudulently induced to enter into that agreement. Nor did Karon and Peddler take issue with any of the provisions of the oral agreement that had been incorporated into the written purchase agreement—the actual terms pursuant to which defendants agreed to act on Karon’s and Peddler’s behalves. Instead, Karon and Peddler alleged that defendants had defrauded them by lying about the price of the plane, causing them to pay more than the plane cost. Thus, the fraud did not go to the heart of the controlling agreement but to a term of a subsequent agreement. In essence, Karon’s fraud claim is more akin to a claim that defendants failed to perform the terms of the initial, oral agreement, as Karon understood they would, than to a fraud in the inducement claim. The district court, however, held that evidence of the initial, oral agreement was not admissible—a holding the supreme court upheld—so that agreement did not enter into the analysis.

Notably, although the supreme court commented that forum-selection clauses generally should be enforced in Iowa, Karon does not overrule Davenport Machinery, leaving open the question whether such clauses should be upheld or disfavored under Iowa law. In addition, because a future case may require Iowa courts to a different set of facts may produce a different result, whether a fraud-in-the-inducement claim must be submitted to arbitration pursuant to a contractual arbitration provision may still be an open question under Iowa law.



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