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Arbitrability and the Non-Signatory

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Arbitrability and the Non-Signatory

Source: New York Law Journal
Date: June 20, 2005
This gateway issue may now be decided by an arbitrator rather than a court.

Over the years many courts have examined whether non-signatories may be compelled to arbitrate against their will, or, on the other hand, whether they can take advantage of an arbitration clause in a predecessor's contract.

The legal doctrines at work are well known. A non-signatory can, indeed, be compelled to arbitrate. In the Second Circuit there are five recognized doctrines of law that permit that result. They include "1) incorporation by reference; 2) assumption; 3) agency; 4) veil-piercing/alter ego; and 5) estoppel." Merrill Lynch Inv. Managers v. Optibase, Ltd., 337 F3d 125, 129 (2d Cir. 2003), quoting Thomson-CSF, S.A. v. Am. Arbitration Assoc., 64 F.3d 773, 780 (2d Cir. 1995). Conversely, a corporate successor is entitled to avail itself of the benefits of an arbitration clause contained in a contract signed by its predecessor.

However, since the U.S. Supreme Court announced the rule on arbitration in First Options of Chicago v. Kaplan, 514 U.S. 938 (1995), a new element has been added to the equation. Courts have now begun to focus not only upon whether a non-signatory can be compelled to arbitrate (or can take advantage of a predecessor's arbitration clause), but who should decide this gateway issue, a court or an arbitrator?

This article will examine the "who decides" issue of arbitrability as it relates to non-signatories -- i.e., can an arbitrator ever decide whether a signatory can compel a non-signatory to arbitrate, or conversely, can an arbitrator ever decide whether a non-signatory can compel a signatory to arbitrate.

The conventional wisdom had been that a court must always decide arbitrability issues as they relate to non-signatories. Recent decisions in the Second Circuit, however, appear to be eroding that rule.

Before examining those rulings, however, any discussion regarding arbitrability must begin with the rule articulated in First Options.

The Supreme Court Holding
In First Options, the Supreme Court reversed the usual presumption in favor of arbitration when it came to the issue of "who decides" whether parties agreed to arbitrate at all.

The Court said that in determining whether a party had agreed to arbitrate a particular matter, the presumption is that a court should make that determination "unless there is clear and unmistakable evidence" that the parties intended for an arbitrator to decide arbitrability. Id. 514 U.S. at 944. In this way, the law treats silence as favoring the party who seeks to litigate and not arbitrate the issue of arbitrability.

First Options sets the rule that it is presumed that the parties would have wanted a court and not an arbitrator to determine threshold issues of arbitrability.

Against this background, the Second Circuit, in Contec Corporation v. Remote Solutions, 398 F.3d 205 (2d Cir. 2005), decided that under the facts there presented, it was for an arbitrator and not a court to decide whether a valid arbitration agreement existed between a signatory and a non-signatory.

The 'Contec' Decision
Contec L.P. and Hango Electronics, a Korean company that later changed its name to Remote Solutions, entered into a manufacturing and purchase agreement. Contec L.P. was later converted to Contec LLC and then merged with Contec Corporation.

The parties continued their business relationship under the original agreement notwithstanding these changes in name and corporate form.

When a dispute arose, Remote Solutions sued Contec Corporation in Korea. Contec Corporation responded by initiating arbitration under Remote Solutions' manufacture and purchase agreement with Contec L.P. Contec Corporation also filed suit in district court seeking to compel arbitration. Remote Solutions defended on the ground that Contec Corporation was a non-signatory to the manufacturing and purchase agreement and, as such, could not avail itself of the right to arbitrate.

Contec Corporation sought to arbitrate the issue of its standing. The district court agreed with it and Remote Solutions appealed to the Second Circuit in affirming the district court, the Second Circuit noted that the contract's arbitration clause referenced the AAA's Commercial Rules Rule 7(a) of these Rules states that "the arbitrator shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope or validity of the arbitration agreement."

The Second Circuit had previously decided that "when parties explicitly incorporate rules that empower an arbitrator to decide issues of arbitrability, the incorporation serves as clear and unmistakable evidence of the parties' intent to delegate such issues to an arbitrator." Contec, 398 F.3d at 208, citing Shaw Group, Inc. v. Triplefine Int'l Corp., 322 F.3d 115, 122 (2d Cir. 2003); Paine Webber Inc., v. Bybyk, 81 F.3d 1193, 1202 (2d Cir. 1996).

The panel then observed that Contec Corporation's ability to enforce the arbitration clause as a non-signatory was "an issue pertaining to the 'existence, scope or validity of the arbitration agreement.'" Hence, the issue of arbitrability was to be resolved in arbitration.

There are really two interesting things going on in Contec. First, the Second Circuit reaffirmed the rule in Shaw Group and Bybyk that a mere reference by contracting parties to the rules of an arbitral institution suffices to sweep those rules into the parties' agreement, at least as to the "clear and unmistakable" intention test of First Options.

Second, the court added a step to the analysis. It did not just determine that, by reason of the clause's reference to AAA Rule 7(a), Remote Solutions had somehow manifested a clear intention to arbitrate and not litigate the issue of arbitrability. Instead, it first undertook an analysis to test the theory advanced by the non-signing party. Contec Corporation was not permitted just to make a conclusory allegation that it was a successor corporation entitled to rely upon the arbitration clause in its predecessor's contract. As the Second Circuit explained:
In order to decide whether arbitration of arbitrability is appropriate, a court must first determine whether the parties have a sufficient relationship to each other and to the rights created under the agreement.1
It is difficult to quibble with the Second Circuit's logic. Clearly, more than conclusory allegations should be needed before a court decides to send the arbitrability issue of a non-signatory's desire to arbitrate to an arbitrator for determination.

In deciding Contec, as it did, the Second District embraced the reasoning in Apollo Computer v. Berg, 886 F.2d 469 (1st Cir. 1989), a decision "virtually indistinguishable" from the salient facts in Contec. The Second Circuit also rejected a contrary holding by the Federal Circuit in Microchip Tech Inc. v. Philips Corp., 367 F.3d 1350 (Fed Cir. 2004).

In declining to follow Microchip, the court observed that that case involved a non-signatory seeking to avoid arbitration. While the Microchip court found that distinction "irrelevant," the Contec court found it significant that the party that signed the original contract was the party seeking to avoid arbitration. The Contec opinion explained that the fact that the signer was the reluctant party was an "important indicator of [the signor's] expectation and intent" when it bound itself to a contract calling for arbitration under the AAA Commercial Rules.2

Two cases that followed Contec, one in the Second Circuit and another out of the Southern District, have also dealt with the non-signatory.

Later Case in Second Circuit
In Sarhank Group v. Oracle Corporation, 404 F.3d 657 (2d. Cir. 2005), the Second Circuit vacated a district court judgment that recognized and enforced a foreign arbitral award rendered in favor of Sarhank, an Egyptian group, against Oracle Corporation, a non-signatory.

The Sarhank Group and an Oracle subsidiary, Oracle Systems (Systems), had entered into an agreement calling for disputes to be resolved by the Cairo Regional Centre for International Commercial Arbitration (CRCICA). A dispute arose and Sarhank commenced arbitration against both Systems and Oracle Corporation.

The arbitrators, over Oracle Corporation's jurisdictional objection, determined that, under Egyptian law (the law applicable under the contract), both Oracle Corporation (which did not sign the contract) and Systems (which did) were liable jointly in damages. After Oracle unsuccessfully moved to vacate the award in the Egyptian courts, Sarhank sought enforcement in the United States. Oracle resisted recognition and enforcement under the New York Convention, claiming that it never agreed to arbitrate at all.

In the Cairo arbitration, the arbitrators, applying Egyptian law, determined that the contract was binding upon Oracle Corporation, the parent, as well as Systems, the subsidiary. Oracle argued in the district court and again on appeal that the arbitrators had no right to make that determination.

While the Second Circuit made no mention of it in its opinion, CRCICA utilizes the UNCITRAL Arbitration Rules with minor amendments.3 One of the UNCITRAL rules adopted by CRCICA -- like AAA Rule 7(a) discussed in Contec -- provides as follows:
Pleas as to the Jurisdiction of the Arbitral Tribunal
Article 21

1 The arbitral tribunal shall have the power to rule on objections that it has no jurisdiction, including any objections with respect to the existence or validity of the arbitration clause or of the separate arbitration agreement... .
The Sarhank opinion did not discuss the impact of CRCICA Article 21 or go through the threshold analysis undertaken in Contec to see if the signatory, Sarhank, had made a colorable claim under a recognized doctrine of law that the non-signatory, Oracle Corporation, should be compelled to arbitrate under a contract it never signed. Given that Oracle Corporation was the parent of signatory Systems, there could very well have been sufficient evidence to have bound Oracle Corporation by its subsidiary's arbitration agreement -- at least to the extent of sending the issue to an arbitrator for decision.

Instead, the Sarhank court focused on the element of consent. This, however, was because the case came up after the arbitration award had been rendered. At that point, the focus is on issues of waiver and consent -- i.e., did the losing non-signatory (i) waive its right to complain about the adverse award or preserve that right during the arbitration, or (ii) otherwise consent to have an arbitrator determine whether it had to arbitrate.

What would the result have been had Sarhank come up not in the context of enforcement of an existing award, but on the non-signatory's motion to stay an arbitration brought against it by a signatory?

That was the very procedural posture presented in another recent decision.

The Southern District Ruling
In Masefield v. Colonial Oil Industries, Inc., 2005 WL 911770 (S.D.N.Y. Apr 18, 2005), Judge Peter Leisure was faced with an application by two Masefield non-signatories, Masefield AG (M-AG) and Masefield Ltd. (M-Ltd.), to enjoin an arbitration brought by Colonial Oil against them, as well as against Masefield America (M-America), the contracting party. The complaint stated that M-America was a separate and independent company, although affiliated with M-AG and M-Ltd. The opinion offers no further explanation of the precise corporate relationship.

The contract between M-America and Colonial Oil provided for arbitration of disputes before the International Chamber of Commerce (ICC). The ICC has the usual rule (just like AAA Rule 7(a) and UNCITRAL Article 21(1)) giving arbitrators the right to decide upon their own jurisdiction. See ICC Art. 6. Colonial Oil argued that the broad arbitration clause in the contract (between Colonial Oil and M-America, presumably incorporating the expansive language in ICC Article 6) manifested the requisite "clear and unmistakable" intention of M-AG and M-Ltd. to have the arbitrators determine whether those parties were bound to arbitrate the dispute.

The district court disagreed with Colonial Oil and refused to send the issue of "who should arbitrate" to the arbitrators. In doing so, however, the district court did not categorically hold that non-signatories, such as M-AG and M-Ltd., could never manifest the requisite intention that an arbitrator decide whether they, as non-signatories, must arbitrate. As Judge Leisure explained:
Here, defendant [Colonial Oil] simply presumes that plaintiffs [M-AG and M-Ltd.] are parties to the Contract before arguing that the broad arbitration provision contained within it manifests plaintiffs' intent to submit the issue of arbitrability to the Tribunal. Defendant has not attempted to explain why the Contract agreed to by [M-America] and [Colonial Oil] should be considered probative of plaintiffs' intent to agree with defendant. Because defendant relies solely on the breadth of the Contract's arbitration provision and does not direct the Court to any clear and unmistakable evidence that plaintiffs agreed with defendant on any issue, much less the issue of arbitration, the Court [and not arbitrators] will decide whether plaintiffs are bound to arbitrate with defendant.4
This explanation implies that if, for example, Colonial Oil had come to court with some prima facie proof of M-AG's and M-Ltd.'s principal-agent or alter ego status vis a vis M-America, the court might have given the arbitrability analysis to the arbitrators under M-America's contract with Colonial Oil. But how could that ever be? How can a non-signatory ever manifest a "clear and unmistakable" intention by means of another entity's signature on an agreement to arbitrate?

The logic is not all that contorted. If say, M-AG was the alter ego of M-America, then M-America's signature on the contract would be, in effect, M-AG's signature. If, say M-America acted as the undisclosed agent of M-AG, then M-America's signature on the contract also bound M-AG.

Assuming the existence of any of several doctrines establishing the obligation of a non-signatory to arbitrate, there would appear to be no logical impediment to a court's referral of the arbitrability issue to an arbitrator. It is really a matter of proof -- what kind and quantum is required to manifest the intention required by the rule in First Options.

The district court in Masefield ultimately declined to send the arbitrability issue to the arbitrators. A subsequent motion by Colonial Oil to dismiss the case or to stay it pending the outcome of the underlying arbitration was also denied. Masefield v. Colonial Oil Industries, Inc., 2005 WL 957344 (S.D.N.Y. Apr 26, 2005). This time around, Colonial Oil apparently cited Contec and urged the district court (again) to refer the matter to the arbitrators. The district court rejected Colonial's reliance upon Contec and did not discuss whether the reasoning of that case might have led to an arbitrability determination by the ICC panel if Colonial had presented some facts evidencing an alter ego or similar relationship.

So here we are. The elephant may not yet be in the room, but he is surely peeking through the door: the issue of arbitrability as it relates to non-signatories is no longer the exclusive province of the courts.

Alter egos and undisclosed principals beware -- even parent companies that do not sign agreements may find themselves arguing to an arbitration tribunal that it has no jurisdiction to hear the claims asserted against them.

As well, signatories who object to arbitrating with non-signatories may also find themselves making their arguments to an arbitrator -- in accordance with the very agreement that only they, and not the non-signatories, are formally party to.
1 398 F.3d at 209.
2 Id at 210-211.
3 Arbitration Rules of the United Nations Commission on International Trade Law, approved by the General Assembly of the United Nations by Resolution No. 31/98 on Dec. 15, 1976. The UNCITRAL Arbitration Rules are well-known in international arbitration circles. They were the rules used at the Iran-U.S. Claims Tribunal and frequently form the basis for the arbitration rules utilized by regional centers such as CRCICA.
4 Masefield, supra. 2005 WL 911770 at pp. 2-3.
Reprinted with permission from American Lawyer Media. Copyright 2005. JAMS, The Resolution Experts. All rights reserved.

Robert B. Davidson, Esq., a full-time arbitrator and mediator with JAMS in New York, is the executive director of JAMS Arbitration Practice and the chair of the Committee on Arbitration of the Association of the Bar of the City of New York.