First published in Dispute Resolution Section Blog of the New York State Bar Association December 13, 2013 (http://nysbar.com/blogs/ResolutionRoundtable.html)
A nonsignatory to an arbitration agreement is not generally subject to it and cannot be compelled to submit to the proceedings, but there are equitable circumstances that may warrant a different result. MAG Portfolio Consultant, GMBH v. Merlin Biomed Group LLC, 268 F.3rd 58, 61 (2d Cir. 2001). The MAG court identified five theories under which a nonsignatory to an arbitration agreement may still be bound by it: “1) incorporation by reference; 2) assumption; 3) agency; 4) veil-piercing/alter ego; and 5) estoppel.” With regard to the 5th theory, estoppel is based on a finding that the nonsignatory received a direct benefit: “a nonsignatory may be compelled to arbitrate where the nonsignatory ‘knowingly exploits’ the benefits of an agreement containing an arbitration clause, and receives benefits flowing directly from the agreement.”
There are two concepts expressed in the MAG court decision, namely “knowingly exploits” and “benefits flowing directly from” that support compelling a nonsignatory to submit to arbitration. Importantly, both concepts require that the knowing exploitation and the receiving benefits flow directly from the agreement containing the arbitration clause. The theory does not extend to nonsignatories receiving benefits indirectly, which means from a business relationship independent of the agreement containing the arbitration clause. Distinguishing direct from indirect requires a discriminating analysis as illustrated in the case of Belzberg v. Verus Investments Holding Inc.which landed in all three levels of our judicial system. The New York Court of Appeals properly notes in Belzberg, 2013 NY Slip Op 06729 (October 17, 2013) that “it can be difficult to distinguish between [direct and indirect benefits].” It notes further that it is an issue federal courts have “grappled with,” citing to several decisions that “provide useful guidance on how to apply the theory.”
The difficulty noted by the court of appeals in Belzberg is dramatized by the different results from the motion court and appellate division. The motion court concluded after an oral hearing that petitioner (the party sought to be added to the arbitration) “did not receive a benefit which flowed directly from the [agreement that contained the arbitration clause].” The appellate division unanimously reversed and held that petitioner received a direct benefit (5 member panel, unanimous decision). The court held that because “Belzberg knowingly exploited and directly benefitted from the Verus-Jefferies customer agreement, he should be estopped from avoiding the agreement’s obligation to arbitrate,” 93 AD3d 713 (1st Dept. 2012). The court of appeals (with Justice Abdus-Salaam not taking part because she had been a member of the appellate division panel) concluded otherwise and reversed the appellate division. Counting the trial justice who ordered arbitration permanently stayed against petitioner, the score was 7 judges to 5 in petitioner’s favor. Petitioner walked away with profits from the transaction while Verus and Jefferies (the parties to the arbitration agreement) were left with tax obligations.
The court of appeals’ decision rests as it noted on decisions from the Second Circuit and district courts within the circuit analyzing a variety of factual circumstances brought on by parties seeking to compel or resisting arbitration. The outcome in these decisions depends upon the documented source of a party’s benefit. Arbitration may be compelled even if the party did not execute the agreement containing the arbitration clause. Thus, in Deloitte Noraudit A/S v. Deloitte Haskins & Sells, U.S., 9 F.3d 1060, 1064 (2d Cir. 1993) the court held that the resisting party was estopped from denying its obligation because it “knowingly accepted the benefits of the Agreement” by operating under “the trade name ‘Deloitte’ in exchange for compliance with the dictates of the agreement.”
In a more recent decision by the resisting party, Carvant Fin, LLC v. Autoguard Advantage Corp., 13-CV-00872 (EDNY 2013) the district court concluded that although plaintiff was a nonsignatory it nevertheless derived a direct benefit “from the agreements in the form of liens on the used cars.” These rulings to compel arbitration rest on the proposition that the resisting party is not relieved of obligations that can be said to be the quid pro quo for future benefits. Carvant cites approvingly Lee v. Grandcor Med. Sys., Inc., 702 F.Supp. 252, 255 (D. Colo. 1988) (“A third party beneficiary must accept a contract’s burdens along with its benefits.”).
In contrast, an indirect benefit “derive[s] from a business relationship independent of the contract containing the arbitration provision.” Lang v. First Am. Tit, Ins. Co., 12-CV-266S (WDNY 2012). Although plaintiffs’ benefit in Lang involved securing a refinanced mortgage it derived from the “mere fact of the contractual relationship between the lender and Defendant, the existence of which was a condition of [the lender] refinancing Plaintiffs’ mortgage.” The underlying agreement incorporated the New York State approved policy rates. The court held “plaintiffs’ ability to secure a refinanced mortgage from a lender” was “incidental” to the lender title policy and independent of the “‘contractual relationship’ between the lender and Defendant [title insurer].”
Belzberg’s benefit was also indirect because it too was incidental. However, the factual circumstances were complicated by Belzberg’s actions in directing the underlying transaction. Both the appellate division and the court of appeals commented unfavorably on Belzberg’s conduct. The appellate division expressed its critical view in noting the inconsistencies of Belzberg’s written and oral testimony: “Belzberg’s contradictory statements on these material issues cast doubt on his present claim that the loan came from Winton and not him, and warrant our rejection of his factual characterization of the money transfer.” This clearly raised an ethical question which the appellate division transposed into a basis for compelling arbitration, but the described conduct is not the key to compelling arbitration. It may be true that “Belzberg’s use of the profits attributed to Winton’s original investment may breach his duty or some role assumed on behalf of Winton, or otherwise constitute an opportunistic self serving exercise of his position with Winton.” However, the critical fact in Belzberg’s favor was that “the use of such monies does not flow from the Jefferies-Verus agreement [that contained the arbitration clause].” Opportunism is not “[t]he guiding principle.” Rather
[t]he guiding principle is whether the benefit gained by the nonsignatory is one that can be traced directly to the agreement containing the arbitration clause. The mere existence of an agreement with attendant circumstances that prove advantageous to the nonsignatory would not constitute the type of direct benefits justifying compelling arbitration by a nonparty to the underlying contract.
Of course, the result does not preclude prosecuting claims actionable in a court of law; it merely postpones the reckoning on the grounds suggested by the court of appeals. Merely setting the transaction in motion and benefitting from an independent agreement is not a sufficient basis for applying the estoppel theory, even if there is a sense that the party is getting away with something.