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Delaware Chancery Defines ‘Quick’ Court Inquiry Before Referral to Arbitration

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By Kelly Zhang

An action for a preliminary injunction to enjoin arbitration proceedings by officers of a Delaware limited liability company has been denied by the Delaware Court of Chancery.

The decision supports the vitality of a limited liability company’s use of arbitration in its operating agreement. But as it develops the Delaware business court’s view of cases to be sent for arbitration, the case arguably increases the chancery court’s gatekeeping function. Angus v. Ajio LLC, Civil Action No. 11895-VCG (May 13, 2016)(available for download at http://bit.ly/1sXAChn).

The matter concerned whether a dispute was arbitrable, and the question was whether the dispute should go to an arbitrator, or be decided by a court. The underlying suit included allegations of a breach of fiduciary duties and fraud brought by some members the company, MoGo Sport LLC, against MoGo’s officers, for entering into a transaction that ultimately sold the company.

Traditionally, questions of arbitrability have been left to the arbitrators, once a court has found that parties had agreed to submit their disputes to arbitration. The landmark case of Moses H. Cone Memorial Hosp. v. Mercury Construction Corp., 460 U.S. 1, 24 (1983) confirmed that the Federal Arbitration Act created a “liberal federal policy favoring arbitration agreements,” and that “any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration.”

This suggested a first look to the arbitration tribunal, which further U.S. Supreme Court cases developed. But the determination of arbitrability ultimately follows the contract. First Options of Chicago Inc. v. Kaplan, 514 U. S. 938 (1995), enshrined the principle that “courts should not assume that the parties agreed to arbitrate arbitrability unless there is “clea[r] and unmistakabl[e]” evidence that they did so.” (Internal citation omitted.) The First Options inquiry turned upon what parties agreed to; the question was settled by the court once it was shown that parties had not agreed to arbitrate.

Subsequent cases like Howsam v. Dean Witter Reynolds Inc., 537 U.S. 79 (2002), and Green Tree Financial Corp. v. Bazzle, 539 U.S. 444 (2003), further narrowed courts’ ability to decide on arbitrability.

Howsam focused on time bars on arbitration, which the Supreme Court ruled was to be determined by arbitrators. Green Tree Financial further held that an ambiguity in the arbitration provision was to be resolved by an arbitration tribunal.

But the May Angus opinion in Delaware’s Chancery Court doesn’t follow the general deference toward arbitration. It shows the Delaware business court examining the frivolity of claims.

In his 12-page opinion, Vice Chancellor Sam Glasscock III affirmed a two-pronged test to show a “clear and unmistakable” intent to arbitrate issues of arbitrability in James & Jackson LLC v. Willie Gary LLC, 906 A.2d 76 (Del. 2006)(available at http://bit.ly/1NZBonr).

The test, Glasscock wrote, requires a “’clear and unmistakable evidence’ of intent to arbitrate arbitrability . . . where there is:

‘1) an arbitration clause that generally provides for arbitration of all disputes; and
2) a reference to a set of arbitration rules that empower arbitrators to decide arbitrability, such as the American Arbitration Association . . . Rules.’”

Glasscock then expanded the test by citing McLaughlin v. McCann, 942 A.2d 616 (Del. Ch. 2008)(available at http://bit.ly/1RGfmke), noting that

only where “a non-frivolous argument in favor of substantive arbitrability exists and the first two prongs of Willie Gary are satisfied, [should] the Court . . . defer to the arbitrator.” [Emphasis added; citation omitted.]

The Angus opinion notes that the additional requirement serves the interests of justice by preventing wasted resources from the adjudication or arbitration of frivolous claims, allowing the court to strike the frivolous claims. But the court’s examination is limited; cases where “more than a quick, facial review of claims would be required” would proceed to arbitration.

Out of the four officers against whom the arbitration demand was brought, only Bruce Angus was a party to the MoGo operating agreement. Consistent with the contractual approach, the motion to halt the arbitration preliminarily against the remaining three officers was granted, as it was held that they would more likely would not be bound to arbitrate because of the lack of contractual obligations under the LLC operating agreement.

On the other hand, the court found at least one “non-frivolous” claim with regard to the original plaintiffs’ standing to force arbitration. As a result, Vice Chancellor Glasscock denied the motion for a preliminary injunction in Angus’s case, and deferred the decision to the arbitrators on the substantive issue of whether the case should be arbitrated.

The court conducted an analysis to determine if there were non-frivolous claims to arrive at the conclusion that the case should be arbitrated.

First, Angus and the other officers who sought to block the arbitration argued that the LLC members who filed for arbitration over the company’s sale lacked standing to enforce arbitration under the operating agreement when they cited a covenant not to compete. The theory was that only MoGo itself could enforce the non-compete provisions, and not the Members.

Glasscock saw these “issues of standing by signatories to a contract to enforce breaches of that contract” as non-frivolous, and that the officers failed to demonstrate that the original plaintiffs’ assertion of standing was frivolous. That finding sent the case to arbitrators for the determination of whether the case arbitrable.

In addition, the defendant officers had said that the arbitration claims against them for a breach of fiduciary duties were outside the scope of the LLC operating agreement because the contract was silent on fiduciary duty.

The court noted that the arbitration provision only covered disputes “among Members or former Member over the provisions of the Operating Agreement.” [Emphasis is the court’s.] It said that whether a breach-of-fiduciary-duties claim would arise from the agreement, and whether the agreement’s silence on the point incorporates default fiduciary duties from state law, was a “nice question” that needed deeper examination.

“This question,” Glasscock wrote, “which warrants more than a cursory inquiry by the Court into the frivolousness of the claim, should be referred to arbitration” under the parties’ agreement.

Angus arguably paves the way for courts to have more say in deciding the arbitrability of disputes despite arbitration provisions. “Litigants’ economy,” the opinion notes, mandates courts to conduct at least the “quick, facial review” of the frivolousness of claims, discussed above, before allowing them to proceed to arbitration. Cases would have to both show a clear intent to arbitrate, as well as present non-frivolous claims, in order to strike a balance between serving the economy and providing parties the benefits of their bargain.

Attorneys from both sides declined to comment.

The case proceeds. An answer and counter-claim was filed by the MoGo LLC members, as they proceed on their fiduciary and fraud claims against the officers not subject to arbitration, on May 27.

The author was a Summer 2016 CPR Institute summer intern and is a third-year LL.B. student from the Singapore Management University.

2nd Update*: Class Waivers and Arbitration: The Battleground Focus Moves to Labor and Employment Law

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*The area of class action waivers and employment law saw an absolutely whirlwind close to 2015, with the NLRB releasing yet another decision midday, on 12/31, following two weeks that saw 16 decisions restricting arbitration practices. Please see below for an up-to-date summary of these rapidly breaking developments.

By Russ Bleemer

The emphasis on the law and politics of consumer arbitrations, and their relationship to class waivers, has overshadowed developments in another closely related area of conflict resolution law.

But the time has come for finality on the legality of employment law class-action waivers.  Developments in 2015’s final quarter indicate that decisive events are coming in the area, which involves the intersection of U.S. labor law and the Federal Arbitration Act.

On the first day of December, the National Labor Relations Board issued two decisions finding labor law violations against companies for using mandatory pre-dispute class action waivers with their arbitration agreements requiring individual processes.  The waivers, the NLRB said, violate Sections 7 and 8 of the National Labor Relations Act, which allows employees, among other things, “to engage in . . . concerted activities for the purpose of collective bargaining or other mutual aid or protection.”

That was only the beginning:  By Christmas, the NLRB had issued at least 16 more decisions striking down mandatory pre-dispute arbitration clauses that coupled class waivers as a condition of employment.

The decisions are crucial because the rights of collective action under the NLRA address far more than union workplaces. The law applies to most employees, and key cases that have arisen in this area focus on white-collar employees.

It’s a major statement by the Board. The NLRB decisions’ reasoning—that the NLRA and the FAA co-exist compatibly but the latter isn’t preferred over workers’ rights to act in concert—had already been rejected by the Fifth U.S. Circuit Court of Appeals.  Twice, in fact, including in a decision just five weeks before the December Board decisions, in Murphy Oil Inc. v. NLRB, No. 14-60800, 2015 WL 6457613 (5th Cir. Oct. 26, 2015).

The Fifth Circuit relied on the U.S. Supreme Court’s high-profile consumer-contract arbitration decision–AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011), along with the business-to-business class waiver in American Express Co., et al. v. Italian Colors Restaurant, 133 S. Ct. 2304 (2013)—to justify rulings that mandatory individualized arbitrations are authorized by the FAA.

Consumer arbitration controversy has rolled over into politics in 2015, when the Consumer Financial Protection Bureau moved to regulate the process by barring waivers of all class processes. Congressional Republicans introduced legislation to hamper the regulation efforts directly, as well as defund the federal agency.

In November, the NLRB said it would request a rehearing in Murphy Oil, but it did not appeal the Fifth Circuit reversal of its first case on the subject, D.R. Horton Inc., 357 NLRB No. 184, 2012 WL 36274 (Jan. 3, 2012), enforcement denied in relevant part, 737 F.3d 344 (5th Cir. 2013) (Graves, J., dissenting), reh’g denied, No. 12-60031 (Apr. 16, 2014).

December’s stream of cases from Board decisions backing its Murphy Oil and D.R. Horton decisions mostly occurred mid-month, leading up to Christmas.  But for good measure, just hours before the close of business on Dec. 31, the Board added its final 2015 decision, again affirming its view in the cases already rejected by the Fifth Circuit.  The decision, GameStop Corp., 363 NLRB No. 89, 20-CA-080497 (Dec. 15, 2015), went even further, affirming a line in those cases barring class waivers in employment arbitration agreements that provide an “opt out” allowing employees to waive participation in the ADR scheme.

“Regardless of the procedures required, the fact that employees must take any steps to preserve their Section 7 rights burdens the exercise of those rights,” the decision states.

It’s clear that the NLRB, an independent federal agency that oversees workplace conduct by enforcing the National Labor Relations Act, is picking and choosing its battles, which experts on both sides of the argument agree will be finalized by a U.S. Supreme Court decision.  The NLRB appears to be seeking a suitable case to ask the Supreme Court to hear, unloading years of litigation in December sourced from a variety of forums that reject the FAA’s predominance over the NLRA.

And while it awaited Murphy Oil’s Fifth Circuit fate, and while preparing the Board decisions it released in December maintaining its insistence on the NLRA’s vitality in the face of required arbitration clauses, the NLRB for the first time filed an amicus brief in a court case on the subject in the Ninth U.S. Circuit Court of Appeals, in Morris v. Ernst & Young LLP, No. 13-16599.

The November filing, just a week after the Fifth Circuit decided Murphy Oil, noted that the Board would seek en banc review of that decision, and strongly defended its own D.R. Horton/Murphy Oil lineage.

At the oral argument on Nov. 18, Ninth Circuit Judge Andrew D. Hurwitz prodded the attorneys on both sides to come up with a formula for NLRA and FAA co-existence.  He suggested severing the waiver clause, but keeping arbitration decisions for a tribunal, rather than blowing up the entire ADR process in favor of litigation.

The Ninth Circuit argument also dissected the class rights being waived by the pre-dispute mandatory arbitration agreement in the context of Federal Rule of Civil Procedure 23, which establishes the ground rules for court class actions.

The details on the December NLRB decisions; the Fifth Circuit’s Murphy Oil reversal; the NLRB Morris amicus filing, and highlights of the Morris oral argument are the subject of the January 2016 cover article in Alternatives, out this week.

Alternatives is available HERE for CPR Institute members after logging into the CPR website.  The newsletter, marking its 33rd year of publication with the January issue, is available to nonmembers at altnewsletter.com.

 

* * *

Bleemer edits Alternatives to the High Cost of Litigation for the CPR Institute.

U.S. Supreme Court’s 2015-2016 Term Has Early Arbitration Focus

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U.S. Supreme Court’s 2015-2016 Term Has an Early Arbitration Focus

By Russ Bleemer

The U.S. Supreme Court began its new term with an early arbitration argument—the fourth case argued on the term’s second day, Oct. 6.

The argument followed a week after the nation’s top court agreed to hear a second arbitration case sometime this term.

Both of the cases involve California arbitration practice.  The new case on the docket–which started out focused on unconscionability but will be argued on whether a problematic arbitration clause is salvageable–is a federal case appeal from the Ninth U.S. Circuit Court of Appeals, which covers the state.

The state-court matter that was the subject of the early-term argument, DirecTV Inc. v. Imburgia, No. 14-462, returned to an issue that already had been covered and decided by the Court: federal preemption of conflicting state law that affected arbitrability.

Or so it seemed.

The official issue in the case was “[w]hether the California Court of Appeal erred by holding, in direct conflict with the Ninth Circuit, that a reference to state law in an arbitration agreement governed by the Federal Arbitration Act requires the application of state law preempted by the Federal Arbitration Act.”

The parties—a satellite television provider and an individual subscriber who filed a class action suit over early cancellation fees—had an agreement that provided for individual arbitrations. The form contract waived class arbitration, and was part of a purchase agreement before another California-derived case, AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (2011), backed class waivers.

In AT&T Mobility, the U.S. Supreme Court invalidated a rule from a California Supreme Court case, Discover Bank v. Superior Court, 113 P.3d 1100 (2005), which forbid class processes. The split AT&T Mobility Supreme Court overturned California’s Discover Bank rule because it interfered with the Federal Arbitration Act.

The DirecTV customer agreement the Court reviewed had hedged its terms about class waivers and arbitration in the wake of the then-pending litigation.  Under the purchase agreement, the parties were bound by the FAA.

But the contract stated that if “the law of your state would find this agreement to dispense with class arbitration procedures unenforceable,” then the entire arbitration provision would be stricken from the purchase agreement.

Seemingly flying in the face of the since-decided AT&T Mobility, the California state Court of Appeal in DirecTV had concluded that the contract provision on “the law of your state,” in the words of the DirecTV petition to the Supreme Court, was a non-severable clause that “nullif[ied] the parties’ arbitration provision, even though [the Discover Bank] rule is concededly inconsistent with, and thus preempted by, the FAA under [AT&T Mobility], and even though the arbitration agreement here is concededly governed by the FAA.”

The petition said that the state appellate court had meant the phrase “the law of your state” to mean “state law immune from the preemptive force of federal law.”

It appeared that the U.S. Supreme Court took the case to reverse it and put it in line with its AT&T Mobility precedent.

At the argument, both conservative and liberal justices found the state appeals court’s reading of the contract, in refusing to enforce arbitration, puzzling.  Associate Justice Antonin Scalia said the state appeals court holding “flouts well-accepted universal contract-law principles.”  Associate Justice Elena Kagan lamented “the extent you can find reasoning in this opinion—which you have to search to find.”  The opinion under review is Imburgia v. DirecTV Inc., No. B239361 (Cal. 2nd App. Dist. April 7, 2014)(available at http://ow.ly/Tg4Mi).

The defense of the California state court opinion was that it must be maintained to prevent federal law from usurping state courts’ ability to interpret contract terms.

But the satellite television provider’s slam-dunk argument ran aground when the Court insisted DirecTV’s lawyer set a standard as to how the Court should evaluate state court contract interpretations.

Still, that argument was far simpler than the plaintiff’s argument, which faced a Court mostly unsympathetic to collective actions and which was looking at odd reasoning in the California appellate opinion.

The argument transcript is available at http://ow.ly/TfFui; the November Alternatives, available here on or before Nov. 9, has a full analysis.

* * *

The November Alternatives also will discuss the case that the Court accepted on Oct. 1, MHN Government Servs. Inc. v. Zaborowski, 14-1458, another matter with allegations of California hostility to arbitration.

The case focused originally on unconscionability.  MHN, a San Rafael, Calif., military contractor that provides life consulting services to military members and their families, sought to compel arbitration against the respondents, who were consultants in MHN’s network.

MHN’s motion to compel arbitration lost in both a California federal district court and in the Ninth U.S. Circuit Court of Appeals.

The Ninth Circuit, in an unpublished opinion, agreed with the lower court that MHN’s consulting contract was both procedurally and substantively unconscionable.

MHN avoided the unconscionability arguments in its successful U.S. Supreme Court cert petition, and instead counters with a focus on severability.  It tells the nation’s top Court that California has a rule on severability for contracts that operates differently when the contract is for arbitration, and the state is biased against arbitration.

The original plaintiffs counter that the federal court opinions exercised appropriate discretion in declining to sever clauses in an arbitration agreement that has been refused to be enforced “by over a dozen judges,” including in a 9-0 Washington state Supreme Court opinion that similarly refused to sever.

Full details, cites, links and analysis will be available in the November Alternatives at the link above.

Russ Bleemer is a CPR Consultant and the Editor of CPR’s award-winning publication, Alternatives