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Non-Signatory Bound by Arbitration Agreement, Court Holds
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September 3, 2007
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By Ronan J. McHugh and Christian Henel
Thelen Reid Brown Raysman & Steiner LLP
A recent federal court decision directly addresses when non-signatories are bound by arbitration agreements; when filing a motion to dismiss in the face of an arbitration provision does not, without more, constitute "active participation" in a lawsuit, thereby waiving arbitration; and considers the role of a choice of law provision in determining the enforceability of the arbitration agreement. Khan v. Parsons Global Services, Ltd., 480 F. Supp. 2d 327 (D.D.C. 2007)
Facts
Khan arose out of an atypical set of facts for an arbitration case, involving a claim for damages by an employee, Mr. Khan, and his wife, arising from injuries allegedly suffered after Mr. Khan was kidnapped in the Philippines. Mr. Khan, a British citizen, had entered into an employment contract with Parsons, a company incorporated in Washington D.C., for certain international assignments. The employment contract contained an arbitration clause. It provided that "any controversy or claim aris[ing] out of this Assignment Agreement or the breach thereof or in any other way related hereto or otherwise related to or arising out of [Mr. Khan's employment with Parsons] shall be settled exclusively by arbitration.." The arbitration was to be in Switzerland. The contract also provided that "[i]n, and in respect of, such arbitration, the Laws of the State of California, USA shall apply to and govern this Agreement, its interpretation, and performance." In 2001 Mr. Khan was assigned to work in Manila, Philippines, where he was kidnapped. He sued Parsons to recover damages in tort for negligence, and he and his wife brought tort claims for intentional infliction of emotional distress as a result of injuries caused by Parsons' alleged mishandling of the kidnappers' ransom demands.
Years of Delay
In confirming that simply filing a motion to dismiss pursuant to Federal Rules of Civil Procedure Rule 12 (a) (6) for failure to state a claim does not waive arbitration, Khan also provides a practical insight into the time it can take for cases filed in court to find their way to arbitration. The suit was filed in the District of Columbia Superior Court and removed to the U.S. District Court for the District of Columbia in 2003. From there, it took until March 30, 2007, for the dispute to be referred to arbitration. During this time, there was no "active participation" in the lawsuit by Parsons that would prevent arbitration. The reasons for the delay, while perhaps extreme, appear to have been due to motions and appeals.
In March 2004, Parsons was granted summary judgment on the basis that worker's compensation statutes provided the exclusive remedy. At that point, Parsons' motion to compel arbitration was denied as moot. On appeal. the decision on worker's compensation was reversed, but the U.S. Circuit Court of Appeals for the District of Columbia did not rule on the arbitration issue. Thus, the case returned to the District Court in April 2006, and a scheduling order was issued. Briefing on a motion to compel arbitration was completed in May 2006. It is unclear why the District Court took nearly another year to decide the issue.
The Issues
The District Court stated that there were four issues to be decided:
|  | Was arbitration waived when the defendants filed a motion to dismiss based on worker's compensation and arbitration?
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| | If arbitration was not waived, was the arbitration clause enforceable and is this decided under federal or state law?
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| | If the arbitration clause was enforceable and has not been waived, does the arbitration clause apply to non-signatories and which claims does it cover?
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| | Should discovery be allowed concerning the alleged unconscionability of the arbitration clause? 1/
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Waiver
The court enunciated three propositions for determining whether participation in a lawsuit waives arbitration: (1) filing a motion for summary judgment does not automatically necessitate a finding of active participation in a lawsuit; (2) a party actively participates in a lawsuit if, under the totality of circumstances, the party has undertaken efforts to utilize the judicial system to dispute the claims on their merits; and (3) a defendant does not waive its right to arbitration unless there is a substantial delay in asserting that right.
The first proposition is the most intriguing because of its possible effects on the arbitration process. This is because the response to a suit involving an arbitration agreement often is a motion to dismiss - not simply on the grounds of arbitration but also for failure to plead a proper claim. Khan acknowledges this, stating, "By their very nature Rule 12(b) motions to dismiss made prior to filing an answer... are designed to effectively prevent litigation of issues on the grounds that those issues might be decided in the predicate as a matter of law. It would offend logic to penalize a party for filing a motion designed to preclude litigation by preliminarily dismissing improper claims at the outset of an action." (The motion in Khan was brought by Parsons as an FRCP Rule 12(b)(6) motion to dismiss but was converted by the court to a motion for summary judgment pursuant to Rule 12 (b). Khan found the conversion from a 12(b)(6) motion to a summary judgment motion irrelevant.)
Ultimately, Khan held that because the defendants had not engaged in any discovery or other pretrial litigation other than filing their motion to dismiss, the defendants had not actively participated in the litigation. Further, the court held that because the defendants timely asserted their right to arbitrate by moving promptly under the Federal Arbitration Act to compel arbitration, defendants did not substantially delay in invoking their arbitration right. The court concluded that because there was no active participation in litigation or substantial delay in invoking arbitration rights, defendants did not waive their right to arbitrate under the agreement.
Choice of Law
The plaintiffs in Khan sought to strike the arbitration agreement as being unconscionable under California law, which was the contract's governing law. Defendants argued that because the agreement fell under the Federal Arbitration Act and the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, the FAA should apply and the agreement should be enforced because unconscionability was not grounds for avoidance of an arbitration agreement under federal law. Plaintiffs asserted that the arbitration agreement was unenforceable as unconscionable under California law.
Relying on the U.S. Supreme Court's decision in Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52 (1995), the court found, without articulating it as a procedural or substantive law issue, that federal law governs the enforceability of arbitration agreements unless there exists clear and convincing evidence that the parties intend that state law govern this issue. The language in the contract that "in, and in respect of, such arbitration, the laws of the State of California, USA, shall apply," even though it referred to arbitration, was held not to be "clear evidence" or an indication that the parties intended to opt out of federal law so that California law's rules of enforceability of arbitration agreements should be applied. Accordingly, the court held that the arbitration agreement should be enforced under federal law.
Non-Signatory Parties
The plaintiffs objected to arbitration on grounds that Mrs. Khan and certain of the defendants were not parties to the arbitration agreement and, thus, their claims were not subject to it. Plaintiffs again relied on California law, asserting that it is impermissible for a non-signatory to enforce an arbitration clause against a fellow non-signatory. The court held that federal law, not California law, applied to enforceability of the arbitration agreement.
The court noted that the case was one of first impression for it. The court applied Thompson-CSF, S.A. v. American Arbitration Assn., 64 F. 3d 773, 776 (2nd Cir. 1995). That decision provided five agency and contract law theories under which a non-signatory may be compelled to arbitrate issues that "arise out of common law principles of contract and agency law." They are: incorporation by reference; assumption; agency; veil-piercing/alter ego; and estoppel.
The court found that under Thompson, courts have been willing to estop a signatory from avoiding arbitration with a non-signatory when the issues that the non-signatory is seeking to arbitrate are intertwined with the agreement that the estopped party signs.
The plaintiffs alleged both negligence and intentional infliction of emotional distress against all of the defendants. The court held that Mr. Khan's negligence and intentional infliction of emotional distress claims all were intertwined under the standard in Thompson for estoppel as they arose out of the employment agreement. If some of these claims had been levied against only certain defendants, then it might have been a different situation, as in Thompson where the court noted the importance of whether a signatory was asking to avoid arbitration. The court found that the claims arose out of claims of breach of duty under the employment agreement. Thus, "the negligence claims the non-signatory Parsons defendants are trying to resolve must be intertwined with the employment agreement (and arbitration agreement therein) because the claims against those defendants arise directly from that agreement." The court found the same was true for the intentional infliction of emotional distress claims as "the defendants actions. were undertaken in their role as Mr. Khan's employer or its agents." The court also held that when a non-signatory spouse's claims are dependent upon a contract containing an arbitration clause, the spouse also is equitably estopped.
With regard to Mrs. Khan's intentional infliction claims, the court held that these claims did not derive from a breach of duty owed her by Parsons related to the employment agreement and thus were not be subject to arbitration. However, the court went on to set the standard for this tort and dismissed the claims because Parson's actions in securing Mr. Khan's release were not extreme or outrageous enough to warrant a finding of liability.
Conclusions
| | Practitioners defending a claim in federal court may move to dismiss under FRCP Rule 12(b)(6) without waiving arbitration provided they invoke their right to arbitrate without substantial delay and without having participated substantively regarding the merits of the case. Examples of invocation that courts have held to be timely are removal under federal removal statutes; sending letters to opposing counsel requesting the matter be referred to arbitration; raising arbitration as a defense in an answer; and filing a motion to compel arbitration at the time of dismissal.
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| | Drafters of arbitration agreements should consider what procedural law the parties intend to govern the agreement and the arbitration. If the parties intend state law or the standard in the rules of an arbitral institution to govern the arbitration agreement and its enforceability, the best practice is to expressly indicate that intention either in the choice of law provision or in the arbitration clause. Generic choice of law provisions will be considered insufficient evidence of intent to apply state law, and federal law will apply in cases involving interstate or foreign commerce.
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| | Khan clarifies the law in the District of Columbia that non-signatories to an arbitration agreement may be bound by an arbitration agreement if the claims are sufficiently intertwined with arbitral claims against signatory parties. If the intent is to keep these non-signatories from becoming subject to arbitration, contracts and pleadings must be drafted with that goal in mind.
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For more information about the issues covered in this report, please contact Ronan J. McHugh in our Washington, D.C. office at 202-508-4125 or at rmchugh@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.
ENDNOTES
| 1/ | This issue was rendered moot by the court's decision.
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©2007 Thelen Reid Brown Raysman & Steiner LLP
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