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June 16, 2014 Articles

Arbitrating Arbitrability with Nonsignatories

By Tom Alan Cunningham

The right to arbitrate a dispute is a right that arises out of a contract. AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740, 1746 (2011).The Federal Arbitration Act (FAA) (9 U.S.C. § 1 et seq.) prescribes the gatekeeping role of the courts in the implementation of these contract rights. Section 3 requires the court to refer arbitrable issues to arbitration, and § 4 requires the court to compel arbitration upon finding that an arbitration agreement exists and has not been performed. Either way, the courts apply sovereign power to require parties to arbitrate according to their agreement. The courts indulge a presumption of arbitrability because the FAA embodies a national policy favoring arbitration. United Steelworkers of America v. Warrior & Gulf Nav. Co.,363 U.S. 574 (1960).

Determining Arbitrability
Under the FAA, determining arbitrability requires the court to address two issues: (1) whether a valid agreement to arbitrate exists, and (2) whether a party to the agreement has failed to arbitrate. Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395 (1967). This includes deciding whether a particular issue falls within the scope of the agreement to arbitrate. PaineWebber, Inc. v. Bybyk, 81 F.3d 1193, 1198 (2d Cir. 1993). These gateway decisions are questions about "arbitrability," which are viewed as questions to be decided by the court and not an arbitrator. John Wiley & Sons, Inc. v. Livingston, 376 U.S. 543 (1964); Atkinson v. Sinclair Refining Co., 370 U.S. 238, 241 (1962).

A slightly different landscape appears when the arbitration agreement itself provides that these gateway arbitrability questions are to be decided by the arbitrator and not the court. On the one hand, it is clear that just as arbitration of the merits of a dispute depends upon whether the parties agreed to arbitrate the merits, the question of who has the power to decide arbitrability also turns upon what the parties agreed to. First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 943 (1995). However, the normal presumption favoring arbitration does not apply in determining who should decide arbitrability. Instead, the presumption is that questions of arbitrability are to be decided by the court unless the arbitration agreement contains "clear and unmistakable evidence," as construed by applicable state law, that the parties intended the question of arbitrability to be decided by the arbitrator. AT&T Tech., Inc. v. Commc'n Workers, 475 U.S. 643 (1986).

Arbitrability and the Nonsignatory
The focus upon the arbitration agreement as the cornerstone of the right to arbitrate is more complicated when one of the parties to the dispute is a nonsignatory to the arbitration agreement. If one must look to the agreement for clear and unmistakable evidence authorizing an arbitrator to decide arbitrability, what authority does an arbitrator have to decide the arbitrability of a dispute with one who is not a party to the agreement? This is the question recently addressed in Kramer v. Toyota Motor Corp., 705 F.3d 1122 (9th Cir. 2013), cert. denied, 134 S.Ct. 62 (2013). The Kramer plaintiffs, purchasers of 2010 Toyota Prius and Lexus HS250h hybrid vehicles, brought a class action in a U.S. district court against the vehicle manufacturer alleging defects in the antilock braking systems. The plaintiffs purchased their vehicles from various dealers by entering into different forms of purchase agreements, which contained arbitration clauses allowing "either you or we" to elect to have disputes decided by arbitration. The arbitration clauses also provided:

This Arbitration Clause applies, regardless of whether the claims or disputes arise in contract, tort, statute or otherwise. It also applies to any claim or dispute about the interpretation and scope of this Arbitration Clause. It also applies to any claim or dispute about whether a claim or dispute should be determined by arbitration. 

The claims against Toyota alleged that the manufacturer had prior notice of the defect but, in violation of California statutes, continued to manufacture and sell the vehicles without disclosing the defect. After its Rule 12(b)(6) motion to dismiss was unsuccessful, Toyota moved to compel arbitration, relying upon the arbitration clauses in the dealer purchase agreements. At first glance, it would appear that, given the specific reference in the arbitration clause to "any claim or dispute about whether a claim or dispute should be determined by arbitration," the court should simply have directed the parties to arbitration. However, the district court noted that the dealer purchase agreements were between the purchasers and the dealers and that Toyota was a nonsignatory to those agreements. On this basis, the district court held that Toyota did not have a right to compel arbitration of the plaintiffs' claims. 

Toyota appealed, maintaining that the plaintiffs' claims grew out of the purchase agreements, giving Toyota the right to refer to those agreements, including the arbitration clause. Toyota also asserted that the district court improperly decided the question of arbitrability because the agreements clearly directed that question to arbitration.

The Ninth Circuit rejected Toyota's position, holding that while the plaintiffs may have agreed to arbitrate arbitrability with the dealers, the particular language of the dealer purchase agreements ("either you or we may choose to have any dispute between you and us decided by arbitration") expressed the plaintiffs' agreement to arbitrate arbitrability only with the dealers and no one else. As a nonsignatory, Toyota was not included. Accordingly, the court could not find clear and unmistakable evidence of an agreement to arbitrate arbitrability with Toyota. The court held that the district court properly decided the arbitrability issue.

While this holding may be good as far as it goes, it must be taken in the context of Toyota's other major argument, that of equitable estoppel. In essence, Toyota argued that the plaintiffs' claims arose in connection with the dealer purchase agreements by which they purchased their vehicles, and the plaintiffs were therefore estopped from seeking to avoid arbitration of claims related to those agreements. The Kramer court conducted a detailed analysis of the legal and factual bases for the plaintiffs' claims, concluding that the plaintiffs' causes of action were not based upon the terms of the dealer purchase agreements. Instead, the plaintiffs relied upon statutory and common law rights independent of the dealer purchase agreements and were not prohibited from disclaiming the arbitration clauses present in the those agreements. Had the Court been presented with different estoppel facts, however, it may have reached a different result on the threshold question of arbitrability.

It is well established that nonsignatories may compel or be compelled to arbitrate disputes concerning contracts to which they are not parties. See Arthur Andersen LLP v. Carlisle, 556 U.S. 624 (2009). If under traditional principles of applicable state law a contract may be enforced by or against a nonsignatory, the nonsignatory may compel or be compelled to arbitrate. Generally, contracts may be enforced by or against nonsignatories applying traditional principles of agency and contract law, including assumption, piercing the corporate veil, alter ego, incorporation by reference, third-party beneficiary theories, waiver, and estoppel. With particular reference to Kramer, California's equitable estoppel doctrine enables a nonsignatory to enforce an arbitration clause when: (1) a signatory's claims must rely upon the terms of a written agreement, or the claims are intimately founded in and intertwined with the underlying contract; and (2) the signatory alleges substantially interdependent and concerted misconduct by the nonsignatory and another signatory that is founded in or intimately connected with the obligations of the underlying agreement.

With this in mind, if a nonsignatory is close enough to the contract to be able to compel arbitration, the nonsignatory should be close enough to the contract also to enforce that portion of the arbitration clause that assigns the arbitrability decision to the arbitrator. This is the holding of Contec Corp. v. Remote Solution Co., Ltd., 398 F.3d 205 (2d Cir. 2005). Contec Corporation had been sued for alleged patent infringement and called upon Remote Solution to indemnify it pursuant to a 1999 agreement. The 1999 agreement contained a provision requiring arbitration of disputes according to the Commercial Arbitration Rules of the American Arbitration Association. Rule R-7 of these rules at that time stated that "[t]he 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."

Remote Solution argued that it was not obligated to arbitrate with Contec Corp. because Contec was not a signatory to the 1999 agreement. Instead, the Contec signatory was Contec L.P. After the 1999 agreement was signed, Contec L.P. was converted to Contec LLC, and later merged with Contec Corp., the surviving entity. The district court found on these facts that Contec Corp. was close enough to the 1999 agreement to enforce its arbitration provision, including the reference to AAA Rule R-7 that authorized the arbitrator to determine its own jurisdiction.

The Second Circuit court affirmed in a two-part analysis. First, the court recognized that just because a signatory may have agreed to arbitrate issues of arbitrability with another signatory does not mean that it must arbitrate arbitrability with a nonsignatory. There must be a sufficient relationship between the parties, the contract rights, and the disputed issues to support involving the nonsignatory in the arbitration. Second, in order to overcome the presumption favoring judicial resolution of arbitrability, there must be clear and unmistakable evidence of the parties' intent that the arbitrability question should be decided by an arbitrator and not the court.

It is interesting to note that in Contec, the Second Circuit found clear and unmistakable evidence in the 1999 agreement's reference to AAA Rule R-7. Given that many arbitration agreements incorporate the AAA rules, the role of arbitrators in deciding arbitrability questions may be more prevalent than may first appear. See Shaw Group, Inc. v. Triplefine Int'l Corp., 322 F.3d 115, 122 (2d Cir. 2003). However, what constitutes clear and unmistakable evidence in this context is not well established.

For example, compare Republic of Iraq v. BNP Paribas USA, 472 F. App'x 11 (2d Cir. 2012), in which the Second Circuit reached a result opposite that of Contec upon the basis of the relationship of the nonsignatory to the contract. Iraq brought a claim as a third-party beneficiary of a contract containing a clause requiring that "disputes relating to his Agreement . . . shall be referred by either party to arbitration" in accordance with the UNCITRAL rules. The court conceded its previous holding that incorporation of the UNCITRAL rules signaled the parties' intent to have arbitrators decide the validity of the arbitration agreement. Republic of Ecuador v. Chevron Corp., 638 F.3d 384, 395 (2d Cir. 2011). Nevertheless, and notwithstanding Contec, the court held that Iraq's third-party beneficiary status was not a sufficient connection to the contract, which specified that only "either party" could refer disputes to arbitration.

Arbitrating arbitrability with nonsignatories is a complicated issue that has not received consistent or uniform treatment in the courts. It seems established that where a contract contains clear and unmistakable evidence of an intent to refer arbitrability questions to arbitration, the courts will enforce the contract. It is sometimes less certain what comprises clear and unmistakable evidence. Furthermore, determining whether a nonsignatory is close enough to the contract to rely upon an arbitration clause is a more subjective analysis and likely fodder for litigation for years to come.

In any event, a court is the body with the ultimate power to enforce an agreement to arbitrate pursuant to the FAA. Consequently, the initial gatekeeping decision to compel arbitration will always be made by the court. And the question will remain, "What is the arbitrator to do?"

Keywords: ADR, litigation, arbitration, arbitrability, nonsignatory

Tom Alan Cunningham – June 16, 2014