In January 2014, the Seventh Circuit affirmed a district court’s decision to partially lift a stay of discovery. The central issue was whether the district judge had authority to allow any discovery to proceed, when the fruits of the discovery might be relevant to or evidence in a related and pending foreign arbitration. GEA Group v. Flex-N-Gate Corp. Case Nos. 13-2135, 13-2594 (7th Cir. Jan. 10, 2014). The facts of the case follow.
In May 2004, GEA Group, a German engineering company, made a written agreement to sell a subsidiary to Flex-N-Gate, a U.S. manufacturer of auto parts. When the deal did not close, GEA alleged that Flex-N-Gate breached the contract and initiated arbitration in Germany. In 2009, GEA also brought suit in federal court in Illinois against Flex-N-Gate and Khan, its CEO. GEA alleged that Khan used his control to strip Flex-N-Gate’s of its assets and that Kahn was its alter ego and was personally obligated to pay an award if Flex-N-Gate could not do so. Meanwhile, Flex-N-Gate filed a counterclaim alleging that it had been induced to sign the contract by GEA’s misrepresentations.
GEA’s motion to stay all court proceedings, including discovery, was denied. In 2010, GEA appealed, and its appeal was denied because the court presumed that an arbitration award granted in GEA’s favor three days earlier was the end of the dispute. However, Flex-N-Gate convinced a German court to vacate that award and order a new arbitration. GEA then filed a new motion to stay discovery in the district court until the German proceedings were completed. The district court denied the motion, but, in 2011, the Seventh Circuit reversed and ordered the case stayed for all purposes until the arbitration proceedings were finished, because the case was “clearly governed by the arbitration provision in the Contract.” Id. at 4.
In May 2013, Flex-N-Gate asked the district court to reopen discovery, and GEA opposed that request. GEA stated that court proceedings were ancillary to the arbitration because GEA would drop its case if GEA lost in arbitration or if the final award were paid in full. GEA said that it would seek judgment in court only if Flex-N-Gate did not pay any award in full, in which instance, GEA wanted to pursue its fraudulent conveyance claims against Kahn so as to secure full payment. GEA argued that discovery was premature and a stay was required under section 3 of the FAA, because the issues the case were all referable to arbitration. Khan argued that his personal liability for any award against Flex-N-Gate was not at issue in the arbitration and that section 3 was therefore inapplicable. The district judge agreed with Kahn and lifted the stay for the limited purpose of allowing Khan to conduct discovery to defend himself from GEA’s claims. GEA appealed.
On appeal, GEA argued that its fraudulent conveyance claim against Khan could be barred by the statute of limitations before a final arbitration award was issued, and that the lawsuit it filed was designed to protect against this possibility and should not move forward until the arbitration was completed and its result known. The Seventh Circuit acknowledged the possibility that GEA’s claims could be time-barred, but it was not persuaded that GEA had effectively preserved that argument in its appeal. More importantly, the Seventh Circuit noted that GEA’s true argument was that Flex-N-Gate should not be permitted to take discovery in the court case because it might use that discovery in the German arbitration. The Seventh Circuit said that GEA brought that potential problem on itself by filing suit against Kahn, who was entitled to defend himself. Moreover, the German authorities would determine whether any information that came out of discovery could be used in the arbitration.
In short, the Seventh Circuit ruled that how the discovery was used in the German arbitration was not its concern, and Khan was entitled to defend himself by taking discovery. Accordingly, GEA’s appeal from the district court’s partial lifting of the stay on discovery was denied. Id. at 17.
Practice Points: This case emphasizes the importance of fully thinking through one’s litigation strategy—including its risks—before taking action, particularly if one is going to file a claim against a sophisticated and well-heeled party. With regard to foreign arbitration, the case illustrates that one of the risks of filing a lawsuit is that it may create a path to discovery that would otherwise not be available in an arbitration setting.
Keywords: alternative dispute resolution, adr, litigation, foreign arbitration, discovery, stay of proceedings, stay of discovery, fraudulent conveyance