Avnet, Inc. v. H.I.G. Source Inc., C.A. No. 5266-VCP (Del. Ch. Sept. 29, 2010), read opinion here.

Short Overview

This opinion decided the recurring issue of arbitrability. Specifically the Court of Chancery decided whether the issue involving the post-merger price adjustment was within the scope of an arbitration clause in the merger agreement, and more specifically, whether that was a matter of substantive arbitrability for the Court to decide, or whether it was an issue of procedural arbitrability for the arbitrator to decide.

The general rule is that issues of procedural arbitrability, such as the conditions precedent for arbitration, are decided by the arbitrator. The Courts will presume, however, that the parties intended issues of substantive arbitrability (for example, the scope of and arbitration clause), to be decided by a Court, absent evidence that the parties “clearly and unmistakably intended otherwise.” See James & Jackson LLC v. Willie Gary LLC, 906 A.2d 76, 79 (Del. 2006). See here for summary of that seminal Delaware case on this topic.

Short Discussion

The Court cited to several other cases involving arbitrability in connection with post-merger price adjustment. See footnotes 38 to 40. The specific issue in this case was whether the arbitration clause in the merger agreement encompassed actions that did not conform with the specific process agreed upon by the parties for resolving disputes about the Closing Balance Sheet. Specifically, there was a four-step process that provided for deadlines by which disputes would be submitted and one of the parties missed that deadline by approximately one year. The Court reasoned that only those disputes that followed the procedure in the agreement were within the scope of the mandatory arbitration clause. That is, the parties did not agree to arbitrate issues that arose outside of those procedures.

Moreover, the Court regarded the dispute presented to it as a contractual issue that should be decided by the Court and not the arbitrator. Namely, the issue is whether the parties agreed to arbitrate the issue and not what rules would govern the arbitration procedure. In contrast, the issue did not include a condition precedent which would only involve whether the plaintiff was entitled to seek relief, and unlike the present case, would not involve the subject matter of the dispute. The question in this case is not whether a condition precedent was met; rather, it involves whether the parties have agreed to arbitrate the specific issues presented. Because that is a substantive matter of arbitrability for the Court to resolve, the Court denied a motion for judgment on the pleadings which sought to compel arbitration. 

As a closing aside, this case is a good example of why arbitration clauses do not always make the resolution of a dispute faster and cheaper, because there is often litigation about the arbitration issues before the merits of a dispute are ever addressed.
 

Orix LF, L.P. v. InsCap Asset Management, LLC, C.A. No. 5063-VCS (Del. Ch. April 13, 2010), read opinion here.

Who Should Read This Court of Chancery Decision?  Anyone who wants to know the latest Delaware law on the frequently recurring issue of: "Who decides whether a particular claim is subject to an arbitration clause, or not–the arbitrator or a court?" In this case, the Court determined that the arbitrator, and not the Court, must decide the issue of both substantive and procedural arbitrability. Thus, injunctive relief was denied.

Why This Opinion is "Blogworthy" to Synopsize: This blog covers all the key decisions on corporate and commercial law issued by Delaware’s Court of Chancery and Supreme Court, as well as related topics of interest to those make their living in the field of business litigation (or who otherwise want to know about the latest developments in the area). This decision covers a topic that frequently arises in the context of whether a particular issue is covered by the scope of an arbitration clause, and whether it makes a difference if the issue is categorized as one of "substantive arbitrability" or "procedural arbitrability".

Notable: The starting point for the Court’s legal analysis is the Delaware Supreme Court’s decision in James & Jackson, LLC v. Willie Gary, LLC, 906 A.2d 76 (Del. 2006), which was summarized here on this blog. Though barely 4 years old, the Willie Gary case already has numerous Delaware progeny, all of them listed by the Court at footnote 2 of the opinion. (By way of background, that case involves one of the few attorneys who has his own Wikipedia entry. See Willie E. Gary, Esq. here.)

Highlights: This opinion does not announce new law but is useful to the extent that it provides in a relatively pithy manner "all one needs to know" about whether an arbitrator or a court will decide the arbitrability of a particular claim based on the specific phraseology of the applicable arbitration provision. For that reason, this case summary warrants "bullet points" as compared to a more thorough review.

Background

  • Orix filed this complaint to enjoin the defendants from arbitrating claims that Orix believed should not be arbitrated because, for example, a condition precedent to arbitration had not been satisfied–namely the consent of a company named Swiss Re.
  • Initially, a TRO was sought, but that motion was converted to  a motion for summary judgment at the very beginning of the case and so the procedural posture for this decision was a motion for summary judgment by the plaintiffs, as well as responsive motions to dismiss by the defendants. In the end, the Court only needed to decide the issue of jurisdiction based on the Rule 12(b)(1) motion. Because the Court determined that only the arbitrator had the authority to decide the issue, the Court dismissed the case for lack of subject matter jurisdiction.

Legal Analysis

  • Relying extensively on the Willie Gary decision linked above, the Court recited the initial presumption that issues of procedural arbitrability are for the arbitrator to decide and issues of substantive arbitrability are usually for courts to decide. The latter presumption does not apply, however, if the "clear and unmistakable" evidence is that the parties intended for the arbitrator to decide all such issues, for example, when the following two conditions are met: "(1) the contract generally refers all disputes to arbitration; and (2) the contract refers to a set of rules that would empower arbitrators to decide arbitrability." (citing Willie Gary, 906 A.2d at 78-79).
  • Those two conditions are met in this case because: (1) the arbitration clause covers "any dispute"  that  "arises out of or relates to" the Fund Agreement, (which phrases the Delaware courts have interpreted to be very broad language for casting a wide net to encompass the widest range of related disputes (FN 46)); and (2) the arbitration is governed by the American Arbitration Association (AAA) Rules. (The AAA Rules provide for the arbitrator to decide issues of arbitrability.)
  • Although the issue in this case was one for the arbitrator to decide, the Court noted (FN52) that the arbitration clause was broad enough to cover an issue in a related agreement that did not have an arbitration clause but that was signed at the same time as part of the same transaction.
  • BOTTOM LINE STANDARD: The Court further reasoned that unless the defendant’s position on arbitrability (i.e., the argument that the claim should be submitted to the arbitrator), is "’wholly groundless’ or ‘frivolous’, the arbitrator and not the court must determine the question of substantive arbitrability. To do otherwise and to resolve good faith disputes about substantive arbitrability, would conflate the substantive arbitrability analysis proper, and usurp the role Willie Gary says belongs to  the arbitrator."
  • Moreover, even though the Court determined that the arbitrator was the appropriate arbiter of substantive arbitrability in this instance, whether or not a condition precedent to arbitration was satisfied (i.e., the prior consent of Swiss Re in this case), is the particular type of issue that is rightly categorized as "procedural arbitrability" which, as we have seen at the beginning of this post, presumptively is decided by the arbitrator anyway.

In Aveta v. Bengoa, No. 3598-VCL (Del. Ch. March 1, 2010), read letter decision here, the Court of Chancery clarified its prior decision, summarized here, regarding the scope of an arbitration clause. This 3-page letter ruling supplements a prior 43-page opinion from the Court  linked above(which is pending appeal before the Delaware Supreme Court.)

The very limited thrust of this decision is to confirm that based on the arbitration clause at issue, the Court had the authority to determine the scope and validity of the arbitration provision because that power was not delegated in the agreement to the arbitrator. The Court cited for this position both the decision in James and Jackson, LLC v. Willie Gary LLC , 906 A.2d 76, 78-79 (Del. 2006),  and 10 Del. C. Section 5703.

The Court also determined that the agreement did not allow the parties to expand the issues to be litigated before the arbitrator beyond those initially presented by the deadline provided in the agreement, and as for the substantial delay caused by one party, the Court provided a remedy for that delay in its prior opinion.  In closing, the Court explained that the arbitrator can determine what information it will–or will not–consider in deciding the issues and the Court declined to "intrude on the arbitral process by ruling on this question."

Lefkowitz v. HWF Holdings, LLC, No. 4381-VCP (Del. Ch. Nov. 13, 2009), read opinion here. This 30-page opinion is a helpful primer on the recurring topics of both procedural and substantive arbitrability. That is, it addresses when the applicability of an arbitration clause in an agreement can, or cannot, be decided in the first instance by a court, for example, where, as in this case, injunctive relief was sought to prevent one party from pursuing a claim in an arbitration proceeding. Many similar cases have been highlighted on these pages involving similar issues.

While I suggest a reading of the entire opinion is necessary for anyone interested in the latest iteration of Delaware law on this topic, for present purposes I will merely provide highlights of several points in this decision that I have arbitrarily determined to be especially noteworthy.

  • Substantive arbitrability addresses whether the parties decided in the contract to submit a particular dispute to arbitration, and those issues historically have been decided by a judge. The Court referred to what it described as the "seminal Delaware Supreme Court opinion" on this topic, James and Jackson LLC v. Willie Gary LLC, highlighted on this blog here, which formulated a two-prong test to determine whether an arbitration clause demonstrates "clear and unmistakeable evidence" that the parties intended to "arbitrate arbitrability". That test is whether the arbitration clause: (i) generally refers all disputes to arbitration; and (ii) references a set of arbitrable rules that empowers arbitrators to decide arbitrability, such as the AAA rules. Willie Gary, 906 A.2d at 80.
  • Procedural arbitrability by contrast covers, for example, issues such as whether the proper notice  of intent to arbitrate was given as required in the arbitration clause, and those issues are presumptively for the arbitrator to decide.
  • The Delaware Uniform Arbitration Act was recently amended to make two provisions that are unique to Delaware (i.e., they depart from the Uniform Arbitration Act in other states), less ambiguous. For example, whether one has a statute of limitations defense to an arbitration proceeding was formerly  considered to be a matter of "substantive arbitrability" that would ostensibly allow one to seek injunctive relief in court  to stop arbitration in some circumstances.  See 10 Del. C. Sections 5702(c); 5703 and 5714(a)(5) (1974).
  • Recent amendments to those sections however, have "converted" them to be presumptively matters of "procedural arbitrability" for the arbitrator to decide–not the court.
  • This opinion also has a very useful discussion of the interplay between the Federal Arbitration Act, and Uniform Arbitration Act and the Delaware Uniform Arbitration Act, and when one applies to the exclusion of the other.

There is much more to this opinion than I have only covered cursorily in this short post, but one concluding comment that I am impelled to make is that this case is a not uncommon example of why arbitration is not always the faster and less expensive alternative it is often touted to be. There are many instances of expensive litigation like this matter that incur substantial costs before the arbitration even begins. In addition there are other examples of post-arbitration litigation that contests the arbitrator’s decision and asks the court to set aside what was supposed to be "final and binding arbitration".

 

Julian v. Julian, No. 4137-VCP (Del. Ch. Sept. 9, 2009), read opinion here. Two of the prior opinions in this case by the Chancery Court were highlighted on this blog here and here.

The Court referred to other proceedings among these parties, including the following separate cases pending in the Delaware Chancery Court in what the Court described as this “unending tale of internecine strife”: Julian v. Eastern States Constr. Serv., Inc., No. 1892-VCP (Del. Ch. filed Jan. 18, 2006) and Julian v. Julian, No. 4099-VCP (Del. Ch. filed Oct. 16, 2008).

Issues Addressed

This opinion dealt with the following issues: (1) Aiding and abetting the breach of a LLC manager’s fiduciary duty by either not objecting to or enjoying the benefit of actions taken by the manager; (2) The statutory requirements under the Delaware LLC Act applicable to the resignation of an LLC member; (3) Issues of substantive arbitrability; and the standards applicable to a motion to dismiss and a motion to stay litigation.

Factual Background

The sum and substance of the factual background involved three brothers whose family controlled a multitude of companies. One of the brothers resigned from seven of the LLCs and alleged breaches of fiduciary duty at two other LLCs from which he did not resign. Some of the LLCs had arbitration clauses and some of them did not. Arbitration proceedings among the brothers have been instituted contemporaneously with the several pending cases in Chancery Court and among the issues addressed was which claims are subject to arbitration.

Right to Resign as LLC Member

Two different versions of 6 Del. C. Section 18-603 of the Delaware LLC Act applied to the seven LLCs from which one of the brothers purportedly resigned. The first version of Section 18-603 applied to those LLCs that filed a Certificate of Formation that was effective on or before July 31, 1996. That version allowed a member of an LLC the right to resign upon not less than six months prior written notice.

Those LLCs formed after July 31, 1996 were governed by the current version of Section 18-603 which “prohibits members from resigning prior to the dissolution and winding up of the company unless such resignation is allowed by the LLC Agreement.” See footnote 6. Generally, the right of a member to resign from an LLC is governed by the terms of the LLC Agreement unless, as here, the agreement is silent in which case the right is governed by Section 18-603.

Standards Applicable to Various Motions

The Court discussed the different standards applied to a motion to dismiss under both Rule 12(b)(1) for lack of subject matter jurisdiction when the claims involved are governed by an arbitration clause–as compared to a motion under Rule 12(c) [which is similar but not identical to a Rule 12(b)(6) motion], and is known as a motion for judgment on the pleadings.

In addition, the Court discussed the standards applicable to a motion to stay litigation, which is governed by the Court’s inherent power to manage its own docket. This power allows the Court to issue a stay pending the resolution of an arbitration, on the basis of comity, “efficiency or common sense.”  When considering a stay of claims that are not subject to arbitration, the Court “looks to the preclusive effects of a pending arbitration elsewhere on the action before the Court and vice-versa, as well as the burden imposed by litigating actions in different fora (citing Salzman v. Canaan Capital Partners, L.P., 1996 WL 422341, at * 4-5 (Del. Ch. July 23, 1996)). The Court found an insufficient basis to stay the litigation.

Substantive Arbitrability

A substantial portion of the 28-page opinion was devoted to the issue of substantive arbitrability. By contrast, procedural arbitrability addresses issues such as whether the proper notice was given to initiate the arbitration, and that ruling is generally made by the arbitrator. Substantive arbitrability is generally addressed in two parts, the first being whether the issue at hand comes within the scope of the arbitration clause. The second part of substantive arbitrability is whether the Court or the arbitrator shall decide whether the issue at hand is within the scope of the arbitration clause. The controlling Delaware law that decides that issue is based on the seminal Delaware Supreme Court decision in James & Jackson, LLC v. Willie Gary, LLC, 906 A.2d 76, 79 (Del. 2006). See a summary of that decision on this blog here.

Although a determination of the substantive arbitrability issue can be quite involved and the Court devotes many pages to the analysis as applied to the facts of this case, the general rule is that unless the parties unequivocally provide for the arbitrator to make that decision, such as referring to the American Arbitration Rules which so provide, the presumption is that the Court will determine whether the issue at hand is within the scope of the arbitration clause. See footnotes 35 to 38.

Aiding and Abetting Breach of Fiduciary Duty

The Court addressed a motion to dismiss for failure to state a claim for breach of fiduciary duty. In response, instead of establishing a breach of fiduciary duty, the plaintiff argued that there was a claim for aiding and abetting breach of fiduciary duty. Thus, analyzing that different claim, the Court described the necessary elements for a claim of aiding and abetting a breach of fiduciary duty as follows: (1) Knowledge of the breach of the duty; and (2) Participation in the wrongful conduct. The complaint alleged that the manager of the LLC increased management fees by 400% with the “consent of” the defendant charged with aiding and abetting the breach. The Court’s reasoning for allowing the claim to go forward deserves to be quoted. The Court explained that:

“Under the plaintiff-friendly motion to dismiss standard, the allegations that Richard [the member of the LLC alleged to have aided and abetted the breach] consented to the increase in fees, which benefited a company controlled by Richard and Francis [the manager of the LLC], are sufficient to support a reasonable inference that Richard participated in the alleged wrongdoing. The fact that Francis could have taken that action on his own as a manager does not negate a reasonable inference that Richard may have been involved in the decision. The evidence conceivably could show that Richard knew about the increase and supported it, even though he also knew that fee increase of 400% would have been suspect, especially in light of the family feud he and Francis had with Gene [the plaintiff brother] and the fact that he and Francis stood to benefit from the increased fees.”

In footnote 69, the Court addressed the argument that the LLC Agreement gave Francis “wide discretion to make decisions.” The Court cited to Section 18-1101(c) of the Delaware LLC Act for the provision that an LLC Agreement cannot eliminate the implied contractual covenant of good faith and fair dealing.

Concluding Remarks with Equitable Flavor

Finally, as an example of its exercise of equitable principles as opposed to strict compliance with procedural rules, the Court rejected an argument that the claim for aiding and abetting was not specifically pleaded in the complaint and should thus be dismissed based on Chancery Court Rule 15(aaa) [which provides for dismissal if a complaint is not amended in response to a motion to dismiss].  The Court reasoned in footnote 69 that “the argument lacks merit for the facts alleged in the Complaint suffice to support an aiding and abetting claim. To the extent a formal amendment to the Complaint in that regard might be considered necessary, I find that a dismissal with prejudice would not be just under all the circumstances. The most that would be warranted in terms of relief is a dismissal without prejudice, and I find that unnecessary.”

 

In McLaughlin v. McCann, 2008 WL 483457 (Del. Ch., Feb. 21, 2008), read opinion here, the Delaware Chancery Court addresses the perennial issue of whether the court or an arbitrator should decide the threshold matter of arbitrability, based on the arbitration clause in an agreement, and a dispute about whether the provision requiring arbitration of claims covers the particular claim involved. The court disects with surgical precision the different analytical approaches and policy considerations related to the matter. In particular, the court parsed and "put under a magnifying glass" the prior decisions of both the Chancery Court and the Delaware Supreme Court in the Willie Gary LLC v. James and Jackson LLC,  case that was summarized here  and here on this blog. The Supreme Court affirmed the Chancery Court opinion though with slightly different reasoning, and this decision highlights those differences in the context of the majority view around the country on the issue of who should decided substantive arbitrability.

Anyone interested in the latest Delaware law on the issue of  "arbitrability" needs to read this decision.

A "collateral" aspect of this opinion, in my view,  is that it provides another example of how much litigation can ensue, and how much time and expense can be spent fighting over whether an arbitration clause (which in part is designed to reduce the time and expense of litigation), requires arbitration of a particular claim or if the claim is not covered by the clause. In my view, this common imbroglio is one of several indications that arbitration may not always be a cheaper and faster alternative to regular litigation.

 Brown v. T-Ink, LLC, 2007 WL 4302594 (Del. Ch., Dec. 4, 2007), read opinion here, ( Here is the court’s revised opinion.) The Chancery Court engages here in one of the most extensive discussions of substantive arbitrability — compared with procedural arbitrability — since the decisions of the Chancery Court and Supreme Court last year in the Willie Gary case. Both parties and the court relied on and discussed extensively the Supreme Court’s  affirmance of a Chancery Court decision last year in James & Jackson LLC v. Willie Gary, LLC, 906 A.2d 76 (Del. 2006). [The Supreme Court’s decision was summarized here on this blog, and the Chancery Court decision was summarized here on this blog.]

 In Baypo Limited Partnership v. Technology JV, LP, 2007 WL  2896369 (Del. Ch., Oct. 2, 2007), read opinion here, the Chancery Court addressed the arbitrability of a claim for reformation of a contract. The opinion includes an introductory summary of the case that is more useful as a short overview than I could otherwise provide in a short blurb for this blog post. Here is how the court introduced the case:

 The plaintiffs in this action lost in arbitration
based on contract language they claim does not
reflect the agreement of the parties but instead (at
least as interpreted by the arbitrators) is the result of
mistake. The plaintiffs now seek to reform the
contract, arguing that their claim for reformation is
not subject to the otherwise broad arbitration clause
governing the parties’ commercial relationship. The
defendants move to dismiss arguing, among other
things, that the claims asserted are subject to
arbitration.
In light of the recent decision of the Delaware
Supreme Court in James & Jackson LLC v. Willie
Gary,
[FN1] the court must first determine whether,
under the terms of the parties’ agreement, the issue of
arbitrability is one that must be addressed by an
arbitrator, rather than by the court. Having reviewed
the relevant agreements, the court concludes that the
issue of arbitrability is for an arbitrator to decide
because the arbitration clause is broadly worded,
expressly references the Rules of the American
Arbitration Association, and explicitly provides that
an arbitrator shall decide all substantive and
procedural issues related to disputes. The court
reaches this conclusion despite the fact that the
arbitration provision expressly permits limited access
to the courts for injunctive or equitable relief to
protect the rights of the parties or the status quo
during the pendency of an arbitration. That limited
right to judicial access does not negate the clear
intention of the parties to assign issues of arbitrability
to an arbitrator.
FN1. 906 A.2d 76 (Del.2006).

I summarized on this blog here the recent Delaware Supreme Court decision in the Willie Gary case that is refered to in the foregoing quote (and I was representing one of the parties in that case as well.)  As I said in the summary of that case,  and as applies equally in this case, this decision highlights the need to be especially careful in the drafting of an arbitration clause if one is interested in seeking any type of equitable relief in the Chancery Court.

The Chancery opinion in this case describes in extensive detail the complex inter-related agreements for a large transaction that led to the litigation.

Courtesy of The Wall Street Journal Law Blog, here is a story about a lawyer who is seeking fees of $11,000 per hour in connection with a mistrial apparently resulting from (or related to) the violation of a sequestration order imposed on witnesses. Relevance to this blog: While we often write here about Chancery Court cases that deal with applications for attorneys fees in class actions or derivative cases, the real reason I include this story, (apart from its entertainment value on a topic that interests all lawyers and their clients), is that the lawyer involved, Willie Gary,  is someone I handled expedited business litigation for last year, which resulted in a reported decision by both the Chancery Court and the Delaware Supreme Court, as summarized here,  in Willie Gary, LLC v. James & Jackson, LLC. (As an aside, I admit that it was fun to meet on his private jet –photos linked in the WSJ  Blog story above–when he flew into Wilmington).

In Country Life Homes, Inc. v. Shaffer, (Del. Ch., Jan. 31, 2007), 2007 WL 333075, read opinion here, the Chancery Court addressed an issue of "competing arbitration awards" and determined that the first decision would prevail. The buyers of a home signed a construction agreement that included an arbitration clause and they later signed a warranty agreement that also provided for arbitration by a different arbitration service. The arbitrator selected pursuant to the warranty agreement (the second agreement),  rendered his decision first and found in favor of the builder on claims regarding the construction of the house. A few weeks later, an arbitrator who heard claims based on the first agreement rendered his decision in favor of the homeowners. Arguably the decisions of each arbitrator, though reaching different conclusions, covered the same claims.

The court reasoned that when 2 conflicting agreements between the same parties on the same subject matter exist, the newer agreement will control to the extent that the new contract is inconsistent with the old one. (citation omitted to case law and to Corbin’s treatise on contracts in which he describes the new contract as "both a rescission and discharge by substitution" of the old one.)  Here the court noted a recent decision giving the arbitrator the power to decide arbitrability if the parties simply incorporate the rules of the arbitration service, such as the AAA. See James & Jackson LLC v. Willie Gary LLC, 906 A.2d 76, 80 (Del. Ch. 2006).

The court also discussed the Delaware statutes for "confirming" arbitration awards, or modifying them and/or vacating them under 10 Del. C. Sections 5713; 5714 or 5715, as well as the public policy that  favors upholding decisions by arbitrators in binding arbitrations. See footnote 17.

In sum, because the parties agreed that the first arbitrator’s award was final and binding, the decision of the second arbitrator  was beyond his powers to grant, thus giving res judicata effect to the first arbitration decision.

In a closing footnote the court recognized that the result might be unsettling due in part to the conclusion in the court’s opinion being impacted by the better administration by the arbitration service that scheduled the hearing faster and rendered a decision sooner (even though the second decision was from the arbitration service where the first claim was filed.)

This case underscores the uneven handling of claims by the various ADR providers such as the AAA, which in my view also emphasizes the need for a few drafting tips to be observed when drafting arbitration clauses:

(i) do not become a hostage to the arbitration service provider. (For example, in this case, if the provider was faster in handling and scheduling the claim, and rendering a decision, that decision may have prevailed.)

(ii) consider your own timetable for scheduling the arbitration hearing and  use your own procedure for selecting the arbitrator;

(iii) do not simply incorporate the rules of the AAA, for example. As noted in the Willie Gary case, supra, such wholesale use of the AAA rules, for example, may prevent the court from granting expedited injunctive relief–and this case provides a striking example of why service providers such as the AAA, in my opinion, are ill-suited for providing expedited treatment of an urgent matter and how, in my humble view,  their lack of administrative speed can have an adverse impact on one’s case.

Yes, one might conclude that the use of an independent arbitrator (such as a retired judge, for example),  may be more effective that the use of an ADR service company.