Five Ways to Avoid Arbitration: An Overview of Recent New York Case Law

By Victor M. Metsch

There is no summary judgment, no appeal except in the most extreme circumstances, and the normative judgments of one person—the arbitrator—can easily overwhelm the rightness of your client’s case or the legal validity of your arguments.

Your client signed the arbitration agreement. But there may still be a way out under New York substantive law. For those cases not within the scope of the Federal Arbitration Act, here are five ways to avoid arbitration.

Litigate the Arbitrability

Read the arbitration clause carefully. Did the parties agree to arbitrate whether the arbitration clause applied? If they didn’t, it is for the court—not the arbitrator—to determine whether the clause applies to the agreement at issue. In Briarwoods Farm v. Lexington Funding Group, 2010 NY Slip Op 31483(U) (N.Y. Sup. Ct., Orange County, June 14, 2010), the Orange County Supreme Court — not the arbitrator — considered whether to compel an LLC to arbitrate.

The movant failed to produce the arbitration agreement, instead relying on the verbal assurances of a synogue’s rabbinical court that a valid arbitration agreement existed. The dispute arose over a commercial foreclosure, and included a second action alleging breaches of fiduciary duty and invalid mortgage assignments. Both actions related to a 342-unit market-value condominium and a 120-unit housing development.

The defendants in the foreclosure action, who were the plaintiffs in the second action, moved to compel arbitration in the foreclosure action, alleging the existence of an arbitration agreement that would bind the parties to arbitrate the question of the validity of assignment in the second action.

After consciously looking beyond the logical fault of applying an alleged agreement to arbitrate one dispute to a different dispute, the court reasoned that the essence of the claim was that Jacob Sofer, an officer of Lexington Funding Group (the non-moving party), had signed an arbitration agreement. And Sofer had — but when the agreement finally appeared — in Sofer’s sur-reply affirmation — it explicitly bound the signatory only in his personal capacity, rather than on behalf of the LLC before the court. The court was prepared to dismiss.

Not content merely to show the misguided wisdom of trying to compel arbitration without an arbitration agreement in hand, the Supreme Court, Orange County, went further. It held that because of the repeated, if not intentional, blurring of lines between and among parties and actions in the case, the plaintiffs had not met their burden of showing that there existed a clear, explicit, and unequivocal agreement to arbitrate the disputes.

Likewise in MF Global, Inc. v. Morgan Fuel & Heating Co., Inc., 71 A.D.3d 420, 896 N.Y.2d 326 (1st Dep’t, March 2, 2010), it was for the court — not the arbitrator — to determine whether an arbitration agreement existed.[1]The First Department considered whether to allow arbitration of derivative swap claims that arose under an International Swap Dealers Association, Inc. agreement. Related guaranties contained arbitration provisions but the ISDA agreement itself did not. Language establishing that the guaranties are separate obligations from the main agreement, though meant only to protect creditor rights, limited the effectiveness of the guaranties’ arbitration clauses by precluding them from being considered intertwined with the agreement they guarantied.

Escape the Scope of Arbitration

Does the language of the arbitration clause specify what kind of disputes are to be arbitrated? MF Global and Briarwoods Farm addressed the fairly broad question of whether there is an arbitration agreement that is part of the agreement between the parties, but arbitration clauses can also be more nuanced. When they are, it is still up to the court to determine whether the arbitration clause reaches a particular dispute.

In Petito v. Antonini, 2010 NY Slip Op 30851(U) (N.Y. Sup. Ct. N.Y. County, April 8, 2010), the New York County Supreme Court refused to require arbitration of multiple claims arising out of a settlement agreement where, inter alia, the arbitration clause referred only to decisions required to be made by unanimous decision of the managing members of a company. The parties to the settlement agreement, a modestly complex affair between seven individuals, four LLCs, and a corporation, had recognized the possibility of a deadlock among the managing members of Bridgeview, one of the LLCs. This mattered because several of the individuals consented to the terms of Bridgeview’s operating agreement as part of the settlement.

The settling parties resolved the issue by specifying that deadlocks on decisions “required to be made” under the law or the agreement would be resolved by arbitration. But this custom arbitration language was too precise to be of practical use in the case. The court reasoned that neither breach of contract claims between the managing members nor disputes between them regarding allegations of bad faith were disputes about decisions they were required to make by unanimous consent.

Similarly, in Deephaven Distressed Opportunities Trading, Ltd. v. 3V Capital Master Fund Ltd., 72 A.D.3d 562, 899 N.Y.S.2d 50, (1st Dep’t, April 22, 2010), an arbitration clause drafted with too much precision cost the client enforceability. The arbitration clause, rather than merely specifying that all disputes between the parties or all disputes under the agreement would be subject to arbitration, explained that third-party plaintiff 3V Capital Master had agreed to the “clearing” terms of a brokerage agreement that contained the arbitration clause.

The brokerage agreement explained elsewhere that it set forth the terms and conditions under which one of the parties, Imperial Capital LLC, would clear 3V Capital Master’s securities transactions. The court found that this “clearing” language narrowed the scope of the arbitration clause, and held that 3V could not be compelled to arbitrate where Imperial, the party seeking arbitration, failed to demonstrate that the claim was related to the clearing of securities under the agreement.

Petito and Deephaven make it clear that drafters must use good, broad boilerplate arbitration provisions with minimal changes to ensure that their arbitration clauses cover all disputes. When they fail to, or if the boilerplate is drawn too narrowly, clients seeking to avoid arbitration can get to court.

Invalidate the Arbitration Clause under Section 399-c

New York’s GBL § 399-c invalidates mandatory arbitration provisions in agreements to purchase goods, wares, paid merchandise or services for personal, family, or household use, provided that the transaction is beyond the reach of Congress’s commerce power. New York Courts tend to interpret Congress’s commerce power narrowly, so § 399-c applies in many cases including, for example, those regarding arbitration clauses in agreements for home building or renovation.

In Diamond Waterproofing Sys. Inc. v 55 Liberty Owners Corp., 4 N.Y.3d 247, 793 N.Y.S.2d 831 (2d Dep’t 2005), the Court of Appeals held that Section 399-c was pre-empted by the FAA in a contract to repair and reconstruct the façade and roof of a nationally landmarked Manhattan building, where there was significant involvement of services and materials from Illinois, Massachusetts, and New Jersey. The court, following Allied-Bruce Terminix Cos. v. Dobson, 513 U.S. 265 (1995), reasoned that the FAA pre-empts GBL § 399-c for all contracts within the limits of the full extent of Congress’s commerce power. However, the court emphasized the heavy interstate connections of the case and failed to give examples of similar fact-patterns that might have shown where the Commerce Power ends — a consumer-friendly move, cloaked in the guise of judicial restraint, to leave Section 399-c intact despite Congressional preemption. The ruling both left wiggle-room for lower courts to continue to apply Section399-c and avoided giving the Supreme Court of the United States reason to review the decision.

In Ragucci v. Professional Constr. Servs., 25 A.D.3d 43, 803 N.Y.S.2d 139 (2d Dep’t 2005), the plaintiffs had paid to design and build a property that would be accessible to their disabled daughter and had become embroiled in a dispute over the quality of the contractor’s work and the lack of supervision from the architectural firm. Looking at sympathetic plaintiffs just seven months after Diamond was handed down, the Second Department found that Section 399-c applied to architectural agreements.

In Baronoff v. Kean Development Co., Inc., 12 Misc.3d 627, 818 N.Y.S.2d 421 (Sup. Ct. Nassau County 2006), the Nasasau County Supreme Court found that the FAA did not reach in-state agreements pertaining to the management of renovations of homes in Lloyd Harbor and Manhattan. The petition to stay arbitration had been filed untimely, but allowing arbitration in violation of Section 399-c would be against public policy, so the court heard arguments anyway. The renovations used materials that had traveled in interstate commerce, but the court held that such purchases were insufficient to implicate the commerce clause: if purchasing out-of-state materials was sufficient to implicate the clause, the court reasoned, then Section 399-c claims would almost always fail.[2]

More recently, in Byrnes v. Castaldi, 72 A.D.3d 718, 898 N.Y.S.2d 640 (2d Dep’t, April 13, 2010), the appellate court upheld an order denying a motion by Castaldi to compel arbitration in a dispute over Castaldi’s construction of a single-family residence for the plaintiffs. Although the Second Department disagreed with the holding of the Westchester County Supreme Court that Castaldi had waived his right to arbitrate by participating in litigation, it allowed a Section 399-c claim as an alternative ground to affirm the order appealed from, but did not discuss the pre-emption issue. Citing to Baronoff, the court held the arbitration clause was voided by the timely assertion of Section 399-c.

Sooner or later, GBL § 399-c will probably be effectively eviscerated, despite the hesitation of New York courts to interpret the Commerce Power expansively and the surprising (but still negligible) indications from the United States Supreme Court that it might be willing to limit that power. In the meantime, however, Section 399-c remains an effective avenue for consumers in home renovation deals and otherwise to challenge arbitration clauses.

Look for Conditions Precedent

If there is a condition precedent to arbitration, or a condition precedent to an arbitration having the power of a binding judgment, it may be possible to avoid (or, in the alternative, to affirm) the arbitration clause. In Petito, supra, largely because the disputes at issue had not first been submitted to mediation as required by a contractual condition precedent, the New York County Supreme Court granted a stay of arbitration.

Similarly, in Osberg v. Litric, 2010 NY Slip Op 31307(U) (N.Y. Sup. Ct. N.Y. County, May 21, 2010), the court held — in a breach of contract action over renovations to 333 East 66th St. — that where an architect failed to timely deliver a decision to the parties as required by an express condition precedent to mediation, arbitration or litigation, the ultimately prevailing party could seek declaratory judgment that the architect’s decision was final and binding. It is worth noting that mere procedural issues, such as compliance with a contractually specified time during which the demand for the arbitration must be made, would have been for resolution by the arbitrator, and thus must be carefully distinguished from conditions precedent.

Let the Statute of Limitations Run

Our last method is a little old-fashioned: live long enough and don’t draw the opposing party’s attention. Contract claims do not survive forever, and our grandmothers do not have to pay now for the cars or cabbages they bought 40 years ago, even if they forgot to pay the full amount at the time. It would be immoral, inequitable, and unjust to surprise someone with an arbitration after abandoning the claim for many years.

In New York, a breach of contract claim may be time-barred if arbitration or litigation is not commenced within six years of the breach. Still, be careful not to assume the contract ended when it says it did: In RCDolner, LLC v. 271 Mulberry St. Co., LLC, NY Slip Op 30989(U) (N.Y. Sup. Ct. N.Y. County, April 21, 2010), the New York County Supreme Court refused to stay arbitration where a contractor that had received its final payment and left the site in August of 2000 was recalled, pursuant to a settlement agreement, to do very substantial repairs as late as the summer of 2004. Mulberry sponsored the conversion of the building to luxury condominiums in or around June of 1998, the final payment to RC Dolner, the contractor, was received on Aug. 1, 2000, and the final certificate of occupancy was issued on Aug. 9, 2002. But leaks in the building led Mulberry and Dolner to enter into a settlement agreement, in June of 2004, under which Dolner would fix the conditions causing the leaks and cracks.

While superficial work might not have been sufficient to extend the statute of limitations on the contract, the work contemplated under the settlement would reasonably take six months to complete, require scaffolding, and include bi-weekly construction meetings and significant masonry, waterproofing, and roofing work. Although Dolner allegedly walked off the job before his obligations under the settlement agreement were fulfilled, the record did not preclude a finding that he performed substantive work as late as the summer of 2004. Thus, when Mulberry found what it alleged were newly discovered pervasive and fundamental construction and design defects and sought arbitration in October of 2009, the six-year statute of limitations did not preclude recovery on the original nine-year-old contract.

(Victor M. Metsch is a Senior Litigation Partner at Hartman & Craven LLP. Tom White, Georgetown Law student and a Summer Associate at the firm, also contributed to this article.)

This Article was originally published by Thomson Reuters.

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