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The Tale of The Arbitration Clause Snare

By: Allyson Cofran and Bari Gambacorta, Stark & Stark P.C., Lawrenceville NJ

Is there an arbitration clause lurking deep within your leasing litigation? Perhaps not. But it’s best not to surprise your client. These clauses can be hard to detect, challenging to eliminate and they may resurface with a vengeance at the most inopportune moment.

A recent New Jersey appellate case entitled Suzanne’s Specialties, Inc. versus American Sugar Refining, Inc. decided April 10, 2013 tells the chilling tale.

It was in March 1993 when American Sugar Refining, Inc. (“American”) agreed to provide Suzanne’s Specialties Inc. (“Specialties”), exclusivity to market cereal syrups (a/k/a/ “Innovative”) to the natural/ health food industry. Thereafter, in 1999 American and Innovative reached a second agreement (the “1999 Agreement”). Specialties was not a party to the 1999 Agreement. However, that agreement set forth the payments that Specialties would receive for all sales of the Innovative products sold by Specialties. The 1999 Agreement included an arbitration clause. In short it stated:

“any dispute or controversy arising under or in connection with any provision of this agreement shall be settled exclusively by arbitration, conducted in Newark, New Jersey…”

Specialties multi-count complaint was filed in July 2010 and asserted a third-party beneficiary claim against American. American’s first move was to file a motion to dismiss the claim as it was subject to arbitration and/or to compel arbitration. That was also the first affirmative defense asserted in their initial answer filed in September 2010. America included that affirmative defense in its amended answer and counterclaim filed in June 2011 and also in its August 2011 answer to a counterclaim filed by third-party defendant Innovative in June 2000.

In December 2011 America filed an arbitration complaint pursuant to the arbitration clause. By that time Specialties had produced more than 10,000 documents in discovery and three depositions had been taken. At that time in December 2011 American had a pending motion to amend its pleadings and Specialist had a motion to compel depositions. Despite significant discovery, two years of litigation and the fact that Specialties was not even a signatory on the 1999 Agreement with the arbitration provision, the Appellate Court held that the arbitration clause would prevail.

Here is how the Appellate Court handled the arguments:

Specialties contended that it could not be bound by an agreement requiring arbitration that they had not signed. However Specialties was a third-party beneficiary to the 1999 Agreement and as such was bound by the arbitration clause. The court noted that the 1999 Agreement actually set Specialties payment terms.

Thereafter Specialties argued that American’s participation in the instant litigation amounted to a waiver of its contractual right to arbitrate. The court was unmoved. Waiver of an arbitration clause may be found if a “party seeking to enforce the agreement has participated in litigation in a manner inconsistent with a bona fide intention to enforce the agreement to arbitrate. Suzanne’s Specialties, Inc. versus American Sugar Refining, Inc. * 9. For example a party that did not file an answer to the counterclaim alleging arbitration as a defense until their answer was amended to include this defense, two weeks before the trial did not prevail Farese v. McGarry, 237 N.J. Super 385, 394 (App. Div. 1989). Litigation conduct that is “unequivocally inconsistent with an intent to invoke an agreement to arbitrate” may not survive without a party showing a “demonstrable prejudice”. Angrosiani v. Fin Tech. Ventures, L.P., 402 N.J. Super 138, 150 (App. Div. 2008); cf. Wein v. Morris, 194 N.J. 364, 376-377 (2008), . Thus where neither party referenced arbitration in their original pleadings and engaged in five years or more of discovery, these parties lost the arbitration they sought. McKeeby v. Arthur, 7 N.J. 174, 182 (1951)

In this case America took twenty months to seek its stay of the trial court proceedings. Nevertheless, Innovative was not acting as if the trial was imminent because Innovative had a pending motion to amend its pleadings. Additionally discovery was not yet complete and Specialties had a pending motion to compel further depositions. American’s conduct was deemed unequivocal. American not only asserted an affirmative defense based on the agreement to arbitrate not only in its initial pleading submitted but with each assertion of the defense, reserved its right to seek an order compelling arbitration pursuant to the agreement. Since American expressly reserved its right to move to compel arbitration it was exceptionally difficult for the appellate court to find a waiver – an intentional relinquishment of that right.

Moreover Specialties, Innovative and the trial court were all on notice of American’s intention. Notice is always critical. Once noticed of another party’s intention to demand arbitration the litigants should have considered the validity of the claim and guided their litigation conduct accordingly. Here both Specialties and Innovative continued discovery without seeking resolution of the asserted arbitration defense. Both were hard pressed to demonstrate prejudice or surprise by American’s complaint for arbitration. Their arguments failed to articulate any specific prejudice or unfair strategic advantage gained by American.

The Alabama Supreme Court considered this issue in Paw Paw’s Camper City, Inc. v. Hayman, 973 So. 2d 344 (Ala. 2007), where court interpreted the standard for the waiver of an arbitration clause when there is substantial “invocation of the litigation process” and where there is prejudice to the opposing party by a subsequent order requiring it to submit to arbitration. Paw Paw asserted the arbitration defense in their initial answer to the complaint but also asserted a counterclaim and demanded a jury trial. When sanctions were sought against it for failure to respond to discovery, Paw Paw did not raise the defense of arbitration but rather served their own discovery requests. No objection was raised that arbitration applied after two depositions and many communications with the court to resolve issues during the depositions. Because Paw Paw continued with the litigation on all issues (including those specific claims that were subject to arbitration) and deferred the depositions of key witnesses on the issue subject to arbitration shortly before trial eleven months after the complaint was filed, the court concluded that there was a waiver of the arbitration defense as well as prejudice to the Haymans’ having participated in full-blown pre-trial discovery addressing all issues in the case.

The Court of Appeals of Texas, Ninth Circuit, also considered this issue in Al Jones and Al Jones Architect v. Mainwaring, 2012 Tex. App. LEXIS 10503 (Dec. 20, 2012), where an answer was filed, discovery exchanged as well as one deposition taken, there after an amended complaint to bring in new defendants was filed and discovery continued, the court found that the defendant has not “substantially invoked the judicial process to its opponent’s detriment.” * 15, and allowed the removal to the arbitration forum. However, the Texas Supreme Court held in Perry Homes v. Cull, 258 S.W. 3d 584, 591 (TX. 2008), that allowing a party to conduct full discovery, file motions going to the merits and seeking arbitration only on the eve of trial was sufficient to show waiver. The Court cites ten factors that should be analyzed when considering a waiver of the clause.

The lesson of this cases is that counsel should carefully consider the applicability of any arbitration paragraphs in earlier and/or related matters before filing any pleading. Counsel should then determine whether or not arbitration is desirable. If it is they should preserve it in the same manner as American did. If it is not desirable they should seek clarification of its application in the pending litigation. At the very minimum, counsel should prepare the client for the possibility of arbitration and make recommendations based upon that possibility. A full and detailed review of all applicable agreements, no matter how tenuous they appear at first blush, at the very outset my well foil arbitration’s hidden snare.