All of us regularly utilize arbitration and other alternative dispute resolution clauses in our agreements. And, while there is some debate about the benefits and detriments of such clauses, I believe we all will continue to utilize them for better and for worse. Moreover, despite some ongoing skirmishes, it is pretty clear at this point that most courts will enforce arbitration clauses, in large part complying with the clear intent of Congress as expressed in the Federal Arbitration Act (the "FAA").
But what happens in the situation where one party is not a signatory to the arbitration agreement? I have encountered this very situation several times. Most often, for whatever reason, some key person or entity has not signed the agreement containing the arbitration clause. It could happen in several different ways. Maybe it was a silent partner of the franchisee who ended up running the franchise business and now needs to be sued personally. Maybe it was a spouse. What then? The Supreme Court has plainly spoken that the FAA only applies where both parties consented to and are bound by the arbitration clause. Still, a non-signatory may be bound by an arbitration clause if "traditional principles" of state law allow a contract to be enforced by or against non-parties or if the party is truly akin to a signatory of the underlying agreement containing the arbitration clause.
The U.S. Court of Appeals for the Third Circuit recently examined the question of whether one such traditional contract principle, equitable estoppel, permitted the defendants to enforce an arbitration clause against a non-signatory to an insurance sales contract. The owner of an insurance policy, a trust, sold the policy to a third party in a life settlement transaction. The deal was brokered by an agent. The contract of sale between the trust and the buyer contained an arbitration clause. Later, upon learning that the buyer of the policy had allegedly paid kickbacks to the agent to not market the deal to its competitors, the beneficiary of the policy sued the buyer, broker and others for fraud. The defendants, pointing to the arbitration clause, asked the court to send the case to arbitration.
The Third Circuit disagreed with the defendants and concluded that the beneficiary could maintain the case in court. The Court said that equitable estoppel requires either a close nexus between the non-signatory and the contract or contracting parties or a situation where the non-signatory has reaped the benefits of the contract containing the arbitration clause. This latter prong is important because it prevents someone from cherry-picking the provisions of a contract which benefit it and rejecting those which do not. In this case, however, the Court said that the beneficiary was not relying on the contract containing the arbitration clause in any way; that the alleged fraud occurred prior to even the existence of the purchase agreement. In my opinion, that conclusion has particular relevance for the franchise industry because many fraud claims allege conduct prior to the signing of the franchise agreement.
The Court acknowledged that this is a narrow interpretation and application of the equitable estoppel exception to the rule that non-signatories are not bound by arbitration clauses. Nonetheless, as the many cases cited by the Third Circuit in its opinion attest, it is not an especially unusual result. The lesson is to make sure, as you're negotiating and preparing for the closing, that you have the correct people and entities signing the agreement containing the arbitration clause. Consider addendums that bind additional parties–franchisee investors, key employees and managers, spouses, etc.–to arbitration in the same manner you probably already do for non-compete and non-solicitation clauses. Don't leave your ability to arbitrate hanging on a court's interpretation of a doctrine like equitable estoppel.
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