Arbitration & Nonsignatories

As many of you are probably aware, arbitration is a less formal means than trial in deciding a dispute. It is usually less expensive than going to trial as well. Many times, parties end up in arbitration because there was an arbitration clause in the contract that the parties all agreed to. Generally, only the parties to the arbitration agreement are bound to the arbitration agreement or can enforce the arbitration agreement.

This article will actually look at two separate cases and how they affect what individuals/entities have to comply with regarding an arbitration provision contained in a contract. Although neither of the cases discussed deal with construction contracts, the outcome of the cases with respect to arbitration could very easily affect a construction contract in the future.

First, we will look at the case of John D. Thomas v. Steven M. Westlake. Katherine Thomas was an elderly widow that opened an investment account where the Brokerage Client Agreement (a contract) that she signed had an arbitration agreement in it. Upon Ms. Thomas' death, her son and successor in interest filed a lawsuit because he believed that the defendants' made unsuitable investments on Ms. Thomas' behalf for the purpose of increasing the defendants' commissions. The defendants included the investment advisor as well as insurance companies that Ms. Thomas purchased policies and annuities from because the plaintiff alleged that all of the defendants were agents of each other.

The defendants requested arbitration as per the agreement that Ms. Thomas entered into. Plaintiff argued that since not all of the defendants were signatories to the arbitration agreement they were not entitled to arbitrate as well as that if the claim was arbitrated with those entities entitled to arbitration, there was a possibility of conflicting rulings. Because of this the trial court denied the defendants request for arbitration.

On appeal, the court indicated that because the plaintiff alleged that the defendants were all agents of each other that meant that the defendant who did not sign the arbitration agreement was actually entitled to enforce the arbitration provision. Therefore, the trial court was wrong by denying the request to arbitrate.

In the case of Epitech, Inc. v. Garry Michael Kann, the court came to what appears to be an opposite decision. In this matter Kann was a financial advisor that entered into a written agreement that included an arbitration agreement, to help obtain financing for AutoLife Acquisition Corp. AutoLife filed bankruptcy and a creditor of theirs, Epitech, sued Kann indicating that fraudulent misrepresentations were made on his part, which prevented Epitech from foreclosing on AutoLife's security. Kann moved to compel arbitration indicating that Epitech was a third-party beneficiary of the contract with the arbitration provision.

Both the trial court and the Court of Appeal disagreed with Kann's analysis. One who is not a signor to the agreement cannot be compelled to arbitrate unless they are actually a third-party beneficiary. Epitech did not meet the definition of a third-party creditor beneficiary because Kann did not contract to pay the creditors any money but only to help AutoLife to obtain financing.

The difference between these two cases: The Thomas case had the plaintiff (a signor to the agreement) indicate that all defendants were agents of one another, thereby admitting that they all had the same stake in the contract. The Epitech case relied on what the contract Kann entered into was for in order to determine if Epitech was a third-party beneficiary by definition. Something to keep in mind for the future!

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Kenneth Grossbart is recognized as one of the foremost authorities in California construction law. Over the past 30 years, Ken has become a respected speaker on Mechanic's Liens and other construction related issues. Abdulaziz, Grossbart & Rudman provides this information as a service to its friends & clients and it does not establish an attorney-client relationship with the reader. This document is of a general nature and is not a substitute for legal advice. Since laws change frequently, contact an attorney before using this information. Ken Grossbart can be reached at Abdulaziz, Grossbart & Rudman: (818) 760-2000 or by E-Mail at ksg@agrlaw.com, or at www.agrlaw.com