Arbitration and the “Direct Benefits Theory of Estoppel”Print Article
- Posted on: Jan 25 2019
Arbitration is an alternative form of dispute resolution where the parties voluntarily agree that a neutral, private person will resolve any legal disputes between them, instead of a judge or jury in a court of law. Rent-A-Ctr., W, Inc. v. Jackson, 561 U.S. 63, 67 (2010) (noting that “arbitration is a matter of contract”). In business and commercial transactions, arbitration is the preferred means of resolving disputes. It is encouraged and recognized as the public policy of the State. Matter of Smith Barney Shearson v. Sacharow, 91 N.Y.2d 39, 49 (1997) (citations and quotation marks omitted). Id. Consequently, courts will interfere as little as possible with the agreement of consenting parties to submit their disputes to arbitration. Id. at 49-50. (citations omitted).
Since arbitration is a “creature of contract” (Louis Dreyfus Negoce S.A. v. Blystad Shipping & Trading Inc., 252 F.3d 218, 224 (2d Cir. 2001)), only signatories to a contract containing an arbitration agreement can be compelled to arbitrate. TBA Global, LLC v. Fidus Partners, LLC, 132 A.D.3d 195, 202 (1st Dept. 2015). Consequently, “a party cannot be required to submit to arbitration any dispute which he has not agreed so to submit.” AT&T Techs., Inc. v. Communications Workers of Am., 475 U.S. 643, 648 (1986) (quoting Steelworkers v. Warrior & Gulf Nav. Co., 363 U.S. 574, 582 (1960)).
There are exceptions to the rule, e.g., incorporation by reference, assumption, agency, veil-piercing/alter ego and estoppel. Merrill Lynch Inv. Managers v. Opibase, Ltd., 337 F.3d 125, 129 (2d Cir. 2003). In Petrides & Co. LLC v. Yorktown Partners LLC, 2019 N.Y. Slip Op. 30157(U) (Sup. Ct. N.Y. County Jan. 18, 2019) (here), the exception at issue was the “direct benefits theory of estoppel.” Belzberg v. Verus Inv. Holdings Inc., 21 N.Y.3d 626, 631 (2013) (adopting the doctrine from federal law and citing federal cases). Under this doctrine, “a nonsignatory may be compelled to arbitrate where the nonsignatory ‘knowingly exploits’ the benefits of an agreement containing an arbitration clause, and receives benefits flowing directly from the agreement.” Id. Where “the benefits are merely ‘indirect,’ a nonsignatory cannot be compelled to arbitrate a claim.” Id. “A benefit is indirect where the nonsignatory exploits the contractual relation of the parties, but not the agreement itself.” Id. (citations omitted).
Petrides & Co. LLC v. Yorktown Partners LLC
Petrides & Co. LLC (“Petrides”) moved to compel various entities managed by Yorktown Partners LLC (“Partners”) to arbitrate claims under a contract to which Yorktown was not a signatory, arguing that the direct benefits theory of estoppel subjected Yorktown to that contract’s arbitration clause.
Partners, a private equity firm that specializes in energy investments, managed the entities bearing the Yorktown name (“Yorktown”). Yorktown collectively owns and controls Riley Exploration Group LLC (“Riley”), a non-party to the proceeding.
Petrides and Riley were parties to a letter agreement pursuant to which Riley engaged Petrides to perform consulting services (the “Agreement”). Yorktown was not a party to the Agreement, nor did the Agreement require Petrides to provide services to Yorktown. Petrides and Riley agreed that all disputes related to the Agreement were subject to mandatory arbitration.
The petition to compel arbitration issue arose from the 2002 investment by a Yorktown entity in Dernick Resources, Inc. (“’DRI”). Five years later, Yorktown increased its investment in DRI. In addition to Yorktown, other investors contributed money to DRI at that time.
In 2009, via an exchange of shares with Yorktown and the minority investors in DRI, Cinco Resources, Inc. (“Cinco”), an oil and gas company formed by Yorktown in 2002, acquired approximately 85% of DRI. In connection with the exchange of shares, Cinco invested additional money in DRI through a preferred stock offering, pursuant to which the “Dernick Group” was given the right to participate to avoid dilution of their ordinary shares of DRI. Subsequently, between 2009 and 2010, at a time when Cinco required capital to invest in additional oil and gas properties at Yorktown’s direction, Cima Resources Inc. (“Cima”) was formed to purchase Cinco’s oil and gas property in Eagle Ford, South Texas. In 2011, the Dernick Group asserted a claim that Cinco, via Yorktown, had acted improperly by selling the Eagle Ford property to Cima, thereby diluting the value of the Dernick Group’s shares in Cinco, while at the same time failing to offer the Dernick Group any participation in the Cima investment. In November 2011, Cima was merged into Cinco.
During February and March of 2012, the Dernick Group conducted settlement discussions with Yorktown and Cinco regarding their dilution claim. Following an unsuccessful mediation, those communications continued over several more years.
In February 2015, Yorktown directed Riley to engage Petrides under the Agreement to manage settlement of the dispute with the Dernick Group. Riley had no interest or stake in the Dernick Group litigation. According to the Court, settling the dispute was important to Yorktown, and its executives, because it was taking up valuable executive time and causing Yorktown and Cinco to incur significant legal expenses. In April 2015, Petrides was able to forge a settlement between the parties. The Court noted that Petrides acted on behalf of Yorktown and its executives during the settlement negotiations with the Dernick Group, notwithstanding that the work was being performed under the Agreement.
In addition to negotiating a resolution of the dilution issue, in March 2016, Petrides successfully negotiated the purchase of an oil and gas field by Riley that was owned by the Dernick Group.
Petrides submitted an invoice for services rendered in connection with the Dernick Dispute. The invoice was not paid. Consequently, in April 2018, Petrides commenced an arbitration against Riley to recover the amounts owed pursuant to the success-fee provision of the Agreement. The Agreement required Riley to pay Petrides a monthly fee of $100,000.00 and success fees set forth in the Agreement.
Although not a signatory to the Agreement, Petrides served an arbitration demand on Yorktown in October 2018, claiming that Yorktown was a third-party beneficiary of the Agreement and the real party in interest and, therefore, jointly liable with Riley for the fees owed to Petrides. Yorktown rejected the demand on the ground that it was not a signatory to the Agreement. In November 2018, Petrides filed a petition to compel Yorktown to arbitrate.
The Court’s Decision
The Court granted the motion.
The Court found that “Yorktown [had] knowingly exploited the benefits of the Agreement” and had “received the benefits of Petrides’ work under the Agreement.” Slip Op. at *8. The Court explained that “Petrides [had shown] that benefits intentionally inured to Yorktown directly from Petrides’ performance under the Agreement and were not merely the byproduct of the relationship between Petrides and Yorktown.” Based upon “the undisputed facts show[ing] that the work performed by Petrides in connection with the Dernick Dispute specifically benefited Yorktown and was done … specifically under the auspices of the Agreement,” the Court granted the motion to compel arbitration against Yorktown. Id.
Although federal and state policy favors arbitration, a party cannot be required to submit to arbitration any dispute that he/she has not agreed to submit. United Steelworkers of Am. v. Warrior & Gulf Navigation Co., 363 U.S. 574, 582 (1960). For this reason, courts are “wary of imposing a contractual obligation to arbitrate on a non-contracting party.” Smith/Enron Cogeneration Ltd. P’ship, Inc. v. Smith Cogeneration Int’l, Inc., 198 F.3d 88, 97 (2d Cir. 1999). Notwithstanding, where a non-party knowingly exploits and directly receives a benefit from an agreement containing an arbitration clause, as in Petrides, the courts will compel the non-signatory to arbitrate any disputes flowing from the agreement.